What’s the #1 Reason for 401(k) Lawsuits?  Overpriced or Superfluous 401(k) Services

In my last blog, I wrote the key virtue of the DOL’s new fiduciary rule is that it aligns 401(k) plan sponsor and financial advisor interests. Once the rule is effective, all advisors will be obligated to act in the sole best interest of 401(k) participants just like 401(k) sponsors. Prior to the rule, some advisors could fleece 401(k) plans without consequences – which often left 401(k) sponsors personally liable for participant losses due to excessive advisor fees.

When writing this blog, I got to thinking about 401(k) fee lawsuits in general. They have been picking up steam for years now and I regularly talk to small business owners afraid of being targeted. I understand their concern. It seems trial lawyers are looking for any excuse to hold 401(k) fiduciaries personally liable for extraordinary plan fees – even excessive participant mailings!

So what’s my advice to small business owners worried about 401(k) fee lawsuits? Avoid overpriced or superfluous 401(k) services that unnecessarily reduce participant returns. It’s that simple. How do you that? I recommend a 2 step process.

Step 1 - Know your options before you start shopping for 401(k) services

I beat this drum a lot.  Why?  Too many 401(k) fiduciaries shop for service providers backwards – they start shopping before they understand their options. When this happens, it can be easy for 401(k) providers to sell overpriced or superfluous services to 401(k) fiduciaries due to an asymmetrical information advantage.

401(k) fiduciaries are obligated to make “prudent” service provider choices. What’s a prudent choice? A provider that offers necessary services at a reasonable price. To make a prudent choice, you should first understand the plan administration and investment options you want for your 401(k) plan:

• 401(k) administration options. All 401(k) plans require fiduciaries to define 6 basic administration options - eligibility, compensation, contributions, vesting, distributions and loans. The process of defining these options is commonly called 401k plan design. To better understand your 401(k) plan design options, check out our plan design checklist.
• 401(k) Investment options. All 401(k) plans require fiduciaries to define just 2 basic investment options – the fund lineup and the nature of participant investment advice. When defining these options, fiduciaries have 2 primary ERISA responsibilities:
  • Pick funds that allows participants to sufficiently diversify their accounts (and minimize the risk of large investment losses) and
  • Ensure participants only pay reasonable fees and expenses for investments or investment-related services.

Step 2 – Compare professional service providers

Once you’ve determined the options you want for your 401(k) plan, you’re ready to shop for 401(k) services. As part of this process, I recommend you compare at least 3 providers based on the following 3 attributes:

1. Competence – How long has the provider been in business? Are they adequately insured for losses? Are they growing? Do their services have turnaround standards?
2. Services – Does the provider offer services that match the plan administration or investment options you want?
3. Fees – Are the fees charged by the provider reasonable when compared to the other providers?

Need more specific help? Check out our shopping companion for help comparing 401(k) administration service providers.

Feel good about your choice!

I believe the DOL’s fiduciary rule will make it more critical than ever for 401(k) fiduciaries to ensure their participants receive value in return for 401(k) fees and expenses. The good news is all professional financial advisors – not just some of them – will now share that responsibility with respect to 401(k) investment services.

401(k) fiduciaries should root out all overpriced or superfluous services from their 401(k) plan. It doesn’t have to be difficult to do that. Following a simple 2 step process can make it easy for 401(k) fiduciaries to pick professional service providers that match their plan’s needs at a reasonable price.