401(k) Plan Fiduciary
In general terms, a fiduciary is a person who owes a duty of care and trust to another and must act primarily for the benefit of the other in a particular activity.
For retirement plans, the law defines the actions that result in fiduciary duties and the extent of those duties.
Fiduciary status is based on the functions performed for the plan, not a title.
Employers should be aware that hiring someone to perform fiduciary functions is itself a fiduciary act.
Fiduciaries are in a position of trust with respect to the participants and beneficiaries in the plan.
A fiduciary’s responsibilities include:
- Acting solely in the interest of the participants and their beneficiaries;
- Acting for the exclusive purpose of providing benefits to workers participating in the plan and their beneficiaries, and defraying reasonable expenses of the plan;
- Carrying out duties with the care, skill, prudence and diligence of a prudent person familiar with the matters;
- Following the plan documents; and
- Diversifying plan investments.
The responsibility to be prudent covers a wide range of functions needed to operate a plan.
Since the business must carry out these functions in the same manner as a prudent person, it may be in the business’s best interest to consult experts in such fields as investments and accounting.
In a nutshell, a fiduciary is required to act solely in the best interests of the plan and its participants and beneficiary irrelevant of all other factors, such as cost or compensation.
For some functions, there are rules that help guide the fiduciary.
For example, if a business’s plan document provides for salary reductions from employees’ paychecks for contributions to the plan, then the business must deposit these contributions as soon as it’s reasonably possible to do so, but no later than the 15th business day of the month following the payday.
If the employer can reasonably make the deposits sooner, it needs to make the deposits at that time.
Plan participants can find out about the fiduciaries in their plan in the Summary Plan Description.
If the participant doesn’t have a copy of this handy, the employer’s human resources department or office should be able to furnish a copy upon request.
This is important for plan participants to know, because the plan’s fiduciary or fiduciaries are responsible for all of the key decisions that were made when the plan was established, such as:
Making sure that the plan investments are well-managed and reasonably priced.
The officers and managers who act as fiduciaries must also monitor the investments, which means that they need to look at them periodically to make sure that they continue to be well-managed and reasonably priced.
Selecting the service providers for the 401(k) plan.
The most common service provider for a 401(k) plan is called a “record-keeper.”
The record-keeper usually provides the plan website, educational materials, information about the investments, executes the investment transactions, maintains accounting records for participant accounts, and so on.
In many ways, the record-keeper is the heart-and-soul of the operation of the plan.
So, it’s important that the fiduciaries hire a record-keeper that can properly do those jobs.
Also, the fiduciaries must make sure that the record-keeper costs are reasonable.
As with investments, plan fiduciaries must regularly monitor, or oversee, the record-keeper to make sure that its services continue to be of good quality and reasonably priced.
Fiduciaries have more than those two sets of duties.
But, that’s a good starting point.
The law that governs the fiduciaries, known as ERISA, is demanding.
If the fiduciaries don’t act competently and knowledgeably, they can be sued for breach of their duties…and they sometimes are.
401(k) Plan Design Options FAQs
What Is a 401(k) Plan?
The 401(k) retirement savings account got its name from the Revenue Act of 1978, where an addition to the Internal Revenue Services (IRS) code was added in section 401(k).
Consequently, 401(k) does not stand for anything except for the section of IRS tax code it was created in.
Traditional 401(k) vs Roth 401(k)
The traditional 401(k), named after the relevant section of the IRS code, has been around since 1978.
With this plan, any contributions you make to the 401(k) account will reduce your income taxes for that year and will be taxed when they are withdrawn.
Roth 401(k)s, named after former senator William Roth of Delaware, were introduced in 2006.
Unlike a traditional 401(k), all contributions are made with after-tax dollars and the funds in the Roth 401(k) account accrue tax free.
Typically, employees can take advantage of both plans at the same time, which is recommended among financial advisors to maximize retirement savings.
Because of the way the contribution limits work, it is possible to invest different amounts into each account, even year-to-year, so long as the total contribution does not exceed the set limit.
Contributing to Your 401(k) Retirement Plan
Contributing to a 401(k) plan is traditionally done through one’s employer.
Typically, the employer will automatically enroll you in a 401(k) that you may contribute to at your discretion.
If you are self-employed, you may enroll in a 401(k) plan through an online broker, such as TD Ameritrade.
If your employer offers both types of 401(k) accounts, then you will most likely be able to contribute to either or both at your discretion.
To reiterate, with a traditional 401(k), making a contribution reduces your income taxes for that year, saving you money in the short term, but the funds will be taxed when they are withdrawn.
With a Roth 401(k), your contributions can be made only after taxation, which costs more in the short term, but the funds will be tax free when you withdraw them.
Because of this, deciding which plan will benefit you more involves figuring out in what tax bracket you will be when you retire.
If you expect to be in a lower tax bracket upon retirement, then a traditional 401(k) may help you more in the long term.
You will be able to take advantage of the immediate tax break while your taxes are higher, while minimizing the portion taken out of your withdrawal once you move to a lower tax bracket.
On the other hand, a Roth 401(k) may be more advantageous if you expect the opposite to be true.
In that case, you can opt to bite the bullet on heavy taxation today, but avoid a higher tax burden if your tax bracket moves up.
Check out this article from Forbes to see the IRS tax rate tables for 2020, but remember that they are subject to change.
A smart move may be to hedge your bets and divide your contributions between the two types of IRAs.
If your employer allows you to add funds to both a traditional and Roth 401(k), then doing so reduces the potential risks of each.
In this case, you will also have the ability to decide what proportion of your income goes into each account, meaning that as you near retirement and have a clearer idea of what position you will be in, you can put more into one or the other.
When you do decide which avenue to take, make sure to thoroughly evaluate your decision.
Moving funds from one account to another, such as from a traditional to a Roth 401(k), is time consuming and expensive, if even possible.
Likewise, transferring a 401(k) from one employer to another in the event of a job change is also tricky.
You want to make sure that when you put money into your plan, it will be able to sit undisturbed for a very long time.
Pension vs 401(k)
If an employer offers an employee a pension, it means that they are promising to pay out a set amount of money to the employee at the time of their retirement.
There is typically no option to grow this amount, but it also does not require any financial investment from the employee.
Pensions, also referred to as defined-benefit plans, are becoming increasingly rare because it puts the financial burden of offering a retirement fund for employees entirely on the employer.
401(k)s, which are also called defined-contribution plans, take some of the financial pressure off of an employer, while also allowing employees to potentially earn a larger retirement package than they would have with a pension.
How Much Should I Contribute to My 401(k)?
Most financial experts say you should contribute around 10%-15% of your monthly gross income to a retirement savings account, including but not limited to a 401(k).
There are limits on how much you can contribute to it that are outlined in detail below.
There are two methods of contributing funds to your 401(k).
The main way of adding new funds to your account is to contribute a portion of your own income directly.
This is usually done through automatic payroll withholding (i.e. the amount that you wish to contribute, counting all adjustments for taxation, is simply withheld when receiving payment and automatically put into a 401(k)).
The system mandates that the majority of direct financial contributions will come from your own pocket.
It is essential that, when making contributions, you consider the trajectory of the specific investments you are making to increase the likelihood of a positive return.
The second method comes from deposits that an employer matches.
Usually employers will match a deposit based on a set formula, such as 50 cents per dollar contributed by the employee.
However, employers are only able to contribute to a traditional 401(k), not a Roth 401(k) plan.
This is especially important to keep in mind if you want to utilize both types of plans.
A key variable to keep in mind is that there are set limits for how much you can add to a 401(k) in a single year.
For employees under 50 years of age, this amount is $19,500, as of 2020. For employees over 50 years of age, the amount is $25,000.
If you have a traditional 401(k), you can also elect to make non-deductible after-tax contributions.
The absolute limit, counting this choice and all employer contributions, is $57,000 for employees under 50, and $63,000 for those over 50 as of 2019.
Plan in Advance
401(k) Plan FAQs
About the Author
True Tamplin, BSc, CEPF®
True Tamplin is a published author, public speaker, CEO of UpDigital, and founder of Finance Strategists.
True contributes to his own finance dictionary, Finance Strategists, and has spoken to various financial communities such as the CFA Institute, as well as university students like his Alma mater, Biola University, where he received a bachelor of science in business and data analytics.