Defeating the purpose of Participant Directed 401(k) Plans

The whole purpose of having a participant directed 401(k) plan has been to take advantage of ERISA §404(c), which limits the plan sponsor from liability from losses incurred by participants through their directed investment.

Plan sponsors were under a misconception is that simply offer the safe harbor mix of 5 mutual funds would simply be enough to afford this protection from liability. Of course, that is not the case.

Plan sponsors need to manage the fiduciary process with a financial advisor to develop an investment policy statement (IPS), select and review plan investments against said IPS, as well as providing education to plan participants. Only after doing that, can a plan sponsor afford that protection.

While it seems a lot of work, selecting the right financial advisor, third party administrator, and ERISA attorney will do the trick.

By not taking these steps, especially not developing an IPS, puts the plan in far worse shape from a liability standpoint than if the trustees directed plan investments. Why? Well, most trustee directed plans have a financial advisor helping with the investments and these plans have an IPS.  The IPS is one of the most important tools that the plan sponsors and trustees have. It has become so important that the Department of Labor routinely asks for a copy of the IPS upon an audit.

The purpose of participant directed investments is to minimize liability. Not taking the steps under ERISA §404(c) defeats that purpose.

In addition regardless the form of investment, it is always recommended that plan sponsors get fiduciary liability insurance to protect all plan fiduciaries.