• Vitaly Novok

The Most Important 401(k) Safe Harbors

Updated: Jun 20, 2018



Due to the increased frequency of lawsuits filed against plan sponsors over the last few years, they have been forced to revisit many aspects of plan operations. Many plan sponsors finally realized that a 401(k), as well as any other qualified retirement plan, is not a static process, but a dynamic process that can cost a lot if neglected.

To minimize potential liability associated with plan administration and the management of plan assets, some plan sponsors urgently reviewed their plan’s fees and investment options. Others focused on due diligence and plan monitoring processes in order to avoid a possible breach of fiduciary duty. Without a doubt, any actions taken to make a plan compliant with current regulations and/or improve participants’ outcomes can limit liability. But wouldn’t you be astonished to know that a certain level of liability could have been avoided from the very beginning?

Certain provisions of ERISA provide plan sponsors with “safe harbors” that may protect them from liability if adopted. Even though these provisions have been around for many years, a majority of plan sponsors are not aware, or decided to not take advantage of them, thus, putting themselves at unnecessary risks.

Key safe harbors for 401(k) plan sponsors are:

  • Delegation of investment responsibility

  • Participant-directed investment actions and outcomes

  • Qualified Default Investment Alternatives (QDIAs)

  • Automatic rollovers


Let’s explore each safe harbor in detail.

Delegation of Investment Responsibility Safe Harbor

Among many other core business responsibilities plan sponsors have, they also have a fiduciary responsibility under ERISA to select, manage, and monitor investments. Since many plan fiduciaries lack investment knowledge and expertise, the Department of Labor and ERISA allow plan fiduciaries to delegate investment decisions to “prudent experts” and minimize, although not eliminate, potential liability.

In order to protect themselves under this safe harbor, plan fiduciaries must check that their plan has an established procedure for delegating investment responsibility. If the plan documents allow for the delegation of investment decisions, plan fiduciaries must:

  • Rigorously follow the procedure.

  • Delegate investment decisions to “a prudent expert” (a bank, registered investment adviser, mutual fund company, or an insurance company) and make sure that they acknowledge their status as a fiduciary.

  • Have proof that they followed a prudent process when selecting prudent experts.

  • Give prudent experts discretion over plan assets.

  • Monitor the actions of prudent experts.


Participant-Directed Investment Actions and Outcomes Safe Harbor

ERISA section 404(c) permits plan participants to opt-out of any default allocations and direct their investment decisions. In order to protect plan sponsors from any liability that may arise from participants’ investment decisions and outcomes, Section 404(c) offers “safe harbor” if the following criteria is satisfied:

  1. Comply with all criteria related to delegating investment responsibilities as outlined above.

  2. Plan participants are provided with a written notification explaining that the plan is intended to be a 404(c) and that fiduciaries may be relieved of liability for participant-directed investment decisions and outcomes.

  3. Participants are provided with an opportunity to exercise control over assets in their individual account.

  4. Participants are offered at least three investment options each of which is diversified and has materially different risk and return characteristics. In the aggregate, investment options should enable the participant or beneficiary by choosing among them to achieve a portfolio with aggregate risk and return characteristics at any point within the range normally appropriate for the participant or beneficiary.

  5. Participants are given the opportunity to give investment instructions to an identified plan fiduciary who is obligated to comply with such instructions. In addition, participants should be given the opportunity to obtain written confirmation of such instructions.

  6. If any investment alternative which permits participants to give investment instructions more frequently than once every three-month period, participants are permitted to direct their investments from such alternative into an income producing, low risk, liquid fund, subfund, or account as frequently as they are permitted to give investment instructions with respect to each such alternative.

  7. Participants must be given the right to diversify their investments in order to minimize the risk of large losses taking into account the nature of the plan and the size of participants' accounts.

  8. Participants must be provided with information and education on the investment options available.

  9. Participants are permitted to make changes to asset allocation with a frequency which is appropriate in light of the market volatility but no less frequent than at least once within every three-month period.


Qualified Default Investment Alternatives Safe Harbor

QDIAs are considered safe harbor investments under the Pension Protection Act of 2006. This safe harbor protects plan sponsors from enrolling participants into QDIAs without participant’s direction. In accordance with the Department of Labor’s guidance, QDIAs are defined as:

  • Target-date funds

  • Balanced or lifestyle funds

  • Managed accounts


Stable value or money market funds are also allowed, but only for a period of 120 days. After this period, a participant should be moved into one of the three QDIAs. Other than legal protection, QDIAs also improve diversification in participants’ investment portfolios and increase participation rates.

In addition to having QDIAs, plan sponsors also need to provide participants with details on alternatives and notify them 30 days in advance of the initial investment to qualify for this safe harbor. Moreover, plan participants should continue to receive an annual notice, or when a plan sponsor makes changes to QDIAs.

Automatic Rollovers Safe Harbor

Locating missing participants or maintaining low balances of terminated employees can be a burden for plan sponsors. To simplify plan administration and potentially reduce fees, the Department of Labor provided plan sponsors with a safe harbor for involuntarily distributions of more than $1,000 but less than $5,000. In accordance with this safe harbor, the plan sponsor is required to roll over a participant’s account balance to an IRA established by a bank or an insurance company.

The plan fiduciary is deemed to satisfy their fiduciary duty under ERISA Section 404 with respect to the investments, if rolled over investments are invested in investment products “designed to preserve and provide a reasonable rate of return, whether or not such return is guaranteed, consistent with liquidity, and taking into account the extent to which charges can be assessed against an IRA.” These safe harbor investments include, but are not limited to money market and stable value funds, interest bearing savings accounts, and certificates of deposit. Safe harbor investments should be offered by a financial institution that is state or federally regulated.

Finally, fees charged by custodian for an automatic rollover IRA cannot exceed the fees charged for comparable IRAs.

Conclusion

Despite being voluntarily, there aren’t any viable reasons why you wouldn’t want to adopt safe harbors. Safe harbors can substantially help plan sponsors with plan operation, administration, and most importantly, potentially insulate them from unnecessary liability. Nevertheless, safe harbors are not a panacea. To get the maximum benefit out of them and significantly reduce chances of future litigation, plan sponsors have to comply with the strict provisions and requirements of ERISA and other governing laws.

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