The sponsorship of a qualified retirement plan can be rewarding but frustrating – there are so many rules. Unfortunately agricultural employers are not given a break when it comes to sponsoring such retirement plans.
Examples of qualified retirement plans are 401(k) plans, profit-sharing plans and money-purchase plans. Leaving the tax rules for another day — I’m offering practical guidance for business owners and boards of directors in fulfilling fiduciary obligations under the Employee Retirement Income Security Act of 1974 – as they relate to qualified retirement plans, specifically the investment of the plan’s assets. The Act is the federal law that regulates employee-benefit plans.
Before I needlessly take you down a scary path, there are some qualified retirement plans that are not subject to the Act. Those plans can be common among small family-owned businesses like farms. If the qualified retirement plan only benefits the self-employed owner of the business and his or her spouse – meaning the business doesn’t have any employees – then that plan is not subject to the Act.
Identify plan fiduciaries
Schill Lazy Acres operates a dairy farm with 15 employees that is owned by a sole shareholder. The business adopts a 401(k) plan for the benefit of the employees and the shareholder. Because Schill Lazy Acres has employees, the plan is subject to the Employee Retirement Income Security Act.
There are several “fiduciaries” with respect to the plan. Each fiduciary has various responsibilities according to the specific function each performs. A person is a fiduciary only to the extent that he or she exercises any authority or control respecting management of the plan’s assets.
Schill Lazy Acres is sponsor of the plan. Its board of directors, members or manager are fiduciaries to the extent they exercise discretionary authority to select and monitor plan investments – or select and monitor the plan’s trustee if the trustee has discretion concerning plan assets.
The plan document should specify who the plan trustee is. It could be an individual or a corporate trustee. It should also specify whether that trustee is “directed” or “discretionary.”
- A directed trustee acts at the direction of another fiduciary.
- A discretionary trustee means the trustee has total discretion concerning investment of plan assets, and responsibility for fiduciary duties.
If a plan has individual accounts and permits participants to exercise control over those accounts, then plan fiduciaries will not be liable for any loss that results from participant control. Essentially that’s a “safe harbor” to limit the fiduciary liability for certain investment losses.
Fiduciary duties detailed
The Employee Retirement Income Security Act requires that a fiduciary must act with the skill, prudence and diligence of a prudent person. Schill Lazy Acres – acting through its board, members or managers – and the plan trustee are subject to the “prudent man” standard as the farm fulfills fiduciary obligations. Perhaps the most important fiduciary function for Schill Lazy Acres is selection and monitoring of the trustee.
With the growing complexity of stock markets and investments, it’s becoming more common for plan sponsors to appoint corporate trustees as opposed to individual trustees. Part of that trend is in response to the personal liability imposed on trustees. It’s also due to the fact that corporate trustees are required to have a minimum level of reserves. Even if the plan’s trustee is a “discretionary” trustee, Schill Lazy Acres still has a duty to monitor the trustee. There must be periodic reporting by the trustee to Schill Lazy Acres. The company needs to be satisfied the trustee is fulfilling its obligations.
One of the fiduciary responsibilities with respect to assets involves the selection of investment options. Whether the fiduciary is Schill Lazy Acres, or the plan’s trustee, the fiduciary has the duties of prudence and diversification in exercising authority over investment-option selection.
Prudence means that investment-option selection must be the result of careful investigation of available options. It must take into account the risk of loss and the opportunity for gain associated with each type of investment. Prudence also means monitoring investment options on an ongoing basis. The prudence requirement may obligate the fiduciary to decide to add an investment option, place an investment option on a “watch list” or “freeze” further participant contributions. That could happen due to an option’s poor performance.
The act’s diversification requirement provides that plan assets must be diversified so as to minimize the risk of large losses – unless it’s prudent not to do so. The fiduciary’s duty is to ensure the plan provides diversification.
- wide range of income, growth and income
- lifestyle mutual funds
The plan’s investment options should provide different risks and returns suitable for participants with varying savings time horizons and risk tolerance.
Fiduciaries are personally liable under the Act if they breach fiduciary duties. If Schill Lazy Acres was found to have breached the duty of diversification for example and plan participants suffered losses, then Schill Lazy Acres would be personally liable to pay for any losses as a result of the breach.
Consider carefully who is a fiduciary of a qualified retirement plan; failure to do so could result in personal liability.