LAST REVIEWED Dec 18 2020 9 MIN READ
By Damian Davila
Since 1974, the Employee Retirement Income Security Act (ERISA) has established guidelines that plan managers must follow in order to act in the best interest of plan holders. Through ERISA, a financial advisor or financial planner giving you advice must act as a fiduciary, putting your financial interests ahead of their own.
ERISA covers both defined-benefit and defined-contribution plans offered by employers. If you have an employer-sponsored 401(k), then ERISA covers your plan. However, there are three types of fiduciaries of 401(k) plans, with different duties and liabilities: 3(16), 3(21), and 3(38).
What are the 3(16), 3(21), and 3(38) fiduciary roles?
The “3” in 3(16), 3(21), and 3(38) comes from Section 3 of ERISA, which contains the rules and defines fiduciary roles into three separate sections.
Section 3(21) of ERISA defines a fiduciary as an individual who exercises any discretionary authority or control regarding the management of an employee benefit plan or the disposition of its assets. 3(21) also refers to an individual who renders investment advice in exchange for compensation and defines a fiduciary as someone with the ability to administer the plan. A section 3(21) fiduciary includes the plan trustee and plan administrator as further defined below.
Section 3(38) of ERISA applies to a fiduciary with discretionary controls of the plan’s assets. This means that a 3(38) can select, monitor and replace investments for the plan. While a 3(21) fiduciary has to wait for approval for such decisions, a 3(38) can go ahead and make those decisions on behalf of the client. This is why a 3(38) fiduciary must be a registered investment adviser (RIA) under federal or state law, a bank or an insurance company.
Section 3(16) of ERISA establishes that the fiduciary has a responsibility to ensure the plan is created and managed according to ERISA requirements. If there is no administrator, the plan sponsor takes on this role automatically. The 3(16) administrator typically handles reporting and disclosure requirements, summary plan descriptions, participant disclosures, and the plan’s Form 5500 filings.
What are the key similarities and differences between 3(16), 3(21), and 3(38) fiduciary roles?
3(21) and 3(38) fiduciary are similar in that the focus is on investment recommendations. A 3(21) investment manager can provide investment recommendations, but he or she has to wait for approval from the client to execute those investments. On the other hand, a 3(38) fiduciary is able to make investment decisions on behalf of the client.
A 3(16) fiduciary focuses on the plan administrative functions, including meeting ERISA reporting requirements, disclosure requirements, filing the correct paperwork with ERISA and making the required disclosures to plan participants.
What are the benefits of hiring 3(16), 3(21), and 3(38) fiduciaries?
There are three key benefits: improved compliance, lower cost, and the ability to focus on your business.
1. Improved compliance
A 2017 survey from the National Association of Plan Advisors found that 76% of plan sponsor respondents have hired or are considering hiring someone to help with fiduciary duties. By hiring a 3(21) and 3(38) fiduciary a plan administrator can share his or her fiduciary responsibilities with the investment advisor or investment manager. Hiring the services of a professional investment professional helps the plan administrator to demonstrate that he or she is meeting the fiduciary responsibilities set by the U.S. Department of Labor and acting in the interest of plan participants.
Keep in mind that hiring a 3(21) or 3(38) doesn’t mean that the plan administrator can just wash his or her hands from involvement. ERISA requires that the plan administrator is responsible for carefully selecting and monitoring the hired advisor.
Hiring a 3(16) plan administrator helps a business owner reduce its fiduciary liability on the administrative side, improving the plan’s compliance.
2. Lower cost
The DIY attitude of owners of small- and mid-sized businesses is essential to run lean, efficient organizations. While business owners are great at wearing many hats, it doesn’t necessarily mean that they’re doing things cost-efficiently.
One major benefit of hiring a 401(k) fiduciary is that you’re hiring an investment professional whose main job is to advise and manage 401(k) plans. This translates into cost savings in operating and maintaining the 401(k) plan. Monitoring your 401(k) costs is not only important to fulfill your fiduciary obligations, but also to minimize annual expense ratios which could cost thousands of dollars in forgone retirement savings down the road.
3. Ability to focus on your business
Offloading administrative tasks and necessary legwork to make informed investment decisions liberates your time to focus on growing your business. By working with investment professionals and third-party administrators you can free up your time and create more value for your company.
What type of fiduciaries are businesses hiring?
In its 2018 Survey of Profit-Sharing and 401(k) Plans, the Plan Sponsor Council of America (PSCA) found that 70% of defined contribution plan sponsors retained an independent investment advisor to assist with fiduciary responsibilities.
In a survey of 590 defined contribution plans, the PSCA found that:
36% of plans used a 3(21) fiduciary
20% of plans used a 3(38) fiduciary
14% of plans used a 3(16) fiduciary
According to data from the PSCA: “More than one-third of plan sponsor respondents offer investment advice to participants. Advice was offered by a registered investment advisor (30.8%), a certified financial planner (28.8%), or a third-party web-based provider (20.2%).”
Are you looking for a fiduciary provider for your 401(k)?
As an employer offering a retirement plan, you have fiduciary responsibilities covered under the standards of conduct covered under ERISA. As a business owner, you want to take care of your employees, and that includes providing access to quality investment advice and low cost. Opting for a fiduciary can help your employees avoid hidden fees and broker commissions. If you want to find an affordable 401(k) that takes care of your employees, a fiduciary is a good place to start.
Consider in your search Human Interest providing investment advising services in 3(38) and 3(21) fiduciary status to protect your assets. Human Interest provides full 401(k) plan compliance with testing, IRS Form 5500 filing, IRS-approved plan documents, audit package, participant disclosures, and recordkeeping services.
At Human Interest we support thousands of small and medium-sized companies and their 60,000+ employees who are saving for their future. Schedule a time to chat, and feel free to ask us anything.
Damian Davila is a Honolulu-based writer with an MBA from the University of Hawaii. He enjoys helping people save money and writes about retirement, taxes, debt, and more.