How Plan Sponsors Could Unknowingly Violate ERISA

Helene O’Brien

Retirement savings are not just numbers on a balance sheet. Employee 401(k) accounts represent years of hard work and the hope of financial security later in life. That’s why plan sponsors carry an important fiduciary responsibility under the Employee Retirement Income Security Act: to safeguard those funds prudently, even after an employee leaves the company.

But what if the common practice of automatically rolling over small, left-behind 401(k)s was quietly undermining that duty?

The Hidden Dangers of Safe Harbor IRAs

Section 404 of ERISA mandates that fiduciaries act in the best interest of employees when managing their retirement funds. Left-behind 401(k) accounts present problems for employers and former employees alike, and automatic rollovers were intended to help, while upholding fiduciary duty.

Under current regulations, most human resources executives routinely roll over accounts with balances of less than $7,000 into safe harbor individual retirement accounts, thinking they are preserving and helping grow employees’ retirement savings. What they may not realize is that some safe harbor IRA providers are charging exorbitant fees that gradually deplete balances, at times down to $0.

Paying Attention to Where Former Employees’ Money Is Going

As a former HR executive and plan fiduciary, I was unaware that the common practice of automatic rollovers posed significant ethical and legal risks. It is one thing to roll dormant accounts into a new IRA; under ERISA guidelines, you’re allowed to do so. But what happens if you roll those funds into an account that erodes, rather than grows, the balance?

Unfortunately, that’s exactly what’s happening with many safe harbor IRAs today.

For instance, one safe harbor IRA provider charges a $5.67 monthly fee, plus a 0.5% annual asset-based fee. On a $3,500 account, this amounts to more than $85 a year. When combined with withdrawal fees and poor returns (often less than 1%), the balance of these accounts diminishes over time, instead of growing.

When automatically rolling over accounts worth less than $7,000, ERISA regulations mandate that plan sponsors select an “investment product designed to preserve principal and provide a reasonable rate of return, whether or not such return is guaranteed, consistent with liquidity.”

In many cases, safe harbor IRAs are doing the opposite. When high fixed fees eat into employees’ savings and deplete their accounts, the consequences could include lawsuits from former employees against the plan sponsor that rolled over their account. That scenario may not be unlike what is playing out right now amid a record wave of ERISA excessive-fee litigation.

A Responsibility Overlooked

A plan sponsor’s fiduciary duty can be thought of as putting up guardrails for employees who may not be financially savvy. It is a role I took very seriously for many years. I was aware of all the rules, but when it came to automatic rollovers, there was always minimal conversation or choice.

I trusted that our offerings upheld our responsibility to employees and former employees. Never in my 20 years as a plan sponsor was it called to my attention that there were alternative providers for automatic rollovers—or that safe harbor IRAs were anything but safe.

Legal and Reputational Risks

The reality is that most employers likely do not realize the gravity of the situation. But by letting former employees’ retirement accounts sit in high-fee, poor-performing safe harbor IRAs, they may be acting in conflict with their core fiduciary duties.

Failing to meet ERISA’s standards can expose your company—and yourself as a plan fiduciary—to legal action and financial penalties. Under ERISA Section 502, employees have the right to sue employers and plan sponsors for breach of fiduciary duty, and those employers may be held financially liable for the damage caused by poorly managed retirement accounts. Additionally, there may be reputational damage if employees or former employees find out their retirement savings were mishandled.

Don’t Wait Until It’s Too Late

In an environment in which lawsuits related to 401(k) plans have become more common, it is time to act. If you’re still relying on subpar safe harbor IRAs, you may already be violating ERISA, and the clock is ticking. Protect your former employees’ retirement savings, avoid legal risks and preserve your company’s integrity by ensuring your provider of choice is not siphoning away your employees’ nest eggs.

Helene O’Brien, SHRM-SCP, PHR, CPSP, C(k)PF is PensionBee’s vice president of employer partnerships. She brings more than 20 years of experience in human resources, with deep expertise in retirement plan governance and employer-sponsored benefits. Before joining PensionBee, Helene served as chief human resources officer at a global manufacturer and distributor in the industrial sector.

This feature is to provide general information only, does not constitute legal or tax advice, and cannot be used or substituted for legal or tax advice. Any opinions of the author do not necessarily reflect the stance of PLANSPONSOR, ISS STOXX or its affiliates.