ERISA Benefits Without ERISA Trouble…A Guide for Business Owners

By Mark Papalia, CLU, ChFC, CFP

Published in the Northeast Pennsylvania Business Journal in April 2003

Sure, it makes good business sense for small-business owners to give their employees retirement benefits--as long as they follow the law. And that means understanding and complying with the rules of ERISA, the federal law governing private pension plans. Failure to do so could result in stiff penalties, personal liability--and even a prison sentence.

The key to understanding ERISA's requirements lies in Section 404c of the law, which stipulates fiduciary responsibilities for a plan's trustee. In a small, closely held business, the trustee is generally the business owner. The owner is typically the person who exercises discretionary authority or control over the plan's management or assets, and has some say in who will provide the plan’s investment advice.

ERISA requirements also lay out specific trustee duties and rights of participants.

For example, according to ERISA:

• Trustees must provide participants with appropriate information. That means regularly giving everyone information about plan features and funding.
• Plans are required to have minimum standards for participation, vesting, and funding. For example, employees need to be at least 21 years old with 1,000 hours of service.
• Plan fiduciaries must be accountable. Those who fail to follow the principles of conduct described in 404c will be held responsible for restoring losses to the plan.
• Fiduciaries also need to:
• Monitor the plan's record-keepers, investment managers and other service providers.
• Monitor the plan's investment offerings for investment policy compliance and general performance.
• Offer at least three investment options that are diversified and have materially different risks and return characteristics.
• Give participants the ability to transfer funds between investment options

• Participants have the right to sue. Specifically, they can sue for benefits and breaches of fiduciary duty.
• An ERISA or fidelity bond must be put in place to insure plan assets against criminal intent. The bond needs to be in the amount of 10% of plan assets, or $500,000, whichever is less.

Small businesses that ignore ERISA requirements can face significant financial losses. And the business owners/fiduciaries who breach their obligations can be held personally liable, facing severe fines, civil actions, or even jail. The stakes are high and pleading ignorance or inexperience won’t help.

So, how can small business owners make sure they're in compliance?

For starters, before enrolling employees, a business owner should establish a detailed investment policy statement defining such matters as target rates of return and risk tolerance. Then, they need to hold an enrollment meeting with employees, at which they formally state that the plan is in compliance with Section 404c and employees receive information about the plan's features.

For small-businesses offering their employees 401k plans in which employees can choose their investments, the business owner has a double exposure. The business first has to offer good investments as options. Next the owner is obligated to educate participants about the specific selections and provide them support in making selections based on risk tolerance.

A business owner can also struggle with the issue of how many investment options to even offer. While the law requires that companies offer at least three choices, some employers have dramatically increased their number of options to give employees more choice and reduce fiduciary risk. But this can back fire; sometimes, the more options you offer, the more likely an employee is to make a poor choice. The bottom line: Small business owners should provide only quality options and ones that both they and their advisors understand and can explain to employees.

Those aren't the only steps employers should take to make sure they're in compliance. They also need to provide participants with an annual summary of the plan's expenses and an overview of total gains or losses, as well as each participant’s account activity for each investment option chosen. In addition, they should implement a participant account-rebalancing feature for keeping participants' accounts in line with targeted percentages for various asset classes. And the business should also purchase fiduciary liability insurance, in addition to a fidelity bond which protects the plan’s assets, to protect the trustee’s or the business owner’s personal assets against acts of negligence by the plan’s fiduciaries.

But understanding your compliance requirements is not necessarily the only protection for a business owner. The most effective form of protection is to hire outside professionals to help manage your retirement plans and programs. For example, many business owners find it helpful to work with an SEC-registered money manager, who can assume, a portion if not the lion share of, fiduciary responsibility for the plan. Others work with both an actuarial professional in addition to investment advisors. Outside professionals can help a business owner ensure that their plan is in, and stays in, compliance, especially as laws change. They can also help owners select the blend and quantity of options to offer and advise and educate employees in making the best and personalized investment selections. While the business owner would still be responsible for monitoring the advisors’ activities, professionals can insulate the owner from the employee and in turn reduce the business owner’s direct liability.

When it comes to ERISA and pensions, remember, the more knowledgeable the business owner and the better their advisors, the less likely you are to end up in trouble.

Mark Papalia, CLU, ChFC, CFP, is both founder and president of Papalia Financial, an advisory firm specializing in the growth, protection and transfer of its clients’ personal and business assets. For more information, contact Mark at mpapalia@papaliafinancial.com, call 1-800-626-1027.

Reprinted with permission from the Northeast Pennsylvania Business Journal.