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Who Is Liable for Retirement Plan Mistakes?

Who Is Liable for Retirement Plan Mistakes?

When a 401(k) or similar defined contribution plan fails to apply the correct definition of compensation in determining benefits, fails to calculate vesting service correctly, or doesn’t make distributions to participants who need to get required minimum distributions, who is responsible? Plan sponsors are often surprised to learn that they are.Why Your Recordkeeper Is Not ResponsiblePlan sponsors may find out that they are still responsible when their plans are selected for audit by the IRS or they are targeted in a lawsuit for miscalculating benefits. More frequently, the recordkeeper may find the mistake when reviewing operations and IRS procedures require that a costly correction be made.Because they rely on their vendors to operate their plans, plan sponsors may mistakenly think that their recordkeeper is the legal plan administrator responsible to fix these mistakes. To understand why administrative responsibility has not been legally delegated to their recordkeepers, plan sponsors need to review their service agreements.Typical Services Agreement LanguagePlan recordkeeping agreements contain disclaimers that the recordkeeper is not performing services as a fiduciary, which means that they are not assuming the legal responsibilities of a plan administrator as defined in the Employee Retirement Income Security Act (ERISA). Admittedly, vendors could and many should do a better job of explaining their limited legal role to plan sponsors. Some years ago, I wrote a post called “What Your Prototype Provider Doesn’t Tell You,” highlighting this problem, but unfortunately too little has changed.ERISA requires that every plan have a legal administrator and designates the plan sponsor as the default administrator when no other person has been appointed. This means that if the agreement doesn’t make the recordkeeper the fiduciary plan administrator, plan sponsors remain responsible for the recordkeeper’s mistakes found on audit or by a court, even if they just did what the recordkeeper told them to do or were unaware of the recordkeeper’s actions. Further, the costs of correcting mistakes are not allowed to be paid from plan assets, so this understanding of the recordkeeper’s real role may coincide with an obligation to pay substantial correction costs to keep the plan qualified. Some recordkeeping agreements do provide that the recordkeepers will indemnify the plan sponsor for errors caused by their gross negligence or willful misconduct, but that is a threshold not reached by most ordinary mistakes. Today the indemnification obligation is also often subject to a dollar cap, which may be a multiple of fees paid to the recordkeeper. While plan sponsors can try to negotiate more favorable indemnification provisions, they will always provide limited protection.There Are AlternativesThere are options available to busy company fiduciaries who want to make sure that their plans are run correctly. Just as they can pass fiduciary responsibility for day-to-day investments on to professional fiduciaries, plan sponsors can hire professional administrators to take over many of the legal responsibilities of plan administration. Professional administrators are referred to as 3(16) administrators after the section of ERISA that defines plan administrator and more busy company fiduciaries should consider hiring them. Professional administration …