What’s a 3(16) fiduciary vs a 3(21) fiduciary vs a 3(38) fiduciary? Today’s webinar covers that and more! Whether you’re a 401(k) plan sponsor or administrator or even part of a 401(k) plan investment committee, this is “must have” information!

Hello and good morning everyone. My name is Greg Phelps. I’m the President of Redrock Wealth Management here in beautiful sunny (typically) Las Vegas, Nevada. I am also a 401(k) Wealth Steward.

Today I’ll be reviewing 401(k) fiduciary services and focusing on the various types of fiduciary advisors you may engage as a plan administrator. Specifically, I’ll explain what is a 3(16) fiduciary vs a 3(21) fiduciary vs a 3(38) fiduciary.

I’ll cover what you need to know as a 401(k) plan fiduciary about engaging fiduciary and non-fiduciary services. We’ll discuss your fiduciary responsibilities and duties, and those of the 401(k) experts you engage.

So I wanted to say welcome and thank you very much for your time! I look forward to spending the next 15 or so minutes with you to go over these topics.

What is a 401(k) plan fiduciary?

First, we’re going to talk about fiduciary principles. The fiduciary principle actually goes back 4,000 years ago (to the early time of man) and the Code of Hammurabi. It’s kind of interesting how far back that the word fiduciary actually dates. “Fiducia” is a Roman term meaning “trust.”

A fiduciary acts on behalf of another person or group of people. That’s who a fiduciary is responsible to—another person or group of people.

A fiduciary is in a position of special confidence and trust. What this means is that a fiduciary has the highest duty of care possible. That duty is relevant to prudence and due diligence within a well-documented process as they execute their duties.

A fiduciary is also a “steward.” If you look at our Redrock Wealth Management business cards, we call ourselves “Wealth Stewards”. We consider ourselves fiduciaries to every person that we work with, and every 401(k) plan participant, sponsor, or administrator as well.

“Fiduciary” entails the highest duty of loyalty also. A fiduciary has a —an overarching obligation—to remove all conflicts of interest in their service, advice, or guidance to you.

Unfortunately, it’s not possible to remove every possible conflict of interest sometimes. Any conflict of interest that cannot be removed should be disclosed to plan participants, their beneficiaries, or the person that you’re acting as a fiduciary for.

That’s just a little bit about the term “fiduciary” and why it’s important to you as a 401(k) plan sponsor or plan administrator. It means that you’re engaging somebody (and you actually are also a fiduciary to the plan), but it means that you’re engaging somebody—a prudent expert—that owes you and your plan participants the highest duty of care and the highest duty of loyalty above all else!

Who is a 3(16) fiduciary?

The 401(k) plan administrator or the 401(k) plan sponsor is typically considered a 3(16) fiduciary under ERISA. The 3(16) section of ERISA defines the 401(k) plan administrator responsibilities.

You probably didn’t realize this as you’re watching this webinar. As you’re thinking to yourself “what is a 3(16) fiduciary?”, look in the mirror . . . because surprise! If you’re a plan sponsor or plan administrator, it’s very likely you!

The 3(16) fiduciary is not always the plan sponsor. However, the plan sponsor always has a fiduciary obligation to the plan and its participants (and their beneficiaries) to ensure the plan administrator is prudently managing their obligations.

Note that a TPA (third-party administrator) is NOT a 3(16) fiduciary. The third-party administrator does not have discretionary control over the plan. Therefore, they are not a 3(16) fiduciary.

The plan record-keeper isn’t a fiduciary either. They don’t have discretion and they don’t make decisions regarding the plan, they simply provide a service.

The 3(16) fiduciary absorbs all the 401(k) plan administrator duties, and they have discretionary control over the plan management. So the 3(16) is you Mr. Plan Administrator or Mrs. Plan Administrator . . . You have the responsibility and discretionary control to make changes that affect your participants’ lives!

You can make changes that affect how they retire—when they retire— those changes. It may not seem the gravity is that large, but it really is!

Having one investment lineup over the other, or one 401(k) expert over the other, or engaging a service provider like a TPA or record-keeper who’s fees are too high . . . You have that control over the plan—and your participants—and ultimately their retirement!

It’s a little crazy to think about it. You as the 401(k) plan administrator have a great degree of control over whether your employee participants retire a year earlier or a year later. You have some control over whether they have more or less retirement income.

The decisions you make will affect them long after you—or they—terminate employment. So it’s important to realize the gravity of the situation is quite large for both you—and your participants.

401(k) 3(16) fiduciary duties & responsibilities

Do you fully understand your fiduciary duties and responsibilities?
A 3(16) fiduciary is responsible for the day-to-day operations of the 401(k) plan.

So what exactly are you as the 3(16) fiduciary responsible for? Number one (as we talked about) is you’re going to embrace that full discretionary control over the plan administration. So you just need to own the fact that you have control and the responsibilities that go with it.

If you accept the highest degree of liability and responsibility for your 401(k) plan as the 3(16), you:

  • Sign off on all plan-related ERISA documents
  • Manage the day-to-day operations of the 401(k) plan
  • Comply with ERISA
  • Adhere to the plan document
  • Are named in the plan document as the plan fiduciary—the “named fiduciary” we call it—under ERISA.
  • Determine employee eligibility
  • Engage and monitor prudent experts, for example:
    • A third-party administrator who helps with the plan and the design
    • A CPA who helps with the tax reporting or filings
    • An attorney who advises you regarding the plan
    • A 401(k) plan advisor such as myself who actually does the investment management, plan advising, and participant education
  • Maintain a distribute timely:
    • Plan documents and records
    • Plan notices and materials of any substantial changes that warrant a notice
    • Participant statements
    • Disclosures
    • Enrollment kits
  • Interpret the plan
  • Publish the rules
  • Ensure that the 5500 is filed (plan information for the IRS).
  • File 8955-SSA (reporting of separated participants and their balances)
  • Manage the participant loans and distributions
  • Maintain the Fidelity Bond
  • Establish a funding policy for the plan
  • Represent the plan to the IRS in the DOL
  • Handle participant claims should any arise

When the DOL comes knocking and they say “Let me see your plan documents. What are you doing? How are you documenting?”. You need to show you’ve been prudent and diligent in managing the retirement assets of your employees and their beneficiaries. You are going to be the one responsible for proving that to the IRS and the DOL.

If you are that 3(16) fiduciary, these are your responsibilities and duties. These 3(16) fiduciary responsibilities can be outsourced just like you would to a 401(k) plan advisor or a plan record-keeper or TPA.

Outsourcing 3(16) responsibilities will remove a great deal of the workload and responsibility from you. However, you still have the ultimate liability because you’re hiring that external or that third-party 3(16) fiduciary.

You maintain the liability that comes with monitoring and managing that third-party plan provider. You need to make sure that they’re doing their job appropriately. However, they would be responsible for doing all of those 3(16) fiduciary duties.

Do I need a 3(16) fiduciary?

As the 401(k) plan administrator, you’re already responsible for the 3(16) fiduciary duties listed (you just probably didn’t know it). You can never completely remove yourself of that liability because, again, you are responsible for engaging other prudent experts including any service provider offering 3(16) services.

Many TPA’s (third-party administrators) and record-keepers will perform or assist with fulfilling your 3(16) fiduciary responsibility. It’s important to take an inventory of services and solutions they provide you.

What is my TPA providing? What is my record-keeper providing? Are they doing this documentation—or are they getting me the information to do the documentation distribution—timely?

Take an inventory of what those service providers are doing for you currently. Cross-check that with your plan administrator responsibilities and duties.

Once you have a list of services already provided and those you’re responsible for, determine if that gap is too big! If so, you should consider getting an external 3(16) to fill those roles and responsibilities

3(16) fiduciary fees may make hiring a 3(16) fiduciary cost-prohibitive however. 3(16) fees are typically charged in basis points, perhaps 5, 10, or 20 basis points to absorb that 3(16) liability and responsibility.

You may determine that the fees just aren’t worth it because your TPA, record-keeper or plan advisor may do much of the 3(16) work OR they help or assist with the 3(16) responsibilities. So there might not be that big of a gap, and the fees might not make it worth it!

Additionally, keep in mind that when you hire a third-party 3(16), their contract may exclude certain responsibilities. There may be caveats in there that say, for example, “we’ll be responsible for this and this and this, but not this and this and this. If you (Mr. Plan Administrator) have a late payroll or something, we’re not responsible for that.

Be aware of any exclusions in the contract, and make sure that it falls in line with what you are expecting the third-party 3(16)fiduciary.

What’s the difference between a 3(16) fiduciary, a 3(21) fiduciary, and a 3(38) fiduciary?

Now we’re going to switch gears a little bit. The 3(16) fiduciary is all about the administration of the plan—the day-to-day operations and paperwork and so forth. It’s more of a managerial role over the 401(k) plan itself.

The 3(21) and 3(38) fiduciaries, those are relevant to your investment services specifically. They’re also relevant to the education component of your plan.

There’s a big difference between a 3(21) investment advisor and a 3(38) investment manager. Those two words alone—advisor and manager—are quite different.

You need to be aware of this difference—advisor vs manager—because you’re most likely going to engage one or the other.

What’s a 3(21) investment advisor?

A 3(21) investment advisor makes investment recommendations to plan fiduciaries. You as the plan fiduciary (or plan administrator or the 3(16)), you are going to make the ultimate investment decisions, however.

The 3(21) investment advisor may come to you and say “Here’s a list of mutual funds we find suitable for your retirement plan. Consider them, and add them if you would like.” From there it’s your decision! You have the ultimate discretion. The 3(21) investment advisor does not have the power to make those decisions.

They may also come to you and say ”Hey last quarter—we had this fund that’s not performing well. We want to replace it. Here are three alternatives. You pick the best one that you want.”

Then that investment decision is put back on you to make as the 3(16) plan fiduciary. You maintain that ultimate liability for that decision almost as if you were making it on your own. The only difference is you have a 3(21) investment advisor to make recommendations.

Is a 3(21) investment advisor a 401(k) fiduciary?

A 3(21) investment advisor is generally not considered a plan fiduciary. However, in some cases, they might be considered a “co-fiduciary.“

You notice at best they’re considered a “co-fiduciary” (if they’re considered a fiduciary at all). Their liability is much lower than your liability—and your responsibility—because you’re approving the investment line-up changes. They just make the investment recommendations.

This puts you—the 3(16) fiduciary—into some very murky waters here. You as the 3(16) plan administrator become the plan investment advisor in a sense.

Do you have the certifications, experience, credentialing, or qualifications to make proper investment decisions?

Additionally, you must monitor a 3(21) investment advisor as a “prudent expert” who provides advice to the plan. Are they providing quality, timely investment advice? Are they competent, experienced, and skilled in investment management?

What is a 3(38) investment manager? Are they a plan fiduciary?

Compare and contrast the 3(21) investment advisor with a 3(38) investment manager. It’s very important to note that only banks, insurance companies, and registered investment advisors—like Redrock Wealth Management here in Las Vegas—can be a 3(38) investment manager.

You can’t get a typical brokerage firm to be a 3(38) investment manager. They don’t follow under that bank or insurance company or registered investment advisor business structure.

A 3(38) investment manager has a much broader scope of responsibility and liability to you than a 3(16) investment advisor does. A 3(38) investment manager actually makes investment decisions. They don’t just provide advice.

They’ll share insight as to what they’re doing possibly. They’ll provide you reports as to how they’re doing and how they’re performing. But the 3(38) is actually making the investment decisions on your behalf. This makes them a plan fiduciary with all of the obligations and responsibilities that come with that title.

The 3(38) investment manager has the ultimate liability for investment decisions. This reduces your liability because you’re not confirming or making those decisions on the investment menu for your plan.

You as a plan sponsor or plan administrator—whoever the 3(16) fiduciary is—you will always have a residual fiduciary duty because you’re responsible for the selection, the monitoring, the maintenance, and oversight of the 3(38) investment manager.

A 3(38) investment manager should be providing you robust reporting to illustrate their worth and value to your 401(k) plan. However—if they’re not doing their job—it’s your job to replace them with another 3(38) investment manager or 3(21) investment advisor.

You (the plan administrator or 3(16)) still has the fiduciary duty to make sure the 3(38) investment manager/fiduciary is performing as they should. However, your actual liability and responsibility is reduced because you don’t make or approve investment decisions.

Investment decision-making is put on the shoulders of the 3(38) investment manager. As such, it’s critically important to engage a highly competent and experienced professional 3(38). You’re literally giving them the liability and responsibility for all investment decisions.

In many cases, hiring a 3(38) investment manager is the right decision to make! You must stay focused on the day-to-day operations of your business and your job. Unless your business and job is investment and finance related, investment decisions for your 401(k) plan likely fall outside of your expertise.

If you’re not an investment professional with the experience and skills necessary, you probably don’t want the liability or the responsibility of making plan investment decisions.

The 3(38) investment manager actually takes discretion. They take that investment liability and responsibility. They don’t just make recommendations, they make the decisions. They may give you the recommendation as well, but they’re ultimately responsible to make the decision.

Those are the differences between a 3(21) investment advisor and a 3(38) investment manager. It’s important that you as a plan fiduciary you understand those differences.

CEFEX fiduciary certification for 3(38) 401(k) investment managers

Decided to engage a 3(38) investment manager? It’s critical you hire the highest-quality most-experienced professional in the investment management field.

A lot of people can serve as a 3(38) investment manager, but have they invested the time—have they gone that extra mile—to put themselves through rigorous training? Training that helps ensure that they’re operating at the highest possible level for you and your 401(k) plan?

Here at Redrock Wealth Management, we’ve actually earned the CEFEX fiduciary certification. CEFEX is the Center for Fiduciary Excellence.

“Fiduciary”—there’s that word again! You’ve heard it a lot already and we’re not done yet.

The Center for Fiduciary Excellence was established back in 2006. It’s a group of retirement plan focused attorneys, accountants, and investment professionals.

The board at CEFEX has done a massive amount of due diligence and research. From that research, they created an ISO certification process that really is about a fiduciary standard of prudent practices.

They approached this ISO process by asking ”What does the absolute highest level of fiduciary do for their 401(k) plans? What do they do for their clients? For their participants? For other plan fiduciaries like the 3(16)? What do they do, and what should they be doing? Where are the gaps? How do we fill these gaps in? How do we make this a streamlined process?”.

A CEFEX certified 401(k) advisor must operate at the highest possible standards of fiduciary excellence.

Part of becoming CEFEX certified is going through an initial comprehensive third-party assessment process of policies, practices, and procedures. As a CEFEX certified 3(38) investment manager, this process took a few months to complete.

During the certification process, we had a group of attorneys auditing us and reviewing our books or records. They were examining our firm to make sure that our due-diligence is in line, that our documentation process is in line, that we’re doing the right types of participant education, that we’re managing the investment portfolio’s correctly and to the highest possible fiduciary standards.

It took a great deal of time and effort and energy to get CEFEX certified. Additionally, we go through re-certification every year. That takes a few weeks as well!

Every year they’re literally rolling up their sleeves going through our books and records and making sure that we are still continuing to maintain the highest level of fiduciary standard and obligation to our plans, our participants, and our clients.

There’s not many CEFEX certified 401(k) plan advisors out there. Actually, there are a little bit over 200 CEFEX certified fiduciary firms worldwide.

CEFEX certification is a very difficult and rigorous process to go through. If you are going to engage a 3(38) investment manager, CEFEX certification should be a requirement!

The 401(k) business practices and policies they developed helps ensure very well defined and documented processes are in place. It’s most likely that with these processes in place you’re going to have a much better participant outcome, a much better investment outcome, a much smarter-calmer participant that understands the markets better because there’s great education in place.

You’re going to have an investment portfolio or lineup in your 401(k) that’s generally going to be lower cost. It’s going to be broadly diversified—more so than what the average 3(21) investment advisor might bring you as a 401(k) plan retirement committee or plan administrator.

That means that your plan, participants, and portfolio are going to be able to deal with a wider range of investment conditions. With this type of approach, we’re generally not as hostage to market swings as the average investor is, you know, mom and pop who are managing their portfolio.

This process anticipates these bad market conditions are going to happen. We know they are deep down inside. Right now we’re in a basically a bear market that we all knew was coming, we just didn’t know when (no one does).

CEFEX fiduciary certification policies and practices

It’s interesting to me. We’ve had the last ten years without much of a correction and no bear market at all! This created a generation of “zombie investors” who just expect the market to go up all the time. Now the market hiccups like it always has throughout history, and they’re more prone to making horrible investment decisions.

The CEFEX process anticipates these conditions. So we put it into practice investing education that helps participants understand how to deal with adverse markets.

The CEFEX process also helps guides our investment selection as well. If participants know their underlying investment portfolio is stellar, they’re less likely to make a bad decision at the wrong time.

Following the CEFEX process, we’re generally going to make fewer strategic mistakes as well. CEFEX policies and practices are so well thought out, the documentation process is so well orchestrated, your portfolio management decisions are so deeply rooted in structure that mistakes are the exception.

The decision rules within this CEFEX process . . . they just don’t allow much room for mistakes at all!

CEFEX practices are very thorough—very robust—and that also helps us manage client expectations through education. Most participants don’t have a great deal of knowledge on their plan or investing at all. CEFEX policies are also going to drive the education process to those participants.

Our whole goal here is to help plan participants retire earlier and with more money confidence than they ever thought possible!

And how are we going to do that? We’re going to do that through all of these things. By building the right portfolios. By managing the right portfolios. By keeping costs low. By educating the heck out of plan participants so they understand (for example) that right now is a great time to be investing more!

401(k) investing and tuna fish

It’s just amazing to me how many calls we get from people who will say “Hey, I’m thinking about working with a financial advisor. You know, I’ve got my 401(k) but I just stopped putting money into it this year.” We’ll say “Why would you stop putting money in your 401(k)?”

The answer is always “Well, the market is not doing well. My portfolio is not doing well. So I just I just stopped putting money into it.” I’ll say “Well listen, let’s just assume you like tuna fish. I’m kind of a tuna fish fan, so let’s just say you’ve allocated $10 your budget to buy tuna fish every week. You go to the store and it’s a dollar a can great! You’re going to buy 10 cans. So you go to the store next week and it’s on sale by 20% just like our stock market is right now It’s on sale by 20%, so now it’s 80 cents a can and you’re going to get 12 and a half cans now!”

I know you can’t cut a can of tuna fish in half . . . well, you probably could but anyways, I digress. The point is you’re buying the same can of tuna fish, you’re just getting a 20 percent sale price. So you’re going to get more cans!

Investing in a bad stock market you’re going to get more shares of the same mutual fund also. If you think about it, Coca-Cola’s not going to sell fewer Cokes just because the market is down 20%. McDonald’s is going to sell the same number of hamburgers. Most likely Best Buy is going to sell the same number of TVs.

You’re buying the same companies, you just getting them on sale! If anything, 401(k) investors should be making sure they’re maxing out their contributions!

My point is through the education process we focus on helping participants make the right investment decisions, even when it seems really dark in the marketplace. We also help them in terms of one-on-one meetings to answer some of their more personal investing questions.

This whole process is designed to make sure that plan participants have the highest possible chances of a great retirement outcome. To me personally, that means they’re going to retire earlier than they thought possible with more money confidence than they thought possible.

Do I need a 401(k) investment advisor or investment manager?

We already know that if you are the plan administrator you are the 3(16) fiduciary. The responsibility to hire a 401(k) investment advisor or investment manager is on you.

Your job is to engage prudent experts: the right TPA, the right record-keeper, and these are things also that you need to put out for bid every few years. Three years is about the industry norm for you to put out an RFP to make sure that your TPA, your record-keeper, your accountant, your plan advisors are still providing you excellent service for the fees that your plan participants are paying.

In a sense—actually not in a sense but in reality—you are spending your plan participants money on these services. So the IRS—the Dol—takes your position very very seriously.

You absolutely need to engage a 3(21) investment advisor or 3(38) investment fiduciary for investment advice and guidance. If you possess the credentials, the time, the skills, the expertise . . . if you’ve got the experience and you can handle this on your own, then it’s possible you don’t.

Ninety-nine percent of the people listening to this webinar today need to hire a 3(21) or 3(38). The question becomes do you want to retain the ultimate decision-making responsibility and that liability? If so, a 3(21) investment advisor relationship is perfectly fine. They’ll bring you ideas after which you’re responsible for them.

I tend to think more along the lines of “If I’m a 3(16) fiduciary I don’t want the investment responsibility also. I don’t want that liability. I would rather have a 3(38) fiduciary in place so I can defer that ultimate decision-making responsibility and liability, and I’m just responsible for making sure that the 3(38) does their job.

If you’re willing to defer the investment decision-making process (and that liability) you want to engage at the services of a 3(38) investment manager. But again, not just any investment advisor will do. Only a bank or an insurance company or a registered investment advisor can be a 3(38) fiduciary and assume the 401(k) investment management responsibilities.

You also don’t want just any 3(38) investment manager. You want one that is CEFEX certified because CEFEX re-certification every year helps ensure that they’re operating at the highest possible level of fiduciary standards.

So I want to thank you for your time today. I know this is a very dry subject . . . talking about a 3(16) fiduciary versus a3(21) fiduciary versus a 3(38) fiduciary. I know it’s a very dry subject and I appreciate your time and your engagement with this webinar.

If you have any questions, please reach out to me through Best401(k).com or redrockwealth.com. I’m happy to answer any questions you might have.