September 10, 2018Client Alert

Common Benefit Pitfalls for Closely-Held Businesses – Part 2: 401(k) Plans

Here we continue our series of five alerts that are aimed at exploring some common pitfalls – or as we like to say, “opportunities” – for closely held companies and their benefits and compensation arrangements (and administration of the same). This second alert tackles the 401(k) plan. If you missed the first alert on health insurance, you can read it here (although each alert stands on its own, so you won’t be lost if you start with this alert).

Without a doubt, most employers – particularly those who genuinely care about and feel some obligation to help aid in their employees’ retirement income security – understand the need for their employees to save for retirement. Responding to that understanding, employers often look to set up a 401(k) plan to foster employee savings. Even where the organization cannot afford to or otherwise chooses not to provide an employer contribution (such as a match or profit sharing contribution), allowing employees to save on a tax-advantaged basis is a “win-win.” 

That said, particularly smaller or emerging organizations often struggle with the obligations that come along with adoption of a 401(k) plan. Here are some of the more common pitfalls to “watch-out” for:

  • Assuming the plan is on auto-pilot.
    • Most times a financial institution comes in and describes how it can handle virtually A to Z when it comes to establishing and maintaining the retirement plan. That may be mostly true; however, there are fiduciary obligations (with respect to investments, claims or other important elements of the plan) that require careful attention. A major mistake is not paying enough attention to the plan – there is no option to “set it and forget it”.
      • Maintaining a 401(k) plan comes along with some of the highest duties known under the law. It’s important to understand if, when, and how company employees and/or the company board will be obligated to remain involved in the plan.
        • Ultimately, when maintaining a 401(k) plan for your employees, it’s important to understand who makes fiduciary decisions, whether they have delegated that responsibility, whether they have been appropriately trained, etc.
      • Formalizing plan governance (e.g., by establishing a committee and adopting a charter governing a retirement plan committee) is key to avoiding some of these common mistakes.


  • Not closely monitoring payroll set up.
    • It is crucial to match the payroll system to the precise definition of “compensation” as set forth in the 401(k) plan document. For example, if bonuses are considered “compensation” under the plan, but the transmission file doesn’t capture those amounts when sending over information from the company to the 401(k) provider, the plan will have an “operational failure” (which, technically speaking, can disqualify the plan and cause adverse tax consequences).

  • Offering company stock without appropriate governance.
    • Offering company stock may seem like a great idea for many reasons (such as increasing the market for the same or incentivizing employees to work to increase share value), however, it comes with special rules and increased risks. Carefully navigating how to set up a company stock fund and the added considerations that come along with doing so (for example, whether engagement of an independent fiduciary make sense) is critical to ensuring that you do not run afoul of any rules or regulations.

  • Confusing how “covered” the fiduciaries are.
    • For those families or executives running closely-held businesses, they may not be (nor have any interest in becoming) an ERISA guru. But even those who don’t speak ERISA will need to understand the fiduciary rules if they decide to set up a 401(k) plan.
    • The difference between fiduciary liability insurance and a fidelity bond is a common area of confusion.
      • A fidelity bond is specifically required by ERISA for any “plan official.” For this purpose, a “plan official” is a fiduciary of an employee benefit plan and/or a person who handles funds or other property of such a plan.
        • A fidelity bond guards the applicable plan against losses due to fraud or dishonesty – for example, theft – by any covered plan official.  
      • Fiduciary liability insurance, unlike a fidelity bond, is not mandated by ERISA.
        • Fiduciary insurance is designed to insure the plan against losses caused by breaches of fiduciary responsibilities and, simultaneously, protect the covered fiduciary or fiduciaries from any personal liability resulting from such breaches.
      • Checking to make sure a fidelity bond (in the appropriate amount and form) is in place is completely necessary; checking to ensure that an approximate amount of fiduciary liability coverage is in place is a best practice. An indemnification agreement/provision benefitting employees serving as plan fiduciaries may also be worth considering. Note, however, that ERISA carefully regulates these arrangements (voiding some as against public policy), so this area should be carefully navigated.

Overall, maintaining a 401(k) plan can be a successful experience; however, it requires some hard work for the employer team who is establishing it – both at the outset and on an ongoing basis.

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