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 Fiduciary Fitness Part 3: Trusts and Trustees Thumbnail

Fiduciary Fitness Part 3: Trusts and Trustees

In Part 2 of our Fiduciary Fitness series, we discussed how and what services can be out-sourced. We also covered a few of the more common concepts like 3(21), 3(38), or 3(16) Fiduciary. In this article we are going to learn the importance of Trusts and Trustees.

Trustees can be a really confusing topic because the line between a Plan Administrator and a Trustee can be blurry at times. While a Trustee is definitely a Fiduciary role, a Fiduciary role is not limited to a Trustee, and a Trustee may be outsourced. There are also different kinds of Trusts that may be inside or outside your organization depending on what your plan may require.

This article is going to cover:

  • Why a Trust is needed in the first place.
  • Who might need a Trust?
  • What it means to be a Trustee.
  • Who can be a Trustee?
  • A few of the most common types of Trust arrangements. Please note that this is not all inclusive. There are other Trust types but for the purposes of this article – we’re going to keep it those we most commonly see.

The 1970s brought us many things, disco, carpeting on the walls, and ERISA. The Employee Retirement Income Security Act of 1974 was the federal law enacted that set minimum standards for retirement (and health) plans aimed at protecting participants in these plans. Part of the regulation required that a qualified retirement plan must hold the assets of the plan in trust for participants. If you have a retirement plan and you are neither a government nor a church, you probably need a trust.

For a long time, the way most companies did this was by sponsoring their retirement plan through a life insurance product (generally a Group Annuity contract). All the assets of the retirement plan were held under this insurance product and invested in Separate Accounts or other investment options backed by the insurance company. When all of the assets reside with the insurance company, the need for a formal trust is lifted because the life insurance company backing the investments meets the criterion.

As time went on, plans started to add features like loans and investment options outside of the insurance product such as mutual funds, employer stock, or brokerage window options were wanted. In these situations, the assets no longer reside entirely within the insurance product so the plan needed to name Trustees and determine the right Trust arrangement for their situation.

Who can be a Trustee and what does it mean?

Trustees have an important role. They are either designated in the plan document or appointed by another fiduciary to have authority and discretion over the management of the plan assets. Generally, their responsibilities include:

  • Administering the plan in accordance with the Plan Document and for the EXCLUSIVE BENEFIT of plan participants and beneficiaries.
  • Following the guidance of other governing documents such as Investment Policy Statements.
  • Acting with skill, care, and prudence (review the Prudent Man rule discussed in Part 1).
  • Making sure the plan does not engage in “prohibited transactions.” That would be the sale, exchange, or transfer of assets or services between the plan and a “party in interest.” Party in interest is an employer, employee, fiduciary, any person providing services to the plan, etc.
  • Diversifying plan investments to minimize market risks. With other regulation, such as 404(a), there is a Safe Harbor protection that allows the Trustee to delegate this responsibility back to the participant so long as certain requirements and notices are met (sufficient investment choice, Qualified Default Investment Alternative).

A Trustee is a Fiduciary and like all others, they need to be very careful in their actions or they may become personally liable.

Most often, a plan sponsor does not name a single individual as the Trustee. Rather, the plan sponsor may establish a committee of employees; or they may name a bank or an insurance company as Trustee. The plan sponsor may name a new Trustee at any time.

Common types of Trust arrangements

It’s very common that the Trust will cover participant loans. Trustees are generally responsible for making sure loans are administered properly. If your plan offers loans today, you likely have a “loan policy” of some kind that outlines the provisions, the process, how the interest rate is determined, what secures the loan, and what happens if the loan isn’t repaid. Some groups use what is called a “Discretionary Trust” arrangement for this.

The Discretionary Trust simply means the Trustees are acting with discretion with regard to the participant’s ability to receive assets from the plan. Since this usually deals with loans, this is generally a committee named by the Plan Sponsor.

Another common Trust type is a “Directed Trust.” In these cases, the Trustee is a bank or insurance company that is taking direction from the plan sponsor about the management and disposition of the plan’s assets. These are usually required for investing in Mutual Funds, brokerage windows, or employer stock because there are things like dividends or valuations that require additional recordkeeping related to the plan assets. There is generally a fee for this service.

You may also hear “Custodial Trust” or “Custodial Account.” Most often, this is a bank or insurance company that has met the requirements to hold the plan assets in accordance with ERISA regulation. While it meets the requirements for holding the plan assets under trust, it does not make determinations about loan provisions or how to reinvest a dividend. There is commonly a nominal fee for this service.

It is possible to have a situation where a plan has few different Trust Arrangements, such as a Directed Trust for the mutual funds a plan has as investments and a Discretionary Trust named to assist with loans.

If you haven’t considered your trust arrangement in a long time, your team at LMC Financial Advisors can help you think through the options.

Stay tuned for Fiduciary Fitness Part 4, where we will cover understanding expenses and how providers are paid.

Securities offered through LPL Financial, Member FINRA and SIPC.  Investment Advisory Services offered through LMC Financial Advisors, a registered investment advisor. LMC Financial Advisors and LPL Financial are separate non-affiliated entities.

This information was developed as a general guide to educate plan sponsors, but is not intended as authoritative guidance or tax or legal advice.  Each plan has unique requirements, and you should consult your attorney or tax advisor for guidance on your specific situation.  In no way does advisor assure that, by using the information provided, plan sponsor will be in compliance with ERISA regulations.