Common Misconceptions of Your 401k Trustee

If you work for a Company or Corporation that has more than a few employees, chances are that you are covered, or have the option to be covered, under a 401K plan. This may be in addition or in place of a Pension plan. Your money has been withheld from your paycheck and deposited into the Plan, and your employer may or may not have contributed money on your behalf into the Plan. The Plan has a number of investment options into which you can direct your assets. The Plan may offer 5, 10 20, 30, or any number of, investment options. You have been getting 401K monthly or quarterly statements for years and tracking the progress of your investments.

Questions Relating to the 401k Trust and Trustee of your 401k Assets

ERISA, the 1974 law that introduced the 401 k plans, mandates that all assets be held by a Trustee. Most people think that the Trustee is a professional or bank that holds and invests the money, and performs all administrative functions under the plan. If people know that the Bank of New York is the Trustee, they assume that Bank of New York is responsible for everything related to the assets, meaning investments, safeguarding, lump sum distributions, etc. This is a common misconception surrounding the term Trustee when discussing corporate 401K plans.

Here are the common questions regarding 401k trustees:

1) What Functions need to be performed for a 401K plan

2) What is a 401 k Trust?

3) Who is normally the Trustee?

4) What is a Directed Trustee?

5) Does the Trustee perform all the functions described in item #1 above?

6) What is a realistic description of the normal 401k Trustee?

What Functions need to be performed for a 401K plan?

The primary functions that need to be performed for any 401k plan are the custody and protection of assets, recordkeeping of the trust assets in total(Trust statement) and for each employee(employee account statement), Portfolio or Asset Management, performance measurement or calculating investment performance of the funds, disbursements or benefit payments to employees. Each of these functions can be sub-divided into further categories.

What is a 401 k Trust?

The law states that all 401k assets must be held in Trust which is a separate legal entity. The purpose of this is to segregate the assets so that they cannot be commingled with other assets of the plan sponsor. In other words, your employer cannot merely put the 401k assets in one of its bank accounts. The Trust is separate from the Company assets. The Trust is established by the sponsor of the 401k plan, usually your employer, which will hold the Plan Assets. This entity is created by the signing of a Trust Agreement between your employer and the firm or person who has been selected to be trustee.

The assets of the Trust must be held In Custody at US Commercial Bank. This does not mean that that the Commercial Bank must be the Trustee, though it normally is. This begs the question: what about assets placed in Mutual Funds? Two scenarios occur:

1) Where a bank is the trustee and a Mutual Fund has been selected as an investment option under the plan, the mutual fund invests the assets placed in the mutual fund; they do not “custody” the assets. Every Mutual Fund Company enters into an agreement with a US Commercial Bank to hold the actual assets of the mutual fund in question. All other functions are done by the Mutual fund Company. If you read the mutual fund prospectus closely, you will see that the actual assets are in custody at a Commercial Bank.

2) The Mutual Fund Companies became huge in the 401k arena since they could do most of the functions and they also had systems that permitted daily valuation. The Mutual Fund Companies were able to become Trustee by establishing Trust Companies under their Holding Companies. These Trust Companies then contracted with a US Commercial Bank to actually hold the assets. The public never sees this aspect, and therefore believes that their assets are actually held at the Mutual Fund. You would need to obtain the trust document of the Mutual Fund Holding Company to discover this fact.

Who is normally the Trustee or corporate 401k plans?

The Trustee can be a single person, possibly one of the Company executives, and I have seen this done, though it is very rare. The very wide majority of 401k plans have commercial banks as the Trustees. The reasons for this are several, including trustee experience, the large fiduciary responsibility that is placed on the Trustee, and the commercial banks’ capability to handle many of the required functions under the plan.

What is a Directed Trustee?

The Trust Agreements normally do not use the word “Directed” and it is a descriptive term for what functions the Trustee will perform. All Trustees have responsibility for holding and safeguarding the assets. However, the Trust Agreement will stipulate that the employer has the power to name the investment managers who will invest the assets. They may hire a separate consulting firm to maintain all the employee records. The employer may also hire a separate firm to handle any interaction with employees, including benefit disbursements.

Going even further, the employer may decide to have Mutual Funds or separately managed Funds or Electronically Traded Funds as the investment options. In this instance the Trustee sends the appropriate assets to the Fund Company, and receives a monthly or even daily statement of assets from the fund company.

The foregoing scenarios actually occur in most corporate 401k plans. The Trustee holds, or has Custody of, the assets, and each of the other functions is put out for bids to other firms. The Trustee may or may bid on performing some of these functions.

What is a realistic description of the normal 401k Trustee?

The only thing one can confidently say about their 401k plan Trustee is that the Trustee keeps track of the assets. I say “keeps track of the assets” because all of the assets may be actually invested in Mutual Funds, in which case, the Trustee simply gets a statement from the Mutual Fund listing the total assets held there, the same as an employee gets a mutual fund statement. All of the other major plan functions may be done by an outside firm. The Trustee does get involved in other legal functions under the Trust, such as, ensuring proxies get voted. For the most part, whenever some aspect of the plan goes awry, such as bad investment performance, or benefit payments getting lost or employee statements not showing up on time, your Trustee is probably not the one who is at fault and probably has no liability for these functions.