When you open a 401(k) retirement plan, it typically comes with a series of advisors who help your business manage that account. Specifically there are three main types of 401(k) advisors, or “fiduciaries,” charged with managing your investments: 3(16), 3(21) and 3(38) fiduciaries. Each oversees a different aspect of your 401(k) plan, with 3(16) fiduciaries handling administrative matters and 3(38) fiduciaries conducting the portfolio’s actual transactions. A 3(21) fiduciary finds strategies for your portfolio and recommends specific assets, investments or overall positions. Here’s how it works.
For more help with retirement planning, consider working with a financial advisor.
What Is a 3(21) Fiduciary?
The Employment Retirement Income Security Act, or “ERISA,” is a law which governs most elements of the 401(k) and IRA system. It established the three categories of 401(k) fiduciaries who run 401(k) accounts, including the 3(21) fiduciary. Each category of fiduciary is named after the section of the ERISA statute defining it.
This is why investors also refer these advisors as ERISA 3(21) fiduciaries.
A 3(21) fiduciary is a paid financial advisor who recommends specific investments or assets to a 401(k) plan. Their advice can take many forms, from trading individual stocks, funds and bonds to recommending an overall strategy that the retirement portfolio should take.
The role of a 3(21) fiduciary can change depending on the circumstances. Some advisors may take a comprehensive role, advising the 401(k) plan on all of its investments over a period of years. Others may take a much more limited role, only recommending individual investments from time to time.
A 3(21) fiduciary does not actually manage the 401(k) account itself. They don’t conduct any transactions on its behalf nor do they have access to its funds or assets. That authority is limited to 3(16) and 3(38) fiduciaries, which administer the account and manage its investments respectively. If a single financial advisor holds multiple roles, they may both recommend assets and conduct transactions, but they would do so based on different sources of authority. In addition, a 3(38) manager can make transactions directly without needing to meet the requirements of a 3(21) fiduciary.
What Are the Duties of a 3(21) Fiduciary?
To qualify as a 3(21) fiduciary, you must meet a series of standards laid out by the ERISA statute. Specifically, you must:
Advise the plan on specific investments, such as whether to buy or sell specific securities;
You must provide this advice on a defined basis;
Under a written agreement;
Based on the specific plan’s needs or overall investment strategy;
For a fee or other form of compensation.
It’s important to note that financial professionals can provide advice to a 401(k) plan without necessarily assuming the rights and responsibilities of a 3(21) fiduciary. If you simply recommend a specific stock to a 401(k) plan or try to sell them on a mutual fund, you have not assumed a fiduciary duty.
Ordinarily a 401(k) will name its fiduciaries specifically in the plan’s documentation. This is what’s known as a “named fiduciary,” someone who the plan specifically designates as its 3(21) investment advisor. Most named fiduciaries either work for the employer who set up the 401(k) plan or for the investment firm managing the plan on the employer’s behalf.
You can also become what’s known as a “deemed fiduciary.” This is someone who provides regular investment advice to the 401(k) plan, has discretionary authority over its assets or otherwise acts like a fiduciary would. In that case, the ERISA law holds that if you have behaved like a fiduciary then you will also be held to the same standards as one.
Legal and Ethical Perspectives
As in all professional fields, a fiduciary has a legal and ethical obligation to act in the best interests of their clients. In general, this means that a 3(21) fiduciary must make recommendations that are, in their judgment, the best choice for the 401(k) plan according to the plan’s financial strategy. The fiduciary must make recommendations only in the interest of the plan and its participants, not based on the fiduciary’s best interest.
They must give advice that meets a reasonable standard of professional care, meaning that the fiduciary doesn’t always have to get it right but the advice must not be objectively incompetent. While the fiduciary should avoid a conflict of interest, such as recommending stocks that they themselves own or a fund which gives the fiduciary a commission, they absolutely must disclose such a conflict to the client. Finally, if the fiduciary’s judgment conflicts with the client’s stated or written wishes, they must follow the client’s instructions.
While these requirements can seem onerous, most simply require that you communicate fully, clearly and in writing with your client at all times.
Oversight and Enforcement
The law does not take these obligations lightly. Any member of the 401(k), whether the employer or an employee, can enforce these obligations. If they feel that the 3(21) fiduciary has breached their duties, for example by recommending a fund that gives them a commission without disclosing the relationship, the plan participants can file a lawsuit and a professional grievance. Penalties can range widely, but can include financial restitution and even the loss of the fiduciary’s professional license.
The purpose of a fiduciary duty is to ensure that the financial advisor acts in the best interest of their clients. While always important, when it comes to programs like a 401(k) this is particularly critical. Most employees have little oversight over their own retirement accounts. They simply have to trust that their employer selected competent, ethical advisors. By imposing an enforceable fiduciary duty on those advisors, the ERISA law helps prevent financial advisors from taking advantage of the hands-off nature of 40(k) portfolios.
The Bottom Line
A 3(21) fiduciary is an investment advisor for 401(k) accounts. Named after the section of the ERISA statute that defines their rights and responsibilities, a 3(21) fiduciary advises 401(k) plans on specific investments and strategies.
Retirement Planning Tips
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