What does the insurance company or trust company in a 401(k) do?
The Employee Retirement Income Security Act of 1974 (ERISA) requires that retirement plan assets—such as for 401(k)s—be held in a trust (with some exceptions). The trust or institutional custodian is not the owner of the assets, as the assets are owned by the participants. Because the plan’s assets are held in trust, they’re protected, should the employer run into financial difficulty and declare bankruptcy.
Insurance companies and trust companies enter into distribution agreements with mutual fund companies that allow them to make the mutual fund shares available to participants. Insurance companies and trust companies also build and maintain the behind-the-scenes infrastructure (such as trading and accounting systems) that's needed to process participants’ investment trades.
From the plan sponsor and the participant perspective, the experience is exactly the same, regardless of whether the plan’s assets are held by, and investments are provided through, an insurance company or a trust company. In both cases, the result is that the insurance company or trust company makes investment options available to the plan’s participants.
The insurance company and trust company are both directed by the plan sponsor
Regardless of whether you select a recordkeeper that makes investments available through a group annuity contract or through a trust company, an individual or individuals from the plan sponsor have authority to provide directions on all matters related to the plan, including selecting the investment lineup and directing participant distributions. The different arrangements, however, use different—and sometimes confusing—terminology to refer to the individual or individuals who direct the provider in plan matters. Regardless of the terminology, the authority of the individual(s) acting on behalf of the plan sponsor is the same in all of these instances.
Trust and trustee in a group annuity with an insurance company
Some 401(k) plan sponsors, including many in use by small businesses, choose recordkeepers that make investments available through a group annuity contract offered by an insurance company. Many insurance companies that offer a group annuity 401(k)—including John Hancock—believe the group annuity contract must be issued to an actual legal entity, such as a trust, and not to the plan, which is not a legal entity separate from the trust.
Therefore, insurance companies issue group annuity contracts to the trustees of the plan, with the trust being the legal entity. Group annuity contracts use the term trustee to refer to the individual or individuals who have the highest level of authority—fiduciary authority—to direct the insurance company regarding all matters related to the group annuity contract and the plan, such as investment lineup selection.
Trust and trustee with a trust company
Other 401(k) plan sponsors choose recordkeepers that make investments available through a trust company. In this situation, the individual or individuals who have the highest level of authority to direct the provider can’t be called trustee because the trust company is already the trustee. Rather, these individuals are referred to using different terms, depending on the recordkeeper. John Hancock, for example, refers to these individual(s) as the administrative fiduciary or the investment fiduciary—depending on their area of authority—as they direct the provider in their designated areas of the plan, such as investment lineup selection.
A plan sponsor of a group annuity contract is accustomed to being referred to as the trustee. If that plan sponsor later chooses a recordkeeper that makes investments available through a trust company, the terminology can cause some confusion. Although the plan sponsor will no longer be referred to as a trustee, the individual(s) who was the trustee will have all the same authorities they had with a group annuity contract—they’ll simply be referred to by a different term.
Insurance company and trust company powers and compensation
Regardless of whether a recordkeeper makes investments available through an insurance company or a trust company, the insurance or trust company’s functions are to hold the plan’s assets and provide the plan with access to investment options. The insurance company and the trust company do not provide investment management or investment advice to the plan, but, rather, take directions from the plan’s fiduciaries (whatever they’re called) regarding investment lineup selection and all other matters. Therefore, the insurance company and the trust company do not have discretionary control over the plan.
The insurance company or the trust company typically doesn’t charge a fee for making investments available, separate from the recordkeeping fee. Particularly with a trust company, it’s possible that it will disclose that it charges an annual fee, but the annual fee is likely to be included as part of , not in addition to, the recordkeeping charge. It’s also possible that the insurance company or trust company may retain any float on the amount of assets held, pending investments or distributions from the plan. This amount is generally negligible, and, in the current low interest-rate environment, there may be no float income at all.
ERISA plans and the flexibility of choice
ERISA imposes fiduciary duties on plan sponsors who are selecting and monitoring a recordkeeper for their plans, but it also allows for great flexibility. Plan sponsors should know and understand whether the plan’s assets will be held by an insurance company or a trust company. Because there’s very little difference between the two structures, however, this fact alone may not be a deciding factor in selecting—or monitoring—a recordkeeper.
The content of this article is for general information only and is believed to be accurate and reliable as of the posting date but may be subject to change. It is not intended to provide investment, tax, plan design, or legal advice (unless otherwise indicated). Please consult your own independent advisor as to any investment, tax, or legal statements made herein.