If you’re thinking about sponsoring a 401(k) plan at your company, you should know about ERISA bonds. ERISA bonds are required for almost all 401(k) plans. And while they are an added expense, the good news is that they are easy to get and manage, and they protect you from incurring possible larger expenses down the road.
What Is an ERISA Bond?
You likely have heard of ERISA — the Employee Retirement Income Security Act of 1974. This act was passed by Congress to regulate the establishment and management of retirement savings plans. Safeguarding money is always a good idea, but retirement funds in particular are critically important because they often act as a safety net for participants, providing needed care and coverage in later years, when many people are too old or frail to be able to work enough to make up for shortfalls.
ERISA bonds are like a type of insurance that protects employers from liability for fraud or mismanagement that could result in a complete devastation of the plan. ERISA bonds cover losses related to theft, embezzlement and other types of fraud. What if the human resources company you pay to deduct contributions to the plan each pay period neglects to deposit the money into the accounts? Worse, what if the money is gone — stolen by your financial advisor, CPA or other trusted account manager?
If the number of news reports regarding stealing out of 401(k)s is to be trusted, it is not infrequently the employers themselves who are stealing from employees’ 401(k) plans. ERISA bonds help protect employees’ funds from unscrupulous employers in these instances (but they don’t help keep the employer out of jail).
What an ERISA Bond Doesn’t Cover
When you think about insurance that protects investments, it sounds pretty good. By definition, investments are risky, and that’s what makes them valuable. But ERISA bonds don’t protect the investments themselves — as long as they were made legally and correctly. Contributions may still be invested in funds that ultimately lose money. Whether the decision to invest in that fund was made by the employees themselves or a third party is immaterial.
Additionally, like any investment, market fluctuations or other factors could turn a good investment into a bad one. The stock market frequently suffers losses, and if employees are near retirement, they may suffer while waiting for their accounts to regain their value.
Separately, a particular investment could be doing well and then suddenly bottom out. Maybe a company’s factory was in the path of a tornado, or a ship full of inventory sunk in a storm at sea.
The bottom line is your ERISA bond does not cover these types of losses.
Do You Really Need an ERISA Bond?
You may know for sure that you aren’t going to steal from your employees, and you may not have a financial advisor, accountant, external HR provider or anyone else involved in your company’s finances, and for this reason, you may think you don’t need an ERISA bond.
The government, however, doesn’t give you the opportunity to take this gamble. You are required to have an ERISA bond unless your company is exempt, and it probably isn’t. Basically, only religious institutions and the government are exempt from ERISA bonds.
Proof of having secured an ERISA bond is required when your company files Form 5500 each year. You might expect that the penalty for failing to secure adequate coverage would be steep fines or worse, but surprisingly, the law provides no penalty for failing to fulfill this requirement. It’s unusual to be sure, but most companies comply with the requirement regardless, since failure to provide proof of coverage is a red flag that could easily trigger a Department of Labor audit, which may reveal more costly violations than absence of an ERISA bond.
Also problematic (although less so) is an ERISA bond that provides insufficient coverage. Your ERISA bond must be equal to at least 10% of the plan’s total assets. As you can imagine, the value of the plan’s assets can change over time, so the amount of your bond can change as well. That’s why you must perform an evaluation on a yearly basis when you’re filing Form 5500.
Where to Get an ERISA Bond
Here at 401GO, we include ERISA bonding as part of the package with our two bigger retirement plans. With our smaller plan, GO-Starter, companies must purchase their bond separately, either through us or through another approved source.
You can’t get an ERISA bond from just any insurance company — it must be one that has been approved by the Treasury Department. The Treasury maintains a list of approved sureties that is available to the public.
The True Cost of ERISA Bonding
Don’t let the cost of an ERISA bond scare you away from sponsoring a 401(k) plan at your small business. A brand-new plan would not have any assets and thus would require little money for bonding. Additionally, this cost is often bundled into the startup costs of a plan. Small businesses are allowed to deduct up to 100% of the startup costs for a 401(k) plan, so your initial layout is even less than you think.
Here at 401GO, we help small businesses start 401(k) plans safely and correctly — so everyone benefits. Contact us today with questions you have about starting a retirement plan at your company.