The Bottom Line | Published in July 2016

3(16) Fiduciary Administrators Help Alleviate the Burden

How 3(16) fiduciary administrators can support plan sponsors

By Judy Faust Hartnett | July 2016
Art by Sally Deng

Is hiring a retirement plan administrator who is also a fiduciary the next step in plan sponsor outsourcing? The vast majority of plan errors occur at the administrative level, in operational areas such as discrimination testing, distributions, and loans; in fact, such errors are so common that the Internal Revenue Service (IRS) provides three programs to help sponsors make corrections. The result has been growing interest in administrative outsourcing, experts agree.

Referring to the requirements of the Employee Retirement Income Security Act (ERISA), Grant Arends, president of Alliance Benefit Group Financial Services Corp. (ABGFS) in Kansas City, Kansas, says, “We spend a lot of our time in the [ERISA] 3(21) and 3(38) fiduciary space talking about liability mitigation. Yet, if you look at most plan sponsors, and where you see errors, they have little to do with lawsuits. Plan sponsors are getting exposed to 3(16) administrators from the adviser community. Once they are exposed to [the idea], there is an interest in perhaps learning more,” Arends says.

Plan sponsors may be most familiar with ERISA’s definition of fiduciary as it relates to investment advice and selections, but recently the fiduciary administrator provision has been gaining attention. According to ERISA Section 3(16), the plan sponsor is the plan administrator unless a third-party provider “specifically so designed by the terms of the instrument under which the plan is operated” handles that role.

All sources say, it is the smaller plan sponsors—the majority of all plans—that may want to consider outsourcing 3(16) services to a fiduciary provider, down the road, just as they did with their plans’ investment management. “These plans don’t have the staff to deal with the day-to-day running of the plan. They are looking for a total outsource solution, and 3(16) administrators are willing to do it as a fiduciary, which is attractive,” says David Kaleda, a principal at Groom Law Group Chartered in Washington, D.C.

Larger companies employ potentially a dozen people in employee benefits who can handle a plan’s standard operations. Small plans may have a committee of one or two who serve as plan fiduciaries; by hiring a 3(16) administrator, the employer acquires an expert to handle its plan’s routine management without having to add to the company’s full-time staff.

TPA vs. 3(16) Role

The role of a 3(16) fiduciary versus a third-party administrator (TPA) is at times misunderstood. Craig Bitman, a partner at Morgan, Lewis & Bockius LLP in New York City, says a 3(16) administrator can be thought of as a “supercharged TPA.”
The administrator takes on the tasks the TPA performs but assumes fiduciary responsibility for them. Further, it handles tasks a TPA does not; for instance, a TPA prepares the Form 5500 but does not sign it. A 3(16) administrator prepares the form, plus also signs it and is responsible for it.
Thus, the appeal of a 3(16) is that, unlike just a contracted vendor, it has a fiduciary stake in fulfilling its services. In this way, Arends says, “A) the client has more protection and is off the hook where the vast majority of errors occur. And, b) the provider has a bigger commitment to deliver its services in a quality fashion, because, like the adviser, it’s deemed [a] fiduciary.
“It’s taking the TPA to the next level, although contractually if a TPA messes up, it is responsible anyway,” he says.
The plan sponsors Bitman works with—all large plans—have found no compelling reason to pay the added fees the enhanced role would demand. Instead, he says, it is the smaller plan sponsor that wants to be free of its plan’s day-to-day management that ends up seeking a more outsourced solution. “That’s where more of these services have been targeted and where there is more uptake,” he notes.
And though the typical role of 3(16)is mainly administrative, it can include signing on as fiduciary in respect to investments, as well, if a full outsourcing of responsibilities is desired, he says.
Whether the 3(16) is a TPA or not, a plan sponsor hiring a 3(16) administrator is making a fiduciary decision when it hands over a customizable contract arrangement and some or all responsibilities it has chosen to include in its plan document.
“It’s pretty cut and dried what a 3(21) and a 3(38) are, but with a 3(16) you read the agreement and take on the responsibilities stated,” Arends says. For instance, the plan sponsor may take on loans and qualified domestic relation orders (QDROs) but not hardship withdrawals.
3(16) Drawbacks
Kaleda says, for plan sponsors that want to maintain some control of their plan, using a 3(16) administrator may not be the best solution. There is coordination between the 3(16) administrator and the plan sponsor to ensure that the administrator fulfills what the plan document requires, but by hiring that administrator the sponsor is giving up the hands-on management and taking a step away from the plan.
Another possible negative is that, in today’s competitive job market, candidates look for a full range of company benefits. Many companies distinguish themselves from their competitors by way of such benefits. “To the extent that a plan administered by a 3(16) may look generic and less customized, could the organization it serves lose its competitive advantage?” he wonders.
Cost is another factor: 3(16) administrators are paid at a premium to do the work for which they are contracted.
Importantly, by hiring a 3(16) administrator, the plan sponsor is not relieved of its fiduciary responsibility—just the plan’s operational tasks. As with all providers, the plan sponsor will want to monitor its performance on an ongoing basis.

Before beginning a search for a 3(16) fiduciary, a plan sponsor should identify its reasons for wanting to hire one. What are the plan’s weaknesses? Is it a complex plan where a unique plan design strategy is being used, or is it a straightforward safe harbor plan?
If a plan sponsor thinks it could use the help of a 3(16) fiduciary, before issuing a request for information (RFI) or request for proposals (RFP), it may want to ask its recordkeeper or third-party administrator (TPA) if it offers such services. Another possibility is to speak with its retirement plan advisory firm, as that may have an affiliated 3(16).
If issuing an RFI or RFP, plan sponsors may want to ask the following:

  • How many clients has the 3(16) fiduciary administrator worked with and
  • for how long?
  • What services does the administrator offer beyond a standard TPA arrangement? Are these all specified in the contract language?
  • What are the limitations or the indemnification obligations that plan sponsors have to the administrator?
  • What investigations and/or litigations have been brought against the administrator that would be relevant?

Between the 3(16) fiduciary and the plan sponsor, whatever is not specifically taken on by the administrator gets left with the plan sponsor.