Saving in a 401(k) is an opportunity to build wealth on a tax-advantaged basis. Most people, however, may not be aware that there are multiple players working behind the scenes to keep a 401(k) plan running smoothly.
Some of these players are required to follow a fiduciary duty; others are not. A 401(k) custodian generally falls into the second category when determining who is (or isn't) a fiduciary.
- Fiduciary duty means that an individual or entity is obligated to act in the best interests of investors.
- There are a number of roles involved in the administration of 401(k) plans, some of which convey a fiduciary duty.
- A 401(k) custodian is charged with holding assets on behalf of plan participants.
- Custodians have no control over how those assets are managed and generally have no fiduciary duty.
- The custodian of a 401(k) is typically subject to the oversight and authority of a trustee who does carry a fiduciary duty.
What Is a Fiduciary?
To understand whether a 401(k) custodian is a fiduciary, it helps to start with a definition of the term. According to the Internal Revenue Service (IRS), a fiduciary is "a person who owes a duty of care and trust to another and must act primarily for the benefit of the other in a particular activity."
The basic responsibilities of a retirement plan fiduciary include:
- Acting solely in the interest of the plan participants and their beneficiaries
- Acting for the exclusive purpose of providing benefits to plan participants and their beneficiaries and defraying reasonable expenses of the plan
- Carrying out duties with the care, skill, prudence, and diligence of a person familiar with the plan
- Following the plan documents
- Diversifying plan investments
The Employee Retirement Income Security Act (ERISA) protects 401(k) plan assets by requiring that certain persons or entities carry out fiduciary responsibilities. Those individuals or entities include anyone who:
- Exercises discretionary control or authority over plan management or plan assets
- Has discretionary authority or responsibility for plan administration
- Provides investment advice to the plan in exchange for compensation
Under ERISA rules, fiduciaries who don't follow the established principles of conduct may be liable for losses to the plan or the restoration of profits generated through improper use of plan assets. ERISA also protects investors who believe they've suffered financial losses as the result of a breach of fiduciary duty.
Though some financial professionals connected with 401(k) plans and investment accounts are subject to fiduciary standards, others are subject to the less-stringent suitability standard.
Role of the 401(k) Custodian
When a 401(k) plan is established, the money that plan participants contribute must be held securely. It's the job of the custodian to safeguard the assets of the plan and the workers participating in it. The duties of the custodian typically include:
- Allocating earnings and losses to plan participant accounts accordingly
- Certifying balances of plan assets
- Investing contributions to the plan as directed
A 401(k) custodian may also assume record-keeping duties, though these may be handled separately. The record-keeper's job is to create a paper trail of transactions, including balances, contributions, and the purchase or sale of assets. The custodian of a 401(k) reports to the plan's trustee, who is able to control plan assets.
A 401(k) custodian does not provide investment guidance or advice on how contributions should be managed.
Is a 401(k) Custodian a Fiduciary?
A 401(k) custodian's main function is holding plan assets, not managing them. The trustee—not the custodian—has fiduciary duties and responsibilities toward the plan sponsor and the plan participants. A custodian can only buy, sell, or move assets under the express direction of the trustee.
This type of arrangement allows for better risk management because it creates a system of checks and balances. The custodian must coordinate with the trustee, who's responsible for coordinating with other parties in a 401(k) arrangement, including the plan sponsor, investment advisors, record-keepers, and any third-party administrators (TPAs) that the plan hires.
In terms of plan hierarchy, the custodian is usually near the bottom of the pile, with fiduciaries assuming the most important rules. That doesn't mean, however, that the custodian's job doesn't matter. A 401(k) custodian must still take proper steps to ensure that they securely hold plan assets and uphold any directions trustees give regarding them.
A direct custodian to custodian transfer is usually preferred for minimizing tax consequences when rolling over 401(k) assets.
Does a 401(k) Need a Custodian?
A 401(k) custodian is responsible for holding plan assets. So even if you've established a solo 401(k) because you are self-employed, you'll still need a custodian that can hold plan funds for you securely. It is an important role.
What Does a 401(k) Custodian Do?
The 401(k) custodian's primary job is to hold plan assets on behalf of the plan sponsor or administrator and the plan's participants. The custodian does not have the authority to make investment decisions or offer advice. Custodians cannot buy or sell assets either unless it's under the direction of the plan's trustee, which follows a fiduciary standard.
Are a 401(k) Trustee and Custodian the Same Thing?
The terms "trustee" and "custodian" are often interchangeable when discussing 401(k) plans, but they're not the same. The trustee has a fiduciary duty for managing the plan while the custodian does not. The custodian is charged with holding plan assets and completing transactions under the guidance of the trustee.
Who Can Administer a 401(k) Plan?
The 401(k) administrator is responsible for overseeing the plan. Unless a separate plan administrator is named, this is usually the plan's sponsor. The plan administrator must also follow a fiduciary standard when directing plan activities.
The Bottom Line
A 401(k) custodian has an important function in the administration and management of a retirement plan by holding plan assets. Though the custodian is not a fiduciary, they are answerable to one in the form of the trustee.
Understanding the different working parts of your 401(k) plan—and who does what—can come in handy if you have questions about your plan, want to execute a rollover, or are ready to start taking withdrawals from your retirement savings.