Guest Author Victor Hicks II, CFP, AIF: Fidelity Bonding vs. Fiduciary Liability Insurance for 401(k) Plan Sponsors

Victor HicksFidelity Bonding vs. Fiduciary Liability Insurance for 401(k) Plan Sponsors
By: Victor H. Hicks II, CFP®, AIF®

Owner, Managing Principal
Lumin Financial, LLC
An Independent Registered Investment Adviser
vhicks@luminfinancial.com

Our clients often ask: Fidelity bonding or fiduciary liability insurance? It’s not an either/or question. Each has its own function in protecting the plan and its fiduciaries against claims for certain plan losses. Below we answer questions plan sponsors may have about fidelity bonding and fiduciary liability insurance.

Are retirement plans required to have a fidelity bond and fiduciary liability insurance?

Pension law (ERISA) generally requires every person who handles funds or other property of a plan (“plan officials”) to be bonded. For example, officers and employees of the plan or plan sponsor who handle the receipt, safekeeping, and disbursement of plan funds are subject to bonding. Fiduciary liability insurance is optional.

What is the purpose of a fidelity bond?

The purpose of a fidelity bond is to protect your retirement plan from risk of loss due to acts of fraud or dishonesty by individuals handing the plan’s assets. These acts include such things as theft, embezzlement, and forgery.

How much coverage must the bond provide?

Each plan official must be bonded in an amount equal to at least 10% of the amount of funds he or she handled in the previous year, with a minimum bond requirement of $1,000. Generally, the maximum bond amount that can be required for any plan official is $500,000 per plan. So, for example, if your plan had $1 million in assets, each plan official would have to be bonded for $100,000. The maximum required bond amount is $1 million for officials of plans that hold employer securities.

If the amount of funds handled increases after the bond is purchased, must the bond be updated during the plan year?

No. The bond amount must be fixed or estimated at the beginning of the plan’s reporting year based on the highest amount of funds handled by the person in the preceding plan year. At the beginning of each plan year, the plan administrator or another appropriate fiduciary should review the adequacy of your plan’s fiduciary bond.

Why would we need fiduciary liability insurance, too?

As discussed, your plan’s fidelity bond insures against losses due to fraud or dishonesty on the part of persons handling plan funds. Fiduciary liability insurance protects against claims for losses sustained because of a breach of fiduciary duty or because of administrative errors.

What additional protection does fiduciary liability insurance provide? 

Wrongful acts that may be covered by fiduciary liability insurance include negligent investment practices, failure to diversify investments, conflicts of interest, failure to provide participants and beneficiaries with required information, errors in computing eligibility, failure to timely deposit money in participant accounts, and other negligence in administering a plan.

What should we consider when we’re looking at fiduciary liability insurance?

Some factors you’ll want to weigh include the amount of coverage available versus your needs, what the coverage includes, exclusions, premiums and deductibles, and whether any defense costs included in the policy count against the overall policy limit.

Can we use plan assets to purchase a fidelity bond and fiduciary liability insurance? 

Yes, with a qualification for fiduciary liability insurance. Because the purpose of the pension law’s bonding requirements is to protect employee benefit plans and bonding doesn’t benefit plan officials or relieve them of their obligations to the plan, you can use plan assets to purchase your plan’s bond. With fiduciary liability insurance, the policy must allow the insurer to recover any paid losses from the fiduciary whose breach caused the loss. For more comprehensive coverage, you, as the employer, may want to purchase the insurance as part of your executive compensation package.

If you have questions about whether fidelity bonding or fiduciary liability insurance is right for your retirement plan, please contact a Lumin Financial advisor.

ABOUT LUMIN FINANCIAL

Lumin Financial is a fee-only independent Registered Investment Adviser, specializing in 401(k) plans for small- to mid-sized employers. Lumin Financial advisors serve plan sponsors throughout the Midwest with a disciplined approach to managing plan investments, counseling on fiduciary risk matters, and reducing excessive plan fees. In addition to managing investments and risk, Lumin delivers personalized financial education to plan participants. Let them help you plan a clear direction for a bright future.  www.luminfinancial.com

Lumin Financial, LLC is a Registered Investment Adviser.  Information presented is for educational purposes only and does not intend to make an offer or solicitation for the sale or purchase of any specific securities, investments, or investment strategies.  Investments involve risk and unless otherwise stated, are not guaranteed.  Opinions provided are those of Newkirk and Lumin Financial, LLC.  This information is from sources we believe to be reliable, but we cannot guarantee or represent that it is either accurate or complete. Please note, changes in tax laws may occur at any time and could have a substantial impact upon each person’s situation. While we are familiar with the tax provisions of the issues presented herein, as Financial Advisors we are not qualified to render advice on tax or legal matters.  You should discuss any tax or legal matters with the appropriate professional.