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Directed Trustee vs Discretionary Trustee: 401k Planning Thumbnail

Directed Trustee vs Discretionary Trustee: 401k Planning


401k plans have plan sponsors or entities that carry out and handle the investments. There are two types of trustees a 401k plan can have - directed vs discretionary trustee. Both roles are vastly different, so here's everything you must know.

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What Is a Directed Trustee?

A directed trustee is someone appointed to carry out the investment decisions of an assigned fiduciary making the investment decisions. Directed trustees are fiduciaries, but the fiduciary responsibility is much less than that of the assigned fiduciary making the investment decisions.

Directed trustees do not make the decisions for the plan. Instead, think of them as the players on a team. The coach tells them what to do, and they do it. That's what a directed trustee does; they wait for instructions from the discretionary trustee or person responsible for the plan assets.

What Directed Trustees Do

While it sounds like a directed trustee doesn't have much responsibility, they do.

First and foremost, they must execute the instructions provided by the person making the decisions. It's a larger responsibility than it sounds because they are responsible for carrying out the intended investments for the retirement plan.

In addition, directed trustees must use their fiduciary responsibility to ensure the instructions provided follow the plan. If the direction provided doesn't meet the plan's terms or violates any laws, the directed fiduciary shouldn't follow through with the instructions.

Directed trustees have some say in what happens with the plan if the instructions they're provided don't meet the plan's goals or go against any ERISA rules.

What Is a Discretionary Trustee?

On the other hand, a discretionary trustee has full authority and discretion to manage the plan's assets. The discretionary trustee will make important decisions for the plan and can execute them.

The discretionary trustee is often a third party but can also be an employee who can act as a fiduciary for the plan. An employee acting as the discretionary trustee mustn't be compensated for their duties in the plan. However, if you hire a third party to handle the responsibilities, you'll pay a fee for their services.

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Comparing Directed Trustee vs. Discretionary Trustee

Understanding the difference between a directed vs. discretionary trustee is important to know the rights of anyone handling your 401K plan, from decision makers to fiduciary responsibilities.

Decision Maker

The decision maker in a 401K plan is the discretionary trustee. This is the person appointed to make the decisions about the assets within the plan. Discretionary trustees can make decisions about the assets in the plan, but a directed trustee cannot.

A. Fiduciary Responsibilities Regarding Assets

Discretionary trustees have the highest level of fiduciary responsibility regarding the plan and its assets. It alleviates the plan sponsor of handling these decisions and puts them on a company or person who handles financial decisions for a living.

However, a directed trustee must also operate as a fiduciary. In other words, they must operate in the best interest of the plan assets. Therefore, if the directed trustee feels something isn't right with the direction provided, they must say something rather than simply oblige.

B. Global Fiduciary

There isn't a set way discretionary trustees must handle the plan assets; however, as a general rule, Global Fiduciary Best Practices created by Fi360 cover 21 categories and 85 subcategories to keep a plan's assets on track.

C. Delegation and Allocations

Understanding the difference between delegating and allocating the responsibility of maintaining plan assets is important.

If a plan sponsor chooses not to handle the plan assets and allocates the responsibility to discretionary trustees, the plan sponsor isn't responsible for the plan or its performance. The plan sponsor may act as the directed trustee and do as they are directed by the fiduciary, but they are not responsible for the outcome.

Directed trustees, however, are delegated by the fiduciary responsible for making the plan's decisions. Therefore, directed trustees must perform the actions suggested unless they feel it violates their fiduciary responsibility.

D. Improving Retirement With Discretionary Trustee

A discretionary authority can help retirees reach their retirement goals. While a qualified retirement plan is meant to provide for employees, helping them have enough money in retirement, only 36% of Americans think they have enough for retirement.

This could be for many reasons, but mostly it's due to plan participants not fully understanding the ramifications of their retirement plans and how they work. Even with proper tools, many don't have a solid enough understanding of how it works, so they don't plan properly.

Discretionary trustees, however, can step in and help. They can choose the investments that make the most financial sense for the plan and take a more active approach to managing the assets at a personal level, helping retirees reach their goals.

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The Need for a Directed Trustee

A directed trustee protects the business owner. However, they still have a certain level of fiduciary responsibility that can be too much for business owners, especially if they don't have the proper training or knowledge.

A directed trustee can help business owners understand if a certain action is a fiduciary duty breach or a violation of the Employee Retirement Income Security Act. It gives the business owner another level of protection to ensure everything follows the law.

Appointed 401K Plan Trustee

All 401k plans must have an appointed plan trustee, and it can be the business, an employee, or a third party.

Business or Company as a Trustee

An appointed employee must oversee the plan if the business or company is the trustee. The designated person must have the proper training to meet all fiduciary responsibilities and understand the duties of being a plan trustee.

External or Private Party Trustee

Companies can also outsource trustee duties to a third-party business or person. This offers more protection against liability and ensures all fiduciary responsibilities are handled. As we said earlier, there's typically a charge to have a third party handle the trustee duties, but it can also provide your company with higher protection.

Is a 401K Custodian and Trustee the Same Thing?

A 401K custodian and trustee are not the same. The trustee has fiduciary responsibilities to manage the plan in the best interest of the plan assets. A custodian holds the assets and handles executing the investments as directed.

The Bottom Line

A discretionary trustee makes the decisions for retirement plans and directed trustees do as their told but still have a fiduciary responsibility. Both operate in the best interest of the plan and the ERISA laws. If you have questions or need investment advice, speak to your investment manager or financial advisor.