Big Trouble in Little 401K: Eighties Movies and the 401K Liability Timebomb

This is Gizmo.


For those of you who are children of the eighties, you probably recognize this cuddly little fella as the star of the classic comedy horror film, Gremlins.  If you are a business owner, you may struggle to realize the relevance of Gizmo to your company’s 401K plan, but your ability to do so could be a matter of life and death for your business.  Since we’re in a cinematic mood today, let’s address The Good, The Bad and The Ugly, in that order.

The Good

Like Gizmo (and his other Mogwai brethren), your 401K plan often times starts out as a cute and cuddly creature.  Perhaps your financial advisor or HR director mentioned that this would be an effective way to provide additional benefits to your employees.  A vehicle that can 1) help you retain good talent 2) lower your tax bill and also 3) provide significant protection from creditors?  Not even the DeLorean or the Millenium Falcon can do that!  The benefits of 401K plans can certainly have us dancing like Kevin Bacon in Footloose.

The Bad

Mogwai, like all pets, require careful maintenance.  The three big rules for the proper care of a Mogwai are as follows:

  1. Do not expose it to bright lights or sunlight – this will kill the Mogwai;
  2. Do not get it wet; and
  3. Do not feed it after midnight.

Similarly, business owners are required to take good care of their 401K plans.  In fact, there is a Federal Law called ERISA which imposes a fiduciary duty on business owners to carry out certain responsibilities.  Some of the most important responsibilities include:

  1. Prudently select and monitor investments – this means that you have to choose appropriate investments for your employees and monitor them regularly to make sure they remain appropriate;
  2. Ensure that fees are reasonable – this means you have to pay attention to the marketplace and assess on a regular basis as to whether the fees are reasonable;
  3. Operate the plan in accordance with the plan terms – this means that you can’t just stick your plan in a drawer and forget it about it. You actually have to read, understand, and accurately carry out the terms of the plan; and
  4. Act in the best interest of the employees and avoid conflicts of interest.

The Ugly


Most business owners aren’t professional investors and most of them aren’t lawyers.  Given their lack of expertise or knowledge, they often fail to respect the rules imposed upon them.  “C’mon … how bad could it be?” you ask?  Just like with Gizmo, if you don’t follow the rules, that adorable 401K plan can turn into a nasty batch of Gremlins that can wreak havoc on your company.  The courts are full of recent judgments of tens of millions of dollars against businesses that failed to give these rules the proper respect.  Even for seemingly small “mom-and-pop” businesses, minor mistakes can cost the business hundreds of thousands or even millions of dollars.

Reading this far has probably made you sadder than Steel Magnolias.  However, there is a New Hope.  With knowledge there is power, and now that we know the risks, we can address them.

Hire a Caretaker for Your Mogwai or 401K plan

It is possible for a business owner to outsource much of the risk associated with operating a 401K plan by hiring an independent, conflict-free advisor to review the plan, select the investments and monitor them going forward.  When selecting such an advisor, it is not enough to choose your golf buddy or your father’s brother’s nephew’s cousin’s former roommate (a la “Spaceballs”), some due diligence is required in order for you to fulfill your fiduciary duty.  Generally, it is best to hire advisory firms or consultants who are registered under the Investment Advisor’s Act of 1940, otherwise known as Registered Investment Advisors (“RIAs”).  These RIAs are also required to act as fiduciaries in their dealings with the employer and the plan administrator.  Having independent, product-agnostic advisors also eliminates the potential conflict where a captive agent might be tempted to recommend proprietary investments.  Often times, these advisors will assist and educate employees on financial planning to maximize their chances of fiscal success, further reducing the risk of litigation.  Similarly, independent Mogwai caretakers offer comparable benefits.

Hire An Expert When Your Mogwai or 401K Plan Requires an Audit

To paraphrase Ronald Reagan, it is not enough to trust but you should also verify.  To that end, it is prudent to enlist the help of an accounting firm that is experienced in 401K audits to make sure that the plan is being administered appropriately.  This is critically important when your plan has over 120 eligible participants or when the plan otherwise requires an audit.

As with finding a good caretaker for your Mogwai, spending some time and energy upfront to select the right accounting firm is key to success.  There are many accountants out there who are willing to conduct these audits but according to a recent study by the Department of Labor, there were serious problems found with nearly 40% of all employee benefit plan audits.  Here are some things to look for when interviewing accountants:

  1. The number of 401K plan audits conducted each year;
  2. The extent of specific annual training the accountant has received in auditing plans;
  3. Whether or not the accountant’s audits have recently been peer reviewed by another CPA, and if so, whether such review resulted in negative findings.

In conclusion, your 401K is a fickle beast.  It requires time, attention, and care so that it can remain healthy and bring you all of its wonderful benefits.  While maintaining your 401K plan properly can be a daunting task, the good news is that you don’t have to go it alone.  By finding good wingmen to run and audit your plan, you can free yourself up to attend to your core competencies while still acting in the best interest of your employees.  After all, even Maverick had Goose.



About brianychou

Brian Y. Chou is an Associate Attorney at the firm of Barth Calderon LLP and his practice focuses on asset protection, estate planning, and business succession planning. Mr. Chou assists clients in all stages of life, from the young professional couple that is concerned about estate planning for their minor children, to the wealthy real estate investor who wants to insulate himself and his properties from lawsuits, to the successful business owner who is agonizing about how to transition his company to the next generation. Mr. Chou understands that coming to grips with an impending lawsuit and confronting one’s mortality are typically not high on most clients’ list of things to do and his goal is to make the planning as accessible, digestible and (dare we say it?) enjoyable as possible. Mr. Chou seeks to build lifelong relationships with his clients to ensure that as their personal lives and legal situations evolve, their planning continues to accurately reflect their wishes. In addition to working with clients to protect and transition their assets, Mr. Chou actively seeks to be a resource to his clients in all aspects of their lives. He encourages his clients to contact him with all manner of needs, whether it be a plumber to fix a clogged drain, or a qualified accountant to contest an aggressive property tax reassessment or anything in between. An avid public speaker, Mr. Chou has presented to numerous groups all over Southern California, including University of California Irvine, Cal State Long Beach, the Planned Giving Roundtable of Orange County, and the California Society of Tax Consultants. He is also especially proud of passing the California State Bar Certified Specialists Exam for Estate Planning, Trust & Probate Law. Mr. Chou has also obtained his Series 7 & Series 63 Securities licenses and is also a licensed life & health insurance agent. For Mr. Chou, establishing a connection with the community is paramount. To this end, he is active in a number of organizations, including the Estate Planning & Trust Council of Long Beach, Provisors, Business Networking International, and Comprehensive Child Development, a non-profit providing early childhood educational programs for low income families in Long Beach. Brian Y. Chou is a native of New Jersey and the son of Chinese immigrants. After high school, he moved out to the west coast to attend the University of California, Los Angeles, where he received a degree in economics. Upon the completion of his degree, Brian earned a JD/MBA degree from Pepperdine University. During his time at Pepperdine, he participated in a number of activities. Notably, Brian was a literary citations editor for the Dispute Resolution Law Journal, the President of the Asian Pacific American Law Student Association, the Vice Magister of Phi Delta Phi Honors Fraternity, and a member of the Moot Court Board. He also worked in the Career Development Office at the Pepperdine School of Law and remains involved with the community there. Before establishing his estate planning practice, Brian worked for a law firm in the Inland Empire specializing in insurance defense and construction defect litigation. Prior to that, he clerked at law firms in West Los Angeles where he participated in the practice of Workers Compensation litigation and general corporate law. He is committed to using his broad range of experiences to build relationships and effectively represent his clients in a way that is thoughtful and pleasant for all parties involved. In addition to his professional achievements, Brian can speak Mandarin Chinese and can understand Cantonese. His interests include: surfing, basketball, tennis, jogging, drawing and cooking.
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