What is an ERISA Fidelity Bond?

The Employee Retirement Income Security Act of 1974 (ERISA) was passed to protect employees participating in employer-sponsored retirement plans such as pension plans, 401(k)s, Employee Stock Ownership Plans (ESOP), and other retirement plans. ERISA sets up a number of rules and standards of conduct for employee retirement plans managed by private employers and the people who invest and manage plan assets.

ERISA requires the people who handle plan funds and other properties (called “plan officials”) to be covered by a Fidelity Bond, which is an insurance policy that protects employer-sponsored retirement plans from losses caused by acts of fraud and dishonesty by the plan’s managers.

Note that a Fidelity Bond has nothing to do with the type of “bond” that is a tradeable, fixed income security.

Fraudulent or dishonest acts covered by ERISA Fidelity Bonds include:

• Theft
• Embezzlement
• Larceny
• Forgery
• Misappropriation
• Wrongful abstraction
• Wrongful conversion
• Willful misapplication

Example:

• The owner of a commercial cleaning service company transfers $30,000 worth of employees’ contributions to their 401(k) plans into her own bank account and uses it to pay the down payment on her new home. An ERISA Fidelity Bond will cover the losses from her embezzlement of funds.

Why do you need an ERISA Fidelity Bond?

ERISA was enacted into law to address serious public concerns that employer-sponsored retirement funds were being mishandled. The benefits of having ERISA Fidelity Bonds are clearly evident. It can be easy and extremely tempting for employers or other service providers who have access and authority over the plans to steal from them or commit fraud.

Especially when people are dealing with difficult economic times personally or struggling financially in their business, they may see plan funds as a way to cushion their finances. However, fraud or dishonesty can take on many forms aside from simply stealing assets from the retirement plans. It could involve charging excessive fees for 401(k) plans, reducing benefits without proper notice, making risky investments, taking kickbacks from fund administrators, and an array of other illicit activities.

Who is considered a manager of a plan?

Since the ERISA Fidelity Bond only applies to fraudulent acts made by people who handle retirement plans, it’s important to understand what exactly constitutes “handling” a plan.

Generally, plan managers must meet at least one of the following criteria:

• Physical contact with cash, checks, or similar property, not including clerical workers who come into contact with cash or checks from time to time
• Power to secure physical possession of cash, checks, or similar property through access to safe deposit box, bank accounts, etc.
• Power to transfer plan funds either to oneself or a third party
• Power to disburse funds
• Power to sign or endorse checks
• Supervisory or decision-making authority over plan funds

Example:

• The director of HR has the power to select investment funds for the company’s 401(k) plan. She selects an extremely risky investment fund that offers her a kickback. When the investments fail, the value of the 401(k) plan falls drastically and impacts the payouts for employees participating in the plan. The losses are covered by a Fidelity Bond under ERISA.

Under ERISA, it is illegal to “receive, handle, disburse, or otherwise exercise custody or control of plan funds or property” without being bonded. The bonding requirement is not just limited to trustees of the plan, employees of the plan, and employees of the plan sponsors. Third-party service providers who have access to the plan’s funds or exercise decision-making authority over the funds may also require bonding. This includes pension professionals, investment advisors, and 3(16) administrators.

Example:

• Your company hires an investment advisor to invest the funds of your employees’ 401(k) plan. The investment advisor, as a service provider that manages the fund, must be covered be an ERISA Fidelity Bond.

Please note that while most fiduciaries of the retirement plan are bonded because they handle the plan funds, not all fiduciaries are required by law to be bonded. If a fiduciary does not handle plan funds, they do not have to be bonded.

What are “funds and other property?”

Note that plan officials do not just handle funds but also “other properties.” In other words, your company may have made investments that will go towards the retirement plan. “Funds and other property” refer to all the cash, checks, and other property held by the company that are earmarked for the disbursement of the plan benefits. This could include:

• Land
• Real estate
• Mortgages
• Securities

How much coverage is required? What’s the maximum coverage?

ERISA requires each person handling the plan to be covered for at least 10% of the amount of funds he or she handles. The coverage can’t be less than $1,000 or more than $500,000, unless the plan includes stock options issued by the employer. Managers of plans that include securities issued by the employer can be covered up to $1,000,000.

Example:

• Your company’s retirement plan has funds totaling $750,000. The company owner and HR director are both fiduciaries of the plan with access to the plan funds and authority to disburse them. Both the owner and HR director must be bonded for at least 10% of the total fund amount or $75,000.

What is the minimum term for the ERISA Fidelity Bond?

An ERISA Fidelity Bond has a minimum term of one year. When the bond term is longer, it will typically include an “inflation guard” which means that the value of the bond will automatically increase as the value of the fund grows.

Is there a deductible for an ERISA Fidelity Bond?

ERISA Fidelity Bonds are legally required not to have a deductible, so it will cover your company’s retirement plan losses from fraud or dishonesty by plan managers starting from the first dollar of loss. Your company will not have to pay a certain amount out-of-pocket before the insurance policy kicks in.

What plans are exempt from the ERISA Fidelity Bond requirement?

There are certain types of retirement plans that are exempt from the ERISA requirements, including:

• Church and government plans
• Unfunded plans (benefits are fully paid from the employer’s general assets)
• Section 125 cafeteria plans (which gives employees the option to use tax-free dollars to pay for their own healthcare)
• Ensured welfare plans where no one “handles” the funds

Exemptions are also provided for some regulated financial institutions, including certain banks, insurance companies, and registered brokers and dealers.

Can all insurance companies sell ERISA Fidelity Bonds?

No. ERISA Fidelity Bonds must be obtained from an insurance company that is listed on the Department of the Treasury’s Listing of Approved Sureties, Department Circular 570. These are insurance and reinsurance companies certified by the Treasury Department.

What is the difference between an ERISA Fidelity Bond and fiduciary liability insurance?

An ERISA Fidelity Bond specifically protects employee retirement plans against fraud or dishonesty on the part of people who handle the funds (who could be fiduciaries or not). The Fidelity Bond will replace the stolen funds from the employee retirement plan after a plan manager commits theft or fraud. It is not intended to cover the cost incurred from any legal claims that may arise from the fraudulent or dishonest act, which is where fiduciary liability insurance would come into play.

Fiduciary liability insurance protects a wide range of employee benefits plans, including retirement plans, from mismanagement of plan assets by fiduciaries. It generally covers unintentional failures of duties when making decisions about the benefit plan, in addition to some types of fraud or dishonest actions. Since it is a type of liability insurance, it will cover the costs of defending a lawsuit and any judgments or settlements that come out of it.

What are the consequences of not purchasing an ERISA Fidelity Bond?

• Your company would be violating the federal ERISA regulations.
• Your plan may be targeted for an audit by the IRS if you do not report the bond when your company files its taxes. The dollar amount of the ERISA Fidelity Bond must be reported on Form 5500, which is required for all retirement plans.
• Fiduciaries of the plan may be held personally liable for losses the Fidelity Bond would have covered.

Final Word

Federal law protects employee retirement plans managed by private employers from fraudulent and dishonest conduct by the people who manage the plans’ funds. An ERISA Fidelity Bond covers these types of losses and will replace any stolen funds from retirement plans. Anyone who handles the plan’s funds must be covered for at least 10% of the total amount of the funds under ERISA requirements, though there are exceptions for certain types of plans and institutions. Failing to meet the ERISA Fidelity Bond requirements could lead to an audit by the IRS, personal liability for fiduciaries, and other legal ramifications for violating federal law. Fidelity bonds provide an important layer of protection for your employees from potential wrongdoing of plan managers.