ERISA Bonding: When Do Advisors Need an ERISA Bond?

Introduction

You've established your independent practice. Your strategy is set, your key structures are in place, and now your custodian notifies you that you need an ERISA bond. This Department of Labor requirement raises important questions: What exactly is required? How can you ensure compliance without overpaying for unnecessary coverage?

This guide clarifies the key requirements for ERISA bonding, helping you understand what you need and what you don't.

Understanding the Two Types of ERISA Bonds

First Party ERISA Bonds

A first party ERISA bond covers the plan sponsor (the "first party"). If your firm sponsors a 401(k) plan, you need this type of bond. These bonds are:

• Easy to secure through any general insurance broker
• Relatively inexpensive
• Usually placed on three-year terms
• Can be bundled with crime coverage

Third Party ERISA Bonds

A third party ERISA bond covers the advisor (the "third party") to an ERISA plan. Key characteristics include:

• Required for advisors who meet specific criteria
• Cannot be bundled with crime coverage
• More expensive than first party bonds
• Typically renewed every two years

Important Note: Some firms may need both types of bonds if they sponsor their own plan AND advise ERISA plans for clients.

Do You Need a Third Party ERISA Bond?

The answer depends on your specific role and authority. According to the Department of Labor, only those who "handle" funds or property of an employee benefit plan require bonding.

The DOL's Definition of "Handling"

The DOL clarifies that firms that do NOT have discretionary authority to buy or sell securities for a plan are not required to be bonded solely for providing investment advice. While this definition may seem counterintuitive (since RIAs rarely have custody of ERISA assets), it establishes a clear standard:

If you have discretionary authority over ERISA plan assets, you need a third party ERISA bond.

Key Exemptions

Certain plans are exempt from bonding requirements:

• SEP IRAs
• SIMPLE IRAs

Practical Guidelines for RIAs

When to Purchase a Third Party Bond

Use this straightforward criteria:

1. 3(38) Advisors: If you serve as a 3(38) advisor, you have discretionary authority by definition and need an ERISA bond
2. Timing: Establish the bond when your first client signs a 3(38) ERISA advisory agreement
3. Coverage: Bond only the assets that require it; exclude exempt assets to avoid unnecessary costs

Common Mistakes to Avoid

Many insurance brokers recommend bonding all ERISA assets across the board. This approach creates unnecessary costs and complexity, especially when managing multiple plans approaching the $5 million asset limit used in bond calculations.

Cost Considerations

Third party ERISA bonds represent a manageable expense when properly structured:

• More expensive than first party bonds but still affordable
• Priced at the firm level based on specific calculations
• Two-year renewal cycles help contain costs
• Avoid bonding exempt assets to minimize expenses

Understanding Your Coverage

It's important to distinguish between different types of protection:

• ERISA Bonding: Protects against theft of funds from the ERISA plan
• E&O Insurance: Covers claims against investment advice provided to plans

As an RIA without custody, the risk of fund theft is minimal. However, DOL requirements still apply regardless of this low risk profile.

Key Takeaways

1. Establish a consistent methodology for your ERISA bonding process
2. Bond only what's required: no more, no less
3. Review requirements when statutes change
4. Work with specialists who understand the nuances
5. Document your bonding decisions and methodology

Conclusion

ERISA bonding requirements don't have to be confusing or costly. By understanding the distinction between first and third party bonds, knowing when discretionary authority triggers bonding requirements, and avoiding common overage mistakes, you can maintain compliance efficiently. Focus on bonding only what's required, establish clear procedures, and adjust your approach as regulations evolve.

Remember: proper ERISA bonding is about precision, not blanket coverage. Get exactly what you need to meet regulatory requirements while managing costs effectively.