When referring to a security measure for a 401(k) plan, the "401(k) bond" is formally known as a fidelity bond. However, the term "bond" can also refer to a type of investment that can be held within a 401(k) account.
The 401(k) Fidelity Bond: Protecting Plan Assets
A fidelity bond is a crucial element of a secure 401(k) plan, mandated by federal law to protect plan assets. It acts as a form of insurance that safeguards the plan from losses due to fraud, theft, or dishonesty by individuals who handle plan funds or property.
Key Aspects of a 401(k) Fidelity Bond
- Purpose: The primary purpose of a fidelity bond is to protect the plan's participants and beneficiaries from financial harm caused by the mishandling, embezzlement, or other dishonest acts of plan fiduciaries and employees.
- Requirement: The Employee Retirement Income Security Act (ERISA) requires that every person who handles funds or other property for an employee benefit plan, including 401(k) plans, must be bonded. This is a fundamental safeguard against potential misuse of retirement savings.
- Coverage: This requirement extends to anyone with discretionary authority or control over plan assets, including plan administrators, trustees, and sometimes even third-party service providers.
- Timing: A fidelity bond is required as soon as a 401(k) plan begins operation, ensuring immediate protection for the plan's assets.
How a Fidelity Bond Works
In the event that a person covered by the bond commits an act of fraud or dishonesty that results in a financial loss to the 401(k) plan, the fidelity bond provides compensation to the plan for that loss. This helps to ensure that participants' retirement savings are protected even if those entrusted with managing the funds act improperly.
Bonds as Investment Options within a 401(k) Plan
Beyond the security requirement, the term "bond" also commonly refers to a specific type of investment. Within a 401(k) plan, participants typically have a variety of investment options, which often include bond funds or other fixed-income securities. These are distinct from the fidelity bond.
Types of Bond Investments Commonly Available in 401(k)s
When you choose to invest in "bonds" within your 401(k), you are typically selecting funds that hold a collection of debt instruments. These can include:
- Government Bonds: Issued by federal, state, or municipal governments.
- Corporate Bonds: Issued by companies to raise capital.
- Bond Mutual Funds or Exchange-Traded Funds (ETFs): These funds invest in a diversified portfolio of various types of bonds, managed by investment professionals.
- High-Yield Bonds: Often referred to as "junk bonds," these are riskier bonds from companies with lower credit ratings, offering potentially higher returns.
- International Bonds: Bonds issued by foreign governments or corporations.
Investment bonds are chosen by participants to help diversify their portfolio, generate income, and potentially reduce overall portfolio volatility, especially compared to stocks.
Fidelity Bonds vs. Investment Bonds: A Quick Comparison
It's important to differentiate between these two distinct uses of the term "bond" in the context of a 401(k) plan:
| Feature | Fidelity Bond | Investment Bond (within 401(k) portfolio) |
|---|---|---|
| Purpose | Protects the plan from fraud and dishonesty | Provides investment growth and/or income for participant |
| Nature | An insurance policy or security requirement | An asset class or investment vehicle |
| Mandate | Required by ERISA for plan operation | An optional investment choice for participants |
| Beneficiary | The 401(k) plan itself (and its participants collectively) | The individual 401(k) account holder |
| Cost Burden | Typically paid by the plan sponsor or employer | Part of the investment expense ratio or trading fees |
In summary, when someone asks "What is a 401k bond called?", they are most likely referring to the fidelity bond which is a mandatory security measure. However, the term "bond" can also refer to the investment class that participants choose for their individual retirement savings within the plan.
