Objective, expert advice crucial when choosing 401(k) vendor
Defined contribution plans are the most popular employer-sponsored retirement plans in the United States, generating trillions of dollars in investment capital. These plans – 401(k)s and 403(b)s – provide employees with tax-efficient opportunities to save for retirement and offer employers important recruitment and retention tools.
Their effectiveness, however, is hampered by:
- Employers’ understanding of the costs and risks involved, especially regarding fiduciary responsibility; and
- Employees’ ability and willingness to take charge of securing their financial futures.
Selecting a 401(k) provider
When selecting a plan vendor or monitoring a defined-contribution plan, large organizations have access to an array of resources. Those often include compensation and benefits subcommittees and/or legal counsel, accountants and/or actuaries who assist the chief financial officer and vice president of human resources, says Kevin Brogan, vice president of HR for Loretto, which provides elder-care services throughout Central New York.
In small to medium-size companies, however, this responsibility falls to the owner or CEO. Busy running the business, small-company leaders often seek to simplify the task by buying prepackaged 401(k) plans – from their payroll providers, insurance companies, investment advisers or brokers. What they may not realize, however, is that fees and expenses can vary extraordinarily from provider to provider for comparable plans.
In any size organization, hiring a 401(k) service provider is a fiduciary function and subject to the mandates of the Employee Retirement Income Security Act of 1974.
That selection process should be documented, says Robert Newton, relationship manager for EPIC Advisors Inc. in Rochester, and if the organization has an internal administrative committee, the plan sponsor should educate committee members regarding their individual roles and responsibilities.
Understanding employer fiduciary responsibility
Recent legal action has shed light on the ways in which employers – as plan sponsors and therefore fiduciaries – may be held liable if the plan fails to serve the best interests of participants, as required by ERISA. Further, a February ruling by the U.S. Supreme Court, which allowed individual plan participants to seek damages for alleged 401(k) missteps, subjects employers to even greater potential risk.
Any employer who offers or plans to change a defined-contribution plan must understand those inescapable duties, which – according to the Society for Human Resource Management – include:
- Understanding all administrative and investment fees paid from plan assets, including those charged directly to participant accounts, and ensuring they are as low as is reasonable.
- Making plan disclosures in regulatory filings and to plan participants.
- Conducting appropriate due diligence in selecting vendors and investment choices.
- Ensuring that participants understand the benefits of participation, and eliminating barriers to their participation.
Components of a request for proposal
When developing an RFP, “sponsors need to be specific about what services they are looking for (and provide each bidder with complete, identical information) so that they can make a meaningful comparison,” Newton says
Sponsors should request details about:
- The vendor’s financial condition, experience with similar-sized retirement plans, performance record, business practices, and the qualifications of its professionals.
- Fee structures and how fees are paid – by the sponsor or participants, and directly or indirectly. Sponsors should insist on full disclosure of all revenue that vendors intend to capture – including any 12(b)1 or sub-tax fees or service agreements embedded in investments. (See more on fees below.)
- The menu of investment options.
- Whether the vendor offers fiduciary liability insurance or will formally accept any fiduciary obligations. A small number of vendors known as discretionary trustees may formally accept legal liability for the plan’s menu of investment options, administration and/or performance, but most investment advisers and brokers do not.
- Any recent litigation taken against the vendor.
- Administrative and compliance services, such as recordkeeping and reporting, non-discrimination testing, government reporting and plan documents.
- Performance guarantees re: transaction confirmations, statement mailing, processing of loans and withdrawals.
- The process and cost of converting from the current plan to a new one.
- Whether support will be telephone- or Internet-based.
- Frequency and type of communication between vendor and plan sponsor.
- Education that will be provided to employees.
More about fees
In recent years, 401(k) plan fees – especially excessive fees, undisclosed fees and those tied to revenue-sharing arrangements – have drawn increasing scrutiny. A one percentage-point difference in fees and expenses will, over the course of a 30-year career, dramatically suppress the growth of assets in an employee’s account.
EPIC’s Newton suggests that plan sponsors determine, before shopping a defined-contribution plan, whether the plan will limit itself to non-revenue-sharing funds. Such funds pay nothing to third parties such as investment advisers, custodians or record-keepers, and therefore carry lower expense ratios. Plans that rely on non-revenue-sharing funds will be invoiced for plan expenses, and the sponsor then will decide whether to pay fees directly or pass them on to plan participants.
Mastering the maze of fees – which typically number in the dozens – is not for the uninitiated. A fee worksheet issued by the U.S. Department of Labor devotes 11 pages to the task. (See http://www.dol.gov/ebsa/pdf/401kfefm.pdf)
Because failure to conduct thorough due diligence on fees and potential conflicts of interest may invite legal or regulatory action, Brogan and others encourage plan sponsors to engage the help of objective third-party experts.
Investment education for employees
The defined-contribution model was designed with the assumption that employees would learn to invest effectively enough to secure their retirements – not only setting aside adequate funds but also embracing basic investment principles regarding growth and risk.
Unfortunately, the evidence shows that the average U.S. employee has fallen short. Many are so unsure of their abilities – and so unwilling to risk their hard-earned money – that they dramatically under-invest, perhaps shunning the company 401(k) altogether, even when employer matches are offered.
For many employers, the task of educating employees to take full and prudent advantage of this opportunity is daunting and endless. While many vendors do offer employee education, Brogan and others suggest being wary of advisers who receive commissions for directing employees to specific funds.
Conclusion
If you’re the owner or CEO of a small to mid-size company, and you feel overwhelmed by all that’s required to implement and monitor a defined-contribution plan, take heart. The process is so complex that proceeding without expert, objective advice would be both time-consuming and legally risky.
Those familiar with the process recommend engaging some combination of benefits consultant, tax expert, actuary or legal counsel to set up the plan, to advise on choosing vendors, and to help educate employees. To ensure the expert’s advice is untouched by any potential conflict of interest, the employer should insist on paying fees directly to the adviser and avoiding commission arrangements.
