Author Archives: rpsplanadvisor

What if you could lower your future payroll and healthcare costs simply by re-designing your company’s 401(k) plan? Well, the good news is that you can.

Two of the largest expenses employers face today are payroll costs and healthcare costs. Regardless of whether you are the CFO, COO, HR Director, or Owner of a company, these costs matter to you. They determine how you will hire, whom you will hire, and how much the company needs to produce just to keep up with these costs.

What does this have to do with the retirement readiness of your employees? Simply this — if your employees are not adequately prepared, or on track, to replace 75% of their income in retirement, they will likely work longer. And studies have consistently shown that when employees work past retirement age because they can’t afford to retire, the company’s costs go up.

The numbers can be staggering. Healthcare costs for a 67-year-old compared to a 35-year-old can be double or more. Not to mention, long-term care, disability and other health expenses more commonly associated with older adults. In addition, older, more experienced employees tend to earn higher salaries.

Does this mean you should only hire younger people, or fire everyone over retirement age? Certainly not. There are numerous advantages to having experienced leaders in your company who can help drive the company’s vision. And if you simply fire older employees, you are just putting off the problem (not to mention breaking the law).

The most appropriate course is to hire an experienced advisor who can look at a company’s retirement plan and implement changes that can significantly alter the retirement readiness of its employees. Using the company’s own census data, the advisor should also be able to show exactly how the demographics and retirement trends are affecting the company’s bottom line.

A good fiduciary advisor does more than just pick investment options for the plan. Helping employees prepare for retirement and improving the company’s bottom line are equally as important.

One of the most common issues we find when reviewing 401(k) plans is the prevalence of proprietary investments inside the plan. A proprietary investment is one that has the same name attached to it as that of the record keeper/TPA (third-party administrator).

This is extremely common with insurance company providers as well as with the handful of mutual fund companies who are still in the record keeping business.

Is this practice illegal or unethical?  Absolutely not, but it is certainly something that you as a plan fiduciary should monitor closely. You also need to understand the history behind proprietary funds.

In the early 1990’s, many of the 401(k) platforms available to plan sponsors were through mutual fund companies. It was very typical to have an investment menu comprised entirely of that company’s funds. The revenue that they received from using their own funds enabled them to offer a “free” 401(k) plan to their clients without any billable fees.

In addition, the record keeping and trading technology at the time was not really built out to allow for a multi-fund family approach. Insurance companies, operating under a group annuity product, were among the first to offer a multi-fund platform. Then you had a few “open-architecture” mutual fund platforms that pioneered a new wave of technology and trading.

Many of the mutual fund companies that used to have their own record keeping platforms realized that the real revenue came from asset management. Most of them soon exited the low-margin record keeping world. Today, open architecture solutions are very common, but some firms still continue to utilize their own proprietary investments for one simple reason:  Revenue.

If you take a look at the menu of fund options in your 401(k) plan, and you find that a number of them are managed by the same firm that handles your record keeping, you have to ask yourself a very important question:  Do those funds occupy a slot in my plan based solely on their merit, or are they there to drive extra revenue to the provider?

In 2012, a paper written by several professors from prominent universities studied this very issue¹. The goal of the paper was to find out if mutual fund companies acting as trustees of 401(k) plans displayed favoritism towards their own funds when constructing 401(k) plan fund menus.

To summarize their findings, the paper’s panel stated the following:

“…we show that poorly performing funds are less likely to be removed from and more likely to be added to a 401(k) menu if they are affiliated with the plan trustee. We find no evidence that plan participants undo this affiliation bias through their investment choices. Finally the subsequent performance of these poorly performing funds indicates that these trustee decisions are not information driven and are costly to retirement savers.”

The paper goes on in great detail to spell out the amount of underperformance of these funds, and how they arrive at their numbers. But, in essence, this independent research study arrives at findings that are no big surprise. We at RPS Plan Advisors have over 20 years experience in the retirement plan business, including time with some of the major record keepers that provided an up-close look at these types of decisions.

Since record keeping is a low margin business, these companies have to look elsewhere for their revenue. And it may come at your employees’ expense.

Certainly not all funds with the record keeper’s name on them are bad funds. Indeed, some of them have some very solid funds. But when it comes to constructing a 401(k) menu for our clients, RPS bases its decisions solely on the merit of that investment option—not the record keeper’s profit margins.

And, so should you.

1. Veronika K. Pool (Indiana University), Clemens Sialm (University of Texas), Irina Stefanescu (Board of Governor of the Federal Reserve System). It Pays to Set the Menu: Mutual Fund Investment Options in 401(k) Plans (July 2012).

Conducting an RFP for your 401(k)/403(b) service providers can be an onerous process. But it’s a very necessary one.

As a plan fiduciary, one of your obligations is to monitor service providers and fees. In fact, in the event of a DOL audit, you will be asked about any RFPs or benchmarking exercises you have completed for the plan.

Typically, for our clients, we take them out to bid for an RFP every 3-4 years depending on the size and complexity of the plan. And we provide fee benchmarking information annually.

When you are considering an RFP for a record keeper and an advisor at the same time, we recommend using an independent search firm that specializes in RFPs but does not perform any of the services you are seeking. If you are just searching for a record keeper, your advisor can usually assist with that endeavor.

For this article, let’s focus on what to look for when searching for a new advisor.

1. FIDUCIARY STATUS

One of the reasons you should hire an advisor is to offload fiduciary liability. When advisors respond to the RFP, make sure they indicate their fiduciary status in writing. A 3(38) fiduciary will assume the liability for selecting and monitoring investments, while a 3(21) will just provide guidance and recommendations. Hiring a 3(38) will remove that liability from your plate.

2. AVOID ONE-TRICK PONIES

Does the advisor responding to the RFP provide more than just investment services? Retirement plans have become more complex over the years, and if you are working with an advisor that only handles investments, you are getting short changed. While we do serve as a 3(38) fiduciary, investments are only about 30% of what we do for our clients. Other services you should look for include: individual participant advice, financial wellness solutions, plan design/compliance expertise, fiduciary training, and substantial industry experience. It can be tempting to choose the lowest cost advisor responding to the RFP, but they may be the lowest cost for a reason. Always request a list of services to see what you are paying for.

3. BROKER VS ADVISOR

These two terms are not synonymous. A broker is regulated by FINRA and is held to a suitability standard when dealing with clients. A Registered Investment Advisor (RIA) is governed by the SEC and is held to a fiduciary standard in all client dealings – meaning all advice provided is provided in the best interest of the client. In addition, the only firms that can serve as a 3(38) fiduciary are banks, insurance companies, and RIAs.

4. FEE STRUCTURE

How will your advisor get paid? Do they collect commissions from the investments? Do they charge an asset-based fee, a hard dollar fee, or some combination thereof? Just make sure you understand this before you enter into any agreements. It’s also worth asking how their fee will change as your plan grows.

5. TARGET DATE FUND SELECTION PROCESS

Target Date Funds (TDFs) hold most of the assets in retirement plans since they are usually the Qualified Default Investment Alternative (QDIA). As such, the DOL recommends that plan sponsors and fiduciaries take extra care in selecting a TDF suite for the plan. Ask about the advisor’s process for selecting TDFs, or if they have other options to satisfy the QDIA. Simply selecting the TDFs that are also managed by the plan’s record keeper is not a process.

6. REVENUE STREAMS

Unfortunately, some brokers, as well as some advisors, view retirement plan participants as a golden goose. In such cases, they will cross-sell other products and services to add revenue for themselves. They may even recommend expensive managed portfolios that generate extra income for the advisor. Make sure all conflicts are disclosed along with other services they could potentially derive revenue from.

While this is not an exhaustive list, making sure you understand these six keys can be a huge boost in cutting through the noise of the many responses you will very likely attract.

Towards the very end of the year, the Setting Every Community Up for Retirement Enhancement Act of 2019 was signed into law. Better knows as the SECURE Act, the bill aims to increase access to tax-advantaged accounts and prevent older Americans from outliving their assets.

The law includes many provisions but one of them specifically provides fiduciary protection for plan sponsors when they choose a lifetime income product (or, annuity) for their company’s 401(k) plan.

These lifetime income annuities have been slow to catch on in retirement plans in the past for various reasons. One of the primary concerns was that plan sponsors did not want to be held liable if they chose an annuity provider that went out of business. The SECURE Act includes a provision that eliminates that concern so that more companies will offer lifetime income products in their plans and give participants a guaranteed income option.

While this provision will most likely be a boon for insurers (it was lobbied for heavily by the insurance industry), it also could be a nice benefit for plan participants. However, since annuities can be difficult to understand, and have a bad reputation to overcome for many investors, a solid communication strategy is critical when presenting this benefit in a company’s 401(k) plan.

Perhaps the worst thing that could happen would be for a company to add this provision to their plan, and then not communicate the details to the employees. Figuring out how much money to allocate to an annuity as part of an overall retirement or financial plan is an important decision that should not be taken lightly.

If your company works with an advisor to manage its 401(k) plan, make sure the advisor is made available to the employees to help educate them on the plan and the opportunities created by the SECURE Act. We do not recommend leaving the communication task up to a sales rep for the annuity provider.

Also, any financial conflicts of interest by a provider or advisor should be fleshed out up front before any type of recommendations take place. Ideally, your plan should be managed by an independent advisor who does not get paid on individual investments or products within the plan.

Overall, the SECURE Act provisions designed to promote lifetime income could be a win for plan participants as long as plans and options are delivered with clear messaging, understanding, and conflict-free advice.

There’s little doubt that everyone remembers the financial crisis of 2008. It was the first recession since 2001, and the longest since the Great Depression era. It also led to a number of changes made to our economic and governmental policies. One of those changes has to do with corporate 401(k) plans and how investments are made into money market funds.

Thanks to a string of events starting in 2007, the Securities and Exchange Commission began closely examining the rules surrounding money market funds. This was due to several factors, not the least of which was the Lehman Brothers bankruptcy. One of the oldest and largest money market funds in the country, the Reserve Primary Fund, had a large stake of Lehman Brothers debt in their portfolio. So, when Lehman went bankrupt, this was disastrous for the Primary Fund. As a result, the NAV (net asset value) for this fund “broke the buck” — meaning the NAV dropped below $1.00 per share and settled at $0.97 cents. Naturally, this made investors nervous and there was a run on money market funds by investors who feared the worst.

Consequently, in July 2014, the SEC approved final rules that amended Rule 2a-7, the governing regulation for money market funds. One of the biggest changes affects how money market funds value their shares. Up until this point, these funds valued their shares at a stable NAV of $1.00. Going forward, only Government and Retail money market funds will be able to utilize this stable NAV. Institutional funds will, instead, have a “floating NAV.” Additionally, retail and institutional funds may impose redemption fees or “gates” during periods of volatility.

These changes will also impact many corporate 401(k) plans, as well. Due to these new restrictions and definitions, money market funds may have to change the way they invest to comply with the new regulations. And, many non-governmental funds may simply close up shop. Currently, over 65% of 401(k) plans hold some type of money market fund. The record keeper, or TPA for your 401(k) plan, will also have some input as they work through contractual and technological issues dealing with the new regulations.

From a fiduciary standpoint, the plan sponsor will have to decide which type of money market is most appropriate for the company’s plan, or whether to invest in money markets at all. Instead of merely accepting the option proposed by a service provider, it is the fiduciary’s duty to investigate all of the options.

So, as a plan sponsor, is a higher yielding fund more important? What about a guarantee of principal? Companies will also need to consider whether having a fund with potential redemption fees might be too confusing for its employees. Enlisting the services of a qualified, 3(38) fiduciary advisor can be a tremendous benefit in helping navigate these decisions.

Do you know someone who is retired now and collects a pension? Maybe they were in the military, worked for a railroad, city government, a large corporation, or were a teacher. You don’t see them as much today as you used to, but they are out there.

How did these people build up a retirement nest egg that now pays them a monthly amount? What did they have to do? How much did they have to save? How did they invest it?

The answer may surprise you, as they didn’t have to do anything except show up for work, and do their job for a long time. These types of plans (known as Defined Benefit plans) don’t require any voluntary action or involvement by the employee — except showing up for work.

In such plans, employees are automatically enrolled into these plans after a certain amount of service with their employer. In most cases, the assets are invested by a professional manager, and employees are not provided access to the money as long as they are still employed. No loans, no hardship withdrawals, no access to the money whatsoever. Also, there’s no worrying about how to invest it, or how much to contribute. Consequently, they’re left with a lifetime income stream once the benefit terms are met and the employee retires.

Similarly, 401(k) retirement plans are a great solution to help people save for retirement. But there is one problem with their design. They require action and involvement by the employees. The employee has to answer questions like: How much should I save? How should I invest the money? And, will I have enough to retire on?

When faced with these types of questions, many employees take the path of least resistance and either don’t contribute at all, or contribute too little. From an investment standpoint, it’s almost as if employees are required to be a professional investor. Yet very few possess the education or experience to make the proper decisions.

It is for these reasons that you will continue to see 401(k) plans evolve for the better. More automatic features are being added, such as:  Automatic enrollment into the plan; Auto-escalation of contributions; and, professionally managed accounts. The goal of these features is to automate retirement saving so it becomes more like a pension plan. And requires less involvement by the employees.

In recent times, many business owners and executives have indicated frustration at the low participation rates from employees in the company’s 401(k) plan. Common concerns include: employees don’t save enough; too many millennials are investing too conservatively; or, employees treat their 401(k) like a bank savings account.

These problems can be solved by developing a creative plan design that evolves your current retirement program into a “next generation 401(k) plan.” The key is to avoid taking a passive role in the Retirement Readiness of your employees, as that not only hurts your employees but can negatively effect your company’s bottom line, as well.

All too often, we see 401(k) plans that have become a “set it and forget it” proposition. Not just with the investments and plan design, but with education. In addition to having outdated fund lineups that have never changed (Fidelity Magellan anyone?), and plan design features that no one can remember implementing, it should come as no surprise when the plan sponsor doesn’t have any idea what their participant education strategy is.

If the plan sponsor already works with an advisor, they might vaguely remember the advisor coming out once or twice in the last 5 years to enroll some new participants. Or, if they don’t have an advisor, they may recall that their record keeper/TPA charged $1000 per day to come out and conduct a group meeting. Neither of these is a very effective strategy for ensuring your employees can retire on time and with dignity.

Although relatively recent on the 401(k) timeline, Education Policy Statements are getting more and more attention. These are written policies or procedures that outline the type and frequency of participant education sessions.

If you think about it, it really just makes sense. From a business standpoint, company leaders are always encouraging employees to have written procedures. Performance reviews are given to encourage employees to stick to an improvement plan and advance to a better job. Disaster policies and procedures are documented and practiced to keep everyone safe. Doesn’t it stand to reason that when we implement a 401(k) plan that we would document a strategy for making sure employees both understand and take advantage of the 401(k) plan?

Just as an Investment Policy Statement (IPS) is important to help govern the selection and ongoing monitoring of the investment options in the plan, having an Education Policy Statement (EPS) can ensure that your plan is effective in meeting the needs of your employees. It does not have to be a 15-page document. It can be as simple as a couple of pages that you and your advisor put together that outlines the strategy for educating your participants about the plan’s features and benefits.

With more and more emphasis on plan health and retirement readiness, it’s hard to achieve either of these goals without putting a plan in place, and that starts with your employees. Each plan is unique and has different needs, and each EPS will be different. But retirement targets can’t be hit if employees don’t know what they are aiming at.

Having a 401(k) retirement plan for your employees is both a benefit and a risk. As a benefit, it can certainly help retain employees and minimize costs associated with turnover. But there is also risk involved if the plan is not managed properly. As we start the new year, it is a good time to review your 401(k) plan to ensure a healthy plan that prepares your employees for retirement. Here is a checklist to help you evaluate your retirement plan advisor or determine if it is time to add one to your plan.

1. Fiduciary Protection

Is your plan advisor a fiduciary? If so, do they put it in writing? If your advisor is not taking on fiduciary status, then the primary responsibility and liability for investment selection, monitoring and oversight falls on you, the plan sponsor. Consider hiring an advisor that will take on 3(38) fiduciary status as this provides added protection you need, and allows you to focus on running your business.

2. Interpreting 408(b)2 Notices

You should have received your 408(b)2 fee disclosure notices in 2012. One of the key functions an advisor performs is making sure that you understand all of the notices you received from your covered service providers, and helping you determine if those fees are reasonable for the services you receive.

3. Target Date Funds

Target date funds have undergone significant scrutiny since the market drop in 2008. It is crucial that you as the plan sponsor understand the methodology behind these investment vehicles. If your target date funds are managed by the same company that handles the recordkeeping, then a potential conflict of interest exists. Has your plan advisor walked you through the process of evaluating target date funds? If you have target date funds in your plan that don’t fit your employee population, your participants could be taking on unnecessary risk.

4. Advisor Fees

If you were asked how much your plan advisor charges to service your plan, would you be able to answer the question? Does your advisor charge a fee, or do they receive commissions? Your advisor should be able to share the fee schedule clearly, the structure or formula for how they are calculated, and explain all of the services they provide for those fees.

5. Retirement Ready Participants

If you have good investments and low fees in your 401(k) plan, but your employees are not prepared for retirement, then you don’t have a successful plan. Your plan advisor should meet with your employees, or be available to answer questions beyond the initial enrollment meeting. Many retirement plan participants have questions about investments and how their plan operates. It is crucial that your plan advisor provides some type of ongoing service to ensure that your employees get their questions answered. A 3(38) fiduciary advisor has the ability to meet with every participant, and help design a tailored strategy.

6. Conflicts of Interest

There are many potential conflicts of interest in a retirement plan. Does your investment menu have proprietary funds? Is the bank that handles your business loans also your 401(k) plan advisor? Does your payroll company double as the plan’s record keeper/TPA? These items may or may not be a conflict, but as a fiduciary, it is your duty to make sure any potential conflicts of interest are disclosed. Your plan advisor should assist with this process without any compensation conflicts of interest.

7. Revenue Streams

Many plan sponsors are unaware that their record keeper, TPA, or plan advisor makes any revenue beyond explicit, billable fees. Unfortunately, in the retirement plan industry, there are many ways for fees to be buried or hidden. Additional fees and commissions to your providers can be found in stable value funds, different share classes of mutual funds, finder’s or solicitor’s fees, TPA partnership programs and the list goes on. 408(b)2 was supposed to make this much clearer, but there is still much confusion over this topic. A plan advisor with your company’s and participants’ interest as their only priority, along with experience in the retirement plan industry, can help shed some light on this for you.

8. DOL Audit Ready

The Department of Labor has hired additional employees to audit benefit plans in the coming years. Seventy-five percent of the plans audited in 2011 received fines or penalties. Your plan advisor should have a solid understanding of what the DOL is looking for when they conduct an audit, and help you ensure your plan passes with flying colors.

9. Plan Design

Even though your plan advisor usually handles the investments, it is important they understand the fundamentals of plan design. A well- designed plan can improve participation and make sure that all employees and owners can contribute as much as they desire, up to the maximum allowed.

10. Low-Cost Funds

Regardless of whether a plan advisor believes in an active or passive investment strategy, they should be using the lowest-priced share class available for those funds. Many classes of mutual funds include all sorts of revenue sharing and commissions. It’s important to strip these out so you can see the true investment cost. This also allows you to make more of an apples-to-apples comparison when evaluating overall plan fees and investments.

When it comes to implementing investment menus for 401(k) plans, the phrase “less is more” really rings true. And, while the overall trend in number of choices is down, there are still companies offering 35 (or more) fund options to their employees.

Presenting such a large number of choices can negatively affect the plan in two ways:

1. It can reduce overall participation rates, and
2. It can hamper individual investment performance

So, is there a magic figure when it comes to the number of investments a company offers to its employees through a 401(k) plan? As stated in ERISA Section 404(c), plan sponsors are given a “safe harbor” if they provide at least 3 diversified investment options with “materially different risk and return characteristics.” Under these guidelines, a company could offer a stock fund, a bond fund, and a cash or money market fund, and be within legal boundaries. However, plans with only 3 options are very rare. On the other hand, studies have shown that when you go beyond 10-11 investments, employee participation starts to drop, and they begin to invest more conservatively.

Think about it from another point of view. A restaurant that offers a menu with a dozen or more pages is simply making it more difficult for their customers to choose something to eat. Conversely, a restaurant menu with just 3 options on a single page may not be offering enough selection to draw customers through the door. The optimal menu size lies somewhere in between the two.

It’s no different for 401(k) plan participants. When presented with an enrollment form or website that has 35, 40 or more investment options, participants can get overwhelmed. Some choose not to participate at all because they are simply confused. Others may invest too conservatively because they are afraid of making a bad choice.

While there may not be a magic number, 10-15 core investment options and a suite of either Target Date Funds (TDFs), or asset allocation models yield a good balance between selection and encumbrance. (Note: A suite of TDFs or models are generally considered to be a single option since participants would ideally pick only one TDF or one asset allocation model.)

As an added benefit to the plan sponsor, managing a portfolio of this size makes the monitoring process much less onerous, as well.

Administering a 401(k) plan for your company is not an easy job. There are a host of requirements that you as a plan fiduciary must comply with. One of those key requirements is to ensure that any fees associated with the retirement plan be considered “reasonable” — a key component of the fee disclosure regulations finalized in 2012.

Determining if your fees are reasonable can be a subjective exercise. Different service providers offer different types and levels of services. This can make it difficult to really perform an apples-to-apples comparison. To further complicate matters, service providers can charge fees in very different ways. Therefore, you must first understand how your service provider collects their revenue.

One method of determining and collecting fees — and perhaps the most difficult and least desirable method —is to collect all or most of the fees through revenue sharing from the mutual funds. By default, this is an asset-based charge, which means the fees collected are a percentage of assets. The challenge with this method is that plan assets grow over time, and while .25% of assets seemed like a reasonable fee when your 401(k) plan contained $8 million, it may seem more exorbitant when your plan reaches $10 million, or more.

For this reason, it is important to work with vendors who provide transparent pricing. Most service providers may have some component of their fees as an asset-based fee, but it should include some hard dollar fees that reflect the true cost of their services and adjusts as your plan grows larger.

Once you determine how your service providers assess their fees, you can then begin the process of evaluating if they are reasonable or not. One of the more common ways of doing this is through benchmarking, which involves either going through a formal RFP process, or gathering 3-5 proposals from other vendors. By working with a reputable advisor, they can quarterback this process for you. If not, you will be left to conduct this analysis on your own. The Department of Labor (DOL) does provide some worksheets and checklists on their website to help you.

Once you gather the proposals, you will then need to evaluate what services each vendor provides and how much they charge for it. If your current fees are substantially higher than the others proposals, some investigation will be needed to find out why. This could provide leverage to take to your current provider and get them to lower their fees. However, as the DOL mentions on their website, cheaper is not always better. Remember, service providers are performing a valuable service, and sometimes you get what you pay for.

The good news is that over the last 3 years since the fee disclosure regulations were finalized, fees have come down. So, if you haven’t benchmarked your plan in the last 3 years, this would be a good time to do so. It is recommended that you perform this exercise at least every 2-3 years.