Small to mid-size professional service firms are currently scrambling to re-adjust their budgets due to the economic disruption of coronavirus restrictions. As a result, 401(k) providers such as myself have been fielding many questions recently from plan sponsors who are asking whether safe harbor contributions may be suspended and what other considerations should be considered prior to moving forward.
Unlike many other aspects of the rules governing qualified plans such as 401(k), the answer to the first question is fairly simple. The IRS does allow plan sponsors to amend their plan documents mid-year to suspend a company’s safe harbor contributions. But there are some caveats as listed below. This would be true whether your plan uses the safe harbor non-elective or one of several qualifying safe harbor matching formulas.
That is the easy part. The considerations that must factored prior to making this decision are more complex. My objective here is to clearly lay out these issues as they apply to safe harbor plans in general. My objective here is to give you an aerial view of the factors that come in to play for mostplans. Because the details of your plan document are critical, plan sponsors should consult with your TPA and other plan providers prior to moving forward.
Removing Safe Harbor
In order to suspend employer contributions, plan sponsors must first amend the plan document to remove the safe harbor provision. The rules require that a supplemental notice be given to all eligible employees not less than 30 days prior to the change.
There are a few contingencies, however, that must be considered:
Participants must be allowed to change their deferrals prior to the change becoming effective.
The employer must have included in the annual safe harbor notice a statement that the plan could be amended mid-year to reduce or suspend safe harbor contributions – or –provide evidence that they would be operating at an economic loss. Employers and related employers in the same controlled group would need to show that expenses exceed income for the year based on generally accepted accounting principles.
The suspension cannot be effective for at least 30 days after the later of the supplemental notice or the effective date of the plan amendment.
An employer who suspends or reduces its safe harbor mid-year must pay the safe harbor contribution amount from the beginning of the plan year up to the effective date of the change. The annual compensation limit used to calculate the safe harbor contribution would be pro-rated up to the date of suspension.
There are, however, some really, really important caveats that must be considered to avoid some unintended consequences for employers.
Year to Date Contributions
Employers who suspend contributions mid-plan year are not relieved of the duty to fund safe harbor contributions for the period from the beginning of the plan year through the date the safe harbor suspension becomes effective. For example, if an employer provides notice on May 1, 2020, the safe harbor contribution will be calculated on eligible wages and deferrals through May 30, 2020.
But for businesses who expect cash flow to return to pre-virus levels, there is some good news. Employers are able to minimize the impact of required contributions by postponing deposit deadlines. In order for your contribution to be tax deductible, the deposit must be made by the due date, with extensions, of your company’s tax return. For a company operating on a calendar tax year ending December 31, 2020,the deposit deadline could be as late as October of 2021. If you are not concerned about claiming the tax deduction, you would have up until December 31, 2121 to deposit the 2020 contributions.
If your plan calculates your contributions on some period other than a full year, e.g. per pay period or per quarter, the deposit deadline is accelerated to the end of the quarter following the quarter in which the match accrues. That means contributions accrued through June 30, 2020 would have to be deposited no later than September 30, 2020.
One final caveat should be considered for extending contribution deadlines. If your plan specifies that the match is to be based on annual compensation and deferrals but operationally chooses to make deposits each pay period, it would qualify as an annual match subject to the former extended deposit deadlines.
If you currently have a pay period match, you can amend your document to provide for an annual match in order to have more time to make the required deposits. Keep in mind this change must be retroactive to the beginning of your plan year. This may result in true-up amounts for any participant who may have front loaded their deferrals. This can be tricky, so make sure you review your plan documents and year to date deferrals with your TPA.
Loss of Top-Heavy Exemption
It is important to realize that a plan that elects to suspend safe harbor is now subject to top heavy rules. In order to avoid punitive top heavy provisions, the aggregate value of the assets of key employees must not exceed 60% of the total assets of the plan. If key employees have been contributing during the year, this could result in a required contribution equal to 3% of wages for all non-key employees. On the other hand, if no key employees have deferred into the plan or received employer contributions year to date, the minimum required contribution is zero.
Since the goal for most employers who wish to suspend safe harbor contributions is to reduce employer costs, a review of year-to-date contributions and a plan’s top heavy status is a crucial step in the decision making process. You may find that suspending contributions would be significantly offset by these addition payments to all eligible, non-key employees. You might be better off canceling your free gym memberships!
However, employers who are required to make these top heavy contributions would have until their tax filing date or extension (e.g. April 15 or October 15, 2020) to make a deposit in order to claim the contributions as a tax deduction, or by December 31, 2020to simply comply.
ADP/ACP Testing
Plan sponsors who elect to suspend safe harbor provisions mid-year will additionally be subject to ADP/ACP non-discrimination testing. Depending on how early in the year the suspension becomes effective, plans should have more flexibility to avoid corrective distributions by limiting or controlling the deferrals made by highly compensated employees from that point thru year end. Corrective refunds, should they be necessary, create additional administrative costs and complexity for plans and should be factored in to this decision.
Reinstatement of Safe Harbor Provisions
For plans with safe harbor provisions based on tiered or match formulas, the current rules do not allow plan sponsors to reinstate to be effective within the same plan year . However, these matching options can be amended not less than 30 days prior to year-end to be effective January 1 of following plan year.
However, the passage of the SECURE Act has given employers additional flexibility to reinstate non-elective safe harbor provisions during the current plan year. It is even possible under provisions of the bill to establish non-elective safe harbor provisions to the plan after year end.
That means plan sponsors are allowed amend their plan documents to remove safe harbor provisions now and should their financial situation improve, amend again to retroactively add back the safe harbor provision for 2020 provided they do so by December 3, 2021.
Unchartered Territory
Let’s face it.Plan sponsors and their providers are navigating uncharted territory with current economic uncertainty and regulatory changes. I have attempted to outline some of the general considerations and consequences of a decision to suspend safe harbor contributions.
Although not a prediction, it would not be surprising to see future rule changes that may impact these decisions. Plan sponsors should be advised to consult your TPA and ERISA attorney for specific guidance based on your current situation and further consider the potential costs and contingencies that would result from a potential suspension of safe harbor contributions.
Brian C. Rall
President-Strategic Retirement Partners, LLC
April 29, 2020
Strategic Retirement Partners is an independent, boutique investment advisory and consulting firm providing plan design, vendor search, investment selection, fiduciary guidance and participant education for company sponsored retirement plans.
Strategic Retirement Partners, LLC is a registered investment advisor in the State of Washington. The investment advisor may not transact business in states where it is not appropriately registered, excluded or exempted from registration. Any information contained herein or on SRP’s website is provided for educational purposes only and is not intended to make an offer or solicitation for the sale of any specific securities, investments, or investment strategies. Investments involve risk and unless otherwise stated are not guaranteed. SRP does not provide legal or tax advice and clients should consult their attorneys and CPA for any strategy discussed herein or on this website.
Often when I first talk with plan sponsors for smaller plans, it is common for them to mention up front that they are very happy with their plan. I have no problem with that. It simply means they do not want to be solicited and that they happen to be loyal to their current providers. I get it! I don’t like to be solicited either and I have loyalties with firms and individuals that have been earned over many years.
But here’s the real problem. If you are a plan sponsor with less than $2 million in assets and fewer than 50 employees, the odds are quite high that your plan may have problems. Many of these issues for small plans are clearly recognizable thru a simple review of Form 5500, if you happen to know where to look. As a professional who regularly reviews hundreds of these forms each month, it is clear to me that small plans have far more problems than larger plans.
This clearly defies common sense or accepted wisdom. After all, lawsuits against plan sponsors typically involve larger, more visible organizations such as Citigroup, Boeing or Yale University. Many sponsors of small plans place a very low probability on the prospects of being sued, so they think they have fewer issues.
“For small plan sponsors, the threat of class action litigation is the least of your problems.“
For a you as a small plan sponsor, the threat of class action litigation is the least of your problems! In practice, it is far more probable that your smaller plan will be subjected to audits conducted by the DOL and Internal Revenue Service based on compliance and fiduciary issues. Many of these are errors of omission. The poison may be different, but the pain is the same.
I once heard a famous cardiologist make the statement: “The first time most people will discover that they have heart disease is just before their head hits the pavement.” Indeed, the first time many small plan sponsors discover that their plan may have serious issues is when they are notified that the DOL has selected them for audit.
The reasons for plan audits can range from certain answers to questions in Form 5500 to possible participant complaints. Increasingly, plan sponsors are selected randomly as the DOL has staffed up to function as a revenue generating agency of the government. Regardless of the reason, audits of all plan sizes result in a loss of productivity for the organization and fines and penalties being assessed in over 80% of all cases.
Most of the issues that surface with the Department of Labor are compliance related, including testing and allocation errors, late transmittals, insufficient fidelity bond coverage, lack of adequate records, applying incorrect compensation formulas, a history of corrective distributions, late filing of Form 5500 and, of course, excessive administrative fees. The corresponding effort to correct these errors, in addition to fines, penalties and possible disqualification, present a greater challenge for small plan sponsors for a number of reasons.
Feelings Will Fool You!
When my youngest son was 11 years old, he spent the summer in a junior golf program sponsored by a local municipal course. He was fortunate to win several age group tournaments and was interested in improving his game. He was then shooting in the mid-80’s, but I knew that if he wanted to improve his skills, he needed professional instruction. We were referred to a local golf pro, Johnny Falsetto, and he and Chris started working together for one hour a week.
One of Johnny’s favorite sayings in teaching his students was the phrase, “Feelings will fool you.” During his first lesson, Johnny did nothing but observe Chris hit balls for most of the hour. After each shot, he would simply say, “Hit another one”. After 50 minutes of this, I was seriously beginning to question whether this guy actually knew anything teaching golf!
At the end of the lesson, Johnny looked up and said, “Chris, to be honest, you have more natural talent than most kids that I have seen at your age. You’re already a good player, but if you want to be a great player, there’s a couple of things that we’re going to have to change”. Then he slowly delivered the challenge, “Chris, get prepared to be really uncomfortable for a while. Feelings will fool you!” After working with Johnny for about a year, Chris was routinely shooting in the low 70’s.
A Golf Lesson for Small Plan Sponsors
I think that this message delivered in this golf lesson applies to plan sponsors of smaller organizations. “Feeling good” about your plan providers without routinely reviewing their performance is not an option under ERISA. Complacency is the cause of many, if not most, of the problems that occur in small plans. In practice, they may delegate some of this due diligence to an experienced advisor. But at the end of the day they know they are personally accountable when things go wrong.
Here are some of the reasons why I think smaller plans have more problems than larger plans.
Smaller plans have less experienced human resource staff.
Larger organizations usually have the resources which allow them greater oversight of their retirement plan. They have the budget to hire human resource officers and employee benefit specialists who are tasked with the responsibility of overseeing the administration of their retirement plan. These professionals have a greater understanding of plan administration and therefore monitor providers more closely than small firms. As a result, they are able to address and correct many administrative and compliance issues before they become real problems.
In truth, plan sponsors have no other choice but to rely on their providers because they don’t know what questions to ask.”
In contrast, the administration and oversight of smaller plans is typically performed by office managers, managing partners or company owners. They are far more likely to rely on plan providers and simply trust that they are not making mistakes. In truth, plan sponsors have no other choice but to rely on their providers because they don’t know what questions to ask.
Going it alone, without the assistance of an experienced plan advisor, is a usually a recipe for disaster.
Larger Plans Are Subject to Audit Checks
Retirement plans with more than 100 participants are required to procure an independent audit from a CPA firm. They are expensive and time consuming but must be submitted along with their Form 5500. The audit’s primary purpose is to verify the financial status of the plan. However, in actual practice, it acts as a crucial check and balance that providers are correctly doing their job. They often reveal hidden plan costs and prohibited transactions that, if uncorrected, could result in penalties, litigation or possible plan disqualification. Smaller plans have a reduced chance of these issues being discovered.
Smaller plans have limited choices for TPA providers.
Because of industry pricing, smaller plans often go with bundled providers who provide TPA services through revenue sharing arrangements. These providers are paid through hidden fees buried in higher expense ratios for plan investments or expensive wrap fees. In the attempt to make the plan costs more affordable for plan sponsors, they have simply shifted higher fees on the backs of participants. Many of these small plan sponsors insist that they pay nothing for administration when in fact their participants pay a much higher percentage for fewer services than larger plans.
Hiring a good TPA is one of the most important decisions that you make as a plan sponsor. You are ultimately responsible for mistakes, errors and fraud which may occur due to their negligence or inexperience. The good news in the small plan market today is that there are many outstanding options for TPA services which are both cost efficient and accurate.
Smaller plans are more likely to experience administrative problems.
Plans designed by payroll providers, insurance companies and bundled mutual fund companies are often sold as a product. Design errors are frequent and TPA’s for these plans are often overburdened, have high turnover and lack a single point of contact. There is nothing more frustrating for a plan sponsor than having to speak to someone new each time there is a question or a problem. Often, there is really no one to consult for accurate fiduciary guidance.
I recently discovered a local TPA for a prospective client was 6 months late in filing their Form 5500. The TPA’s excuse was the unexpected death of a spouse for the employee assigned to the task. Although a tragic circumstance for the employee, it did not excuse the TPA of the duty to their client.
A late filing for Form 5500 is a huge red flag and this client now faces a higher probability of a future audit as a result. The fines for this error are also quite punitive- up to $2,140 per day. Additional IRS penalties for late filing are $25 per day up to a maximum of $15,000 per occurrence.
Late filing is an unforced error and a “rookie mistake” for any TPA firm. Short of the client itself being uncooperative or unable to supply the needed census data, it is simply inexcuseable.
My recommendation to this client? Regardless of your personal loyalties or friendship, you have no choice but to hire a new provider.
Larger plan providers, on the other hand, generally are more independent, have more checks and balances in place and have a single point of contact which enable them to proactively avoid most common errors. Because they generally have more training and less turnover, these providers are better able to spot plan errors and self-monitor each other. Many TPA’s provide access to ERISA attorneys to further assist with correcting issues that may arise from time to time.
Small plans are more likely to hire the wrong advisor.
What I see frequently with small plans is an advisor who is a family member or acts as the personal wealth manager or financial planner for one or more of the firm’s owners or managing partners. This is a dead giveaway to me that the plan may have more serious issues.
Their qualifications often do not match up with the job requirements of a true retirement plan advisor.
Mariners pitching coach
As a way of illustrating, suppose the Seattle Mariners were to hire a successful pitching coach. Without question, they will be looking for a candidate who knows a lot about pitching. This candidate must be able to communicate clearly and can spot and correct poor mechanics before they become ingrained habits and result in poor performance. Most good candidates will be former pitchers that had good careers in the major leagues.
Now suppose the Mariners needed to fill an open position for a batting coach. Their process would focus on candidates experienced with proper swing fundamentals and similar ability to observe and correct swing flaws. Usually, the best candidates have put up consistent hitting statistics as a player.
Having hired these coaches, it would be highly unusual for the Mariners to then rotate their pitching instructors to work with hitters or conversely ask the batting coaches to work with the pitching staff. Their roles within the organization are both unique and specialized.
So too the distinction between individual wealth managers and institutional retirement plan advisors. The job descriptions for these advisors are radically different. Baseball is highly specialized. So is the investment world. An arbitrage manager and a manager for a small cap value fund both purchase stocks, but for very different reasons strategies and holding periods.
Institutional investment advisors create and monitor plan investment menus and assist plan sponsors with fiduciary guidance and participant education. Wealth managers and financial planners assist individuals to achieve their own unique financial goals. They both understand financial instruments, but their job descriptions are unique and specialized.
Watch out for advisors who have conflicts of interest.
“Try this – I just bought a hundred shares!”
Hiring advisors who are directly or indirectly affiliated with other providers can present other problems. Some TPA firms like to package their plans with advisors who are apathetic to their higher fees.
These arrangements are highly unethical yet are more common than you might assume in the small plan world.
Psst… Here are a few of the red flags that will help you identify these “advisors”:
A pre-set investment lineup with proprietary funds and revenue sharing arrangements that benefit one or more providers or certain preferred vendors. I know a local TPA that has a majority of its clients using a high priced insurance company as its exclusive recordkeeper because of revenue sharing arrangements with that company.
Failure to provide written evaluations of plan investments. At best, their actual investment advice is re-active rather than pro-active, since replacing current investments may result in reducing the advisor’s total compensation.
No investment policy statement (IPS). Although not legally required, an IPS is part of a sound fiduciary process and serves as the basis for all future investment decisions. A sound IPS would in most cases shine a light on unreasonable fees or proprietary investments which benefit providers.
Failure to actually follow the IPS. A plan which has agreed on an IPS yet does not consistently follow the process is opening itself up for future liabilities. It would almost be better had they not had an IPS in the first place. If you have one, you better follow it.
The advisor does not provide on-going education regarding plan investments to the participants as required in Section 404 (c). Simply handing out investment materials or informational brochures does not meet this standard.
In contrast, larger plans more frequently hire advisors who are both fiduciaries and specialize in company sponsored retirement plans. Smaller plans should do the same.
An independent advisor experienced in ERISA can help you in your obligation to review the performance of your other providers. He knows the right questions to ask and can keep you out of trouble.
Small plan sponsors must be diligent in their oversight of providers.
This article has pointed out a number of reasons that smaller plans tend to run into more problems than those of larger plans. But it doesn’t have to be that way.Assembling a team consisting of independent providers is a practice that will pay off in the long run for small plan sponsors.
The next time you say that you are happy with your plan, make sure that you have subjected it to a professional review.
Because feelings will fool you!
Brian C. Rall
President – Strategic Retirement Partners, LLC
March 2, 2020
Strategic Retirement Partners is an independent, boutique investment advisory and consulting firm providing plan design, vendor search, investment selection, fiduciary guidance and participant education for company sponsored retirement plans.
Strategic Retirement Partners, LLC is a registered investment advisor in the State of Washington. The investment advisor may not transact business in states where it is not appropriately registered, excluded or exempted from registration. Any information contained herein or on SRP’s website is provided for educational purposes only and is not intended to make an offer or solicitation for the sale of any specific securities, investments, or investment strategies. Investments involve risk and unless otherwise stated are not guaranteed. SRP does not provide legal or tax advice and clients should consult their attorneys and CPA for any strategy discussed herein or on this website.
I work as a retirement plan financial advisor to professional service organizations such as legal practices, physician groups and dentists. A big reason for these firms to sponsor a plan is that it is a huge employee benefit. More importantly for the plan sponsor, it is a key component used to recruit and retain top-level employees and highly compensated partners and talent. These organizations must constantly be evaluating recruitment and retention because it is the lifeblood of their growth.
Compared to health insurance premiums that seem to increase 20% or more annually, the costs of administering a retirement plan are far more forecastable. The value to partners and staff of building future wealth through a qualified retirement plan can far outweigh health benefits provided through a Cadillac health plan.
For this reason, the dominant plan of choice for professional service organizations is the 401(k). Despite what you may have heard otherwise, 401(k) plans are only bad if they are run poorly or administered by incompetent providers. When it comes to retirement plans, a well-designed 401(k) is the gold standard for professional service firms. This article will tell you why.
Pension Plans have become as rare as the slide projector!
Vintage Slide Projector
Prior to the broad acceptance of personal computers in the 80’s, the slide projector was the presentation tool of choice. In similar fashion, prior to the introduction of 401(k) plans in the early 80’s, the retirement plan of choice was the good old-fashioned defined benefit plan. These plans are far less popular now, primarily because 401(k) plans are far cheaper for employers to maintain. The bulk of savings in the average 401(k) is funded by the employee through salary deferrals, while pension plans, which seek to fund a future benefit at retirement, are almost entirely funded by employers.
Pension vs 401(k)
This higher cost of pension plans to the employer, combined with soaring premiums for employer funded health insurance benefits, made it inevitable that defined benefit pension plans were going to be a casualty. Fortunately, lower cost 401(k) plans became an increasingly attractive alternative for employers who could now largely shift the cost and liabilities incurred with pension plans to the employees.
Pension plans are still a great tool for sole proprietors and small, family businesses. For many professional service organizations, certain “hybrid” defined benefit plans such as cash balance plans have flourished in recent years as a way to allow the most highly compensated owners and partners to substantially increase their pre-tax contributions and tax savings when paired with a traditional 401(k) plan.
For many legal, physician, dental and accounting practices with highly compensated employees, these newer defined benefit plans, paired with a traditional 401(k) defined contribution plan, are still something that you should consider. But fundamental to this strategy is a well designed 401(k).
SEP’s and SIMPLE IRA plans are very efficient… unless you have employees!
Clearly there are some company sponsored retirement vehicles that are cheaper to manage and free of the compliance requirements of a 401(k) plan. These plans have virtually no administrative cost, are easy to set up and maintain, and have minimal filing requirements (no Form 5500). The two most popular are the SEP- IRA (Simplified Employee Pension) or the SIMPLE-IRA (Savings Incentive Match Plan for Employees). The limitations of these two options are flexibility and that total employer costs are directly related to headcount.
SEP-IRA plans allow only employer contributions.
The good news with the SEP is that it has virtually no administration cost and it allows employers to make discretionary, pre-tax contributions up to 25% of compensation without administrative or compliance duties of a more complex qualified plan. Under the SEP, employers make contributions to eligible employees through a traditional retirement arrangement called a SEP-IRA. The employee owns and controls the account and the employer makes the contributions to the financial institution where the assets are maintained.
Employees cannot make contributions to a SEP meaning that 100% of the contributions are made by the employer. SEP plans get very expensive because all employer contributions are made pro-rata. This means that the same percentage of compensation is applied to all employees. In a SEP, there is no flexibility to favor certain employee groups of higher paid employees, partners or owners.
SIMPLE IRA’s have lower contribution limits and less flexibility.
The SIMPLE IRA is similar to the SEP in the sense that it is an IRA-type arrangement, but there are three major differences:
A SIMPLE-IRA allows participant contributions up to $13,500 or up to $16,500 if they are older than 50. Contrast this with $19,500 and $26,000 limits for 401(k) in 2020.
Certain minimum employer contributions must be made each year, regardless of whether the business is profitable. Employers must make these contributions either in the form of a dollar-for-dollar match up to 3% of the employee’s compensation or a flat 2% for each employee. Adding to this employer expense, every employee making more than $5,000 annually is eligible. In comparison, the employer match with 401(k) is discretionary and can be adjusted annually. Eligibility can be restricted to full time employees, age 21 or older, with a service requirement up to 12 months from hire date.
SIMPLE plans are only available to employers with fewer than 100 employees.
When it comes to retirement plans for legal, medical and other professional service organizations, the 401(k) plan is the “gold standard”!
Highly compensated employees cannot save enough in a SEP or SIMPLE to fund retirement.
Highly compensated individuals are severely limited by the lower contribution limits of SEP and SIMPLE plans. In contrast, annual participant deferral limits for 401(k) allow $19,500 or $26,000 if they are over age 50. Optional employer contributions in the form of discretionary match and profit-sharing contributions allow total annual contributions up to $57,000 annually for 401(k) participants who meet the income requirements.
When you factor that these additional investment savings compound free of tax for 30 years to retirement age, just do the math!
There is no flexibility in contributions for a SEP or a SIMPLE.
A SIMPLE requires a contribution every year. Both SEP and SIMPLE plans require pro-rata employer contributions. This means that if you are an owner and want to give yourself a 25% contribution, under a SEP, you must give the same pro-rata contribution to all of your eligible employees. That requirement becomes expensive very quickly for a plan sponsor. With a SIMPLE, there is no profit sharing feature and simply limited to a 3% match.
The flexibility of 401(k) plan design allows the option of both a flexible match and an additional profit sharing contribution. For those employees that are eligible yet choose not to contribute to the plan, the plan may be designed so that no match from the employer is required.
401(k) allows legal discrimination through profit sharing contributions to key employees.
In organizations where some highly compensated employees make over the Social Security Wage Base ($137,700 in 2020) or where higher compensated employees in general are older than lesser paid employees, 401(k) designs allow flexibility to make much higher allocations for these employees through profit sharing allocation features. An allocation formula arrived by cross-testing/new comparability may produce the same result.
Employee Groups
So unlike in a SEP where you would be forced to give every eligible employee a pro-rata 25% contribution, these profit sharing allocation formulas allow certain employee groups up to 25% of compensation while only 5-7% of compensation would be required to lower paid staff.
The after-tax benefits of a well-designed 401(k) plan often exceed the total annual costs of the plan.
In most plans, the bulk of the contributions are made by the participants. Because of this, it’s safe to say that with respect to employer contributions, the 401(k) is the most cost effective plan for organizations with more than a handful of employees.
Thanks to competition and recent fee disclosure, 401(k) plans have seen considerable fee compression in recent years. Despite of the lack of administrative costs for SEP and SIMPLE plans, these plans lack the flexibility to achieve higher contributions for your highly compensated employees.
Law Firm
If your firm has highly compensated owners, partners and key employees and you have a SEP or SIMPLE, you have the wrong plan.
For certain professional organizations that I work with, a 401(k) can be combined with a “hybrid” cash balance plan that may allow older, more highly compensated partners to legally contribute up to $250,000 in annual tax-deferred contributions in some cases without proportionate increases to the rank and file. While this requires some additional administrative costs to the organization, there simply is no other plan design that comes anywhere close to providing this level of annual pre-tax deferral and tax savings for both the organization and these highly compensated individuals.
An experienced 401(k) advisor is usually available to help 401(k) participants.
Employers who sponsor 401(k) plans are required to provide education to employees with regard to their investment options and decisions. This is one of many reasons that informed plan sponsors should hire a financial advisor both to select and monitor plan investment options and to provide guidance to employees
With SEP’s and Simple’s, most employees make these decisions without the help or guidance of a financial advisor. This is a serious disadvantage for most employees who are not investment savvy. In most cases, SEP or SIMPLE plans are funded with higher cost mutual fund share classes, further reducing future returns. I recently reviewed a SIMPLE IRA for a client that offered A shares with a 5% load fee in addition to annual expenses of nearly 0.75%. She thought the plan was free.
Technology provides limited liability to employers for participant direction of investments.
The booming stock market and technology advances in the late 90’s converged to produce a boom in the creation of 401(k) plans by mutual fund companies. Online daily valuation coupled with participant direction through custom website portals simplified the administrative process for plan sponsors.
Employers who followed the rules established in ERISA 404c could also now rely on a layer of protection against liability for participant investment decisions. As long as you did the work of selecting and monitoring investment options and educating participants, you would not be held liable for plan losses incurred by participants. Lower liability for investment returns became a significant advantage not possible with defined benefit plans..
A well designed 401(k) is not an expense. It is a valuable business asset.
The additional flexibility in 401(k) employer contributions allow both savings to the employer and significant tax saving benefits to talented employees who have started saving for retirement in their 40’s. Proper 401(k) plan design allows your key talent to build wealth much faster than other plans.
Asset vs Expense
In most cases, the after tax benefits of a well-designed 401(k) plan far exceed the additional costs. When the ability to recruit and retain talent is added to the equation, the decision to sponsor 401(k) retirement plan becomes a no-brainer for the firm’s growth.
The 401(k) market is loaded with talent.
Because 401(k) is the dominant plan in the marketplace, it is loaded with talented providers that can assist you with your fiduciary duties. With most other plans, you probably will to get no help. If you are overwhelmed with the process of establishing and managing a 401(k) plan for your firm, there are excellent providers who can walk you through everything without a lot of stress.
It’s a 401(k) world!
If you are a professional organization such as a legal or CPA firm, a physician group or dental practice, you will quickly outgrow less sophisticated plans. Rather than convert an inferior plan after only a few years, it is far preferrable to design a 401(k) plan that complements your current business revenue growth and is flexible as you grow the business. For you, it’s a 401(k) world!
Brian C. Rall
President – Strategic Retirement Partners, LLC
February 27, 2020
Strategic Retirement Partners is an independent, boutique investment advisory and consulting firm providing plan design, vendor search, investment selection, fiduciary guidance and participant education for company sponsored retirement plans.
Strategic Retirement Partners, LLC is a registered investment advisor in the State of Washington. The investment advisor may not transact business in states where it is not appropriately registered, excluded or exempted from registration. Any information contained herein or on SRP’s website is provided for educational purposes only and is not intended to make an offer or solicitation for the sale of any specific securities, investments, or investment strategies. Investments involve risk and unless otherwise stated are not guaranteed. SRP does not provide legal or tax advice and clients should consult their attorneys and CPA for any strategy discussed herein or on this website.
For the past 8 years, I have had the opportunity to help hundreds of plan sponsors to design and manage successful 401(k) plans. In my opinion, successful plans for small to mid-size employers typically display the following attributes.
1. The costs, fees and expenses of the plan are reasonable.
Understanding the importance of plan costs, expenses and fees is one of the most important duties of plan sponsors and fiduciaries. When asked about plan costs, some plan sponsors actually think their plan is free. This perception is most common when their providers are paid by hidden revenue sharing arrangements.
One of the key services I provide to employers is an annual evaluation of overall plan expenses and a determination as to whether they are reasonable. Your plan is not required to be the lowest-cost in its peer group, but if your fees fall in the highest quartile, it is a red flag that cannot be ignored.
In reality, receiving more and better services as well as retaining providers who are better positioned to help a plan achieve its goals are all valid reasons to pay a little more. Hiring a provider because he or she is a family friend or because they have provided personal financial services to the CEO or owner are not sufficient reasons and may in fact increase your fiduciary liability.
Finally, if you or your advisor is not actively monitoring plan costs and documenting the process, you need to begin to do so. To the regulators, process trumps results!
2. A high percentage of eligible employees participate in the plan.
Employers who sponsor 401(k) and other retirement plans such as defined benefit cash balance plans for their highly compensated employees have made a substantial investment of time and money to provide this benefit. The best plans should have at least 85% of eligible employees who are participating in making payroll contributions.
These plans are effective in communicating the virtues of saving for retirement. In addition, they usually feature generous employer matching contributions that incentivize participants and build in automatic enrollment options for newly eligible participants.
3. New employees roll money into the plan. Departing employees leave their balances in the plan.
The best plans have characteristics that set them apart. A plan that has an open-architecture platform which provides access to outstanding investment options and low cost share classes becomes a magnet for other retirement assets.
New employees who compare these lower cost options to “retail” IRA accounts with limited investment menus are eager to combine other qualified accounts with their company’s 401(k) plan. When these employees terminate employment, they are comfortable in maintaining their plan balances because they view management as a friend, not an enemy.
4. Employees understand the plan.
The best plans effectively communicate how the plan works to their employees. These companies are intentional in communicating the benefits of participating in their plan to both new recruits and to retain their best talent.
These employers include a clear and simple description of plan benefits, with emphasis on employer contributions, vesting schedules and professional advice available to participants. More importantly, employees who are on track to achieving their retirement goals become the strongest advocates for participation.
5. The fund design and investment lineup has a home for everyone.
There are different types of investors in every plan.
Some want to be well diversified over the core funds lineup and need professional allocation tools to achieve a successful outcome.
Index investors are interested in utilizing low-cost index instruments in a variety of asset classes to properly diversify their accounts.
Some participants are opportunistic and look for unique specialty investments in the plan.
Finally, almost every plan has a high percentage of participants who don’t want to get into the weeds of investment allocation and prefer balanced, “do it for me” default options such as target date funds.
In addition, many professional service organizations which I assist offer additional “hybrid” plans in addition to a traditional 401(k) to allow highly compensated members to boost their levels of tax-deferred savings. These individuals often find themselves behind in saving for retirement in their early 40’s or 50’s due to lower compensation levels and debt reduction needs earlier in their careers. Combining a defined benefit cash balance plan with the 401(k) becomes not only a significant tax saving tool for these members but an important competitive advantage in recruiting and retaining talent for their firms.
In most cases, the greater the number of participants in your plan, the broader and more flexible your investment menu should become.
6. The leaders in your organization talk about the plan.
This trait can sometimes be difficult to measure. Companies that care about their human capital and talent take personal pride in their benefits package. These leaders not only find a way to talk about the plan at official corporate gatherings, but plan benefits are featured as a recruiting and retention tool in their everyday conversations. Mobile apps for successful plans can be used to instantly demonstrate that leaders are not only engaged with the plan, but well on their way to a successful retirement.
7. The plan’s fiduciaries understand their role and document their decisions.
Most plan sponsors need some fiduciary education and guidance in what is expected from them. Many simply rely on their providers and trust in the myth that they can outsource all of their fiduciary duties. In reality, this attitude can be extremely dangerous. Many providers are not acting in a fiduciary role to the plan, including plan advisors who are affilliated with broker dealer firms.
Plan sponsors should know and understand the details of their plan document and the disclosure notices which must be provided to participants. They should monitor plan investments and fees and have a process in place which documents these duties. If they do not have the knowledge or experience to carry out these responsibilities, they are required to hire experienced providers who do. In my experience, plan sponsors of the best plans have established a process for all of these important functions.
8. The investment advisor is a fiduciary and specializes in company sponsored retirement plans.
The best plans hire advisors who specialize in the expertise and functions most important to plan sponsors. These include plan design, creating Investment Policy Statements (IPS), selecting and monitoring of plan investments, provider search, monitoring plan expenses, fiduciary guidance and effectively communicating plan benefits to participants. In the best plans, the advisor usually takes a proactive role as the “point man” or plan quarterback.
Plans which hire advisors affiliated with broker-dealer firms are exposed to conflicts of interest which impact key decisions. If your advisor is paid based on revenue sharing arrangements with a mutual fund company or recordkeeper, you have a fiduciary duty to find a new provider.
9. Participants have access to tools and technology that help them stay on track to meet their goals.
Successful plan providers provide useful online tools that keep participants informed and on-track. Most recordkeepers today offer real-time access to participant information such as deferral rates, plan allocation tools, re-balance features and transparent fee disclosure. Mobile apps that allow participant access are now available from most recordkeepers. Advisory services that calculate and project monthly retirement income allow participants to make more informed retirement choices.
10. The plan sponsors and advisor have a written Investment Policy Statement that guides investment decisions.
Although not specifically required by ERISA guidelines, the best plans have adopted a written Investment Policy Statement which defines the criteria for all investment decisions. Investment asset classes are defined in this document and based on the demographics and investment sophistication of participants.
As an example, our plans evaluate each investment by 11 different criteria such as manager tenure, minimum net assets, net expense ratios, style and composition, 1,3 and 5 year performance as well as measures of risk such as alpha and sharp ratios. When current investments fail to measure up to these standards, they are placed on a watch list for further evaluation or deleted and replaced.
The best plans employ a rigorous and disciplined approach to investment decisions and document this process on a consistent basis. It is important to understand that ERISA does not hold plan sponsors or providers to a performance standard in regard to investment returns. But it does emphasize that there is an investment process that is consistently adhered to by plan fiduciaries.
This is not a complete list!
In reality, there are probably additional attributes that are shared by the best 401(k) plans. However, I have found these ten attributes to be universally shared by successful plans.
Brian C. Rall
President – Strategic Retirement Partners, LLC
Strategic Retirement Partners is an independent, boutique investment advisory and consulting firm providing plan design, vendor search, investment selection, fiduciary guidance and participant education for company sponsored retirement plans.
Strategic Retirement Partners, LLC is a registered investment advisor in the State of Washington. The investment advisor may not transact business in states where it is not appropriately registered, excluded or exempted from registration. Any information contained herein or on SRP’s website is provided for educational purposes only and is not intended to make an offer or solicitation for the sale of any specific securities, investments, or investment strategies. Investments involve risk and unless otherwise stated are not guaranteed. SRP does not provide legal or tax advice and clients should consult their attorneys and CPA for any strategy discussed herein or on this website.
If you are like me, your email this month is full of Holiday invites, year-end offers, and requests for charitable donations.
December is also the month those market guesses (politely referred to in the industry as “market forecasts”) begin to pour into my inbox from seemingly every investment firm and advisor on the planet.
While I confess these forecasts to be highly entertaining (Barrons Roundtable has been my personal ritual for 41 years) they are neither useful nor beneficial for investors saving for retirement. In fact, they can actually be harmful to your long-term retirement outcome.
The widespread practice of producing annual market predictions is one of the worst tendencies in the retirement industry. Investors whose goal it is to fund their child’s future college expenses or retirement income are by definition looking to compound their returns over many years. A one year time horizon is both irrelevant and reinforces an emphasis on short-term thinking that can actually harm most retirement participants.
“The widespread practice of publishing annual market predictions is among the worst tendencies in the retirement industry.“
Just think about that for a minute. If your time horizon is one year, you should not even be in the market. And if you are in the market, you better be right.
It should not be surprising to anyone that these Wall Street experts make excellent guests on the financial networks. After all, the producers at Fox Business News and CNBC have much to gain by simply keeping alive the mistaken belief that smart people can routinely predict what the market will do in the short term.
As we tune in to watch these Ivy League educated experts in $3000 suits discuss their current macro theory – weaving together monetary policy at the Federal Reserve, geopolitical threats and a massive developing short position in soybeans – we observe an impressive human ability for higher order thinking and pattern recognition. What we don’t often see is that these strategists are seldom right about what actually takes place in the markets during the next 12 months.
So why is that the case?
Daniel Crosby, an expert in the field of behavioral investing, offers us some compelling clues based on normal human behavior. He compares these market wizards to “a game show contestant who has overcomplicated the task by half”.
In Crosby’s view, set out in an outstanding article titled, Are You Smarter Than a Rat, “the elegance of the story has overtaken the likelihood of its occurrence.” 1.
The elegance of the story has overtaken the likelihood of its occurrence.
Daniel Crosby on market forecasts.
In other words, it sure sounds smart even though it probably will never happen! According to Crosby, even a rat makes better decisions than a human, because he simply acts on what will probably happenmost of the time.
Most of us should learn to think like a rat. But believe it or not, that’s harder than it seems
‘It’s like the old days in the lab, Charlie. You learn the maze, you get the food pellet, you go home. What else can I say?’
I have always wondered why market strategists get paid big bucks by their investment firms to make forecasts which have a little probability of working out as advertised. For example, few experts this January predicted that the S&P 500 would be up 23.16% through October 31 when the same benchmark actually declined 13.52% in the 4thquarter of 2018. Even fewer these experts forecast the whopping year to date annualized return of the S&P U.S. Treasury Bond Current 30-Year Indexof 24.03%. Who saw that coming?
You should know that while the individual forecasts themselves are seldom correct, their authors always hedge their bets, usually imbedded in fine print in the footnotes:
“These views are subject to change without prior notice.”
I consider myself fortunate to have known some very successful investors in my 30+ year career in the financial services industry. When asked for their market forecast, most have no grand thesis or series of dominoes waiting to fall. Rather, they will talk about a disciplined investment process as being the key to investment success. To them, the rest is just crowd noise.
Successful investors talk about a disciplined investment process. The rest is just crowd noise.
To be clear, these investors are usually not invited to participate in CNBC’s year end roundtable. If they do come on, they are seldom invited back (unless your last name is spelled B-U-F-F-E-T ). Sadly, when it comes to financial new shows, there is far more demand for sophisticated nonsense than boring-but-true market wisdom.
The urge to “do something” is usually bad.
When average retirement fund participants hear these forecasts, they think they should be looking at how their portfolio will perform next year. There is an urge to “do something” and therefore believe that the more engaged they are, the better their returns will be. In practice, the exact opposite is true.
Discipline
Investors who have a sound, disciplined process and make infrequent portfolio changes are far more likely to do better over the long term. As Crosby explains:
…“(successful investors) live in the world of a process driven path which tilts probability in their favor at every turn, secure in the knowledge that “probably” is the most powerful word in investing”.
Daniel crosby, Ph.D-Chief behavioral officer, Brinker Capital
Common Sense Investment Advice
For an investor saving for retirement, here are three practical ways you can boost your success:
Disengage from the day-to-day fluctuations of the market.
Ok, on the surface this may sound irresponsible. But for most of us, our ideas about money are very much tied to our emotions. The inevitable short term market changes often trigger fear of loss or inspire a false optimism that cause us to make poor decisions. The more we can emotionally disengage with day to day market changes, the better our long term results
Throw away your account statements.
This is another radical practice, but I know a lot of successful long term investors who operate this way. I highly recommend it for those who tend to be emotionally impacted by short term market volatility. Market declines are always temporary, but the urge to “do something” often produces activity that results in permanent loss. I know a lot of 401(k) participants wh refused to open their statements during thelast recession. Most of them are glad they did!
Toss those statements!
Seek professional advice.
One of the biggest mistakes I see investors make has to do with ego and the belief that they are smart enough to do this on their own. An experienced advisor can help you with some of the heavy lifting such as creating a custom portfolio allocation based on your goals and needs. But in my opinion, the true value of seeking investment advice is simply gaining objectivity when markets are volatile. Good investors have mastered their emotions. An experienced advisor can help you overcome making emotional decisions when often the best course of action is to do nothing.
As we head into the new year, I suggest that you ignore the annual investment forecasts. Sure, they can be highly entertaining but they are not likely to be predictive of what happens in the year ahead.
Instead, focus on saving more, worrying less and living in the world of a process-driven path!
Brian C. Rall- President, Strategic Retirement Partners, LLC
Daniel Crosby, “Think Like a Rat”, November 2017
Strategic Retirement Partners is an independent, boutique investment advisory and consulting firm providing plan design, vendor search, investment selection, fiduciary guidance and participant education for company sponsored retirement plans.
Strategic Retirement Partners, LLC is a registered investment advisor in the State of Washington. The investment advisor may not transact business in states where it is not appropriately registered, excluded or exempted from registration. Any information contained herein or on SRP’s website is provided for educational purposes only and is not intended to make an offer or solicitation for the sale of any specific securities, investments, or investment strategies. Investments involve risk and unless otherwise stated are not guaranteed. SRP does not provide legal or tax advice and clients should consult their attorneys and CPA for any strategy discussed herein or on this website.
It is highly probable that your company’s 401(k) plan will be subjected to audits conducted by the DOL and the Internal Revenue Service at some point in the future. If you are not 100% certain what documents you will need, download this free copy of our “Fiduciary Audit File Checklist” and be sure!
