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.
“We give advice, but we cannot give the wisdom to profit by it.”
-Francois de La Rochefoucauld
With the recent trend toward fee transparency in small business retirement plans such as 401(k), plan sponsors are increasingly examining the fees charged by financial advisers and consultants. Although we have extensive data to quantify and benchmark advisory fees, a deeper understanding of the true value of these services is often needed by plan sponsors.
Historically, the process of quantifying this value has been highly subjective or simply not undertaken at all other than to identify the range of fees charged by other advisers for similar plans. Yet it should remain obvious to most prudent individuals that paying an adviser a fee greater than the value returned would not only be irrational but irresponsible.
While value and price considerations are central to making investment decisions in the financial markets, many plan sponsors have never taken the time to analyze the true value of a retirement plan investment adviser and his or her long-term impact on plan results. I liken this process to purchasing a security in the market by determining its value beforehand. Both price and value must be considered to make a successful investment. In a similar way, the fees that you pay your 401(k) adviser should have some relationship to the values received by both the plan sponsor and participants. The purpose of this article is to move you to take a deeper dive into the true value of institutional investment advice.
As a 401(k) plan consultant and adviser specializing in small business retirement plans, I found a recent analysis published by Vanguard Research to be a highly credible effort to determine the value of services provided by institutional retirement plan advisers and consultants.
Study Conclusions:
“Consultants can enhance and distinguish their value by placing even more emphasis on their fiduciary expertise, their experience with investment policy statements and other topics such as retirement plan design.”
“We believe that, when executing the Vanguard Institutional Advisors Alpha framework, consultants can add about 3.5% in value”.
If Vanguard’s calculations are accurate, a qualified adviser truly makes a significant quantitative as well as qualitative difference to a retirement plan and its participants. In isolation, however, it may be overly simplistic to apply this equation to every plan. Here’s a good way to explain why:
As the general manager of an NFL team, the value of adding a player such as Russell Wilson to your roster might be vastly different, depending on whether you are the New England Patriots or the Oakland Raiders. It would be logical to assume that Russell’s services today would likely be more highly prized by the struggling Oakland Raiders who are currently looking to rebuild their roster than by the Patriots who seem to find themselves in the Super Bowl on a fairly consistent basis.
Just as NFL teams have a diverse set of needs, so, too, with 401(k) plans. Do plan sponsors, for example, prefer higher absolute investment returns, or is reduced portfolio risk higher on their priorities? Are reducing plan costs and expenses high on the checklist, or is there a corporate mandate to increase the participation and deferral rates among participants? Finding an adviser who can guide, recommend and implement plan design features which achieve these overall plan goals may ultimately provide more value than one who focuses on directly reducing fees and expenses. In practice, both objectives are important, yet a consultant’s recommendations in regard to plan design may add significantly higher utility than simply attempting to reduce overall plan costs.
There appears to be little argument that the traditional approach to institutional adviser selection, retention or replacement has historically focused on investment performance. However, the Vanguard study concludes that a more accurate ratings system should focus on “non-investment issues within the adviser’s control” as well as higher investment returns. Importantly, the study attempts to quantify this value-add based on best practices in four advisory service areas:
Fiduciary Considerations
Investment Policy Statement
Plan Design & Monitoring
Investment Selection & Strategy
The conclusions of this study, with the term “alpha” representing additional advisor value, are summarized in the following table:
Service Area
Defined Contribution
Fiduciary Considerations
>0 bps
Investment Policy Statement
150 bps
Plan Design & Monitoring
200 bps
Investment Strategy
N/A
Total Alpha:
About 350 bps (3.5%)
Source: Vanguard Research; “Quantifying the Value of a Consultant”, Michael A. DiJoseph, CFA; Sneha Kasuganti; Christopher Celusniak; Donald G. Bennyhoff, CFA; Francis M. Kinniry Jr., CFA. September, 2018
Tier 1: Fiduciary Considerations
As the Vanguard report observes, “effective consultants understand the complex landscape of fiduciary law and regulatory compliance and communicate this understanding to clients”. In addition, they act on this knowledge by applying best practices and conducting fiduciary training. But in truth, the best consultants will do much more. As an example, they are far more proactive in research on future trends and shifts in regulatory focus and litigation. Says Vanguard, “By helping clients to successfully navigate the regulatory backdrop and avoid lawsuits and enforcement actions they set their clients up for success”.
Although the consequences of compliance issues, class action lawsuits, and enforcement actions can potentially be financially devastating to all plan sponsors, this report’s assessment of the ultimate value of fiduciary guidance is very conservative. In fact, Vanguard quantifies this value as “something greater than 0 bps” to the average plan (a basis point is equal to one one hundredth of a percent). However, the reality is far too many small plans, particularly those currently represented by an agent of a broker dealer, or perhaps those lacking an assigned adviser altogether, are often dangerously unaware of even the most basic fiduciary practices. Although it is true that the proposed DOL Fiduciary rules mandating a higher standard of prudence and care for qualified retirement plan advisers was recently vacated by the US Court of Appeals for the 5th Circuit, plan sponsors should be reviewing their internal operations and their current and future providers in light of a higher future standard.
Added Value Through Fiduciary Considerations: > 0 bps
“In the business world, the rearview mirror is always clearer than the windshield.”
–Warren Buffet: CEO, Berkshire Hathaway, Inc.
Tier 2: Investment Policy Statement
As a second tier in regard to practices which are within the adviser’s control, the Vanguard analysis also places high client value on a well-crafted document called an Investment Policy Statement (IPS). The IPS essentially acts as a protective guard rail for the many decisions that must be made in regard to small business retirement plans such as 401(k). The authors point out that while commonly used ratings systems for business decisions are often based on past performance, these ratings systems can be risky when making investment decisions for a portfolio.
By helping clients create and adhere to an investment policy statement, a trusted adviser can add significant value and help prevent behaviors such as performance-chasing and market timing. Crucial elements of this document focus on portfolio objectives, asset allocation, risk management framework, manager search and selection, and committee governance.
Recent investment studies have found that clients and consultants alike can be swayed by historical performance. Among those cited by the authors is the 2014 Wimmer study sponsored by Vanguard and based on a sample of over 3500 mutual funds and over 40 million hypothetical outcomes to quantify the impact of chasing fund performance. Underperforming funds were sold and replaced with top performers using a three year evaluation window. [2] The results? Lost returns between 1.6 and 4.0% per year, not including transaction costs. The study concludes that a disciplined process of adhering to a well-crafted IPS as opposed to chasing performance can lead to significant long-term value.
Fiduciaries versus Experts
“An expert is somebody who is more than 50 miles from home, has no responsibility for implementing the advice he gives, and shows slides!”
-Edwin Meese, Former US Attorney General
One of the primary value-adds from an experienced investment adviser is that of a behavioral coach. As Vanguard states, “for a majority of plan sponsors, going against peers, consensus, intuition and human behavior is very difficult”. Most good advisers would probably describe their primary role as more of a “behavioral consultant” as opposed to an “investment expert”. Creating an investment policy statement that accurately reflects the goals and objectives of the plan sponsor effectively imposes even more safe guards around policies which truly benefit participants. Acting as a fiduciary as opposed to simply making recommendations as an expert carries with it the added responsibility to ensure that these policies are implemented.
-Added Value Through Adhering to Investment Policy Statement: 1.5%
Tier 3: Plan Design and Monitoring
A third tier of non-investment services within the control of an institutional adviser involves constructing an appropriate investment lineup, implementing intelligent plan design options (choice architecture) and regularly conducting informed monitoring of plan effectiveness.
Constructing an Investment Lineup
An experienced plan adviser would be expected to adhere to four important criteria in constructing a plan investment lineup:
Identify plan objectives.
Focus on the fundamentals of investing.
Create and maintain a tiered lineup that reflects plan objectives.
Provide active and ongoing oversight
In many cases with small business 401(k) plans, decisions with regard to plan investments are simply predetermined, one-size-fits-all choices made by the plan recordkeeper. Many of these investment lineups contain self-serving conflicts of interest, higher fees and lower performance. We discussed these issues in an earlier blog, “Is Your 401(k) Plan a Product or a Service?”[3]On the other hand, an experienced adviser acting in the best interests of the participants can be a significant asset in this important process. The result are more appropriate investment choices, lower fees and better performance.
Plan Design Considerations
In the area of plan design, recent surveys reveal significantly higher participation rates for plans with auto-enroll and auto-escalation features. Despite these dramatic results, baseline plan experience for 401(k) plans remain one in which plan participants must individually make active decisions to save at all, to save more and to invest wisely. Vanguard estimates that the addition of an automatic enrollment plan design feature increases the plan participation rate as well as adding approximately 1.4% annually to the wealth of the average employee over 30 years. Further, including an automatic escalation feature increases this additional return by 20 bps, or to 1.6% annually over the same period. Finally, Vanguard’s study reveals that utilizing a proper QDIA or default investment choice would increase this additional return to 2.00%, primarily due to minimizing the negative effects of market timing and performance chasing.
How is it working?
An adviser who includes the service of monitoring plan effectiveness through capturing and analyzing metrics such as participation rates, savings rates and investment decisions can identify specific areas of employee communication and education that could be the key to ensuring that this 2% in added value is actually compounded over time.
-Added Value Through Plan Design and Monitoring: 2%
Tier 4: Investment Strategy
Because 401(k) investment decisions are made by the participants, the Vanguard study deems this expertise not applicable to advisers representing defined contribution plans. However, advisers who differentiate their services based on participant education and communications can add tremendous value to participants in positively influencing their individual investment strategies and as a result, their long term results.
The-Added Value Through Investment Strategy: N/A
Wrapping it Up
While it is vitally important to understand that the true added value of your adviser should be based on the individual objectives of your plan, there is no doubt that retaining the services of a qualified plan advisor adds significant quantitative and qualitative value to most 401(k) plans. With financial markets increasingly unsettled and volatile, participants are asking fundamental questions regarding the risk characteristics, investment performance and fees associated with their investment choices.
Based on my experience, most plan sponsors would gladly defer those conversations to a highly qualified investment adviser. As the Vanguard study reveals, they would be wise to do so!
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.
[1]Michael A. DiJoseph, CFA; Sneha Kasuganti; Christopher Celusniak; Donald G. Bennyhoff, CFA; Francis M. Kinniry Jr., CFA. Vanguard Research, September 2018.
[2]Wimmer, Brian R., Daniel W. Wallick, and David C. Pakula, 2014. Quantifying the Impact of Chasing Fund Performance.Valley Forge, PA.: The Vanguard Group.
[3]Brian C. Rall, President, Strategic Retirement Partners, LLC. August, 2018
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!
