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.

Audit Proof Your Company’s 401(k) Plan!

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!