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.
In the past 30 years, I have had the opportunity to review hundreds of 401k plans sponsored by small to mid-sized employers. Although none of these plans are exactly the same, they can generally be characterized as falling into one of two categories: a product or a service. In almost every regard – investment options, plan design, plan costs and customer service – the best plan providers offer services at a much lower cost than providers who treat 401k as a product.
When I began my investment career in the early 80’s, cost effective 401(k) provider options for employers with few or no assets were limited to large mutual fund families and insurance companies. The business and tax advantages which motivated employers to sponsor these plans was a significant opportunity for providers who had expertise in offering pooled investment options (i.e. Mutual funds), data management (i.e. insurance companies), or both. Therefore, it was not surprising for these providers to treat 401(k) plans as a one-size-fits-all product, restricting investment options to proprietary funds (expensive) and to streamlined plan designs which featured hidden fees and were easier to administer.
As a plan sponsor, it is important to know whether your current providers treat your plan as a product or a service. Providers who treat 401k as a product have restrictions that lead to higher fees, lower plan returns, lower participation and poor customer service. While providers who treat 401k as a product are still very common, they should be avoided at all costs. On the other hand, providers who treat 401k as a service have fewer investment restrictions, consultative plan design and personalized customer service.
So how does your plan stack up? I would suggest the following 5 criteria will indicate whether your current plan provider treats 401(k) as a product or a service:
1. Restricted Investment Choices vs. Open-Architecture Investment Platforms
Mutual fund companies that bundle recordkeeping and/or administrative services with investment management typically restrict their plan investment choices to proprietary funds as opposed to the top funds available for each investment category. Often, these funds have hidden fees and higher expenses than more competitive funds. Insurance companies typically offer insurance products such as variable annuities with higher wrap fees and other expenses but disguised as mutual funds. Payroll companies often sell plans with pre-set investment options that are sponsored by both mutual funds and insurance companies. These pre-set plan lineups streamline their setup and administration yet represent less competitive investment choices and higher costs to participants. Plans like this are a product.
On the other hand, many independent record-keepers offer impartial investment fund advice through “open-architecture” platforms. These platforms allow plan sponsors or their advisors to access investment options based on quantifiable values of performance, volatility, fees and other criteria. They also allow access to index funds and target-date funds with significantly lower expenses than actively managed funds. Fee based advisors love open-arch platforms because they provide more fund choices at lower cost. These plans offer 401(k) as a service.
2. Retail vs. Institutional Share Classes
The mutual fund industry has evolved over the years in response to fiduciary concerns regarding fees. Share classes are essentially financial agreements between the fund company and the distributor of the fund (a broker, advisor or a retirement plan). As a result, investors can pay very different prices for the same fund depending on which share class they select. If your fund offers share classes other than R (retirement plans) or I (institutional) shares, you probably own “retail” shares and are paying higher expenses than you should. Ask your provider if these share classes are available for funds offered in your plan. If not, your plan is a product.
3. Hidden vs. Transparent Fee Structure
A 2015 study of 4,368 active retirement participants revealed that 58% did not know that they were paying fees on their employer sponsored retirement accounts. Translated, that means that nearly 40 million participants in qualified plans have little to no clue about plan fees. And for those that did know that they were paying fees, only one in four could accurately answer how the fees were calculated.
In my opinion, most of the confusion for participants involve indirect or hidden fees that are imbedded in the expense ratios of the plan investments. These can sometimes be difficult to identify and include revenue sharing arrangements with providers such as 12(b)1 fees and wrap fees associated with insurance plans. It is not uncommon to see indirect fees of over 1% for many bundled 401(k) plans, and even higher fees for insurance company plans. These additional expenses directly diminish investment returns and can have a profound negative impact on a lifetime of savings. Hidden fees indicate that your 401(k) plan is most likely a product. Transparent fees are an almost certain indicator that your plan is a service.
4. “Capturing A Few Signatures” vs Consultative Plan Design
A proper plan design must involve an exchange of important information between the plan provider and the sponsoring employer. This would include a recent census with hire dates and payroll information, identification of key and highly compensated employees, and understanding the specific employer motivations to establish and maintain the plan itself. Key decisions need to be made regarding employee eligibility, vesting schedules, employer match options, included compensation, contribution limits, among other important considerations.
Working with a provider who promises to set up your plan in 15 minutes by simply “capturing a few signatures” on the plan documents or checking a few boxes on a list should be a cautionary flag. You are probably being sold a product. On the other hand, working with a trusted advisor who is consultative and takes the time to guide you into the proper plan choices aligned with your business goals and values is a strong indicator that your plan is a service.
5. Call Center Support vs. Dedicated Relationship Managers
Sooner or later, you’re going to need help. It is important to understand the level and type of support available from your 401(k) providers. Those that provide 401(k) as a product offer support through call centers or require plan sponsors to open an online ticket for questions and issues. While this may work just fine for some day-to-day, non-urgent issues, when you sponsor a 401k plan there is a good chance that you will need urgent plan advice at least occasionally. The frustration and poor guidance that results from this impersonal and time-consuming support model is real and it can be costly.
When it comes to getting help with your 401(k) plan, you should choose providers who support their clients with a single point of contact where questions can be directed to a relationship manager who is accountable for a solution. Plans that offer this type of support have far fewer problems. Period. It indicates that your plan is a service, not a product.
It’s Time to Convert Your 401(k) Plan to a 401k Service!
With an increasing number of employers both scrutinizing fees and demanding higher levels of professionalism, there are far more 401(k) providers today who offer high quality services at reasonable and fully transparent fees. If you think it might be time for you to convert your “product” to a service, we can help.
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 to 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.
Your Insurance Company’s 401(k) Fees Are Too High!
The Cost of Cell Phones and 401(k) Services in 1985.
I purchased my first cell phone in 1985. It was a Motorola DynaTAC model and it was more or less permanently attached to the center console of my car. “The Brick” was not portable, provided only voice telephone service and cost over $9000 when it was introduced in 1984. Today, a smartphone fits in your pocket, provides an unlimited number of functions and (depending on the model) costs just a few hundred dollars.
If you were a small business or professional organization shopping for a 401(k) provider in 1985, you would have also had few, if any, choices outside of an expensive insurance company to provide recordkeeping, investment options and compliance services. Today it’s a different story for these smaller plans.
The availability of low cost 401(k) recordkeeping, administration and compliance services for smaller plans today is very much a reality. Despite this fact, a shockingly high percentage of these smaller plans are still managed by bundled insurance company providers and are among the most expensive 401(k) options for smaller businesses, including physicians, dentists and attorneys.
Why We Put Up With High Fees.
The question we should all be asking is why insurance company plans so expensive. And more importantly, why do plan sponsors continue to put up with these high costs?
My answer? Insurance plans are expensive because the insurance companies know they can get away with higher fees. And many of these plan sponsors either don’t know or don’t care. They should.
Despite all of the sophisticated and expensive marketing and enrollment materials they provide to plan participants, insurance companies are often the least transparent in regard to plan fees. In many cases, their fees are simply buried in annuity contracts with employers. And when employers decide to change providers, surrender charges can hold them hostage. This makes it nearly impossible for a plan sponsor to meet their fiduciary responsibility regarding reasonable fees.
Are My Plan’s Fees Reasonable?
Plan sponsors have a fiduciary responsibility to ensure that their 401(k) fees are reasonable. In practice, this requires that they calculate the “all-in” fees (service provider fees + investment fees) and compare these fees to 3 or more providers. This benchmarking process should be done on an annual basis.
Your fees don’t have to be the lowest available in order to be reasonable. But they must be justified based on the services received. At my firm, we work with 401(k) providers whose fees are transparent. In practice, lack of fee transparency is the most common red flag that your fees are too high.
What Do Variable Annuities Have to Do With High Plan Costs?
If your retirement plan’s provider is an insurance company, your plan’s investments are likely a variable annuity. Understanding the differences between a variable annuity and a mutual fund is key to unlocking the high fees typically associated with insurance providers.
Variable annuities are essentially mutual funds wrapped in a layer of insurance that renders the investment returns and income from the investment tax-deferred. This makes them an attractive alternative to certain individual investors who may be in higher tax brackets.
When used inside a 401(k) retirement plan, however, this is a distinction without a difference, since all investments returns inside of a 401(k) are already tax deferred. So, do variable annuities have other advantages when used in a 401(k) plan? Not really. But they present a number of disadvantages, including additional fees and onerous trading restrictions.
Wrap Fees, Surrender Charges and Commissions.
A retirement plan funded by variable annuities is structured so that participants do not directly own a mutual fund. Instead, they own “units” of an account that holds mutual funds owned by the insurance company. These units have a variety of wrap fees including investment management fees, surrender charges, mortality and expense risk and administration fees. Variable annuities also include a commission which is paid to the broker who sold them.
These fees can range from .25% up to 1.25% of assets, depending on the size of the plan. They are often estimated as a percentage of assets in 408b-2 fee disclosures, as opposed to stating the actual dollars that are being extracted from participants. Even more frequently, they are buried in dense and often confusing group annuity contracts with the employer. These hidden fees can be destructive to your long term financial health. A plan with total assets of $1 million invested in a group annuity with a 1.00% wrap fee would generate annual hidden compensation of $10,000 to insurance companies and plan advisors yet provide questionable participant benefits. And since these fees are variable based on assets, they are increasing over time.
Surrender Charges: Adding Insult to Injury.
One of the most devastating wrap fee consequences associated with plans funded with variable annuities are serious and onerous trading restrictions. Because annuity contracts are written with an expiration date, an employer who wishes to terminate the contract prior to expiration is subject to surrender charges often as high as 7%. While the industry defends these fees as an offset to the cost of setting up the plan, their true and obvious purpose is to hold plan sponsors hostage. They create a nightmare scenario for plan sponsors who wish to terminate their provider for poor performance or high administrative fees.
Revenue Sharing Arrangements: Hidden Fees
Revenue sharing arrangements are another source of hidden fees for participants. These fees are far from transparent and are often buried within the expense ratios of plan investments. Often identified as 12b-1 and sub-TA fees, these fees are used to indirectly compensate recordkeepers, custodians, TPA’s and advisors for services provided to the plan. Because the true cost of most plan services scale based on the number of plan participants as opposed to the total plan assets, these fees become increasingly expensive as plan assets continue to grow. They are seldom justified.
“I Own A Mutual Fund in My 401(k), Right?”
Variable annuities are often identified in marketing materials and other plan communications by their underlying mutual fund. This can lead some participants to conclude that they are investing directly in a mutual fund when in fact they are investing in variable annuity units subject to additional fees. As a result, plan participants who wish to invest in low-cost mutual funds may not realize that while the underlying fund has low fees, the unit expenses could be considerably higher. That’s not my idea of transparency!
Good News! You’ve Got Options!
Fifteen or twenty years ago, the smallest 401(k) plans had few options outside of variable annuities and bundled insurance providers. Today, the 401(k) landscape has changed. Mutual fund minimums have been reduced and lower cost share classes are available on most competitive recordkeeping platforms. Regulatory reform in recent years has mandated fee disclosure to both plan sponsors and participants. As a result, there has been an acceleration in the number of insurance companies who have sold or exited their 401(k) recordkeeping business in the past 5 years.
What Must I Do Now?
Insurance companies get away with high fees for two reasons: The first reason is that their fees are often intentionally hidden. True, fee disclosure reform has increased transparency somewhat in recent years, but insurance company fee disclosure continues to be among the most confusing and least transparent.
I have found that many, if not most, plan sponsors need help when it comes to properly identifying and benchmarking their 401(k) plan fees. You should ask your advisor for help if he is not already providing you with that service.
You should also understand how your advisor, as well as other 401(k) providers are paid for their services. Revenue sharing arrangements and insurance company wrap fees are often expensive and involve conflicts of interest that should be avoided.
Apathy and indifference among plan sponsors when it concerns high fees, however, is both expensive and inexcusable. Putting up with high 401(k) fees charged by insurance providers when there are far less expensive options available to smaller plans increases your legal liability, reduces participant outcomes and is a serious breach of fiduciary responsibility. Both you and your employees deserve better.
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 to 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!
