A retirement plan is a necessity – and it needs regular attention. When you offer a retirement plan to your workers, you take on major legal, ethical and financial responsibilities. If that scares you, you aren’t alone among plan sponsors.
As a business owner, you have a long to-do list – and running a retirement plan probably isn’t at the top of it. You probably don’t have the time to look “under the hood” and check to see if the plan is really delivering for your employees.
If you want your retirement plan to run smoothly, turn to an experienced fiduciary. To reduce associated risks, many business owners hire financial professionals with experience in retirement plan administration to serve as plan fiduciaries. This way, the business owner can arrange to take some of the burden of these responsibilities off his or her shoulders. Additionally, the plan can be scrutinized to see if it is really delivering on its promise.
Many retirement plans leave much to be desired. Most private-sector employers offer 401(k)s to their workers, but many 401(k)s charge plan participants high fees, offer a narrow selection of investments and a minimal educational component, and ultimately fail to attract the participation they should.
An experienced retirement plan administrator can help you plan to meet your fiduciary responsibility and help you to refine and improve your retirement plan offering so that it is truly appreciated and utilized by your workforce.
Let’s first talk about the fiduciary role – and who plays it.
In the Department of Labor’s view, a plan sponsor quickly becomes a plan fiduciary. The DoL defines the role of fiduciary through function, not merely title. So even though a business owner may not think of himself or herself as a retirement plan fiduciary, any discretion used in managing or administering a plan or controlling the plan’s assets conveys the responsibility and the definition. A plan sponsor is therefore a fiduciary, and by implication, the retirement plan trustees are also considered fiduciaries. A plan’s named fiduciary can be a person, a board of directors, or an administrative committee.
Being a fiduciary means more than filing Form 5500 with the IRS and administering plan functions. You have to keep up with rule changes and communicate regularly with your service provider or payroll department, even if you buy a pre-approved plan rather than create a custom one. If you buy an off-the-rack plan, you have to fully understand its adoption agreement – the details on who can enroll, when employees become fully vested, when and how plan benefits are to be paid, and so on. If the plan ever becomes non-compliant, you are charged with returning it to ERISA compliance.
All this may make you want to hire an outside fiduciary for your retirement plan. Consider, however, that third-party offers of “fiduciary services” do not necessarily involve that third party assuming Real Fiduciary responsibility, or acting by a fiduciary standard as they counsel plan participants.
Registered Investment Advisors do often take on responsibilities as co-fiduciaries of such plans. All CERTIFIED FINANCIAL PLANNER™ professionals are asked to abide by a fiduciary standard and to act in the best interests of their clients (both plan sponsors and plan participants). In contrast, the default in the financial services industry and insurance industry for many years was the suitability standard. Investment brokers were only held to a suitability standard when they provided advice rather than a fiduciary standard – an investment or a product only needed only to be “suitable” for a client or customer rather than in their best interest.
Many wealth management and retirement planning firms offer third-party administration services for business retirement plans. There are actually three levels of TPA according to ERISA guidelines.
An ERISA §3(16) fiduciary is simply a TPA that assumes fiduciary responsibility and related liability, yet offers no consulting about investment selection to plan sponsors or participants. A limited-scope ERISA §3(21) fiduciary is essentially a financial advisor who takes on some fiduciary liability yet exercises no control over investment selection or fiduciary processes; with this TPA arrangement, the plan sponsor may still held liable for inadequacies in the investment policy statement (IPS), plan reviews and participant education. A full-scope ERISA §3(21) fiduciary, on the other hand, becomes the named fiduciary for the plan and has full discretion over investment choices and its operations. Finally, an ERISA §3(38) fiduciary is defined specifically as an “Investment Manager” under ERISA regulations and becomes “solely” responsible for investment selection and every aspect of the fiduciary process; however, the plan sponsor still has a “residual” fiduciary duty to select the ERISA §3(38) fiduciary (i.e., the investment manager) and to see that the ERISA §3(38) fiduciary is performing assigned duties appropriately.
Recently, the DoL ushered in some new rules pertaining to fiduciaries. Anyone sponsoring a retirement plan needs to be aware of these changes, which apply to all ERISA-covered defined benefit and defined contribution pension plans.
Covered service providers (CSPs) to these plans must now fully describe their services & fees to you. Financial advisors, financial consultants or third-party administrators who expect to receive $1,000 or more in direct or indirect compensation for their services have to detail not only what they are providing, but also their compensation and/or fee structure to any plan sponsor. (CSPs also include financial advisors or TPAs who serve as fiduciaries or Registered Investment Advisors for plan sponsors.) If applicable, a CSP also has to denote any fees charged for recordkeeping and/or recordkeeping methods.
Plan sponsors have to detail fees to plan participants. As a fiduciary, you have to provide plan participants with quarterly fee disclosure statements. If you don’t, then it could come back to haunt you – a plan participant or beneficiary could claim a violation of fiduciary duty on the part of the plan sponsor. These fee disclosures may prove illuminating in more ways than one – some small business owners, who are often the largest plan participants in the retirement plan they sponsor, can be disappointed when they see how much the administrative fees are for a particular retirement program.
Plan fiduciaries now have to disclose (and update):
**Rules related to the dissemination of investment instructions for the plan
**Plan fees & expenses paid from participant accounts (plus a breakdown of said fees, i.e., portfolio management fees, admin fees, cost-of-advice fees)
**Any other specific fees or charges that may be drawn from a plan participant’s account.
This is all in the name of transparency.
You want your workers to appreciate your company’s plan. In addition to making a retirement plan run effectively and staying on the right side of the DoL and ERISA, you have another goal when you provide a retirement plan – you want your workers to participate in it, consistently. They should avow themselves of the opportunity to build retirement savings.
That said, there are some retirement plans that go underutilized. Companies sometimes find that participation rates are lower than expected (that phenomenon gave birth to automatic enrollment, which some firms have adopted). Or, workers find that investment and management fees are subtly cutting into their ability to save for retirement.
Employers who offer retirement plans have a fiduciary duty to act in the best interest of participants – and by extension, that includes providing the financial education resources and encouragement to help employees understand, value and participate in the plan.
Why don’t all employees participate in retirement plans? Two factors keep people from enrolling: a lack of financial knowledge (the root of the lack of appreciation of the plan) and the perception that enrolling is a hassle and a prelude to some sort of involved, bewildering ordeal (definitely not true).
Here is where representatives of a retirement planning or wealth management firm (as opposed to financial product salespersons) can make a difference. They can let an employee know that the hour or two spent enrolling in the plan may lead to them accumulating retirement savings that last for decades. That one or two hours spent – an insignificant amount of time in the big picture – could even lead them toward lifetime financial freedom.
They can also introduce employees to the concept of dollar cost averaging – that is, making manageable contributions per month or per paycheck via automatic salary deferrals.
Contributions to a traditional 401(k) also reduce the amount of taxable income listed on an employee’s W-2 form. In addition, most states exempt traditional 401(k) contributions from tax. Employers also get a major tax break: they may deduct annual allowable contributions for each participant in a qualified retirement plan such as a 401(k).
The 2013 401(k), 403(b) and 457 plan contribution limit is $17,500, with $5,500 in additional “catch-up” contributions permitted for workers 50 and older. These limits may rise slightly in subsequent years, as they are indexed for inflation.
How dramatically can plan contributions help employees build wealth? Hypothetically, let’s say an employee enrolls in a 401(k) or 403(b) plan at age 25 and contributes $2,000 a year for 40 years with an annual return of 10%. At age 65, that $80,000 of contributions will result in an account balance of $973,684 thanks to compounding, investment aided by tax-deferred growth, and a consistent inflow of new money.
If the employer matches employee contributions (in such cases, a dollar-for-dollar match on the first 3% of salary is often the standard), that will result in an extra $1,800 pouring into the retirement account if the worker makes $60,000 annually. So with a match, even more money has a chance to grow tax-deferred.
Math like this is hard to dismiss. When you combine it with a myth-shattering presentation revealing how easy it is to enroll, participate and make investment selections in a plan, employees are drawn to its retirement savings potential.
How can you make a 401(k) or 403(b) even better for yourself & your employees? Often, a business will go with an “off-the-rack” retirement plan out of convenience. Years later, a review of the plan may reveal that employees are paying as much as 2-3% in annual account maintenance fees, or as much as 5% in surrender charges. These numbers aren’t unheard of, and they can cut into the annual savings effort in irritating ways – after fees, the employees may not be making all that much. Another complaint about off-the-rack plans: the investment choices are too limited.
In the big picture, when you keep plan costs low and simplify investment decisions for employees, you take significant steps toward making the plan more user-friendly and rewarding.
Let others play quarterback. When a wealth management or retirement planning firm serves as a retirement plan fiduciary, it is often able to help the plan sponsor make welcome adjustments. An employer might want to search for a less expensive TPA, keep closer tabs on investment performance, alter investment offerings to expand choices and weed out poor performers, and arrange financial education after the initial enrollment in the form of individual consultations for employees.
A wealth management or retirement planning firm providing assistance to the plan sponsor should ideally assume fiduciary liability for the plan’s investment choices. One, it takes this liability off the employer’s shoulders. Two, it helps to ensure that the plan investments are selected in the best interests of the plan participants, and not the plan provider (i.e., the big brokerage or fund company supplying the investment opportunities).
ERISA states what has become known as the “prudent expert” rule for a retirement plan fiduciary. The fiduciary has to make investment decisions for the 401(k), 403(b), etc. in the manner of a “prudent expert”. To be precise, a fiduciary has to act with “care, skill, prudence and diligence,” and in the same way that someone “familiar with such matters” would act in overseeing the investments in a retirement plan. The average business owner may find it difficult to live up to this standard – and the attempt could put the owner and the business at enormous risk.
The wealth management or retirement planning firm should also step up and become the go-to resource for employee and HR questions. A business owner or HR director shouldn’t have to be left guessing who to direct a particular question to – the TPA, the fund company or investment custodian, or the investment manager.
A retirement plan is all but a necessity at a business – as an employee retention tool, as a way toward tax savings, and as a vehicle that may be used in pursuit of your own retirement objectives. There are myriad choices of plans out there – not just the 401(k) but many others.
About the Independent Financial Advisor
Robert Pagliarini, PhD, CFP®, EA has helped clients across the United States manage, grow, and preserve their wealth for the past 25 years. His goal is to provide comprehensive financial, investment, and tax advice in a way that was honest and ethical. In addition, he is a CFP® Board Ambassador, one of only 50 in the country, and a real fiduciary. In his spare time, he writes personal finance books, finance articles for Forbes and develops email and video financial courses to help educate others. With decades of experience as a financial advisor, the media often calls on him for his expertise. Contact Robert today to learn more about his financial planning services.