Over the past few months I’ve fielded more questions than usual regarding overhauling 401k plans and switching providers outright. The concerns have come from employees and business owners who have found that all or most of the investments in their 401k plan correlate too closely with the major stock and bond indexes. Participants are having a hard time finding ‘hiding spots’ during the turmoil. At a time when most of the major indexes are suffering badly, workers are seeking access to alternative asset classes such as gold and special minerals, energy, fixed accounts and even inverse or ‘bear market’ investments. So what makes a 401k plan good or bad? What can you do to get a better plan in the door at your company?
There are five primary areas in which a 401k plan can either shine or fall short. They are: cost, investments, service, plan design, and fiduciary responsibility. The easiest conversation I have with my 401k clients is regarding cost. Analyzing the expense ratio of investments and related wrap fees, sub-transfer agent fees and 12b1s is always an interesting exercise. A surprising number of investors think they pay little or no money in fees and expenses and ultimately receive 99% or more of their investment returns. What an expensive misunderstanding! According to a recent case study by pension fiduciary Matthew Hutcheson, the average expenses of a 401k plan fall in the neighborhood of 3%, perhaps closer to 4% if you include insurance company 401k platforms which are fairly common.*
As for investments, 401k plan participants usually have a mix of stock and bond investments along with target date or ‘life cycle’ funds. The mix usually varies on the equity side with large-cap, mid-cap, and small-cap, and on the fixed-income side with a few government and corporate bond choices. Sometimes investors will find a commodity or real estate investment, or something else a bit outside the box. What many 401k plan sponsors and participants fail to realize is that a variety of open-architecture plans allow the sponsor to choose from a huge universe of investment options. We’ve customized 401k plans in which participants can create a total portfolio outside of the S&P 500 or Dow if they wish to. As I discuss in a prior blog article, some 401k plans even allow up to 30% of account balances to be invested through self-directed brokerage accounts. This allows investors the ultimate in flexibility, even if debatable how beneficial this option ultimately is for investors.
The service argument speaks for itself. How often does your 401k team come into the office and sit down with you? They should be discussing various 401k allocation options, financial planning issues and the economy. Feedback from my clients has been that most 401k plan vendors dramatically decrease their efforts to service a plan shortly after selling it. It’s a true shame because a simple phone call advising a client to be cautious of continued market turmoil and uncertainty could make a big difference. Some clients don’t even realize when money market or simple cash investments are available to them. I’ve also noticed that 401k plans serviced by independent financial planning firms such as my own tend to offer a much better service option for participants. Rather than calling up an investment company or insurance company to ask a question (which often involves extensive waiting to speak with a poorly trained customer service rep) my clients can call me or any Certified Financial Planner™ Practitioner at my firm to get answers to their questions and discuss their 401k concerns. While service may be an ‘intangible’ in the short run, it ultimately makes all the difference to have a team of people who you can call and trust to discuss your financial issues.
Plan design issues are often voiced by plan sponsors and more senior executives. Some of these issues would include the rate of participation within the plan, the ability to auto-enroll new employees to the plan, concerns regarding annual compliance testing for the plan, and ascertaining the most effective way to have both highly compensated employees and lower-level employees benefit from the plan equally. These are all issues which are handled better by some TPAs (third-party administrators) than others. In my experience, payroll providers have been a ‘convenient choice’ for administering 401k plans for record-keeping purposes, but ultimately don’t have the best flexibility. After working with a variety of TPAs, I’ve noticed clear differences between each.
Fiduciary responsibility is an area of 401k plan design which has taken on greater importance over the past year or two. Few plan sponsors realize that they can be held liable for plan inefficiencies or errors, especially when those errors have a widespread effect on participants. Some of the ways a company can combat or protect against this liability is through an investment policy statement which outlines the objectives of the investment chosen for the plan and distributes it to participants. This sort of action would tie in to 404c compliance and can come in handy in the event of a confrontational employee. It also helps to review the investment options in the plan annually and document that review. It’s also nice to feel comfortable regarding full ERISA compliance, which a good TPA should help with.
If you have questions or concerns regarding any of the above issues with your 401k plan, feel free to give me a call or send an e-mail. Switching plans is easier than one might think and can save loads of money over the long-run.
*Uncovering and Understanding Hidden Fees in Qualified Retirement Plans 2nd Edition – Published February 1, 2007: Matthew Hutcheson, Independent Pension Fiduciary