SponsorNews - April 2017
Posted by Eric Droblyen on Jun 3, 2015
Saving for retirement is one of the most important things we must do during our working years. After all, nobody can work forever and living expenses don’t stop after you stop earning a paycheck. And yet too many of us aren’t saving enough for retirement. Why is that? For workers that can afford to save, I think the number one reason is the inability to cut through the complexities of saving and investing. Today, workers must answer complicated questions to successfully participate in a 401k plan. I believe these questions scare a lot of workers away from giving their savings enough thoughtful consideration.
When people are faced with complicated questions, they tend to delay a response – while doing nothing in the meantime. Some call this behavior “analysis paralysis.” I believe the best approach for participants is to break the process down into simpler decisions that can be addressed independently. To overcome analysis paralysis, I suggest savers do just two things to keep their retirement savings on track - establish a retirement savings goal and monitor progress towards that goal at least annually. Focus on saving and not investing. Unless you’re an investing expert, leave the investment of your retirement account to professionals.
Establish a retirement savings goal
When saving for retirement, your goal should be an account balance likely to “buy” you a monthly income during a retirement that can last 30 or more years. Don’t simply target an account balance alone! It can be too easy to underestimate the amount you’ll need for retirement if you simply focus on account balance.
You can set a goal using two approaches – determine a percentage of preretirement income you want to replace or a dollar amount that will cover your monthly living expenses. Many experts say your income replacement target should be 70 to 80 percent of your preretirement income.
There are free online tools available that can help you set a savings goal:
- The Vanguard website offers two calculators to help you estimate your nest egg at retirement and how likely it will last through retirement.
- Their Retirement Savings Calculator estimates a nest egg at retirement based on how much you’re saving as well as a monthly income during retirement.
- Their Monte Carlo Simulator calculates the probability your nest egg will last through your retirement years. It includes sliders to demonstrate how changes impact results.
- Other sites with retirement income calculators include MarketWatch, Bankrate, AARP, and BlackRock.
Monitor your progress
Once you have determined a goal, estimate the amount you need to save, on a per paycheck or annual basis, to hit that goal. Generally, the same calculators that help you determine a retirement savings goal can also be used to determine a savings rate during your working years. It’s best to start saving as early as you can so investment earnings grow your account.
You should use a savings calculator at least once a year to be sure you’re on track for meeting your retirement savings goal. If you’re not estimated to reach your goal given your current savings rate, increase it.
Get professional help!
Are you an investment expert? Most of us aren’t. Studies have shown that professional portfolio management can help 401k participants increase investment returns. An Aon Hewitt study found that median investment returns for 401k participants using Target-Date Funds (TDFs), managed accounts and personal investment advice were 3.32% greater than returns earned by participants that picked an investment portfolio themselves.
If you are not an investment expert, you should STRONGLY consider utilizing a professionally-managed portfolio option provided by your plan.
The key to overcoming saver apathy is simplicity
The best time to save for retirement will always be today. The more time your savings can grow, the better your chances for a secure retirement given the power of compounding interest. Determine your savings goal ASAP and evaluate where you stand in meeting that goal - you may be surprised by the results. Maybe that new 80” flat screen TV today becomes a lower priority when you know that contributing that money to a 401k instead will make the path to a secure retirement easier.
Don’t let apathy impair your retirement savings – having a proper nest egg at retirement is too important. Keeping things simple will help keep your retirement savings are on track. When you delegate investment selection, saving becomes the key to retirement security and you can boil that down to two things - a goal and a savings rate necessary to reach that goal. When things are simple, you feel in control. When they are not, you feel can lost, and that feeling can lead to apathy.
The U.S. Supreme Court recently ruled that plan fiduciaries that are responsible for choosing retirement investment lineups (“investment fiduciaries”) have an ongoing fiduciary duty to monitor the investment funds. Although many experienced fiduciaries and industry lawyers view the decision as merely confirming what they had already believed was an investment fiduciary’s responsibilities, there are a number of important takeaways such fiduciaries, particularly those for plans that utilize revenue sharing, should be mindful of.
In Tibble v. Edison International (“Tibble”) participants in the Edison International 401(k) Plan (the “Plan”) claimed that the Plan fiduciaries were imprudent for using “retail” classes of funds when “institutional” classes were available. In other words, participants claimed that the investment options were more expensive than they should have been. The investment fiduciary in Tibble argued that participants’ claims should be time barred by the six-year statute of limitations because the participants brought their claim more than six years after the funds were selected.
The Court sided with the participants and sent the case back to the lower courts to determine whether the plan fiduciaries breached their fiduciary duties. In so ruling, the Court concluded that investment fiduciaries have an ongoing duty to monitor the plan investments options, and that duty is in addition to the duty to be prudent when initially selecting the funds. The Court based its ruling on trust law principles and stated that a “fiduciary normally has a continuing duty of some kind to monitor investments and remove imprudent ones.” However, the Court did not define the scope of the continuing duty and expressed no opinion about whether or not a breach occurred in Tibble. Industry stakeholders, including Reliance Trust will continue to monitor this case for further developments on those critically important issues.
Although the Court did not specifically rule on revenue sharing issues, it provided an important reminder about the lower court’s decision regarding the use of retail funds. Citing the lower court, the Supreme Court wrote that the investment fiduciaries had “ ‘not offered any credible explanation’ for offering retail-class, i.e., higher priced mutual funds that ‘cost the Plan participants wholly unnecessary [administrative] fees,’ and it concluded that, with respect to those mutual funds, respondents had failed to exercise ‘the care, skill, prudence and diligence under the circumstances’ that ERISA demands of fiduciaries.” The lower court had awarded the plaintiffs more than $370,000 in damages for that breach.
While the courts continue their deliberations in Tibble, investment fiduciaries and other professionals that advise and educate plan sponsors and investment committees should consider these important takeaways from the Court’s decision. Investment fiduciaries:
1) have an ongoing duty to monitor the plan investment options and remove imprudent ones;
2) should have procedures for the periodic review of the plan investment lineup;
3) should review the share classes being used, gather information about potentially more cost-effective classes that may be available, and justify the choices made;
4) should seek information and advice from experts when they do not have the necessary expertise;
5) should document the reasons why investment options have been retained or removed; and
6) should review their document retention policy and consider keeping documents related to the plan investment decisions for a considerably long time.
As noted above, responsible plan fiduciaries should consider hiring an expert, such as an ERISA 3(38) investment manager, if they are not experts on investment and ERISA matters. After hiring an ERISA 3(38) investment manager, the plan sponsor and investment committee will not be responsible for the individual acts of the manager, and will have no fiduciary liability for the manager’s decisions, provided the plan fiduciaries prudently select and monitor the manager.
Most people believe that the value of the retirement advisor is the ability to enhance returns. But if that were true, there would be no asset allocation because that strategy deliberately reduces returns. The fact is that a well allocated portfolio offers asset preservation at the expense of enhanced returns. There is no conclusive evidence that retirement advisors increase investment returns.
The value of the retirement advisor is far greater than marginal investment returns.
Understanding the real value requires stepping away from the investment itself and focusing on the outcome if the retirement advisor was not in the picture. The answer lies in how different the 401(k) industry would look if there were no retirement advisors:
- There would be far fewer plans. Of the over 600,000 plans, 90% to 95% would not exist without the efforts of advisors.
- Participation rates would be lower. Instead of 87% participation, the no-advisor world would have fewer that 25% of eligible employees participating.
- Diversified investments would be the exception. Stable value and fixed income investments would dominate.
These estimates are not mere speculations but were the facts in the 401(k) marketplace before retirement advisors were active.
With an estimated 5 million businesses still without a retirement plan, it becomes obvious that advisors will continue to play a critical role in achieving a more secure retirement for more workers.
The Retirement Advisor’s Challenge
Providing the value of a secure retirement may appear on the surface to be a simple task. Experienced professionals recognize that this is not the case. Enhancing retirement security requires uncompensated and labor-intensive work that is required before a plan is in effect for an employer and then for each employee.
A successful retirement advisor must overcome the resistance of the employer to increasing employment expenses by offering a retirement plan. The highly visible direct and indirect expense to the employer has to be justified by an altruistic and often illusive long term benefit that employees may or may not value.
Before the typical retirement advisor receives compensation, he/she must also convince employees to participate in the 401(k) and then wait for years for contributions to accumulate to a meaningful level. The effort to convince the employee requires making the case to lower their current standard of living in the hope that this sacrifice will yield a more secure retirement that is often decades in the future.
It is only after overcoming both of these challenges that the retirement security is improved.
Several tools have been developed that streamline the role of the retirement advisor. These include regulatory waivers and exemptions that reduce the employers’ burden as well as incentives and automatic features for employees. On the other hand, there have been regulations and proposals that make the retirement advisor’s job even more difficult.
The retirement advisor faces business risks that are unique. Most serious is the risk of not recovering the cost in time to establish and operate the plan through its formative years. The retirement advisor who establishes the plan and builds participation and contributions is rewarded only as long as the employer remains a client. Unfortunately, such a profitable plan is an attractive target for other advisors, who can offer lower fees since there are no more start-up costs.
This risk pushes retirement advisors to pursue larger employers, where the time for start-up cost recovery is shorter.
The second unique risk is being held responsible for plan losses and failing to comply with regulatory requirements. These liabilities put an additional administrative burden on the retirement advisor that translates to higher operating costs.
This risk increases the fees that must be charged for the retirement advisor to operate profitably.
The trigger for advisors became active in enhancing retirement security was the introduction of compensation programs to fund these activities. These compensation programs funded the activities necessary to start up, retain and improve the 401(k) plans.
Today’s successful compensation programs evolved after other attempts at funding failed:
- Employer Funded: This is a non-starter because employers could not be convinced to pay an expert to convince them to start a 401(k) plan.
- Employee Funded: While this might appear to be logical, since the benefit is enjoyed by the employee, it is highly impractical and very costly.
- Government Funded: This possibility is still under consideration but is unlikely to materialize since Washington has little appetite for additional spending.
The successful funding approach has been to treat the advisor’s compensation as an expense of the retirement plan. This has the added benefit of creating and incentive for the advisor to succeed.
Having solved the funding, the issue of the standard of care now looms large. Market forces have produced an adequate level of care but a significant gap still exists between the best and worst practitioners. Few of the best practitioner take advantage of a superior standard of care and fewer of the worst suffer for being inferior.
The reason is the disparity in the standard of care is the lack of generally accepted quality measures combined with the use of investment returns as a measure of advisors’ value.
The disparity can be resolved by the best advisors adopting a uniform standard of care and using this standard to win business from competitors who cannot operate at that level.
The critical role played by the retirement advisor has not been understood. This failure threatens the retirement security of the 68 million workers with no retirement plan who are primarily employed by small businesses. Instead of focusing on investment returns and lowering expenses, real benefits can be achieved on finding additional ways of funding retirement advisor activities.
Jun 24, 2015
Each 401(k) plan requires three types of services: investment services, recordkeeping services, and administrative services. An investment advisor typically provides investment services such as selecting funds for the plan, educating participants on choosing their funds, as well as fiduciary responsibilities like monitoring the investment options. Recordkeeping services keep track of each individual account within the plan at the participant level as well as the source and tax treatment of each contribution. They also provide loan administration, payouts, and execute transfers between funds.
Administrative service providers design the plan, create plan documents, and oversee ERISA compliance testing. The work of the administrator is critical during the design of the plan, but also continues on a consultative basis to provide ongoing plan support.
In an “unbundled” plan, the administrative services are performed by an expert third party administration firm. In a “bundled” plan, the recordkeeping and administration services are provided by the same entity.
While bundled plans may seem simpler, using a qualified third party administrator offers various advantages when compared with a bundled plan provider:
Transparent Fees. With bundled services, it may be difficult to determine the real cost for administrative services, since they are reported together with the recordkeeping costs. Unbundled plans provide greater transparency of all fees, including recordkeeping, investment, and administrative.
Comparable Costs. Often, bundled plan providers quote the administrative services at a lower rate to appear more attractive. In reality, unbundled plans tend to be only marginally more expensive that bundled plans. Administrative work is important for the success and compliance of the plan and involves real costs. Bundled plan providers offer bundled services in order to cut costs on the administration services and enjoy higher profits on the overall plan. Using an expert TPA may increase the cost of the overall plan slightly, but will provide higher service and avoid expensive penalties and fees for potential non-compliance.
Resources, Service, and Expertise. With an unbundled plan, sponsors and participants often have access to greater experience and expertise than with a bundled plan. Established TPA firms typically employ experts with more years of experience and relevant education than the staff of a bundled provider. The quality of service offered may be higher since TPAs usually involve smaller groups who have greater interest in each plan, because they work on fewer plans.
Greater Plan Flexibility. TPAs are specialists with extensive expertise on ERISA requirements that can customize each plan to the needs of the plan sponsor. This allows them to provide sophisticated plan design that can overcome more challenges for business owners. Unbundled plans may provide for non-401(k) features such as profit sharing or defined benefit options. The increased flexibility may result in higher retirement savings, benefiting the employer and employees alike.
Avoiding Mistakes. Often, when experienced TPAs take over bundled plans, they encounter basic mistakes that should have been avoided and may have put the plan at risk for penalties. Bundled providers are not usually responsible for any errors in the plans they create. Working with a qualified administrator to create a plan may reduce these errors.
Investment Diversification. Unbundled plans allow for more diverse investment options that may provide greater diversification to participants. They also provide greater ease of changing investment options if necessary. Additionally, access to more investment advice providers may be possible with an unbundled plan.
Reduced Fiduciary Liability. An unbundled plan allows for use of a 3(38) fiduciary, transferring the liability of investment management to a professional advisory firm instead of the plan sponsor. Even if a 3(38) fiduciary is not used, unbundled plans may help meet fiduciary obligations. Because unbundled plans offer more available investment options from more mutual fund companies, the fiduciary responsibility of the plan sponsor may be better satisfied with unbundled plan.
Checks and Balances. One important disadvantage of a bundled plan is the inability to simply change the provider of administrative services, if service or expertise is lacking. This would also require changing the provider of the entire plan. Because TPAs can be replaced without a change to the plan provider, they are incentivized to provide a higher level of service.
Choosing a bundled vs. unbundled plan is a lot like shopping for a new suit. In some cases, an off-the-rack suit may be adequate, but for an important event, a tailored or custom made suit is desireable. A bundled plan may be appropriate for a very simple, straightforward start-up plan, but for plans with any level of complexity or for a larger plan, a third party administrator is a valuable investment towards the best outcome.
Jul 08, 2015 | By Chris Carosa
Forget everything you’ve ever read on a Department of Labor website. It all boils down to this: 401k plan sponsors have only one real worry--their employees.
Look at all those class-action law suits. They wouldn’t exist if not for employees. Without employees, enterprising trial attorneys would have nothing to base a case on.
If employees are the 401k plan sponsor’s one worry, then it makes sense for corporate benefits officers to fully alert themselves as to the things that employees say they want and what they say they don’t want. (For a hint to some specifics based on a recent Cerulli survey, read “These 7 Employee Concerns can Befuddle a 401k Plan Sponsor/Fiduciary,” FiduciaryNews.com July 7, 2015.)
Employee concerns can fall into three broad categories. A winning service provider will be the one who best helps the 401k plan sponsor solve these three dilemmas. Let’s look at each of these three groups of concerns and how the service provider can help address the issues in them.
The smart plan sponsors are now requiring service providers to frame investment due diligence not just in traditional terms, but...
#1: Concerns you know about and should do something about.
Of all the issues in this category, the most prominent deal with deferral rates (aka the employee’s ability to save). Smarter employees recognize the need to save more. The trouble is they put up self-imposed obstacles that prevent them from saving in a timely way.
A lot of ink has been spilled on correcting poor savings habits. The most direct way to resolve lagging deferrals is through the plan document. This would involve our two favorite “autos”—auto-enrollment and auto-escalation. This takes the decision right out of the employees’ hands and gets recalcitrant savers started on the path to retiring in comfort.
But these auto programs are usually not enough. Higher deferral rates are needed. For this, employers can restructure the matching algorithm by extending it to a higher percentage of one’s salary.
This needn’t increase the cost of the matching program, as the entire range can be shifted to higher percentages (e.g., a dollar for dollar match not on the first 3 percent but on the second 3 percent of an employee’s salary).
Likewise, the range can be extended but the match dropped in proportion. For example, instead of a 100-percent match on the first 3 percent, make it a 50-percent match on the first 6 percent.
#2: Concerns you know about and should do nothing about.
Most of the investment concerns fall into this category. Face it, (and this is a difficult reality for those in the investment business to admit), investments, beyond a certain, easily attainable threshold, simply shouldn't be an issue.
Employees need to focus almost on the things they can control – i.e., when they start to save, how much they save, and when they retire – and not on the things they cannot control – i.e., investments. The best way to “do nothing” about concerns like this is to reduce the likelihood of them sprouting up in the first place.
Once again, adopting a “21st century” plan design can help. This means using a “tiered” or “category-based” investment option menu with heavy emphasis on Qualified Default Investment Alternatives.
#3: Concerns you don’t know about and absolutely positively need to do something about right now.
This is the most dangerous group. It lurks in the shadows. It won’t show itself until it is too late to do anything about.
These are the concerns you should have anticipated, and will be blamed for when they finally do surface. How do you anticipate these concerns when they show no warning signs? That’s simple. Read.
Engage your peers (conventions and online communities are the best way to do this). The most important thing to know for #3 is this: Just keep swimming.
In other words, never lose your zest for learning, never accept the status quo, and never, ever, believe you know everything.
It’s true, 401(k) plan sponsors have many duties, but they only have one worry. They worry their employees won’t be satisfied, for whatever reason. If you can proactively appease employee concerns, you’ll be a winner in the eyes of the plan sponsor.