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Sponsor News - October 2014

5 Critical Components of a Plan Diagnostic Test

Conducting a period plan diagnostic test is often seen as an easy way for the typical 401k fiduciary to reduce fiduciary liability. An ERISA plan trustee or fiduciary will usually hire an independent fiduciary consultant to conduct a comprehensive plan fiduciary diagnostic test. A plan fiduciary diagnostic test, to effectively reduce fiduciary liability, must thoroughly examine each of these five critical components of fiduciary liability:

#1) State & Federal Regulatory Compliance –
401k plans fall under the Employee Retirement Income Security Act (ERISA) as maintained by United States Department of Labor (DOL). In addition, certain state may add further regulatory burdens (or opportunities) to the plan for the fiduciary to meet. It’s good to obtain a comprehensive regulatory compliance checklist from your plan’s employee benefits attorney prior to conducting your plan fiduciary diagnostic test.

#2) Service Vendor Fees & Conflicts of Interest – State and federal fiduciary laws generally state the fiduciary must act solely for the benefit of beneficiaries. The fiduciary, therefore, has an obligation to seek the most favorable fee arrangements. In addition, the fiduciary has the duty to insure personal and vendor conflicts of interest do not interfere with what’s best for beneficiaries. Unfortunately, many vendor conflicts of interest lay hidden in complex packages. In general, the DOL expects the 401k fiduciary to: Review the service providers’ performance; Read any reports they provide; Check actual fees charged; Ask about policies and practices, such as trading, investment turnover, and proxy voting; and, Follow up on participant complaints.

#3) Integrated Investment Policy Statement – While the DOL does not require a plan to have a written investment policy statement, the DOL does state “The maintenance by an employee benefit plan of a statement of investment policy designed to further the purposes of the plan and its funding policy is consistent with the fiduciary obligations set forth in ERISA section 404(a)(1)(A) and (B).” Once plan trustees adopt an investment policy statement, it becomes a legal guideline for the plan. Therefore, it is critical the investment policy statement be drafted in a manner that integrates it fully into the existing documentation of the plan. Too often, the plan adopts an off-the-shelf investment policy statement provided by a vendor. Ironically, adopting such investment policy statements may actually increase fiduciary liability.

#4) Investment Due Diligence – Even if a 401k plan satisfies the diversification requirements of 404(c), the DOL still hold the plan fiduciary responsible for monitoring and selecting those investments. If one exists, the investment policy statement provides a clear roadmap for the 401k fiduciary to follow regarding the selection and monitoring of investments. In addition, regular due diligence reports must be consistent with this roadmap. With a clearly written roadmap, the 401k fiduciary can reduce fiduciary liability. Without a clearly written roadmap, it may be difficult for the ERISA fiduciary to successfully defend investment due diligence actions during a DOL audit.

#5) Trustee & Employee Education – Section 404(c) does not require employers to offer employee education. According to the DOL, if an employer or vendor merely provides general financial and investment education, then it is not acting as a fiduciary. On the other hand, if the employer hires a professional investment adviser to provide individual advice to employees, both the selection of that vendor and the vendor itself takes on fiduciary liability. This vendor selection falls under the same issues as #2 above, especially the conflicts of issues concerns.
This short article can come nowhere near the comprehensiveness required for an effective plan fiduciary diagnostic test. This kind of test goes far beyond the independent audit requirements of larger plans. The 401k fiduciary can delegate this testing to a competent independent fiduciary consultant.

Selecting An Auditor for Positive Audit Experience

The benefit plan auditing process is very detailed and requires numerous steps from start to finish. The DOL created a guide to assist plan sponsors with selecting a qualified auditor, which includes a directory of employee benefit plan auditors that have agreed to meet specific experience and training requirements. Also, the American Institute of Certified Public Accountants (AICPA) Employee Benefit Plan Audit Quality Center (EBPAQC) has compiled tools and resources from plan sponsors, administrators, and trustees. The Plan Sponsor Resource Center can be accessed here.

Plan Sponsors (please share this with your plan sponsors): Here are a few questions to ask yourself when selecting an auditor that will help you become IRS audit-ready (from Maria T. Hurd, CPA at Belfint, Lyons & Shuman):
Does your auditor:

  • Request executed copies of amendments and updates to the plan document to reflect recent law changes?
  • Verify that your plan operations are consistent with your plan provisions for all significant audit areas?
  • Work with your payroll department to ensure they understand the importance of using the correct definition of compensation as defined by the plan?
  • Test the timeliness of deferral deposits and assist with correction of any late deposits?
  • Verify the census information submitted to the TPA for discrimination tests is complete and accurate?
  • Test whether eligible employees were erroneously excluded from the plan?
  • Test whether participant loans are administered in accordance with the plan provisions and IRC Section 72(p)?
  • Test distributions, including hardship withdrawals and loan offsets were made only to participants who met the eligibility requirements for distribution?
  • Make themselves available for assistance with questions throughout the year, working hand-in-hand with your TPA to prevent errors before they happen?

One of the most common reasons for deficient accountants' reports is the failure for an auditor to perform tests that are unique to employee benefit plan audits.

Ongoing communication with your plan's auditor is key. During the planning stage, inform the auditor of the plan's activity for the year being audited and co-develop timing expectations. Be prepared for onsite fieldwork and strive to conclude the audit process as dictated in the project plan. Frequent communications and developing a positive relationship with your auditor will lead to a successful employee benefit plan audit experience.

Note: We can recommend experienced employee benefit plan auditors, if needed.

Top Steps for DC Plans to Take Next Year

December 20, 2013 ( – Consulting firm Mercer has compiled a list of the top 10 recommended steps that defined contribution (DC) plans should take over the next year.

These steps include:

  1. Redefining Success. Ultimately, a plan is successful if it meets plan sponsor objectives and delivers future financial security to participants. Move beyond flat metrics such as participation levels and deferral rates. Analyze all participant behaviors that ultimately drive retirement outcomes, and develop sophisticated metrics and interventions to improve those outcomes.
  2. Take a Broader, Sophisticated Approach to Investment Risk. A delegated investment solution may help manage risk through the lens of plan participants. Research in behavioral finance has shown that risk management involves more than just the prudent selection of a diverse set of investment options. Employees can be supported by tailoring a plan’s investment risk profile to participant demographics. If resource constraints exist, plan sponsors need to consider the appropriateness of employing a delegated investment solution for all or part of the plan. A delegated approach to developing a demographically based investment strategy leverages time while transferring fiduciary risk.
  3. Understanding Target-Date Fund Fiduciary Responsibility. The Department of Labor (DOL) may be watching. As an increasingly popular asset class within DC plans, target-date funds (TDFs) have come under heightened scrutiny by the DOL. Plan sponsors need to consider whether or not the target-date funds in their plan will lead to the desired retirement outcomes for the plan’s participant base. Plan sponsors should review and document the evaluation of these options based on the DOL’s Target-Date Retirement Fund Tips for Plan Fiduciaries.
  4. Saying Goodbye to Revenue Sharing. Paying administrative fees based on each fund’s level of revenue sharing may not stand up to scrutiny. A red flag arises if some participants pay higher administrative costs simply because their fund options carry revenue sharing. Achieve transparency and level allocation of administrative fees by reducing or eliminating revenue sharing, or by allocating it back to participants.
  5. Considering the Impact of Inflation on Participants’ Retirement Readiness. Don't let inflation erode outcomes. Despite the low interest rate environment from 2000 to 2013, participants’ purchasing power decreased by more than 20%, according to research by Mercer. Purchasing power erosion and its effect on retirement readiness can lead to work force planning issues. Plan sponsors can help participants address this risk by assessing the appropriateness of offering a diversified inflation option within the plan.
  6. Helping Participants Sleep at Night. Financial wellness can promote a more productive work force. Employees face significant financial burdens throughout their working lifetimes, from home buying to college saving to retirement preparation. Plan sponsors helping employees put their financial house in order not only helps them save for retirement, but can also improve engagement and decrease stress levels.
  7. Addressing the Diversification Challenge. Consider implementing custom funds to increase participant diversification while keeping the investment lineup lean. In an effort to avoid participant confusion and investment choice overload, 60% of plan sponsors offer participants fewer than 15 investment choices and many are looking to reduce that number to 10 or less. Custom funds can provide participants with access to greater diversification through exposure to alternatives, opportunistic fixed income and real asset strategies without adding complexity to their investment decisionmaking process.
  8. Reassessing the Market. The evolution of the DC market has driven changes in vendor position, strategy and focus.  How long has it been since the plan was put out to bid? In response to market pressures and financial constraints, many vendors have changed their strategy and target market. At the same time, plans have grown and their needs have evolved. It may be time to explore what else is out there.
  9. Thinking Beyond Borders. Globalization is here. International markets make up a larger percentage of the investable universe than U.S. markets. According to Mercer, delivering streamlined access to global investment opportunities across the asset class spectrum helps address participant behavioral biases, leading to improved asset allocation decisions and ultimately enhanced retirement outcomes.
  10. Keep Pushing the Communication Envelope. Employees are accessing information in new ways and plan communications need to keep pace.Employees are increasingly using mobile technology, and the best communicators are engaged in generational targeting and strategies based on behavioral finance. Looking ahead, the success of gamification in education and employee training can be applied by plan sponsors to retirement and financial education. Mercer recommends that plan sponsors assess how new approaches to communications and targeting can more effectively reach the various populations within the plan to help drive engagement.

How to reduce employee cravings for 401(k) loans

For many plan sponsors the revolving door of 401(k) loans is an all-too-familiar issue. As technology has evolved, initiating a participant loan is as easy as a few clicks of the mouse. No credit checks, I’m borrowing my own money and paying myself back the interest, no creditors calling me if I default … how bad could it really be?

But the opportunity cost of a 401(k) loan in many cases can be substantial even if employees pay it back. In addition, participants routinely run into a tax nightmare if they leave their employer while still having a loan balance.

Many participants need this money in a pinch and don’t take the time to realize the long-term ramifications of earnings lost by pulling this money out of their pre-tax account. Consider someone who is 35 years old and wants to borrow $10,000 from the 401(k) and repay it over a five-year period. If this individual assumes a 7% rate of return on their investments and the loan interest rate is 4.25% (prime +1) this participant will lose $4,123 in retirement earnings even if they repay the loan on time. To compound matters, many participants either reduce their contributions or stop them all together in order to pay the loan back, further exacerbating the problem.

This lack of forward thinking can rear its ugly head once again if participants don’t consider the ramifications of leaving their employer while still having an outstanding loan. The Bureau of Labor Statistics reports that people born between 1957 and 1964 held an average of 11 jobs from ages 18 to 44, so this issue arises quite frequently.

Since loans typically are not transferrable to a new employer, the participant is faced with a difficult decision: either pay the loan off in full (usually within 30-60 days) or default on the remaining balance. By this point, the loan money is already spent and very few have the ability to pay off the remaining balance, so in reality it’s not much of a decision at all. In 2009 the U.S. Department of Labor estimated that 401(k) loan defaults were roughly $670 million a year and climbing.

These defaults can drain retirement accounts above and beyond the original loan amounts. Consider a 40-year-old employee who takes out a $15,000 401(k) loan and repays only $3,000 of it before voluntarily or involuntarily leaving their employer. In this case, the remaining $12,000 balance would be considered a premature withdrawal subject to federal tax, state tax and a 10% penalty. For someone in the 25% percent bracket, the end result could be $3,600 federal tax bill, plus state tax.

Many participants justify taking a 401(k) loan since they would prefer to pay the interest on the loan to themselves than to some other financial institution. We must remember that participants are paying these loans back with after-tax dollars, which means double taxation on the interest portion. Consider the interest payments as a new contribution going into their accounts: again, these are funded with after-tax payments so the participant has already paid taxes once. Fast forward 20 years and the participant is getting ready to retire and take a distribution from his or her account. Now, these after-tax interest payments will then be subject to taxation again, along with other pre-tax money.

Plan sponsors should consider some options to limit the amounts of loans while still offering them:

  1. Allow only one outstanding loan at a time. Years ago, it was not uncommon for plans to allow participants to have two, three or even more outstanding loans. This can create an administrative nightmare and can do significant damage in eroding a participant’s retirement savings. Once a participant takes out one loan, he or she is more apt to dip into that well again in future.
  2. Limit participant loans for hardship reasons only. Most plans today allow their participants to take a loan for any reason. However, plan sponsors have the ability to add in a hardship provision so that participants can only take a loan for a financial hardship that is “immediate and heavy.”

Examples of hardship reasons include the purchase of a primary residence, unreimbursed medical expenses, the prevention of eviction from your primary residence, and college tuition for yourself or a dependent. This not only limits the reasons for taking a loan, but the employee also has to prove the severity of the financial hardship and will be limited to that amount if he or she qualifies.

A more creative step is for the plan sponsor to take the extra step of allowing participants to take out the maximum loan amount of 50% of their vested account balance (up to a maximum of $50,000) for hardship reasons only. The maximum loan is smaller for those who wish to borrow for a reason other than a financial hardship (assuming the plan document allows such a provision).

The issue concerning 401(k) loans continues to be the lack of education surrounding them. Yes, it’s true there are certain situations where taking a loan from one’s retirement plan could make sense, but for many it signifies a much larger problem: living beyond their means.

Let’s not forget that the spirit of the 401(k) system is for these plans to be used as long-term saving and investing vehicles, not as a savings account for a trip to Cancun.

DOL set to take a look at 'brokerage windows' in 401(k) plans

Department wants to make sure investors are protected when given more latitude in picking investments

By Mark Schoeff Jr.
Jan 22, 2014 @ 12:00 pm (Updated 5:27 pm) EST

The Labor Department is poised to take a closer look at whether investors are protected in company retirement plans that enable employees to go beyond the plan's menu to choose investments.

The department is scheduled to release a request for comment in April on so-called brokerage windows in 401(k) plans. The mechanisms provide a way for workers to select investment vehicles that are not offered offered in the plan.

In 2012, the DOL addressed concerns about brokerage windows in two Field Assistance Bulletins. But the answers to the frequently-asked-questions posed in the documents generated more questions in the financial industry.

The comment solicitation is the first stage in a “rule-making project” that will focus on the “fiduciary obligations and regulatory safeguards” surrounding brokerage windows, according to the DOL, which put the topic on its regulatory agenda for the first time.

“This is potentially the beginning of a regulatory effort on brokerage windows that could be very broad and significant,” said Bradford Campbell, counsel at Drinker Biddle & Reath and a former DOL assistant secretary for the Employee Benefits Security Administration. “It is one of the surprises on the regulatory agenda. They're sticking their toe in the water.”

Plan sponsors are looking for more guidance on the use of brokerage windows, according to Timothy Kennedy, a partner at Montgomery McCracken Walker & Rhoads. There are questions about disclosures as well as whether a registered investment adviser has to be hired to help participants.

“It's a little unclear out there the fiduciary framework for brokerage windows,” Mr. Kennedy said. “Right now, people are doing their best. A more clear process would help plans.”

Harold Anderson, president of Parkshore Wealth Management, supports brokerage windows because they benefit clients who work for companies that provide limited investment options in their 401(k) plans. One large California employer, for instance, doesn't offer emerging market, real estate or small-cap value options.

“It allows the person to go out, especially working with a good adviser, and build a portfolio that's really adapted to their needs and risk tolerance,” Mr. Anderson said. “It's more custom to them.”

The efficacy of brokerage windows depends on who's using them, said Neal Solomon, managing director of WealthPro.

“When you get into something that is self-directed, all the risks and rewards that come with somebody having complete control of their own investment decisions comes into play,” Mr. Solomon said. “The individual participant may or may not be sophisticated as an investor.”
The brokerage windows need to have some kind of safeguards, Mr. Anderson said.

“You don't want people to lose their life savings,” Mr. Anderson said. “I think it's good to have some kind of warning light to say, 'Get an adviser,' or understand that the investment choices you make may not be as good as the investment choices the plan trustees have made on your behalf.”

Brokerage windows are not widespread. In 2012, they were offered in 17.1% of 686 401(k) plans surveyed by the Plan Sponsor Council of America.

“It's more of a niche in the industry,” said Robert Kaplan, national retirement consultant at ING U.S.

The focus on brokerage windows reflects the DOL's concern that plan participants are on their own if they opt to use the mechanism.
“They may make their decisions on emotion rather than investment savvy; that's the Department of Labor's worry,” Mr. Kaplan said.
Even when a brokerage window is included in a retirement plan, its use may be limited. The Employee Benefit Research Institute has included the mechanism in its plan for more than a decade.

“Over all these years, I'm the only one who's used it,” EBRI chief executive Dallas Salisbury said.

But he said that it is an important part of EBRI's retirement program for its employees.

“In a self-directed plan, you should allow individuals to pursue whatever [investment] fits their risk tolerance,” Mr. Salisbury said.