By Christopher Carosa, CTFA | December 2, 2014
As we enter the final month of the year, 401k plan sponsors won’t be satisfying their fiduciary duty should visions of sugarplum fairies be the only thoughts dancing in their heads. Year-end brings with it a laundry list of “must-do” tasks every 401k fiduciary needs to accomplish before that brilliant crystal ball completes its decent in Times Square. We surveyed retirement plan specialists from all corners of America. Their answers converged on these five key tasks:
#1 Review and
Update the Plan Document
“Update that document…it is time…get it done,” says Joshua Austin Scheinker, Senior Vice President at Scheinker Investment Partners of Janney Montgomery Scott LLC in Baltimore, Maryland.
Truth be told, most plan sponsors could live with the same plan document from year to year. But it’s not safe to assume regulators haven’t changed the rules. Many rule changes either expire at year end or begin immediately after year end. Fred Barotz, CPA and Tax Director at accounting firm Anchin, Block & Anchin in New York City, says, “Certain amendments to plans that are intended to be effective throughout 2014, must be formally adopted by December 31 in order to be valid.”
It’s not just regulators, it’s plan sponsors themselves that may have taken actions earlier in the year that require closure by the end of the year. Alan H. Vorchheimer, principal, retirement, Buck Consultants at Xerox in New York City, suggests 401k plan sponsors need to “assure that any discretionary plan amendments effective in 2014 are adopted by December 31, 2014 or the plan could be judged as not operating in accordance with its written terms and subject to penalty.”
Of course, if companies are going to take the time to insure the plan document remains in compliance, it behooves them to confirm its overall effectiveness. “Every plan sponsor needs to review their plan details and make sure the plan is still working for its participants and sponsor,” says Celia Rafalko, Managing Principal and CEO at Piemont Independent Fiduciaries in Glen Allen, Virginia. “Are there new rules that are attractive and useful, like this year’s change that allows after-tax contributions to be rolled to a Roth IRA? Are the eligibility rules still working well? These are just examples. It doesn’t take too long and it is a great way to be sure your plan is fulfilling its purpose.”
Finally, updating the plan document now helps give the plan sponsor a head start going into the new year. Robert A. Massa, Director, Retirement, Ascende, Inc. in Houston, Texas, says, “If you have a calendar year plan, you should review your plan design and make any changes prior to the new plan year. This will provide time for HR, benefit and payroll to prepare for the upcoming changes and any improvements to the plan can be communicated to employees at annual benefit meetings. Also if your plan is a safe harbor 401k plan, changes to the plan design can only be made annually or you risk losing your safe harbor testing exemption.”
#2 Confirm All
Required Plan Disclosures Have Been Made.
The last several years have witnessed several changes in mandatory disclosure reporting, both on the part of the plan sponsor and its service provider. Massa, says, “Year-end is when many of the required disclosures must be delivered to employees, such as the 404(a) fee disclosure notices, safe harbor notices, summary annual reports and qualified default investment notices, just to name a few.”
“The most important task every 401k plan sponsor needs to address before the end of the year is to ensure that all required disclosures have been sent out to participants,” says Todd Kading, Managing Director, LeafHouse Financial Advisors, from Austin, Texas. “Plan sponsors are required by law to make ensure participant awareness of their rights in investing plan assets on a consistent basis, so it is imperative that participants receive a qualified default investment alternatives (QDIA) disclosure and a safe harbor disclosure.”
Kading goes a step further when he suggests “a thorough review of their compliance file is imperative for responsible plan sponsors. All communication with participants, including disclosures distributed by them as well as any fee disclosures distributed by the plan provider, should be reviewed and appropriately documented. This is a preventative measure to ensure that there are no future auditing issues that could arise due to lack of appropriate compliance procedures and execution.”
Compiling such documentation may help protect plan sponsors. Vorchheimer offers specific advice along these lines when he suggests plan sponsors “issue required participant disclosure notices (Auto-Enrollment, Safe Harbor Notice, QDIA, etc.) by Dec 2, 2014 for calendar year plans. Failure to furnish these documents could subject your plan’s fiduciaries to liability and penalties.”
#3 Review (and
Remove if Possible) Legacy Participants.
Much has been said about the so-called “advantages” for former employees who keep their retirement assets in their old employers’ retirement plans. Less has been said of the disadvantages, not just for those former employees, but also for the former employers. One of the biggest negatives of keeping too many ex-employees on the plan’s roster is the potential increased compliance cost to the plan. “Frequently a plan does not have enough participants to require an annual audit by a CPA,” says Barotz, “but may reach that total by the January 1 measurement date. In these cases it is often possible to ‘force’ former employees retaining small plan balances to exit the plan by year-end, thus averting the time and expense of an audit.”
Retain too many legacy employees can impose additional unnecessary costs to the plan and therefore hurt the growth of current employees’ retirement assets. Rafalko points this out when she reminds us, “January is an important month for plan purposes. The number of participants and eligible participants determines whether the plan will require an audit and the count is taken on the first of January. Those plans that pay a ‘per participant’ fee to a third party administrator or a record keeper usually have the count taken in January and that count is used for billings all year. If a plan can move out terminated employees before the end of the year, it might be able to avoid triggering an audit and can also reduce its plan costs for the coming year.”
Maximum Year-End Contributions.
“Time waits for no man,” goes the old adage. Indeed, retirement savings are fraught with deadlines. For many, the end of the calendar represents one of those deadlines. Drew Weckbach, Certified Financial Planner, Commerce Trust Company, St. Louis, Missouri gives one such example. He says, “End of the year priorities for a solo business owner would be contributing to a solo 401k. The Solo 401k deadline is Dec 31st of the given year.”
Vorchheimer broadens this idea to a general reminder to all employees. He advises 401k plan sponsors “remind participants of the new 401k deferral limits for those that might be able to increase their savings rate – Some participants may elect fixed dollar per paycheck and not otherwise maximize their contributions.”
The end of the year often ushers in the bonus season as successful companies seek to share profits with employees. These good intentions may pose challenges in terms of compliance as employees seek to use them to jumpstart their retirement savings. Barotz says, “If year-end bonuses are paid, sponsors should ensure that employee contributions to the plan, and any company match, are made in a manner consistent with the terms of the plan document. This eliminates the possibility of a costly correction process during the subsequent year.”
On the flip side of saving, we have withdrawing. While many rightly associate “Required Minimum Distributions” (RMDs) with Individual Retirement Accounts (IRAs), they are also relevant for corporate retirement plans. Barotz says, “If current or former plan participants are required to receive a plan distribution (‘required minimum distribution’) during 2014, in most cases this must be accomplished by December 31.”
Part of this is simply reminding those who fall under the RMD demands. “Make sure to send out any necessary communications to retirees about their impending annual Required Minimum Distributions,” says Massa. “Retired employees over age 70½ with an existing account balance are required to withdraw at least a minimum amount out of their 401k account annually. These notices remind employees to make their elections, or face a 50% excise tax.”
It’s more than merely communicating with participants. Service providers need to be able to execute these instructions in a timely fashion. Vorchheimer warns that 401k plan sponsors need to “assure their record keeper will process any required minimum distribution payments by December 31 as required by statute. This may not be an automatic process at some providers.”
As we enter the Holiday Season beloved by so many Americans, we can’t lose sight of these critical year-end tasks. Diligently completing them will help protect both the plan participant and the plan sponsor.
The Internal Revenue Service on December 9, 2013, published final regulations (the “Final Regulations”) which, in part, modified the rules applicable to mid-year reductions or suspensions of safe harbor matching contributions in certain types of cash or deferred arrangements under Code Section 401(k) with a matching contribution feature under Code Section 401(m) intended to satisfy a design-based safe harbor. The Final Regulations took effect as of January 1, 2015. The modification was enacted to ensure that the requirements that apply to a mid-year reduction or suspension of safe harbor nonelective contributions are not stricter than those applicable to a mid-year reduction or suspension of safe harbor matching contributions.
Background. Contributions under a cash or deferred arrangement, including matching contributions made by a sponsoring employer (think: 401(k) plan that includes an employer match), are required to satisfy certain nondiscrimination tests set forth in the Code. With respect to elective deferral contributions made by a plan participant under a cash or deferred arrangement, a plan can meet the nondiscrimination requirements by satisfying the actual deferral percentage test (often referred to as the “ADP” test), a nondiscrimination test aimed at limiting the disparity in elective contributions made by highly compensated employees (HCEs) and nonhighly compensated employees (NHCEs). An actual contribution percentage test (or “ACP” test), with a similar nondiscriminatory intent, applies when the plan provides an employer match. As an alternative to the foregoing testing, a plan may rely on one of the design-based safe harbor alternatives, using specified qualified nonelective contributions (QNECs) or qualified matching contributions (QMACs) to remediate discrimination between HCEs and NHCEs.
General rule. A safe harbor plan must be adopted before the beginning of a plan year and it must be maintained throughout the complete 12-month plan year. For example, a plan sponsor that wishes to use a design-based safe harbor for the 2016 plan year generally must adopt the safe harbor plan prior to the beginning of the 2016 plan year, and then maintain the plan as a safe harbor plan throughout the 12-month period that makes up the 2016 plan year. Unless an exception applies, the plan sponsor cannot decide to abandon the applicable QMAC or QNEC safe harbor alternative and use instead ADP or ACP testing prior to the end of the plan year for which the safe harbor design was adopted. Exceptions to the general rule, including the requirements and notice requirements necessary to meet an exception, are found in the regulations accompanying Code Sections 401(k) and 401(m).
New rules. The Final Regulations permit a plan sponsor to adopt a mid-year amendment to its safe harbor plan to either reduce or suspend safe harbor nonelective contributions if (1) the plan sponsor can show that it is operating at an economic loss, as described in the minimum funding waiver rules in Code Section 412(c); or (2) regardless of the sponsor’s financial condition, the sponsor provides notice to participants and beneficiaries in the safe harbor plan, before the start of the applicable plan year, which discloses the possibility that such contributions might be subject to a mid-year reduction or suspension, and informs such individuals that (A) they will be provided a supplemental notice if a reduction or suspension does occur and (B) such a reduction or suspension will not occur apply until at least 30 days after the supplemental notice is provided to them. This rule applies to mid-year amendments to reduce or suspend safe harbor nonelective contributions that are adopted on and after May 18, 2009. Additionally, the Final Regulations modified the rules relating to safe harbor matching contributions and, effective for plan years beginning on or after January 1, 2015, permit a plan sponsor of a design-based safe harbor plan to adopt a mid-year amendment reducing or suspending such safe harbor matching contributions as long as the same economic loss or participant notification standards described above in relation to nonelective contributions are met.
What Is The Take Away?
The Final Regulations allow plan sponsors a measure of breathing room, permitting a mid-year reduction or suspension of otherwise required safe harbor contributions if a plan sponsor is experiencing economic loss or, regardless of its financial situation, the sponsor complies with the preliminary and supplemental notification requirements outlined above. Plan sponsors should take note that, as described above, effective dates for the Final Regulations relating to safe harbor nonelective contributions differ from the effective dates relating to safe harbor matching contributions. Our employee benefits attorneys welcome the opportunity to address any issues or questions you may have in processing or implementing the Final Regulations.
Nothing in life
is perfect. But when it comes to investment accounts, Roth
individual retirement accounts and Roth 401(k) plans are as close as it
gets. Roth 401(k) plans offer a combination of benefits and options that is
unavailable with any other investment account type. There are at least seven
reasons why you need a beg your employer to offer one, if it doesn't have one
1. Tax-Free Withdrawals in Retirement
With a regular 401(k) plan, all the good news on income taxes happens on the front end. You get to deduct the amount of your contribution from your taxable income for each year that you put money into the account. That lowers your income tax liability each year that you make a contribution.
That arrangement works especially well if you're currently in a high tax bracket. The theory on tax deferral is that you take the tax break now -- when you're in a high tax bracket -- then withdraw the money in retirement, when presumably you'll be a lower bracket. Save big now, pay small later -- fair enough.
But where a regular 401(k) is concerned, you're merely deferring your tax liability, not eliminating it. Since your contributions to the plan were tax-deductible when made, and since all investment earnings accumulated in the account since inception have been tax-deferred, any and all withdrawals taken during retirement will be subject to income tax.
A Roth 401(k) is a remedy to this dilemma.
A Roth 401(k) is
a remedy to this dilemma. Unlike a regular 401(k) plan, your contributions to
the plan are not tax-deductible when made. But just like a regular 401(k) plan,
any investment earnings that accumulate within the plan are tax-deferred. Based
on these two facts alone, it appears that a traditional 401(k) plan is superior
to a Roth 401(k).
But here's where a Roth 401(k) makes a radical departure from a regular 401(k): Money withdrawn from a Roth 401(k) plan is completely tax-free, not merely tax-deferred. The only requirements for this status is that you have to be at least 59½ when you begin taking distributions, and you have to have been a participant of the plan for a minimum of five years.
While the news on income taxes favors regular 401(k) plans prior to retirement, the advantage shifts entirely to a Roth 401(k) plan when you are retired. And that's the time that it will really count.
2. Income Tax Diversification
Tax deferral is probably the main reason why so many people take tax-sheltered retirement plans. It's a way to shield current income from high taxes and defer taxes on investment earnings within the plan.
But an often-overlooked strategy in retirement planning is income tax diversification. It's important to realize that the general assumption that you will be in a lower tax bracket when you retire may not be what happens. This is particularly true if you do have a variety of income streams. Consider the potential income sources you could have in retirement:
· Your Social Security benefit.
· Your spouse's Social Security benefit.
· The annual distribution from your regular 401(k) plan, especially if it has a very healthy balance.
· Any pension income that either you or your spouse have.
· Rental real estate income.
· Non-tax sheltered investment income.
· Any income from employment, self-employment or passive income arrangements.
individually, none of these income sources may be enough to put you in a higher
tax bracket. But if you have several of these sources -- and chances are you
will -- the possibility of being in a high tax situation cannot be ignored.
If that's the case, your cash flow will be helped immensely if at least some of your income is derived from non-taxable sources. Because withdrawals from Roth 401(k) plans are tax-free, these plans qualify as a form of income tax diversification for retirement.
This is even more important since Social Security is subject to income tax, based on your overall income. If your investment income is high, a greater percentage of your Social Security be subject to income tax. If a substantial amount of your income is tax-free, such as distributions from a Roth 401(k) plan, then less of your Social Security benefits will be taxable.
You won't be able to do much to change that arrangement by the time you retire. That's why it's important to do something now.
3. If You're In a Low Tax Bracket Right Now
If you are in a low tax bracket right now, say the 10 percent or 15 percent marginal rate on the federal, you should have even greater interest in participating in a Roth 401(k) plan.
When you're in a lower tax bracket, the benefit of income tax deferral from regular 401(k) plan contributions is minimal. For example, if you are in the 15 percent bracket, you'll save $1,500 this year by contributing $10,000 to your regular 401(k) plan.
Now everyone can use extra $1,500. But let's say that your retirement income turns out to be higher than your income during your working years, and you're in the 28 percent tax bracket. You will pay $2,800 on a $10,000 withdrawal from your regular 401(k) plan. That means that while you saved $1,500 when you made the contribution, you'll paid an additional $1,300 when you withdraw the money in retirement. ($2,800 - $1,500). Using a Roth 401(k), you'll pay the $1,500 in tax now, but save $2,800 in retirement.
The calculation is actually more complicated, because between the time you made the contribution and the time you withdrew money, you also invested the money and generated tax-deferred income. But the point still stands -- you'll be paying 28 percent on withdrawals of money that saved you only 15 percent at the time you made the contributions.
That's a negative exchange, even factoring investment income tax deferral. However if you have a significant amount of money in a Roth 401(k) plan by the time you retire, the distributions that you take have a plan could very well keep you out of that higher tax bracket in the first place. Not to mention that at least some of your income will be completely tax-free.
4. You'll Probably Still Get the Employer Match
Even people who do have a Roth 401(k) plan at work often fail to take advantage of it out of fear that they won't get the company matching contributions the way they would with a regular 401(k) plan. While it's true that not all employers provide the company match for a Roth 401(k) plan, some do. You need to investigate this.
Employers that do extend the company match to the Roth 401(k) plan typically place the match into the regular 401(k) plan. If they do that, it's OK. It will enable you to have all the benefits of a Roth 401(k), while also helping to expand contributions of your regular 401(k).
5. No Required Minimum Distributions
One of the lesser-known benefits to a Roth 401(k) plan is that it does not impose the required minimum distribution rule. On virtually every other tax sheltered retirement plan, you are required by the IRS to begin taking mandatory plan withdrawals -- subject to income tax -- no later than age 70½. The withdrawals are at least loosely based on your remaining life expectancy, and there are stiff penalties if you fail to take them.
We can think of this as the government's way of forcing money out of tax-sheltered plans, where it can finally be taxed as ordinary income. If you are trying to minimize your income tax liability by deferring withdrawals from tax-sheltered plans, that strategy will only work until you turn 70½.
The Roth 401(k) plan is exempt from RMDs. You can allow the money in the account to grow for the rest of your life, enabling you to pass the full amount of the account on to your heirs. That's an excellent estate planning strategy, and it also provides you with 100 percent control over all of the money and income that you have in the account.
6. More Flexibility for Your Life in Retirement
Having a well-funded Roth 401(k) plan gives you options for retirement.
Let's say that rather than waiting until 65 or 67 -- or what ever the Social Security Administration determines your age of normal retirement to be -- you decide that you want to semi-retire at 60, while you are waiting for Social Security benefits to begin. A Roth 401(k) plan can help you.
You can choose to live on a mix of part-time employment or business income, along with regular distributions from your Roth 401(k) plan. The tax-free nature of the withdrawals from the plan will be especially important since the portion of your income that is earned from a job or business will be subject to FICA taxes.
You can take distributions from a Roth 401(k) plan in lieu of Social Security income. You can also rely on Roth 401(k) distributions, so that you won't have to touch your regular 401(k) plan before you fully retire.
With people living longer than ever, worrying about out-living your money has become a common retirement concern. But a Roth 401(k) plan is one of the best solutions to that problem.
Since there are no RMDs, you can leave the money in a Roth 401(k) plan for as long as you want, and it will continue to grow. In the meantime, you can live primarily on your regular 401(k) plan, and when that begins to deplete, you can begin taking withdrawals from your Roth 401(k) plan -- at any age you decide upon.
You can think of it as a two-tiered retirement strategy, with one plan to cover you in the early stage of retirement, and the other -- the Roth -- continuing to grow so that it will take care of you in the later stages of your retirement.
7. Advance Protection From Widely Anticipated Income Tax Increases
A lot of experts predict that income tax rates will only get higher in the future, probably much higher. When you consider the size of the national debt -- now officially at nearly $18 trillion -- and the retirement of tens of millions of baby boomers -- higher taxes in the future are practically a given.
The current top federal income tax rate is 39.6 percent -- but additional taxes on high income earners push the effective rate into the mid-40s. But that rate is reasonable by historic standards. The top federal income tax rate hit 94 percent during World War II, and it remained no lower than 70 percent until 1981. A budget crisis or a swamping of the Social Security and Medicare systems could push tax rates much higher than we can imagine right now.
They may tax everything else you have -- but not your Roth 401(k) plan.
Once rates are increased substantially, it will be too late to do
anything in reaction -- short of simply refusing to earn or accept additional
income. The best strategy to deal with the anticipation of higher tax rates is
preparation. A Roth 401(k) plan -- with its tax-free withdrawals -- represents
exactly that. They may tax everything else you have -- but not your Roth 401(k)
The combination of three benefits give you more flexibility with a Roth 401(k) plan than virtually any other plan you can have -- taxable or tax-sheltered:
· Tax-deferred investment earnings.
· Tax-fee withdrawals.
· No required minimum distributions.
Once you have a Roth 401(k) plan up and running, you can do virtually
anything you want with it. For that reason alone, a Roth 401(k) plan is a must
have investment account.
That's why you need to beg your employer to offer a Roth 401(k). And if your begging doesn't work, you still may have the option of opening a Roth IRA. Here's a look at some of the best places to open your own Roth.
Managing small retirement accounts for employees who no longer work for you can be time consuming, and labor intensive, but there are some employer benefits to keeping past employees’ 401(k) accounts on your books or having new employees roll their past retirement accounts into yours.
If employees have all of their retirement savings in one spot it “helps them set retirement goals and meet them, which will benefit the employer,” said Meghan Murphy, a director at Fidelity in Boston.
If a new employee decides to rollover past accounts into their new account “it is a good time to engage with an employee,” says Murphy. “ If you can crack that engagement nut and get them in the plan and paying attention, it is a good opportunity to send them a message about the right saving rate or putting a plan in place for meeting retirement goals.”
Most employers don’t want to continue to manage balances under $5,000 for employees who no longer work for their company. It becomes a headache to manage such a small amount of money. But larger amounts can boost an employer’s plan. Additional dollars can open up investment opportunities for the entire retirement plan, allowing the 401(k) to purchase lower cost institutional shares instead of higher cost retail shares, she added.
Currently, employers have the right to transfer amounts under $5,000 out of their retirement plan and into an individual retirement account for their former employees. A recent study by the Government Accountability Office found that greater protections are needed for these “forced transfers” of inactive accounts because in its research it found that “fees outpaced returns in most of the IRAs analyzed” so account balances tended to decrease over time.
The GAO asked Congress to consider alternatives investment options employers can utilize in these situations that still allow them to get the money out of their plan but don’t erase the account balances employees have left.
Many employees don’t know what to do with the money they’ve left behind so they ignore it or cash it out.
“It is a real opportunity for a new employer to communicate with their employee, ‘hey, even if it is a small balance today, there’s a benefit in rolling that over where it will grow exponentially throughout your career,’” Murphy says.
The GAO recommends that Congress or the retirement industry come up with a better way to track participants’ many retirement plans. The organization reviewed the policies of other countries and found that many require orphaned accounts to be consolidated into money-making investment vehicles, even without the participant’s consent. Others keep a registry that give participants a single, online resource where they can keep track of their accounts.
“Participants in the United States, in contrast, often lack the information needed to keep track of their accounts. No single agency has responsibility for consolidating retirement account information for participants and, so far, the pension industry has not taken on the task,” the GAO stated.
From an employee perspective, “they may have access to lower cost funds in a 401(k) structure than if they go to an IRA,” Murphy says. “Certainly, cashing out should be the last option.”
GAO recommends that Congress consider “amending current law to permit alternative default destinations for plans to use when transferring participant accounts out of plans, and repealing a provision that allows plans to disregard rollovers when identifying balances eligible for transfer to an IRA.”
Currently, employers can force out accounts with $20,000 in them because less than $5,000 of the account was accrued through their company, the GAO said. Most of it was a rollover from a previous company.
Retirement plan sponsors should consider bringing up the topic of prior account rollovers during new hire benefits sessions, Murphy says.
“It’s a good opportunity to say, ‘don’t forget about your old 401(k). Let me remind you of your options. Consider rolling over to our plan,’” she says. “Most employers are fiduciaries so they need to give all the options.”
Posted by Eric Droblyen on Apr 20, 2016
On April 6, the Department of Labor finalized its long-awaited fiduciary rule for retirement plan investment advice. Under this rule, all financial advisors to retirement plans are required to act according to a “fiduciary” standard – in other words, they must give impartial investment advice that’s in their clients' best interest. Prior to this rule, only some advisors were subject to a fiduciary standard. Brokers and insurance agents were subject to a lesser “suitability” standard.
The problem with the suitability standard is that there is practically no investment that is “unsuitable.” Hidden fees, outrageous redemption charges, lousy performance and house funds with high commission payouts – everything is suitable and anything goes. The old standard allows for certain advisors to provide financial “products” that give the appearance of unbiased advice, but in reality represent blatant conflicts of interest.
Freed from the consequences of self-dealing, certain plan advisors recommend investments that pay them well, but often have excessive fees and lower investment returns. When this happens, retirement security is less likely for plan participants and personal liability is more likely for plan sponsors. The DOL’s fiduciary rule roots it out, which makes it great news for 401k participants, sponsors and specialized financial advisors.
Conflicted advice is bad for both 401k participants and sponsors
I think it’s pretty obvious why conflicted advice is bad for 401k participants – when financial advisors recommend investments based on their compensation, and not their value, participant returns can suffer. According to a White House study, conflicted advice lowers participant investment returns 1% per year on average. This reduction can add up over time. According to the DOL, a 1% difference in fees per year can reduce a 401k account balance by 28% over 35 years assuming a 7% rate of return. That’s a lot!
What’s less obvious is how 401k plan sponsors can be harmed by conflicted advice. 401k sponsors have a fiduciary responsibility to pay only reasonable plan fees and expenses. When sponsors follow conflicted investment advice, and participants pay too much for investments or investment-related services, personal liability for the sponsor can result.
The irony is that non-fiduciary advisors are rarely held accountable for giving conflicted advice that results in excessive 401k fees. Why? Because they have no legal obligation to make impartial recommendations. That’s a pretty raw deal for plan sponsors who thought they had paid for 401k investment advice and got sued because they followed what turned out to be only a conflicted “recommendation.”
Financial advisor “value” will be more important now than ever
The DOL’s new fiduciary rule is a game-changer. It puts 401k plan sponsors and financial advisors in the same boat – they’re both fiduciaries that must put the interests of 401k participants first.
Why is that a big deal? When a 401k plan sponsor and a financial advisor are both fiduciaries, the value of 401k investments and investment-related services becomes a critical consideration for both parties. When 401k participants pay more, they should get more. With respect to 401k investments, that means more costly investments should deliver greater returns than their less costly alternatives and ancillary services should improve participant retirement outcomes.
So what’s the benchmark 401k fiduciaries should use to evaluate the value of investments and investment-related services? In my view, it’s Target Date Index Funds (TDIFs). TDIFs offer 401k participants access to professionally managed portfolios that deliver diversified market returns at a low price. They also offer 401k plan sponsors protection from fiduciary liability when they’re used as a plan’s default investment alternative.
A 401k plan can pay higher fees for a professional financial advisor, but participants should receive commensurate value in return. Otherwise, personal liability for both the plan sponsor and the financial advisor can result.
The DOL’s fiduciary rule is good news for 401k participants, sponsors and specialized financial advisors
While the DOL’s new fiduciary rule is primarily meant to protect retirement plan participants from conflicted investment advice, it will also help plan sponsors meet their fiduciary responsibilities by rooting out conflicts of interest that could otherwise go unnoticed and result in personal liability.
I also believe the rule is a good thing for financial advisors that specialize in retirement plans. Many 401k plans can benefit from the use of a professional financial advisor, but too many financial advisors treat 401k plans like a cash cow today. And why not? Prior to the DOL’s fiduciary rule, there were no consequences for fleecing a 401k plan with unnecessary fees. These bad apples will likely leave the 401k market before the fiduciary rule is effective – April 10, 2017. Their departure will mean new opportunities for specialized retirement plan advisors that can demonstrate value.