SponsorNews - August 2017

The IRS is Back with Some Brand New Corrections

Let’s face it. Finding out that the IRS wants to poke around is not going to be the highlight of anyone’s day. Voluntarily admitting a mistake to the IRS and asking for forgiveness is probably even lower on the wish list! So hearing about new voluntary corrections from our friends at the Service might seem like a waste of time.

Not so fast! Believe it or not, the division of the IRS responsible for qualified retirement plans actually does not want to find problems and hand out sanctions. Their goal is to help preserve tax-favored retirement benefits that exist within retirement plans. Of course, if someone doesn’t play by the rules, they shouldn’t then be able to claim the same benefits as someone who does satisfy the various requirements.

That is where the various voluntary correction programs come into play. The IRS recognizes that there are a lot of moving parts involved in the proper care and feeding of a retirement plan. More than 20 years ago, they created the first iteration of a program that allowed companies to voluntarily get their plans back on track, provide participants with any missed benefits and avoid most, if not all, of the penalties the IRS might otherwise assess. Over the last two decades, the IRS has continued to evolve, update and consolidate these programs to make them more accessible and meet the needs of an evolving business climate.

That evolution continued earlier this year when the IRS expanded the correction options for situations when participants are not signed up to make 401(k) deferrals when they are supposed to be. The Service also finalized a pilot program for certain single-participant plans that file their Forms 5500-EZ after the deadline. Let’s take a look.

Missed 401(k) Deferrals

The “Old” Rules

For the last several years, the “standard” correction for not timely enrolling an employee in the 401(k) plan has been a five-step process:

  1. Determine how much the employee would have deferred—referred to as the missed deferral opportunity;
  2. Calculate a corrective qualified nonelective contribution equal to 50% of the missed deferral opportunity;
  3. Calculate the related matching contribution using 100% of the missed deferral opportunity;
  4. Adjust the qualified nonelective contribution and match for investment gains; and
  5. Deposit the sum of steps 2, 3 and 4 into the participant’s account in the plan.

Prior to 2008, the qualified nonelective contribution in step #2 was required to be 100% of the missed deferral opportunity, so the reduction to 50% was a welcome change.

The IRS provides guidelines for determining how much the employee would have deferred. For example, if an employee enrolled but the enrollment was never implemented, the missed deferral opportunity is based on the actual enrollment. If the employee wasn’t given the opportunity to enroll, the missed deferral opportunity is equal to the average of the employee’s group (either highly compensated or non-highly compensated). There are several other parameters for different situations, but we will spare you those gory details here.

Fortunately, this correction methodology is still completely acceptable. In a Revenue Procedure published in the spring of this year, the IRS provided a couple of new options for correcting missed deferral opportunities, one for automatic enrollment plans and one for traditional 401(k) plans.

Before getting into some of the details, it is helpful to note that the new options only apply to the calculation of the qualified nonelective contribution (step #2, above). Any missed match must still be corrected as noted in step #3, i.e., applying the match formula to the full amount the participant would have deferred if timely enrolled.

It is also worth noting that unless the plan’s investments suffered a loss for the time period in question, corrective contributions must always be adjusted to compensate for lost investment earnings.

New Option for Traditional Enrollment 401(k) Plans

For traditional plans that require participants to make an affirmative deferral election, the new option creates a rolling three-month correction window. In a nutshell, if the participant in question is properly enrolled and has deferrals withheld no later than three months following the initial failure, then no qualified nonelective contribution is required. If correct deferrals begin after more than three months but less than two years, the qualified nonelective contribution is reduced to 25%.

There are a couple of small strings attached. The first string is that if the missed employee catches the problem earlier than three months after the initial failure, the company must implement the correct deferrals no later than the first pay period of the month after the employee brings it to the company’s attention. In other words, the company can’t sit back and say, “Bummer, but we can wait up to three months before we do something about it.” Seems like that would have been obvious, but they probably have to plan for that one person who tries to get snarky.

The second string is that the company must provide written notice of the failure to all affected participants. More on that later.

New Option for Automatic Enrollment 401(k) Plans

Ever since Congress passed the Pension Protection Act of 2006, automatic enrollment has become an increasingly popular concept. One of the challenges in getting it from concept to implementation has been the fact that it is easy for new hires to fall through the cracks, especially in plans that have eligibility requirements that extend beyond a month or two after date of hire. And it has been a pain in the neck to go through the corrective calculations every time it happens.

In response to that concern, the IRS also created a new correction for automatic enrollment plans. As long as the failure to automatically enroll a participant on a timely basis is caught and correct deferrals withheld no later than 9½ months after the close of the plan year of the failure, then no qualified nonelective contribution is required. In addition, if the participant did not make an investment election, the lost earnings calculation for the match can be determined using the plan’s qualified default investment alternative.

The same strings are attached. Specifically, the correct deferrals must begin earlier if the participant in question brings it to the company’s attention, and the company must provide written notice to the impacted participants.

The Notice

It seems like every new rule in the last 10 years has been accompanied by a notice, and this change is no exception. Fortunately, this notice is relatively straightforward. In order to take advantage of either of the new options, the sponsor must provide a notice to all impacted participants no later than 45 days following the date correct deferrals begin that provides:

  • General information about the failure;
  • A statement that correct deferrals are now being withheld;
  • A statement that corrective matching contributions (if the plan provides for one) have been made;
  • An explanation that the participant may increase deferrals to make up for those that were missed; and
  • Plan contact information.

Is There a Catch?

Some may wonder why a company wouldn’t take advantage of the new correction options. I mean both of them are less expensive than the standard 50% qualified nonelective contribution. There are several reasons that come to mind, both related to the notice. First, some companies may be reluctant to provide to employees a written statement of an error involving payroll and retirement accounts, especially in a case of already strained employee relations.

The second relates to the timing of the notice. If a company catches the failure and starts withholding the correct deferrals but doesn’t provide the notice within 45 days, they are no longer eligible for the reduced qualified nonelective contribution and must revert to the 50% level.

Late Filing of Form 5500-EZ

Most retirement plans are required to file a Form 5500 each year, and the deadline is the end of the 7th month following the close of the plan year (July 31st for calendar year plans). The deadline can be extended by 2½ months (to October 15th for calendar year plans) by filing Form 5558. Hefty penalties could apply ($1,100 per day to the Department of Labor and up to $15,000 to the IRS) for failure to file timely.

For many years, the Department of Labor has had a delinquent filer program that allowed late/non-filers to get caught up and pay a very reduced fee, as low as $750 in some cases. However, that program only applies to companies that must file a Form 5500-SF or Form 5500.

Plans that cover only the owner or partners of a business and their spouses do not normally file one of these forms. Instead they file Form 5500-EZ. If an EZ filer happened to be late, the only option has been to write a so-called “reasonable cause” letter to the IRS to ask them to accept the late filing and forego any fines.

In 2014, the IRS created a pilot program that formally addresses late filing of Form 5500-EZ. After running that program for a year and soliciting feedback from the community, the Service finalized the program earlier this year.

Under the permanent program an EZ filer, as described above, can submit delinquent returns for a plan and pay a reduced penalty of $500 per delinquent filing, up to a maximum of $1,500 per plan if more than three years of returns are submitted. The returns that are submitted must be the forms that applied for the year in question. There are certain limited exceptions that allow use of the current version of the Form 5500-EZ.

In addition, the submission must include a completed Form 14704, attached to the front of the oldest delinquent return in the package, along with a check payable to the United States Treasury for the reduced penalty amount.

The Revenue Procedure that described the correction program makes it clear that EZ filers still have the option to submit a reasonable cause letter in lieu of using the program. However, the IRS also makes it clear that if the reasonable cause is not accepted, the plan will no longer be eligible to use the delinquent filer program and will be assessed the otherwise applicable penalties. If past experiences with government agencies are any indication, they tend to be much less accepting of reasonable causes once there is a formal correction program available, so proceed along that route with caution.

Conclusion

Unfortunately, retirement plans are complicated and have many moving parts that can lead to the occasional OOPS! Fortunately, the IRS continues to provide newer and easier ways to correct many of the more common oversights that can occur without breaking the bank in the process. If you think there might be a mistake lurking in a dark corner of your plan, let your team of service providers know so that they can help you fix it voluntarily rather than after the IRS finds it.

 

 

Who gets a cut of your retirement plan fees?

By Chad Parks
August 28, 2015

“Are you paying anything for your retirement plan?”

When asked that question during an AARP survey, 71% of respondents answered no, compared to 23% who believed they do pay for their plan (6% were unsure).

The fact that seven in 10 Americans do not believe they pay anything for their plan is troubling, especially because 401(k) fees can be exorbitant and are distributed to multiple sources. The industry has done a stellar job of remaining opaque on the subject of fees, despite the Department of Labor enacting tougher fee disclosure rules in 2012.

Where do these fees go? There are a number of hands in the pot, so to speak. Here are the three entities that collect on your 401(k) fees, no matter how high or low they are.

1) Administration

For every 401(k) plan, an important legal component is the third-party administrator. Administration refers to the responsibilities of a third party to manage the intricacies of the federal regulations that govern the actual 401(k) code of retirement planning. In short, this is a group that ensures your 401(k) is compliant.

Those responsibilities include, but are not limited to, making required amendments to the documents, administering the required year-end testing and reporting the Form 5500 (think 401(k) tax forms) to the IRS.

2) Record keeping

The record keeper is the person who looks after the numbers for your business. They keep track of employees’ money and the gains/losses on the funds that need to be entered each day. They are also responsible for year-end reporting, calculation of vesting, numbers reported back for IRS tax forms and compliance testing, etc. The numbers are just as important as, if not more than, the legal aspects.

3) Investments 

All 401(k) plans contain asset-based fees that vary and go into three different sources. These fees can run anywhere from 1-2% of your 401(k) balance, which is like a double-edged sword; the larger your balance, the more you pay in investment fees.

First, the fees are distributed to the fund company that created the fund for you. Then, fees are paid to your adviser. While this is usually someone whose job is to meet with you and educate you on your 401(k), they’re also licensed to sell these funds and get a kickback for doing all the foot work to bring the client to the table in the first place. As long as your 401(k) is running, they’re getting a percentage, too.

401(k) participants should realize that while there is no free lunch.

 

 

 

Does Your Small Business Buy Into Bogus 401(k) Misconceptions?

 

by Andrew August 25, 2015 at 8:15 am

Small business owners wear quite a few hats:

Accountant, HR consultant, sales lead, recruiter and face of the company. It’s no wonder why they would shirk any additional responsibilities – including offering employee benefits like a retirement plan.

 

Don’t give into small business 401(k) misconceptions

In the past, small businesses have had few retirement plan options that were built for their needs and employees. The industry had no problem marginalizing small businesses in favor of large ones with huge plan assets.

The good news is that those days are long over! Still, many small business owners wrongfully buy into mistruths about retirement plans – especially 401(k)s – that were perpetuated a long time ago and continue to be believed today without merit.

I want to clear the air and put these common 401(k) misconceptions to rest once and for all.

  1. 401(k) plans are time-consuming and designed for big businesses

Unfortunately, a lot of small business owners are under the impression that 401(k) plans are a one-size-fits-all benefit that can’t be customized to meet their needs without the labor and high fees. Owners envision a heap of confusing paperwork, and they want to sidestep the additional time commitment.

The good news is there are plans available to small businesses that were designed with their needs and employees in mind. No longer do small businesses have to accept plans that are built for gigantic corporations with hundreds, if not thousands of people. Nowadays, plans exist that are customized for businesses with 50 or less employees. There are even 401(k)s built specifically for sole proprietors.

As far as the perceived time commitment, those same plans can be up and running in less than a week and require only an hour each month to maintain.

  1. Matching is a must

Even though matching employee contributions is a great way to recruit and retain talent, it’s not a requirement.

If a small business owner doesn’t want to or can’t afford to match, that’s perfectly fine. As an employer, you are already offering a wonderful service to employees by implementing a plan – matching, while there are tax benefits that come along with it, is simply icing on the cake.

For your hard-working employees, at the end of the day, some savings is better than no savings.

  1. 401(k)s are too expensive to implement and maintain

We know the thought of extra administrative fees weighs heavy in the minds of small business owners. Though there is some relief–through a tax credit—up to 50 percent of the cost to set up and administer the plan.

Ultimately, a plan’s cost depends on the bells and whistles that come with it—some basic plans can cost as little as $90 a month – that’s less than what your business likely pays to fill the water cooler each month!

  1. High fees and poor advice are just part of the deal

Small business owners face many challenges and work way more than the average person to keep their business running efficiently. Why then do some retirement industry companies still expect you to settle for an inferior plan that charges exorbitant amounts and doesn’t offer solid advice on how to invest? Just because you may have fewer employees does not mean your retirement plan should suffer.

When the right plan is selected, small businesses are able to access low cost, effective funds for their 401(k) plan. No longer will small businesses and their employees settle for poor performing, high cost funds that just absorb returns.

Likewise, employees should not feel like they’re alone and in the dark when selecting the retirement plan that will hopefully lead to their dreams coming true.

Small business owners shouldn’t be misled and buy into common myths that will discourage them from offering a 401(k) plan. Giving your employees a way to save for their retirement is a cheap and easy way to attract and retain talent and maintain an edge against the competition. For employees, participation in a 401(k) plan is a simple, effective way to save for retirement.

Now that you’re armed with the truth, march fearlessly into the next steps of retirement planning!

 

 

 

 

 

 

Benefit Opportunity Results From Weak Markets

September 29, 2015 by Robert C. Lawton


By Robert C. Lawton, AIF, CRPS, President, Lawton Retirement Plan Consultants, LLC

The bad equity markets have one silver lining for those executives in your organization that might have large 401(k) account balances: In-plan conversions to Roth 401(k) accounts.

Why now?

Most of us have experienced significant declines in the value of our 401(k) account balances as a result of weak equity markets. For executives, these losses may have been even greater if they had a well diversified 401(k) account with a heavy allocation to equities and exposure to commodities. These executives may have unrealized losses in their accounts of as much as 20% or 30%.

Converting pre-tax 401(k) balances into after-tax Roth 401(k) balances results in taxation of the previously tax-free amounts. Converting when the account value is lower may result in a substantial tax savings. Following is an example.

In-plan Roth 401(k) conversion example

Let’s assume one of your executives has a $1,000,000 account balance and is interested in converting 20% of it into a Roth 401(k) account. Prior to the recent decline in market value, assume that the existing $200,000 slice of this executive’s account was worth $300,000. In other words, assume the executive has experienced a 33% decline in the value of his/her account.

Taxes are due on any amounts converted into Roth 401(k) accounts. So the executive would owe state and federal income taxes on the $200,000 of his/her account balance that was converted. However, the executive would save paying taxes on the difference between the previous value of $300,000 and the current value of $200,000. In this example, an executive subject to a combined 30% state and federal tax rate would save $30,000 in taxes, and possibly much, much more.

Additional benefits of Roth 401(k) accounts

Roth 401(k) account balances residing in the accounts for five or more years and withdrawn for permissible reasons are not subject to any state or federal taxes when distributed. We know the markets will bounce back and assuming that this executive experiences a reasonable rate of return for the next 10 years, his/her tax savings on the $200,000 that is converted and withdrawn completely tax free sometime in the future could be enormous.

What you should do

Roth 401(k) in-plan conversions can benefit almost any plan participant. In order for your 401(k) plan to permit such exchanges, it needs to allow for Roth 401(k) accounts and in-plan conversions. If your plan currently isn’t structured this way, don’t worry, all you need to do is amend it.

There aren’t many benefits your executives can enjoy these days. Consider sharing this opportunity with them.

 

 

 

 

 

 

 

Delinquent Form 5500 filers find help

 

Late to file? You might still avoid a penalty

Sep 28, 2015 | By Nick Thornton

A joint initiative by the Internal Revenue Service and the Department of Labor is examining Form 5500 filings for the plan year ending in 2011 to smoke out those sponsors that have yet to file but were required to.

The initiative is being overseen by the Employee Plans Compliance Unit at the IRS and the Office of the Chief Accountant at the DOL, according to information released on the IRS’s website earlier in September.

The IRS says the primary goal of the program is to ensure compliance.

However, the regulators would also like to know why sponsors who were required to file Form 5500s didn’t, and whether or not the agencies need to do anything to remove “impediments to compliance.”

Under the Employee Retirement Income Security Act, Form 5500s are due to the IRS the last day of the seventh month after the plan year ends, according to the agency’s website.

So for the plan year ending in 2011, the due date would by July 31 of the next year for a calendar-year plan.

The DOL and IRS try to discourage late filers by imposing steep fines. The IRS penalty is $25 per day, up to a maximum of $15,000. That would mean 600 days worth of fines.

For the DOL, the penalty is potentially far more severe. It can run up to $1,100 per day, with no cap on a maximum penalty.

Those penalties present the potential for some massive punishment. More than 1,100 days have passed since July 31, 2012—the due date for plan year 2011 filings.

Conceivably, plans delinquent for that entire period could face fines that surpass $1.2 million.

But the IRS and DOL are not without a more merciful side.

The DOL’s Delinquent Filer Voluntary Compliance Program significantly reduces delinquency penalties if late filers submit the Form, along with those reduced penalties, before the DOL notifies the plan administrator about the delinquency.

Which is to say, if a plan turns itself in before the DOL catches the delinquency, a lot of money can be saved.

Just how much? For small plans with fewer than 100 participants, the fine is $10 per late day, with a $750 cap.

Large plan filers also pay a fine of $10 per day, with a cap at $2,000 per benefit plan.

There is one important “wild card” in the question of whether a sponsor, who might have been under an honest but mistaken perception that it was not required to file a Form 5500, would be eligible for relief under the Delinquent Filer Voluntary Compliance Program.

Plans that receive a late-filer letter from the IRS are still eligible for the relief under the program.

However, if a plan administrator fails to self-correct the issue before receiving DOL notice, they are not.

If a sponsor were to discover that it should have filed when it had not, why wait and take the chance of hearing from the DOL first, potentially eliminating eligibility for the fine relief under the delinquency program, asks Christopher Allesee, an attorney with Graydon Head and Ritchey.

In a blog post, Allesee says, “if you do not file a Form 5500, take a second look at your health or welfare plans to make sure they are not subject to ERISA, or that your plan meets an exception to the filing requirements.”

He adds: “For any filings you have missed, consider submitting under the delinquent filer program as a proactive measure, or you may wind up explaining your actions to the IRS and might even lose out on the chance for a far cheaper resolution through the DOL’s delinquent filer program.”

 

 

 

401k Document Retention Rules Made Simple

Posted by Eric Droblyen on Oct 7, 2015

Did you know that ERISA requires all employers to retain detailed 401k documents, including testing results, transactions and employee activity – for at least 6 years? If you did not, you’ve got a lot of company. Nevertheless, it’s important to understand and comply with these rules. While only small civil penalties are possible if required plan records are not preserved, missing records can make it more difficult for a 401k sponsor to defend plan operations or the accuracy of benefit payments if they are ever challenged by the IRS, DOL or plan participants. That can increase liability.

In general, 401k plan records must be kept for a period of not less than six years after the filing date of the IRS Form 5500 created from those records. However, records necessary to a participant’s claim for plan benefits must be kept longer. These records must be kept “as long as a possibility exists that they might be relevant to a determination of the benefit entitlements of a participant or beneficiary.” This can mean indefinitely.

Some of the most common plan records a 401k sponsor must retain are itemized below. To organize this information, I recommend using three files – a file to store documents that govern plan operation (a “Plan Document File”), a file for participant records (a “Participant File”), and a file for plan year information (a “Plan Year File”). This simple three file system should make it easy to access plan records if they are ever needed.

Plan Document File

This file should contain the plan’s operating documents. As items in this file are replaced by new documents, it is recommended you archive each replaced item in a safe spot for historical reference.

Items to keep in the Plan Document File include:

  • Plan Documents – adoption agreement, base document, IRS advisory letter, amendments, QDRO policy, and loan policy (if loans are permitted)
  • Participant Disclosures – Summary Plan Description (SPD), Summary of Material Modification (SMM)
  • Corporate Actions – resolutions, agendas, minutes, and documents distributed at meetings  
  • Service Agreements – Includes all plan service provider contracts
  • 408b-2 Fee Disclosure(s) – Includes fees and services delivered by plan service providers
  • Fidelity Bond – ERISA Section 412(a) requires every fiduciary of an employee benefit plan and every person who handles funds or other plan property be bonded.                  

Participant File

This file should contain forms provided by plan participants. Generally, these forms direct the 401k sponsor to take certain actions on the participant’s behalf.

Items to keep in the Participant File include:

  • Payroll Records
  • Participant Deferral Election Forms
  • Investment Election Change Forms
  • Beneficiary Designation Forms
  • Distribution Request Forms (with any supporting documentation)
  • Loan Request Forms
  • Rollover Requests
  • QDRO Split Requests (with supporting documentation)

Plan Year File

This file should contain important records related to a plan year. A Plan Year file should exist for each plan year the plan has existed.

Items to keep in the Plan Year File include:

  • Annual Valuation – Contains participant-level transaction information for the plan year, including contribution, distribution and fee activity. If received quarterly, file all four quarters.
  • Annual Trustee/Custodian report – Contains trust-level transaction information for the plan year, including all purchases and sales that occurred in trust. If received quarterly, file all four quarters.
  • Annual Nondiscrimination Testing – 401(k) plans have various testing requirements. Most common tests include:
    • Coverage (IRC Section 410(b)) testing
    • Actual Deferral Percentage (ADP) and Actual Contribution Percentage (ACP) testing (non-safe harbor 401(k) plans only)
    • Excess Deferral (IRC Section 402(g)) testing
    • Annual Addition (IRC Section 415(c)) testing
    • Top Heavy (IRC Section 416) testing
    • Rate Group (IRC Section 401(a)(4)) testing (“new comparability” plans only)     
  • Annual Participant Notices – Any notices provided to participants, including (as applicable):
    • Participant fee disclosure (ERISA 404a-5) notice
    • Safe harbor 401(k) plan notice
    • Qualified Default Investment Alternative (QDIA) notice
    • Automatic (negative) enrollment notice               
  • Form 5500 – Copy of Form 5500 with related schedules as filed with Department of Labor (DOL)
  • Independent Audit Report – If required to be filed with Form 5500
  • Summary Annual Report – Summary of Form 5500 provided to participants

Don’t get into trouble when document retention is easy

A retirement plan, by its very nature, generates large amounts of documentation and preserving much of it is required by ERSIA. Developing a filing system can make it easy for 401k sponsors to review, update, preserve, and dispose of documents.

These systems do not need to be complex. A simple system with 3 file types can do the trick. Ready access to plan documentation can mean the difference between a quick, cost-free settlement to a 401k dispute or a drawn-out, costly battle.

 

 

 

 

 

 

 

Selecting 401k Service Providers: Determine the Professional Help You Need Before You Shop

Posted by Eric Droblyen on Oct 21, 2015

  • Selecting competent service providers is the most important - and most confusing - fiduciary duty of a 401k sponsor. Why? Services offered by 401k providers can vary dramatically in breadth, depth and price. This variability makes it difficult for 401k sponsors to match appropriate services to plan needs. Many small business 401k plans pay for superfluous services participants do not use. These excess services are often expensive, dragging down participant investment returns and creating potential personal fiduciary liability for the 401k sponsor.

If you sponsor a 401k plan, I recommend following a two-step process to ensure your plan does not pay fees for services your participants will not use: 1) understand the services that compose a 401k plan and 2) determine which of these services require professional assistance to deliver. Once this process is complete, you’ll be ready to shop for professional service providers.

Step 1 – Understand 401k services

Every 401k plan requires multiple services. These services fall into two categories, plan administration or investment management.

a. Plan administration services include:

  • Custody – to hold plan assets in a trust and execute trades
  • Recordkeeping – to track contributions, earnings and investments on a participant-level and direct the custodian to execute trades
  • Third-Party Administration (TPA) – to complete plan design and annual ERISA compliance (testing, Form 5500, plan document maintenance, participant notices)

b. Investment management services include:

  • Plan-level services – to select a fund lineup for participants to choose from
  • Participant-level services – to assist participants in choosing investments for their account

Step 2 – Determine the 401k services for which professional assistance is needed

  1. Plan administration services

    Virtually every 401k plan today outsources plan administration services to a professional service provider because it’s rarely cost effective to do this work in-house - recordkeeping software is expensive, while securities trading and ERISA compliance requires years of specialized experience.

    The question is not whether your plan needs a professional plan administration service provider, but how many it needs – it can sometimes take more than one provider to deliver plan administration services. While Employee Fiduciary provides all 3 plan administration services, many providers just offer 1) custody and recordkeeping (“recordkeeping only”) services, or 2) TPA services. When a provider fails to offer all 3 plan administration services, a second provider must be found to deliver the missing service(s).
  2. Investment management services

    While a professional service provider is required nearly 100% of the time to deliver plan administration services, the same is not true for investment management services – a professional financial advisor may not be required. To make this determination for your plan, consider:
  • Your plan’s investment objectives
  • The type of investment advice wanted for participants

Plan investment objectives

For decades, actively-managed mutual funds were the most popular type of investment used by 401k plans. Actively-managed mutual funds employ portfolio managers to attempt to select stocks that beat market benchmarks like the Standard & Poor’s 500. Recently, however, passively-managed index funds have grown increasingly popular. In contrast to actively-managed funds, Index funds try to track (not beat) the performance of a particular market benchmark—or "index"—as closely as possible.

Why are index funds growing in popularity? While it may seem counter-intuitive, a growing body of academic research has shown that index funds outperform most of their actively-managed counterparts over decades of 401k investing, particularly after all fund expenses are considered.

If you prefer index funds, a financial advisor may not be required because it’s not difficult to pick funds that deliver “market returns.” An example of an all index fund lineup can be found here.

If you prefer actively-managed funds, use of a financial advisor is highly recommended. It takes a lot of skill to consistently pick actively-managed funds that outperform their index fund counterparts. Using actively-managed funds also requires much more sophisticated monitoring to ensure investments outperform their index benchmark and peer group averages. Fiduciary liability can result if high-priced actively managed funds underperform their lower-priced index fund counterparts.

Participant investment advice

Participant investment advice is important. 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. In short, professional advice is proven to help participant investing success.

Generally-speaking, there are two ways 401k plans deliver participant investment advice today:

  • Design-based – TDFs or Target Risk Funds (TRFs) are included in a fund lineup to give participants access to professionally-managed investment portfolios. Participants invest 100% of their account in the most applicable fund.
  • Advisor-based - A financial advisor is hired to either construct custom TDFs or TRFs for participants to select or give one-on-one investment advice.

If you prefer the design-based approach, a financial advisor may not be required since participants can achieve professional portfolio management by investing 100% of their account in the fund that best matches their estimated retirement date (if TDFs are used) or risk tolerance (if TRFs are used).

If you prefer more customized investment advice, you should hire a professional financial advisor.