The Pension Protection Act and recently passed pension legislation amounted to hundreds of pages of regulations affecting 401(k)s and other retirement plans. The size and heft of these laws speak volumes about the complexity and difficulty of administering retirement plans.
In addition, the Department of Labor has increased the number of retirement plans that it audits. DOL statistics show an estimated 70 percent of retirement plans audited in 2009 and 2010 were fined, received penalties or had to make reimbursements for errors. During this time period, the DOL collected $1.08 billion in corrections, reinstatements and fines.
“Fortunately, business owners who provide retirement plans for their employees don’t have to digest the Act or become experts in pension administration if they simply consult a local third-party administrator,” says Brian M. Smith, Director of Sales and Consulting with Tegrit Group.
Smart Business spoke with Smith about how to utilize third-party administrators (TPAs) when trying to decide how to structure your company’s retirement plan.
How can a TPA help with retirement plans?
TPAs provide a wide range of retirement plan services for business owners, from consulting on regulatory changes and maximizing retirement plan designs to administering defined contribution and defined benefit plans. Many small and medium-sized employers lack a dedicated, in-house specialist to administer retirement plans. Working with a local TPA fills the need to have a benefits expert close at hand.
TPAs work closely with dozens of business types in a variety of industries. They understand the challenges business owners face such as rising taxes and business expenses, health care reform, retaining talented employees and more. That means your local TPA is well equipped to help you design a retirement program that meets the unique needs of your company, squeezes the most out of your benefit dollars, provides incentives for your employees and helps you accomplish your own retirement goals.
Why is this kind of assistance so important to business owners?
Running a successful business of any kind is more difficult than ever in today’s challenging economic climate. For many business owners, offering a qualified retirement plan is an ideal way to attract and retain key employees, as well as help the owners plan for their own retirement. For example, given the competitive work landscape, employer match programs are becoming more popular as tides are turning.
The issue facing many business owners is determining the type of plan that is best for their employees and themselves. Is it a defined contribution plan like a 401(k) or a defined benefit plan?
Selecting the right plan for your business is a crucial step and a third-party administrator, with expertise in plan design and administration, can help assist you in meeting your fiduciary responsibility to the plan while providing a path for your participants to achieve their retirement goals.
Has it become common for business owners to utilize TPAs to administer their retirement plans?
When you bring together years of experience implementing and serving plans, the retirement plans can be more specialized. Businesses can think more outside the box with the expertise of TPAs, as there’s no longer a check-the-box, cookie-cutter solution.
What should an employer look for when deciding on a TPA?
Before you team up with a local TPA firm, make sure you do your due diligence, as not every TPA has the same level of expertise. Ask the right questions to make sure you have a good fit, such as:
- How extensive are the TPA’s services? Does the TPA specialize in a specific niche such as 401(k) plans, or does the firm consult on a broader range of retirement benefits?
- What is the TPA’s reputation in the marketplace? Check references to determine if the TPA is easy to work with, whether or not it delivers quality service and if it designs effective retirement plans. Ask for specific case studies.
- How long has the firm been in business? How many plans and participants does it service?
- Is it willing to propose a retirement plan design for your company, at no cost, that takes into account your employee and business needs?
- How many employees does it have? Do employees have credentials or receive training from professional organizations such as the American Society of Pension Professionals and Actuaries?
If you are unaware of the TPA firms that are available locally, contact the provider of your retirement or other benefits programs for referrals. Most providers work with a nationwide network of TPAs that most likely includes some in your area.
Is a team approach or one administrator better when using a TPA for your retirement plan?
There is no right or wrong answer as it depends on the needs of the business. However, a larger TPA firm has the ability to fill more needs than one CPA. The large firm can focus on a host of services from actuarial consulting to plan design to document services. A one-person CPA firm that provides TPA work will be limited in what it can do, so these firms often focus on one piece of the business.
Brian M. Smith is the Director of Sales and Consulting for Tegrit Group’s Columbus, Ohio, office. Tegrit Group is a national leader in actuarial consulting, plan administration and technology solutions for public and private retirement plan sponsors. Reach him at (614) 458-2060 or email@example.com.
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Many companies offer their employees bundled 401(k) products from mutual fund or insurance companies, but if the organization is unhappy with any component of the plan, it is forced to physically move the plan’s assets and start over by selling them and then repurchasing them elsewhere because the individual plan components cannot be “unbundled.”
However, an open architecture plan allows employers to change any of the silos of the plan — the registered investment adviser, the third-party administrator, the record keeper — without having to move the plan itself, says Peter Mooney, CEO of Source Companies LLC, a subsidiary of The Ancora Group.
“The strength of open architecture is that you can custom build your plan to meet your needs and those of your work force,” says Mooney. “You can change any of the components of the plan without having to start over.”
Smart Business spoke with Mooney about how open architecture can ensure that you never have to move your plan again.
What are the disadvantages of bundled products?
When you use a bundled product, that plan is not owned by you, the employer. Instead, it is owned by the investment company, which negotiates each of the components and their fees, and then sells them bundled together.
As a result, you are tied to whatever the investment company has negotiated. If you are not happy with some component of the plan, you must sell all the assets, move the entire plan to another investment company and then repurchase the assets. That also requires terminating the relationship with your third-party administrator and setting up a relationship with a new one.
What is changing in the 401(k) industry?
Instead of the insurance or mutual fund company owning the 401(k) plan, companies are moving toward having a direct relationship with a custodian through open architecture. Then if, for whatever reason, you are not happy with an investment, for example, you can just change the investment. The same would be true with your third-party administrator, your record keeper or the performance of your investment adviser. The employer has control and can change out any of those components without ever having to change that core custodial account because your company owns that relationship.
With the recent requirements of full disclosure of 401(k) plan fees and more thorough reporting, there is an increasing trend toward open architecture. People are tired of physically moving their plan from company to company. It is disruptive to employees to have to sell everything and then repurchase it, requiring them to fill out forms and re-elect how their money is being allocated.
Open architecture makes everyone’s lives easier, allowing you to have a direct relationship with the custodian and giving you control over that relationship. You can replace your investment adviser, the third-party administrator or the record keeper, but you do not have to replace the base of what you started with.
Is an employer qualified to make decisions about changing components of the plan?
If your investment adviser is doing his or her job properly, you should be educated enough to make those decisions. There should be checks and balances of what to look for and to make sure that other people are doing their jobs. It sounds like it puts more onus on the employer, but it really does not.
As long as the plan sponsor and the advisor establish a proper investment policy statement, there is no more burden on the employer. In fact, it actually makes their life a lot easier in the long run.
What would you say to an employer who doesn’t want to be involved in those decisions?
Your investment adviser can take a fair amount of the responsibility off of the employer, but ultimately, you are still responsible for the plan. You need to be educated about the issues, and if you do not want to be involved in it at all, I would recommend that you do not offer a retirement plan.
What does a company need to be aware of regarding 401(k) fees?
Previously, many advisers claimed to sell 401(k) plans but were not really in the 401(k) industry. They may have sold two or three plans but were not advising them properly. Fees at that time were very, very high.
Over the years, the industry has consolidated and the surviving organizations that are in the business really understand 401(k) plans and make them their focus. The good ones are trying to drive down fees for employees as well as the employer while educating the trustee on the changes in the industry.
Most important, regarding fees, an employer must understand the value of the services being delivered by each of the service providers to ensure it is getting what it is paying for.
Employers should drill down to find out what each of the fees are. What are the investment adviser fees? What are the third-party administrator fees? What are the record keeper fees? And what are the custodian fees? Those are the biggest areas of fees associated with a 401(k) plan, outside of the expense ratio for mutual funds. What questions should a company be asking to ensure that they have the right 401(k) plan to meet their needs?
The plan sponsor should ask every service provider: How are you going to help my employees meet their retirement needs? What type of education do you provide me and my employees? Do you have a product that can grow with me as my business expands and changes? Can you provide me three references of similar companies to mine in size and industry?
Then make your decision based on what you learn.
Peter Mooney is CEO of Source Companies LLC, a subsidiary of The Ancora Group. He is also a Registered Representative of Safeguard Securities, Inc. (Duly Registered Member FINRA/SIPC and an SEC Registered Investment Advisor). Reach him at (216) 593-5095 or firstname.lastname@example.org.
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Successful retirement plan financial management requires careful coordination on the part of the employer. Without the knowledge to properly manage the plan, plan sponsors could face serious repercussions, says Gary Gausman, a senior consulting actuary at Towers Watson.
“For plan sponsors to manage their programs, there are four main areas to focus on — benefits policy, funding policy, investment policy and accounting policy,” says Gausman. “There are a number of things you can do in each area, and there is a lot of interaction between them that you need to be aware of.”
Smart Business spoke with Gausman about the keys to successful retirement plan financial management.
What do plan sponsors need to know about their benefits policy?
Look at the plan design to determine benefits that are going to be earned in the future and how you are going to deliver those. Also, look at your exit strategy for legacy liability. Employees have already earned benefits for service rendered to date, and there’s liability associated with those that you need to deal with. With legacy liability, there are former employees who are retired and are currently receiving benefits, those who have terminated employment and are not earning additional benefits but are entitled to benefits in the future, and active employees.
Retirees are receiving a monthly benefit and there’s not a lot the employer can do because benefits have already been earned and are being received. But you can mitigate the risks associated with retirees by purchasing an annuity contract from an insurance company to take that liability off your hands.
For those who have terminated employment who have not yet started their benefits but are entitled to future benefits, consider offering them the benefit in one lump sum payment. If someone is 45 and entitled to $1,500 a month starting at age 65, perhaps that person would rather get a lump sum now equal to the value of those payments. That removes some employer risk. Annuity benefits are payable until the person dies, which might not be for decades. But if you pay a lump sum equal to the actuarial value of the payments, you are done.
With active employees, look at plan design. Traditional plans are final average pay plans, where if you work for a company for 30 years, you get, for example, 1.5 percent of your final average pay per year, or 45 percent of your final average pay, starting at age 65. The risk to the employer is that the benefit is indexed to what the employee earned, for example, in the last five years before retirement, which could spike dramatically in an inflationary period. As a result, many employers have shifted to a career average approach, in which benefits are instead based on what the employee earned ratably over his or her career.
How can employers address funding policies?
To maintain the tax-qualified status of plans, employers must satisfy various rules, including putting in a certain amount of money every year. Historically, some have put in the bare minimum, but in 2006, new rules said that, in addition to satisfying minimum funding requirements, you also have to maintain a certain funded ratio, which is the assets of the plan divided by liability, to continue to operate the plan according to all of its intentions and be able to take advantage of funding exemptions. For example, if a plan allows lump sums, it must maintain an 80 percent funded ratio in order to be able to pay out lump sums
If a company is just trying to satisfy the minimum funding rules while maintain that 80 percent ratio, additional volatility in the contribution amount could ensue. Companies could instead consider a more generous funding pattern to develop a cushion so that in lean years, when plan assets may have dropped and business results aren’t up to expectations, you can draw on that excess. This funding policy could involve, for example, contributing a certain percentage of pay each year.
In the 1990s, when things were going well, some companies took their eye off the ball. They didn’t have to make minimum contributions because their assets were doing so well, and in many cases, that has come back to bite them, as they haven’t built up the excess they now would like to have.
How can investment policies impact employers?
For years, employers chased returns and forgot about liabilities in the plan and how those would play out over time. In the last 10 years, that strategy has not worked well, as the stock market has been very erratic. As a result, when liabilities increase, assets may decrease, creating an even wider gap. Employers are taking a more focused look at investments, trying to better match assets and liabilities so that if liabilities increase, assets increase, as well, and the gap will not change as much. With the transition to cash balance type plans that allow employees to take lump sums at termination, you need to make sure you have the liquidity to pay those out. And to do that, employers need to look at investments in a different light and better align them with their liabilities.
How do accounting policies play into the mix?
When implementing pension plans, companies made certain elections, and they are mostly tied to those. If you change your accounting policies or methods, it must be to a ‘preferred’ method. For example, many companies chose smoothing in their accounting policies. Depending on the methods chosen, this could mean that if assets tanked last year, they would not have to recognize the full decrease in one year, but rather could spread it out over up to five years. That’s been fine, but the trend in accounting is toward ‘mark to market’ accounting, which eliminates smoothing. The auditor wants to know exactly what your assets and liabilities are based on current market conditions, i.e., current interest rate market and current asset markets. This can have implications for a company’s investment policy and funding policy, for example. By understanding each of these areas and how they work together, companies can position themselves for successful retirement plan financial management and minimize their risks.
Gary Gausman is a senior consulting actuary at Towers Watson. Reach him at (818) 623-4763 or Gary.Gausman@towerswatson.com.
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Today, it’s not enough to simply select a retirement plan to offer to your employees. The rules are changing for plan sponsors, even if you have been working with the same broker for decades.
Business owners must understand and defend their retirement plan decisions. As a plan sponsor, you are considered a fiduciary, held to the standards of an industry expert.
And the Department of Labor is enforcing the laws with increased civil and criminal penalties being assessed. In 2010 alone, the DOL collected more than $1 billion in fines, says Richard Applegate, president, First Commonwealth Financial Advisors.
“Plan sponsors are trying to do the best thing they can for their employees, but increasingly, they have to be able to defend their plan decisions,” says Applegate. “There has been a movement toward expecting plan sponsors to understand their fiduciary responsibility and to develop processes that can be defended.”
Smart Business spoke with Applegate about a business owner’s fiduciary responsibility as a plan sponsor and how to withstand an audit.
How has the fiduciary environment changed for business owners who offer retirement plans?
In years past, retirement plans were primarily seen as a product, offered along with a company’s other benefits, such as group health, group life and other coverages. That was the case until the enactment of the Employee Retirement Income Security Act of 1974, which oversees how retirement plans are managed. But in the decades since ERISA’s enactment, many companies continue to handle their retirement plans as products, not processes that support the plan’s operation with the best interests of plan participants in mind.
Under George W. Bush’s administration, Secretary of Labor Elaine Chao emphasized procedures and processes that underscored a plan sponsor’s responsibility as a fiduciary. The DOL published guidelines to help plan sponsors adhere to these expectations and offered numerous regional seminars as part of that educational effort. Now, regulations going into effect in April 2012 hold plan sponsors responsible for knowing how their plan’s service providers are contracted, what they charge for their services, what those specific services are and whether the provider is acting as a fiduciary.
The message is this: Be prepared to defend all of the decisions made concerning your retirement plan and to show that you have a defined process that can be measured and repeated.
What responsibilities do plan sponsors bear by offering a retirement plan to employees?
Business owners who offer retirement plans generally do so because they believe the benefit is valuable for their workers. They are giving employees an opportunity: the ability to accumulate retirement dollars through a company-sponsored investment account.
But what many company owners may not recognize is that, as a plan sponsor, there is a tremendous amount of fiduciary responsibility. As fiduciaries of the plan, they are held to an expert standard, at least in the eyes of the DOL. If they don’t have the skills to meet such stringent standards, plan sponsors should choose and retain outside experts who can help guide them through the decisions that must be made on a recurring basis. But the DOL says the plan sponsor must be able to support the choice they made for the expert based on their qualifications and experience.
They also must be able to explain why the plan they chose and its underlying investments are the best options for their employees. Ultimately, this focus on process and the requirement to make informed fiduciary decisions is designed to build more plan sponsor accountability into their retirement plan operation. And since the DOL has stepped up its auditing and will continue to do so, plan sponsors must take care to understand their role and take the job of a fiduciary seriously.
It’s critically important for business owners in 2012 and beyond to completely understand the expertise of the professionals they hire to service their plan and find out whether they are contracted to serve as co-fiduciaries. This will be required by law, effective April 1, 2012.
How can a business owner find qualified fiduciary professionals?
Review the credentials of financial professionals and look for designations such as Certified Financial Planner™, Accredited Investment Fiduciary Auditor and Registered Investment Adviser. Choose an experienced fiduciary analyst and ask for referrals. Obtain disclosures that explain in detail what the professionals’ services include. What are the expenses? This must be spelled out in black and white as part of the new regulations. These disclosures allow business owners to compare one plan with another and to fully understand what they are paying one plan service provider versus competitors. Also, these disclosures are intended to shed light on any hidden fees.
How does a business get started with assessing an existing retirement plan and mitigating risk of an audit by the Department of Labor or other regulatory agencies?
The reality is, many business owners do not realize that they are at risk for an audit because they assume the financial services professionals they have worked with for years are looking out for their best interests. And perhaps this is true.
But that assumption is not acceptable in an audit situation in which a process must be defined and defended. It’s a good idea to consult with an Accredited Investment Fiduciary Auditor (AIFA™), who can take stock of your current retirement plan and help to develop best practice standards for the plan’s fiduciary processes.
Richard Applegate is president of First Commonwealth Financial Advisers, a Registered Investment Adviser. Reach him at (412) 562-3232, (724) 933-4515, or RApplegate@FCBanking.com.