As part of the Department of Labor’s safe harbor requirements, plan administrators must review their plan regularly. My recommendation is that you have a comprehensive review of your plan a minimum of every five years.
Most 401k plans underperform, meaning reduced returns for participants and increased risk of lawsuit against plan administrators, who act as fiduciaries. The 401k plans that I review generally underperform in one or more of five main areas…
1. Safe Harbor Laws
Every business owner who provides a 401k platform for his or her employees is sold the program with the assurance that it is compliant with the safe harbor rules set out by the Department of Labor. This is almost never true. I know this because it is simply not possible to meet every DOL safe harbor provision. And yet, you as a business owner are told that you are “okay”, that you are safe from a lawsuit by a former employee because you meet the requirements of safe harbor. You owe it to yourself to find out exactly how well you do meet the guidelines and where you might be at risk. An audit by the Department of Labor is no picnic. You must be able to demonstrate a due diligence to comply.
Despite its importance both to participants and administrators, diversification is widely misunderstood and grossly lacking in most 401k plans. It’s important for three reasons:
i. The investor’s risk of loss in any given period is increased if he or she is not diversified prudently. This adds unnecessarily to your employees’ stress levels, which further incites them to make poor investing decisions and often keeps them from saving what they need to. Incidentally, offering twenty mutual fund options does not necessarily mean you have given your plan participants the ability to diversify prudently based on the Department of Labor’s definition of the term prudent.
ii. A lack of diversification reduces the returns in portfolios. For an employee who saves $500 per month over 30 years, a 2% decrease in return due to lack of diversification will lead to $350,000 of lost account value. Not only is this a big negative for the employee over time, it is also the single greatest reason you may be liable as a fiduciary and open to lawsuit by the employee. I’ll talk more about this in number five below.
iii. As alluded to above, if the Department of Labor does not see that you have given your participants the ability to diversify, your entire safe harbor “covering” is removed. You’ve failed the test. To offer prudent diversification, you need to know the standard against which your plan will be measured.
This starts by evaluating the need for 401k, SoloK, or one of the simpler plans. If your company has changed size or shape in the past five years, then you probably need to have this evaluated. And yet, annual 401k plan costs are not the most costly component of your offerings. Costs that you know about often pale in comparison to the costs you don’t see. “No load” mutual funds and target-dated type funds are among the costliest fund choices you can offer your employees. The example given above of a participant missing out on 2% in return due to lack of diversification would result in the same way here for costs—a potential loss of $350,000. And the same litigation risks apply to you the plan administrator.
4. Automation and Technology
This includes both participants and the HR staff. Moving your plan into the year 2012 is not difficult if you are working with a provider who understands how to leverage technology. Your 401k plan ought to sell your business to your current employees and to new recruits. It should be impressive. Your plan also ought to be easy to work on and in. It ought to adapt easily to changing laws and to your changing work force. And time is money, so a plan should be cost effective to you the administrator. Do you love your plan? Do your employees love it? All of you should.
5. Undisciplined Behavior
There are two reasons why your employees will not have enough money to retire: they haven’t saved; and/or their mutual fund manager has ruined their returns by bad behavior. It’s time that plan administrators recognized two things: One, many of your employees are so stressed out about money that they will not save in their 401k plan, and they will likely not be as productive at work as they could be. Two, your employees (even the ones who do save) have no idea how to be disciplined and successful investors. You don’t have the time to coach them, and yet, according to the safe harbor rules I mentioned above, you need to be coaching and educating them. If you are not providing them with valuable educational opportunities annually to help them succeed as investors, you are not compliant with safe harbor regulations. Just as important though, with some discipline, your employees’ success in your plan and their loyalty to you and your vision could be far greater than it is today.
401k plans should be fully reviewed every five years
Given these areas of concern, your plan ought to be evaluated every five years. This is not a difficult process and does not take a large investment of time or money. But you need to do it so that you are reducing your exposure to risk, reducing your exposure to costs, and giving your employees the best opportunity to achieve market returns and experience peace of mind with respect to their financial futures.
When DALBAR = MARKET, I’ll stop. Until then . . .
Why am I so passionate about this? I am convinced that the average family, coached well, can achieve full market returns in their investments over the long haul and have peace of mind along the way. DALBAR studies show year after year that the 20-year investor is getting 3 or 4% while the market is getting 10%. Adding to that frustration, the number of fiduciary lawsuits by employees against employers is rising annually as investors are being convinced by attorneys that their employer and their 401k platform were in fact responsible for these poor returns.
This is disheartening for the investor, and it has the potential to be devastating for plan administrators. You work hard for decades to build a team, build your vision, and build wealth for you and those who work for you. You work hard only to find that your valued employees have achieved less than adequate results and that you are more liable as a result. This is no way to live.
Plan Administrators and Investors, meet your Free Market Fiduciary partner…
The Free Market Fiduciary is the answer for any employer, family or investor working in any capacity on behalf of others.
The Free Market Fiduciary is the only system that will reduce all forms of fiduciary and investor risk while increasing the opportunity to achieve full-market returns.
The Free Market Fiduciary partners with Financial Peace for the Workplace to provide on-going, personal financial coaching for companies of any size so that every employee can win financially.
Contact us today for your free Awareness Guide and make plans to attend an upcoming event.
CORNERSTONE WEALTH PARTNERS.
Offices in Grand Rapids and Mid-MichiganCorporate Office 1600 East Beltline SE Ste 212 Grand Rapids, MI 49525 616-458-6480
Mid-Michigan Office 2525 Jolly Road Ste 220 Okemos, MI 48864 517-381-3450
Many of the above issues apply to anyone managing money on behalf of another. The following is a non-exhaustive list of other types of portfolios and plans that should also be reviewed every five years.
~ Children acting as Fiduciary to aging parents
~ Fiduciary for a sick or permanently disabled person
~ Parent or grandparent managing a portfolio for the education of children
~ Association Director managing an investment portfolio on behalf of the association, its members and/or constituents
~ Pension plan administrators
~ Non-profit organization managing wealth for future expenses
~ Endowment fund fiduciaries