My latest JDSupra.com article can be found here.
They often say that the road to hell is paved with good intentions. I don’t know who said it first (I heard it was originated with St. Bernard, the saint, not the dog), but perhaps they were a 401(k) plan sponsor that had a loan provision that did the plan a lot of harm.
While the idea of a retirement plan is for a savings vehicle and any access by the participant to that money defeats that purpose, I like offering the provision so that a participant can leverage it when they are in a cash bind. If it’s their money, they should be able to tap it if they really need it.
The problem with the loan provision is that I have come across too many compliance issues with it that has caused plan sponsors lots of grief. The grief usually involves the requirement that the loan be paid back in at least a quarterly basis or be considered a default, where the participant is required to receive a 1099 form for a deemed distribution. This error is as result of the third party administrator not keeping tabs on the loan. This may be a result of an incompetent administrator, incompetent plan sponsor, or as a result of the plan offering multiple loans. Any loan that does not meet any of the plan loan requirements is considered a prohibited transaction, which risks the plan’s tax qualification.
How to avoid the mess? I still think having a loan provision that offers multiple loans is a recipe for a disaster, I always recommend only allowing one loan outstanding at a time. In addition, make sure the TPA you work with has the software necessary to track these loans, as well as making sure the payroll information is correct for loan repayments.
About a dozen or so year ago, there was a medical report that dental plaque could cause heart disease. The cynic in me tells me that this was some sort of dental conspiracy to increase revenue as fluoridated water and other dental hygiene has had to have a negative effect on the dentists’ bottom line. Regardless of my cynicism, good oral health is important.
While some people only see a dentist when something in their mouth hurts them, many visit the dentist for annual or semi-annual checkups as preventative care, to avoid dental problems later. Brushing, flossing, and checkups help avoid the root canals, caps, and dentures.
As an ERISA attorney, sometimes I see myself as a retirement plan dentist. While some plan sponsors only seek counsel from an ERISA attorney when something terribly goes wrong with their retirement plan, there are many plan sponsors these days that seek ERISA counsel as a form of preventative care for their retirement plans. Seeking counsel from an ERISA attorney can be like seeking a dentist in avoiding greater harm. Part of the marketing of my practice has been to advise plan sponsors and their financial advisors that their retirement plan should be reviewed on annual basis to determine whether it’s being properly administered and whether the expenses for the plan are reasonable. These are preventative steps to avoid potential liability as a plan fiduciary. My Retirement Plan Tune-Up (which you will be hearing more about in the near future) is a legal review where I look at the plan terms; plan administration, and fiduciary to determine what works and what needs to be corrected.
Plan sponsors should review their plans to determine whether the plan still fits their needs and whether there are potential liability pitfalls in plan administration and the fiduciary process.
In my articles and my blog posts, I highlight the potential liability pitfalls that a plan sponsor needs to avoid. Whether it’s the lack of an investment policy statement or high fees, these are pitfalls that plan sponsors can minimize through best practices.
Some critics of my writings claim that small to medium sized employers rarely get sue for breaches of fiduciary duty, so I am in the market of selling useless legal services. I guess that is my version of the plaque causing heart disease theory. While the chances of a small to medium size employer getting sued are slim, the threat is still there. The chance of getting hit by lightning is remote; we still minimize the risk of getting hit by avoiding standing near trees or staying outside. In addition, ERISA litigation progresses and when ERISA attorneys run out of suing the larger plans for fiduciary duty breaches, where will they turn next? Regardless of the small risk or not, plan sponsors should follow good practices because good practices tend to avoid bad results. In addition, poorly run small retirement plans have other things to fear such as an audit by the Internal Revenue Service and the Department of Labor or just the threat of litigation by a terminated employee who just wants a couple of shekels after termination of employment.
Like their teeth, plan sponsors should have their plans checked on an annual basis to avoid a retirement plan root canal later.
A family member once said: “there are a lot of yous (sic) and only one me.” That may not be the nicest and most selfless thing to say, but that’s something retirement plan sponsors should think when it comes to the needs of the retirement plan. Maybe Captain Kirk said it best in Star Trek III, when he contradicted the viewpoint of Captain Spock who gave his life to save the Enterprise at the end of Star Trek II by saying: ‘the needs of the one outweigh the needs of the many.” The needs of the retirement plan sponsor’s plan outweigh the needs of the retirement plan providers.
A retirement plan sponsor always needs what is best for the retirement plan and if their current plan provider can’t handle what they need, it’s time to wave goodbye. There are too many third party administrators (TPA) who don’t have the flexibility to administer plan provisions or different retirement plans that a plan sponsor needs. If what’s best for a plan sponsor that they have a defined benefit plan in addition to a 401(k) plan to maximize the retirement savings of their highly paid people and their current TPA can’t handle it, it’s best to find a TPA who can. Otherwise, the plan sponsor can’t maximize retirement savings and Uncle Sam gets more tax dollars.
I recently came across a retirement plan sponsor that has a plan with two adopting employers where there is some common ownership, but not enough to be a controlled group. By not being in a controlled group, these three companies have to bee separated for testing purposes. The incumbent TPA said they can’t handle this type of plan (the plan is now considered a multiple employer plan) and the plan sponsor would have to set up separate plans for the companies, which would unnecessarily drive up administration costs.
A plan sponsor has a fiduciary responsibility to the plan, not the plan sponsor. If the plan provider no longer fits, it’s time to find one that does, like a glove.
While the talk about retirement plans is usually centered on 401(k) plans, the value of a defined benefit plan for those companies that could afford it should not be discounted. Thanks to the generous deductible contribution of the requirements of minimum funding, small business owners can certainly sock away more money than they ever could do with a defined contribution plan.
The problem with these huge deductible contributions, is that there are always some unscrupulous plan providers that exploit the defined benefit plan sponsor’s ability to make large contributions to their own advantage.
Defined benefit plans are huge savings vehicle for retirement, but they should not be used solely as a vehicle to purchase life insurance. I have seen too many defined benefit plan sponsors purchase large life insurance policies where their minimum funding contribution is used solely to pay the premium of a large insurance policy within the plan. The problem? When times go bad and the plan sponsor doesn’t have the financial wherewithal to continue making the contributions, they essentially forfeit the goal of the life insurance policy. A company that didn’t buy a policy or bought a smaller policy is in a better spot as ceasing future accruals isn’t such a calamity as to those that lost their policies.
Life insurance is an attractive tax savings vehicle with a defined benefit plan, but like red meat and wine, it should only be used in moderation. I would recommend avoid setting up a defined benefit plan with the whole purpose of funding life insurance. I would recommending not using a third party administrator (TPA) who also sells life insurance because I believe it’s the ultimate conflict of interest when your plan designs you create as a TPA is used to sell life insurance you’re selling. Let’s face it; there are bigger margins in life insurance than plan administration. Also avoid defined benefit plans that feature special trusts and special trustees as the Internal Revenue Service have found these as possible grounds for plan disqualification.
How to avoid these insurance hucksters? Pick a TPA that is independent from an insurance sales person, make sure your entire annual minimum contribution isn’t fully used to pay the life insurance premiums, and get a second opinion from an ERISA attorney.
Defined benefit plans should be used to save for retirement, not to net an insurance salesman a huge commission.
When the great Bill Parcells (go Big Blue!) was the head coach of the New England Patriots, he got into a tiff with owner Robert Kraft because Parcells wanted more of a say in the personnel decision-making process. Parcells famously said: “They want you to cook the dinner; at least they ought to let you shop for some of the groceries. Okay?” It sort of reminded me of my old law firm, where I was asked to feed people (by getting new clients) and I had someone who doesn’t cook (the Advertising Committee of one) tell me which ingredients I could use.
I admit it; I am more comfortable when I have control over things. When I have control, I succeed or fail based on my decisions instead of a bureaucracy that is less interested in my success and more interested in playing political games.
As someone who likes being in control, it should be no surprise that I like the proliferation of ERISA §3(38) fiduciaries and I think registered investment advisors (RIAs) who are interested in the retirement plan business should have the goal of offering it to some of their clients.
Once again, the use of ERISA §3(38) fiduciaries is a great fit for some plan sponsors who have none of the time or interest in keeping up their end in the fiduciary process of selecting plan investments and educating plan participants. The ERISA §3(38) fiduciary is a great solution for these type of plan sponsors because the fiduciary is defined as an “investment manager” under ERISA and assumes almost all of the liability (hiring a bad fiduciary is a breach of the plan sponsor’s fiduciary duty) of handling the investment decision making process.
I think advisors (as long as they are surrounded by a good team including a good ERISA attorney (cough, cough) ) should consider entering that space so that this solution could be offered as one of their services.
While some RIAs consider the liability aspect of it, the increased liability will always be offset by engaging in good processes (recording decisions, offering educating, memorialized investment choices in an investment policy statement) and by picking the right type of plan investments (most of these investment managers are using passive funds such as exchange traded funds, Dimensional Fund (DFA) and Vanguard index funds).
I always say that if you can’t do it right, don’t do it all. ERISA §3(38) fiduciaries should be for those RIAs that are serious about their trade as retirement plan financial advisors and should not be for those who don’t understand their roles as financial advisors for retirement plans. If you are serious about entering the space, speak to an ERISA attorney or speak to current ERISA §3(38) fiduciaries who partner with RIAs who don’t want to be in the space like James Holland at Millennium.
In addition, I will be making an announcement in the coming year on how I will be providing a bigger role for RIAs who want to be in this field.
As an ERISA §3(38) fiduciary, you get to buy the groceries and cook, the only thing to avoid is burning the meal.