The Rosenbaum Law Firm P.C. Blog

The safe harbor notice deadline for calendar year 401(k) plans is December 1. This notice is one of the requirements for a plan to be a safe harbor, in addition to the fully vested contribution that gives 401(k) plans a free past in the ADP test (for deferrals), the ACP test (for matching), and Top Heavy test. The notice in a sense is a proactive solution since you have to give the notice before the plan year starts (and you won’t be certain 100% that you failed until after the plan year ended), but most times, it is reactive because it is usually done in response to bad testing results.

I think one of the differences between a good third party administrator (TPA) and a bad TPA is how they handle safe harbor. Once again, a safe harbor option whether it’s the 3% non-elective, 4% match, or the automatic deferrals QACA match, it’s not for every plan. A plan that easily passes testing doesn’t need it and some plans can’t afford it. However, I have seen TPAs administer plans where the plan sponsor is already making a fully 100% vested contribution to plan participants that exceeds the contribution needed for safe harbor.  For example, I just came across a plan where the TPA is telling the client that they will likely fail the Top Heavy tests for 2011 even though they make a fully vested, 7.5% matching contribution.  So even though they make a contribution that could have satisfied safe harbor, it doesn’t, so the plan sponsor has to make another 3% contribution to non-key employees.  So if a company is consistently making a fully vested contribution that exceeds safe harbor, there is no harm for making it a safe harbor, it can be a pro-active solution to make sure the demographics of the plan don’t eventually one day cause the plan to fail one or more of the discrimination tests.

Plan design is like a game of chess, it is based on strategy and finding the right moves to achieve the maximum contributions and avoiding unnecessary harm like compliance testing issues. The good TPA is going to be pro-active and have a plan formula of contribution that will maximize contributions and avoid unnecessary contributions.

One of the most positive developments in the retirement plan business is the ERISA §3(38) fiduciary. The idea that a plan sponsor can shift almost all of their liability in the fiduciary process to an ERISA defined investment manager is attractive in a litigious happy environment. Sort of like having the folks at Fairway Market cook my Thanksgiving dinner, it allows the plan sponsor to delegate almost all of the headaches of being a fiduciary to the experts.

While I support the work of ERISA §3(38) fiduciaries, I have two concerns. They are two minor concerns that should not overshadow the good work of ERISA §3(38) fiduciaries.

First, I can’t put a sign on my front lawn that I am a lawyer unless I have been admitted to the state bar. The same can be said of advertising being a registered investment advisor (RIA) without the proper licensing and registration. However, I can claim to be an ERISA attorney without any experience and an RIA can claim to be an ERISA §3(38) fiduciary without any experience. While any RIA can learn to be an ERISA §3(38) fiduciary, it’s not something you can wake up one morning and can become one. So plan sponsors should be wary of people advertising themselves as an ERISA §3(38) fiduciary, because not all ERISA §3(38) fiduciaries are created equally. The proliferation of ERISA §3(38) fiduciaries will create a herd mentality where RIAs will tout their ERISA §3(38) services without understanding what that job entails.

So with the marketplace expanding with people claiming to be ERISA §3(38) fiduciaries, there will be some incompetent ERISA §3(38) fiduciaries out there who will make some mistakes that will lead to litigation and the issue is that ERISA §3(38) was drafted in 1974, years before there were ever 401(k) plans and daily valued, participant directed plans. While ERISA §3(38) fiduciaries assume the liability of being an investment manager in the contract (if drafted correctly), will courts decide that what the ERISA §3(38) fiduciaries really are who they say they are? Are their function covered under a definition that was drafted before there was a 401(k) industry> I don’t know, I’m not a litigator. I am also not stating that hiring an ERISA §3(38) fiduciaries are a mistake nor do I want to spread any innuendoes (like what happened with multiple employer plans), I just think that plan sponsors should hire competent fiduciaries and if RIAs want to be in the §3(38) game, they need to learn the rules. Learning the rules can be as simple as partnering up with a §3(38) like the my good friends at Loring Ward or my good friend, James Holland at MilleniuM Investment  & Retirement Advisors or learning to become one. 2012 is a year I will dedicate to helping RIAs understand the role of ERISA §3(38) fiduciaries and how to become one.

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As bad as I believe it is for plan sponsors, I believe that many retirement plan providers are not prepared for the coming changes in 2012. Many retirement plan providers have been ready for years, but I think there is quite a few that are not and that is a problem on many levels.

Obviously, every retirement plan provider has to be in compliance. It hard to be a third party administrator (TPA) or an ERISA attorney or financial advisor and touting how you can keep your client’s plans in compliance when you are not in compliance. However, I am thinking from a business standpoint.

As many of you know, I am a big fan of business history and why certain companies succeed and others fail. My belief is that one of the reasons why companies thrive or die can sometimes be based on changes in the marketplace.  In 1993, Blockbuster Video was a darling of Wall Street and was trying to merge with Viacom. Blockbuster never saw the changes going on with the Internet and streaming videos, allowing a small upstart called Netflix to help destroy their business. Eventually, Blockbuster will only survive as a brand name only for streaming videos and DVD rental kiosks, sort of the way Polaroid or The Sharper Image’s names only survive today. Ask the folks at Borders Books and look at the folks at Barnes & Noble, who are probably only in business today because of the Nook.

Changes in industry have winners and losers. The winners and losers are only determined as to who decide to allow the changes to add a competitive advantage to their business while the ones who died sat and did nothing.  The paralegal who had taught me most of what I know when I started in this business in 1998 really said it succinctly. She said when the Tax Reform Act of 1986 came out, many plan providers such as TPAs and ERISA attorney simply left the marketplace because they couldn’t handle the change and that is what changes do in the retirement plan industry. There will be winners and there will be those that will exit stage left.

Marge was right, only time will tell who will thrive and who will die.

If you are a plan provider and you haven’t decided to what to do with the coming changes, you still have time. Change with the times; don’t let the times change you.  

If you are a retirement plan provider that doesn’t have a plan to survive these changes, I suggest you develop one. If you need help how to proceed or just wanted to say hello, please feel free to contact me and I will leave the light on for you.

My latest JDSupra.com article can be found here.

Sociologist Robert K. Merton popularized the term “unintended consequences.” Unintended consequences are outcomes that are not the outcomes intended by a purposeful action. Unintended consequences can be roughly grouped into three types:

• A positive, unexpected benefit.
• A negative, unexpected detriment occurring in addition to the desired effect of the policy.
• A perverse effect contrary to what was originally intended (when an intended solution makes a problem worse).

For me, the law of unintended consequences is usually how positive changes can cause unexpected detriment. For example, Prohibition (debatable whether that banning alcohol consumption is positive) had the effect of being a boon for organized crime.

When it comes to the changes in the retirement plan industry, I believe many of the positive changes such as fee disclosure and the new 401(k) advice regulations will have some positive effect, but may have some detriments because it may leade to some unintended consequences.

For example, the fee disclosure regulations will certainly lower plan expenses and that is certainly going to hurt the margins of many plan providers, which will include a group of excellent third party administration firms and financial advisors.

The same can be said of the 401(k) advice rules. I think advisors who can offer advice (at least afford the auditing requirements of the regulations) will be at a competitive advantage. So advisors who can’t afford to comply or can’t because they are brokers (and won’t be allowed to become fiduciary advisors as required by the regulations) may have their book of business depleted.

I certainly look forward to these positive changes, but I am wary about the negative impact that these changes will certainly create. Your guess is as good as mine.

I was told by a financial advisor that he had a $3 million prospect that is currently being serviced by a broker on an insurance company platform. The plan has been on this platform for over 10 years. If the plan decides to change the platform, they will take a $130,000 charge from the insurance company. Yes, $130,000 in charges.

Clearly, the broker has socked the plan with a platform that really does not suit their needs as the alternatives laid out with the same insurance company provider is high in fees as well.

There are plans like this everyday, who are paying too much in fees or unaware of any hidden charges should they decide to change providers. This is why we have fee disclosure coming in April 2012, to curb these type of abuses.

My old college newspaper had the tagline of “Let Each Become Aware”. This is what fee disclosure is all about, it’s the release of information. Information is power as long as plan sponsors use it and use it that will best serve the needs of plan participants. I anticipate eagerly the implementation of fee disclosure. As I stated in my speech at Schwab Impact in San Francisco a few weeks back, I have no idea what fee disclosure will bring to the marketplace. There may be some good things it brings and there may be some bad things it brings like my law of unintended consequences. Then again, it may have no effect like the calorie disclosure of meals at fast food restaurants.

Years ago, I was the Executive Editor of my law school’s news magazine. In one of my final issues, a friend of mine wrote an article that was serious, but really funny at times. His bone of contention was over professor evaluations and how they were given before the final exam, so it was before we got our grades. This author’s contention was that evaluations should be given after we got our grades because the grade turned his view of a specific professor based on the grade. In his critique, he basically said a a grade turned him from wanting to saying hello to a professor on the street into not wanting to take a leak on them if their rear end was on fire. It was a really funny article because it was so truthful, a grade most of the time would tell us whether we would enjoy the class or not.

When it comes to retirement plans, I often find that plan sponsors only start to understand the competency of their third party administrator (TPA) during the de-conversion process. The de-conversion process is what it says it is the de-converting of a retirement plan from a TPA during a change of providers.  I often liken the de-conversion process to moving your residence because it can be a harrowing experience.

Why is de-converting so harrowing? It can be based on the competency over the TPA you are leaving, as well as the plan sponsor’s diligence in their role as plan fiduciary. For a plan that has reviewed their TPA’s work by themselves or the use of a third party or a plan being handled by a competent TPA, it isn’t so harrowing. For a plan sponsor that doesn’t know the ADP test from ADP, the payroll company, it can be. The reason why it can be so harrowing because if there is no review of the TPA’s work, the de-conversion process is the only time that a plan sponsor will be ware whether there are any compliance issues that need to be fixed. So often, I have worked with clients who didn’t know they should have failed their Top Heavy test because the TPA did it wrong or realize they were being overcharged for services. Again, there are so many competent TPAs that offer such a seamless transition during the conversion process; it’s almost so clean that you can eat off the floor. However, there are too many times where plan sponsors get a little shock as to the compliance problems they are now forced to fix as a new TPA will not like to assume the administration of a plan with so many issues.

That being said, to avoid the shock of the conversion process, I recommend that a plan sponsor have an administrative review of their plan annually. Whether it’s the use of my Retirement Plan Tune-Up for $750 or whether it’s someone else’s independent review, I always say the evil you know is better than the evil you don’t.

My latest JDSupra.com article can be found here.