The Rosenbaum Law Firm P.C. Blog

When drafting new 401(k) plans for clients during the middle of the year, I like drafting them with an effective date of the first of the year and with deferrals effective as of when they can run the plan with payroll. Like with Apple, I think simplicity is the ultimate sophistication. A short plan year requires a proration of the annual compensation limit. This could be an issue if Highly Compensated Employees want to maximize their deferrals in a non-Safe Harbor plan and with the short plan year, are the only ones that could do that.

Of course, what I like is irrelevant to the plan sponsor who may have to fund contributions. By pro-rating the Plan year and the compensation, they pro-rate their contributions and could save some serious money, especially if the plan is a safe harbor. I like what I like, but I let plan sponsors figure out how to spend their money.

In England, many of the top pubs are owned by British breweries because watering holes are an effective means of beer distribution. Pepsico (owners of Pepsi) used to own Yum Brands (KFC, Taco Bell, Pizza Hut, etc.) for that very same reason.

The 401(k) industry is dominated by mutual funds, so it should come as no shock that many mutual funds companies offer services as a third-party administrator (TPA) because it’s an effective means of distributing their mutual funds. Mutual fund distribution is extremely important for mutual fund companies because their bread and butter are the funds’ asset management fees and more assets under management equal more revenue for the mutual fund company.

While many mutual funds companies only offer TPA services for larger plans, there are a few mutual funds companies that have been rather aggressive in offering TPA services to small and medium-sized plans. While mutual fund companies do offer an attractive alternative as part of a one-stop shop, plan sponsors are under the impression that the mutual fund companies’ TPA services are free.

As shown in fee disclosures that you should be getting as a 401(k) plan sponsor, there is no such thing as a free lunch or free 401(k) administration. Mutual fund companies make their money as a TPA through those very same mutual fund management fees that I had discussed earlier. Many of the same companies that offer TPA services are the very same mutual funds companies that offer revenue sharing or sub-TA fees to TPAs for plans that use their funds. So by keeping plans under their roof, these mutual funds companies can keep their revenue sharing/ sub-TA fees to themselves. These mutual fund companies also guarantee the fees they make, by requiring that a percentage of a plan’s assets (up to 100%) be invested into their proprietary mutual funds.

For plan sponsors and trustees who serve as fiduciaries under ERISA, it is a question of the prudence rule and whether it is prudent to offer investments into a specific mutual fund company, only because that mutual fund company is the TPA. While some mutual fund companies have sterling reputations, there are still several mutual fund companies that have been tainted by the late trading scandals of the last decade, as well as poor performance and high fees. All plan sponsors that utilize a mutual fund company as a TPA should understand that there is a cost involved with their plan’s administration, as well as be advised as to the standing of the mutual fund company within the entire mutual fund industry to make sure it doesn’t become the next Steadman fund family.

Plan sponsors should consult with their 401(k) financial advisor to determine whether a mutual fund company as a TPA is the right fit for them. Mutual fund companies may be an attractive option for some, but plans that offer what is known as out-of-the-box provisions may not be a good fit, as well as a plan sponsor that wants unbundled options in the selection of mutual funds.

Fidelity is clamping down on third-party access to 401(k) plans, which will likely restrict outside advisors from managing clients’ assets in those accounts.

Fidelity said it would “begin taking steps to prevent platforms reliant on credential sharing from accessing and taking action in customer accounts held at Fidelity.”

This will be an issue for many fintech companies that specialize in giving advisors a way to access clients’ accounts without having 401(k) participants give advisors their login credentials directly.

Missing that deadline to file a Form 5500 is a huge problem. Sometimes people forget even when the Third Party Administrator (TPA) completes it promptly. I’ve had clients not realizing they had a year or two years’ worth of 5500s that needed to be filed.

The greatest mistake they made was filing those late 5500s. Why? Well, they didn’t file those Form 5500s, coupled with a contemporaneous filing of an application to the Department of Labor’s Delinquent Filer Voluntary Compliance Program (DFVCP). By not filing with the DFVCP, a plan sponsor can get a crippling penalty of $150,000 per year (depending on how long the Forms are outstanding). It’s unsettling when the penalty amount of the DFVCP could be just $1,500 maximum.

The problem is so many plan sponsors aren’t aware of this option and there is only so much a TPA can do. So that’s why I’m mentioning that filing a late 5500 without DFVCP is a weapon of mass destruction.

When you start fixing up the house (for me, a never-ending battle) and replacing appliances or items like the front door or the roof (had to fix it again), you realize that the replacements are more energy efficient. Replacing that old refrigerator or that washing machine can lead to some savings in your energy bills.

When it comes to retirement plans, there are so many of them that are inefficient in either their cost structure or plan design. While cost structure will be all disclosed to plan sponsors (who have the duty as fiduciaries to determine their reasonableness), plan design inefficiency is something that won’t be discovered until the plan goes through an independent review (like my Retirement Plan Tune-Up) or takes the plan to another third party administrator (TPA). Inefficient plan designs come in all sorts, but it wastes money like that 40-year-old furnace I replaced almost 20 years ago.

An inefficient plan design wastes money because it either makes less cost-effective contributions or it doesn’t maximize tax-deductible contributions to highly compensated employees. So it either wastes money in unnecessary contributions or is inefficient for tax savings.

In terms of wasting money, it could be a defined benefit plan that has outlived its usefulness or it could be a 401(k) plan with a new comparability plan design and a safe harbor matching contribution (because unlike a safe harbor 3% profit sharing contribution, you cannot use the safe harbor matching to offset any new comparability contributions to non-highly compensated employees like you could with the safe harbor 3% profit sharing contribution). A plan that doesn’t maximize contributions could be a 401(k) plan that consistently fails discrimination testing and doesn’t implement a safe harbor plan design or a plan that doesn’t offer a new comparability profit sharing allocation to highly compensated employees when the plan sponsor can afford it.

Retirement plans are a great employee benefit for retirement savings, but you should never forget the tax savings component it has.

So when I consistently state the claim that plan sponsors need to find a quality TPA that is not predicated on price, but predicated on its competency and knowledge of cost-effective, retirement plan design.

When you look for new appliances, you always look for those with an Energy Star sticker. When shopping for TPAs, look for those who would deserve a Tax Star sticker (if one existed, don’t steal my idea!).

I call this time of the year Retirement Plan Crazy Season where plan sponsors decided to change plan providers to get things changing smoothly on January 1. I call it Crazy Season based on NASCAR’s Crazy Season when drivers and car sponsors switch teams by making new deals for the following Cup season.

In addition, it is this time of the year that many employers decide to implement a plan for the current year as the deadline for putting a plan in place for a calendar year plan is now the due date of your tax return.

One of the difficult choices for an employer in deciding to sponsor a plan is which type of qualified plan to sponsor. Here is just a small list:

1. Number of employees to participate: The more, maybe not the merrier. But the more, is less likely you will be pursuing a defined benefit plan and more likely pursuing a 401(k) plan.

2. Age and compensation of the owner(s)/highly compensated employees. Despite what the folks protesting at Wall Street believe, one of the goals of setting up a retirement plan is saving the maximum for the owners and highly compensated employees of the business. One way to achieve maximum savings is the use of a defined benefit plan or a cross-tested allocation that will award higher contributions to these high-paid employees and some of the key factors are age and compensation.

3. How much can the Employer afford to contribute? When it comes to defined benefit plans and safe harbor 401(k) allocations, as well as the near obsolete money purchase plans, the employer must dedicate a fixed contribution each year (which is decided after the end of the Plan Year). Does the Employer see that it has the cash flow over the next couple of years to make such a financial commitment? I can’t tell you how many times I have had sole proprietors say they want to save the maximum under a defined benefit plan. All of a sudden, they needed to pare back after the sticker shock of the maximum contribution that the actuary determined.

4. Ask the Employees. A small business is usually not a democracy but it may be wise to ask employees for input in setting up a retirement plan. Namely, the questionnaire really should be tailored towards trying to identify whether they see this plan as an important employee benefit and if the employer decides the 401(k) route, whether the employees would defer. Now employees shouldn’t have a say in designing the plan since they aren’t going to be the ones funding the contribution.

5. Find a financial advisor. If a small business has a non-owner employee, a financial advisor should be hired. No ifs, ands, or buts.

6. Find a good TPA/ERISA attorney. To have a good retirement plan, you need a good team. I cannot stress the need for businesses to find a solid third-party administration firm (TPA) and a good ERISA attorney (preferably an independent ERISA attorney who will draft plan documents at costs comparable to what a TPA would charge).

When I first started in the retirement plan business in 1998, I worked for a law firm that served as the counsel for a third-party administration (TPA) firm in Syosset, NY.

There was an office worker there named Orville. I remember Orville because I never saw someone who was male who sang “My Heart Will Gone On”, the Titanic theme song sung by Celine Dion.

Orville wasn’t much of a worker, but for some reason, my boss had an affinity for him. When the office work wasn’t panning out, they made Orville a computer tech guy. I think Orville knew as much about computers as my grandmother did. When the tech thing didn’t pan out, they put Orville in an administrative position of dealing with retirement plan distribution to participants. As my boss would probably say: “he’s a good guy, he’s loyal.”

Well, one day, Orville tried to overpay a participant $18,000 more than what the participant had in their account. The person managing the daily operation of this TPA had enough and Orville had to go. From what I was told, Tom had to call my boss to get permission to fire Orville. Never understood why my boss had this loyalty towards Orville. I thought it was a lot of misplaced loyalty.

Loyalty is an admirable trait, but misplaced loyalty is another thing. I see that with many plan sponsors and their misplaced loyalty to their plan providers, which is not reciprocated but is betrayed. Plan sponsors should pick plan providers based on competence and they should check every so often to make sure these plan providers are doing their jobs. Just sticking by providers because you have retained them for so long is one reason to maintain that relationship, but it shouldn’t be the only reason. I had a client being sued by the Department of Labor because the client had used a TPA for 28 years, and wasn’t doing the necessary work in the administration of a defined benefit plan. Saying you used someone for 28 years is nice, you have longevity. It’s not so nice if you discover that they didn’t do the work and as a plan fiduciary, you are the one on the hook for what the plan provider did or didn’t do.

There is nothing wrong with always using the same plan providers, but there is something wrong is that the only reason you keep them is because you have been using them for so long. Every plan provider should be evaluated every so often to determine their competence because you may be shocked when your long-time provider turns out to have thrown you under the boss with poor work.

There are those TPA that sell financial products, there are some that sell insurance, and there are those that just administer and record keeping.

This story reminds me of another producing TPA that is only a few villages over from where I live. I interviewed for an attorney position there around 20 years ago before my son was born when I was serving as the lead attorney for another New York-producing TPA. The owner of this TPA said my TPA was not in the administration business but in the asset-gathering business. Looking back, it was kind of funny because this TPA was consistently butting heads with the IRS over these special trusts with special trustees for these defined benefit plans stuffed with life insurance policies. In addition, I once reviewed a plan of theirs when the plan moved over to my TPA. The defined benefit plan has a normal retirement age of 35! This was not the defined benefit plan for professional athletes, this was a plan for a food wholesaler. This was before the IRS instituted that any normal retirement age before 62 is suspect, so we didn’t take the plan over since I stated that the normal retirement age was not reasonable for that industry and was just used as a gimmick to have inflated tax deductions. In other words, it was a tax evasion scheme.

The lesson to be learned here is that some TPAs are in the insurance-selling business, the asset-gathering business, and the administration business. Pick a TPA whose main business is plan administration.

As Michael Corleone said in the very underrated “The Godfather Part III”, “Just when I want to get out, they keep bringing me back in.”

Since 401(k) plans are not subject to the joint and survivor annuity requirements of the Internal Revenue Code, very few plans offer them. The very few that offer them usually do so because there may be assets in the plan that are subject to the joint and survivor annuity requirements such as assets from a previously merged money purchase plan. When the Internal Revenue Code allowed many of the 401(k) plans that had them (and didn’t have assets from a plan subject to the joint and survivor annuity requirements) to eliminate them without running afoul of the Internal Revenue Code §411(d)(6) anti-cutback rule, many of them did to avoid the added paperwork of purchasing an annuity or having to get a joint and survivor annuity waiver if the participant and spouse wanted another payment option.

There has been a call to add back annuities as an option for 401(k) plans because most plan participants won’t have enough savings to last through retirement if they get a lump sum.

It should be interesting that with the discussion about fee transparency plan sponsors and their financial advisors would consider adding back an option to 401(k) plans that are laden with fees.

I am certainly no annuity expert, it has always been an assumption that the more exotic the features that annuities have, the more fees it has. Just like straight-term policies have lower fees than those term policies with a return of premium. Exotic insurance products come with heavy a premium that is what I always have been taught. So while straight life and joint and survivor annuities should be considered, I am always wary of exotic insurance products such as some of the new retirement plan-centered annuities that are currently being developed.

While the Department of Labor has made it easier for defined contribution plan sponsors to use annuities within their plan, there is still concern about cost and a review of annuity fees would be an added burden for plan sponsors to master.

In addition, plan participants always have the right to pick an annuity upon distribution by rolling over the 401(k) assets into an individual retirement annuity. So the option is always there outside of the plan if it’s not offered within the plan.

While I am not going to state whether I am against annuities within 401(k) plans, I am always cautious about offering insurance products within a retirement plan. So plan sponsors and their advisors should be cautious as well if the benefits of adding an annuity are outweighed by some of the risks.

When I was at law school at American University Washington College of Law, I was the Executive Editor of The American Jurist, which was the student news magazine for my final year of law school. I wasn’t a particularly fond fan of my law school, I think they made promises to students that they couldn’t deliver on and some of the great opportunities like their law clinics were only available to a small group of students. For example, while I was led to believe my interest and coursework in tax law would merit my consideration in the tax clinic, I did not get a slot for the tax clinic because my name was not pulled out of a hat. So my year as the top editor was dedicating my columns to lambast what was wrong with the school and suggestions on how to improve certain aspects of it like the career services office, the journal and law clinic selection process, and orientation.

Certain students and faculty were very critical of my views because they said my columns would hurt the school because potential students would read the columns and then not get to our school because of what I wrote. It was pure nonsense because my columns criticized the school and then offered suggestions on how to fix the problems I pointed out. After I graduated, many of my suggestions were acted upon by the administration and I am proud of my role in helping the school out.

People don’t like criticism, they can’t handle it. If you criticize, you get labeled as a hater. It’s a label to discredit you and your opinion.

Years ago, an advisor I know sent an e-mail to one of the big movers and shakers in the 401(k) industry. The e-mail had a quote from an outspoken columnist who has been critical of the abuses of the 401(k) industry. The 401(k) big shot was very offended by the quote and took many exceptions to it.

My point is that there are enough problems within the retirement plan industry to criticize and simply attacking those that do is certainly not going to help the industry out. Those who try to shout down those 401(k) critics do a disservice to the industry because it is those critics of fees and investments that have helped spur change within the 401(k) industry. That being said, some consistently attack 401(k) plans without a suggestion to improve them or a realistic way to help the retirement savings crisis in the country. When managed correctly, a 401(k) plan is one of the best employee benefits out there that has helped plan participants save for retirement and lower their current taxable income. People within this industry don’t have to be like Anthony’s neighbors in the Twilight Zone episode “It’s A Good Life” and think “nice, happy thoughts.” If you see something wrong within the industry, say something and offer a way to make things better.