Retirement Plan Options: Should 401(k) Plans be Outsourced?
Taking their name from a subsection of the Internal Revenue Code, 401(k) plans are an increasingly common (and exceedingly complex) way of enabling employees to plan for their retirement—a method that has recently reentered the spotlight due to the spiking number of companies that are looking to leverage this tool via outsourcing. In fact, it is this complexity (i.e. the level of financial and investment expertise that is required to manage these plans) that has created the issue; and prompted the outsourced option to become increasingly popular with employers who don’t wish to go to the expense and trouble of developing and retaining that expertise in-house. Yet scores of organizations have remain on the fence for years when it comes to 401(k) plans—constantly debating the merits of outsourced versus in-house administration. Now though, all that might be changing thanks to the Employee Retirement Income Security Act 1974 (ERISA); in which the “prudent expert rule” specifically states that the plan should be outsourced to independent experts if you do not have the necessary expertise.
What Are the Potential Benefits of Outsourced 401(k) plans?
ERISA aside, the usual benefits that can be realized (e.g. cost savings, better outcomes, increased productivity, employee engagement, etc.) from outsourcing any benefits function applies. However, according to a recent report from Forbes (401k Outsourcing: The Next Big Thing), these benefits are supplemented by a number of specific points such as reduced liability, increased objectivity, fewer conflicts of interest, and an increased level of service.
Managing Risk and Liability
As in any investment program, managing a 401(k) plan involves a degree of financial risk. As such, outsourcing that management can reduce your liability should something negative happen. That said it all depends on what role you want your outsourced provider to take on:
Investment Fiduciary – ERISA Section 3(21) – a plan advisor, offering objective advice and expertise to the plan sponsor (business owner, board of directors, etc.) who takes the actual decisions on investments (and therefore remains liable).
Investment Manager – ERISA Section 3(38) – not only responsibility for advice but also for selection, monitoring and removal of investment options. An investment manager acts independently, relieving the plan sponsor of legal responsibility for investment decisions.
Plan Administrator – ERISA Section 3(16) – a step further, the plan administrator takes overall responsibility for the operation of the 401(k) plan, including the appointment of an investment manager, timely filings, disclosure notices, and so on. The only responsibility left to the employer is to select and monitor the plan administrator.
Just as it is when contemplating larger-scale comprehensive business process outsourcing, factors such as in-house expertise, control requirements, and the size of your business will influence not only the decision to outsource but also the choice of fiduciary option. According to the Forbes article, “small to mid-sized plans are beginning to outsource 401(k) fiduciaries”, and as such one option for smaller businesses would be a multiple employer plan (MEP); in which a single plan administrator (and appointed investment manager) operate a plan for more than one independent employer—passing on the cost savings that come with larger plans to the smaller businesses.
The Increasingly Important Issue of 401(k) Fees
Clearly the cost of outsourcing a retirement plan will differ according to what level of responsibility you’re outsourcing; but sometimes those fees can be less than transparent (an especially true sentiment when it comes to 401(k) fees). These charges fall under one of two broad types; either administration (including record keeping, legal work, and accounting) or investment management (which accounts for the larger portion of the overall cost). The reason fees are so critical in 401(k) management is that they can impact on the final value of the plan. As a July 2012 article on SmartMoney.com points out, “Fees are extremely important. For example, if fees amount to 1% of assets, they reduce a 401(k) participant’s rate of return by about 25 percent.”
The current shake-up we’re seeing with 401ks (along with accompanying press and media commentary) is due to new rules from the Department of Labor mandating full disclosure of the cost of managing 401(k) plans. As of July 1st 2012, companies administering 401(k) plans must disclose to plan sponsors details of all associated costs. Furthermore, although sponsors isn’t obligated to pass on this information to plan participants, they do have to now provide expense ratios for investments offered by the plan, showing participants the charges per $1,000 invested (initial disclosures are due on August 30th 2012). The purpose of the disclosures is to help sponsors and employers to select and monitor plan providers more effectively.
Organizations should be cognizant though that one of the most common employee misconceptions is that 401(k) accounts tend to be cost-free; in large part due to the fact that traditionally the costs of administration were effectively obscured by the bottom line plan value figures. As such, this may mean that the first round of disclosures will bring employers a real (albeit brief) storm of discontent from participating employees. So, keep this in mind and keep communicating the fact that quarterly disclosures can only help in ensuring that your 401(k) plans are being managed effectively.
401(k) Outsourcing – Final Thoughts
As stated earlier, ever-increasing numbers of businesses (irrespective of size) are outsourcing their retirement plans either to a specialist service provider or to companies that offer bundled HR, payroll and benefits packages—a fact that (at least from a benchmarking perspective) could well mean your company is ready to take that process on. However, if you’re shopping for a provider to manage your 401(k), there are certain key issues that should nevertheless be considered. For instance, what are the types of investments available to choose from? How much (if any) employee education will be provided? And of course what is the bottom-line price? While undoubtedly daunting to try and take on this type of endeavor, the good news is that new Department of Labor rules should make the selection process easier—ultimately furnishing better quality information on which to base your decision.