In this article, I will highlight the most pertinent aspects of these regulations and those issues requiring plan sponsors’ close attention. Since disclosure on the Form 5500 and its Schedule C has been in effect for several years, I will not discuss this phase of the regulatory process, except to mention that the regulators are accumulating a massive amount of information regarding fees assessed by service providers in the qualified plan arena on a national basis. It is difficult to say how this information may be used in the future. Needless to say, the regulators will have excellent information in the future to evaluate the reasonableness of fees assessed by service providers across thousands of qualified retirement plans.

It’s important to acknowledge that a change of this scale has never occurred before in the pension industry.  On a national basis as many as 483,000 retirement plans and their service providers will be affected. The retirement plans impacted have nearly 72 million individual participants, collectively. Simultaneous disclosure to regulators, plan sponsors, and ultimately to plan participants, has the potential to be disruptive to the marketplace. Plan sponsors will likely be mobilized to improve their plan design and fee structure.

As referenced above, there are two sets of regulations that will impact retirement plan sponsors, service providers, and participants in a significant way in 2012. These include Regulation 408(b)(2), which covers service provider fee disclosures to retirement plan sponsors, and Regulation 404(a)(5), which mandates both an annual and a quarterly disclosure to participants of fees which impact their account performance. The service provider fee disclosure regulation, or Regulation 408(b)(2), will go into effect on July 2, 2012 and Regulation 404(a)(5) goes into effect on August 30, 2012.

Service Provider Fee Disclosure/Regulation 408(b)(2)

Regulation 408(b)(2) provides guidance regarding compliance with ERISA and the Internal Revenue Code prohibited transaction exemptions that permit reasonable contracts between retirement plans and their service providers.  For a contract to be considered exempt under these prohibited transaction rules, the compensation paid to the service provider must be deemed reasonable based on the regulation’s detailed requirements.

This regulation requires that specific terms of the arrangement be disclosed to retirement plan sponsors. If all of the appropriate items are disclosed, the plan sponsor should theoretically have the information necessary to determine whether the arrangement is exempt from prohibited transaction restrictions. Interestingly, if a service provider does not provide the plan with the required disclosure by the deadlines stated in the regulation, the plan and its service provider will be deemed to have engaged in a prohibited transaction. This prohibited transaction may result in excise taxes under the code and a requirement to correct the violation.  These corrective procedures could obviously be quite costly.  Therefore, it is critical that, at a minimum, plan sponsors know who their service providers are and collect a 408(b)(2) disclosure by the deadline stated in the regulation.

The service provider fee disclosure rules apply to all ERISA governed plans other than SEP IRAs and SIMPLE IRAs. Therefore, plans such as 401(k)s, 403(b)s, defined benefit pension plans, and profit-sharing plans are all covered by these regulations.

Service providers responsible to provide these disclosures are broadly identified as “covered service providers who reasonably expect to receive $1,000 or more in direct or indirect compensation over the life of the contract that provides covered services.”  Examples of covered service providers include registered representatives of broker-dealers, advisory representatives of registered investment advisors, third party administrators, recordkeeping firms, and platform providers.

The regulations provide a great deal of specificity regarding how the disclosures are to be structured for delivery to plan sponsors.  In subsequent articles, I will provide a more detailed overview of how these disclosures will be structured and the types of information which will be disclosed to plan sponsors.

Participant Disclosure/Regulation 404(a)(5)

These regulations have the potential to be a true game changer for the defined contribution industry.  They require that every one of 72 million defined contribution plan participants on a national basis are informed how much they pay each quarter for costs associated with administering their retirement plan. The fees disclosed will not simply be presented using a formula. They will also be disclosed in actual dollars and cents on the participants’ quarterly statements. Under Regulation 404(a)(5), there are two categories of disclosure requirements that plan sponsors will be required to meet – quarterly and annual disclosures.

Quarterly Participant Disclosures/Regulation 404(a)(5)

The quarterly disclosures which must be made directly to participants under Regulation 404(a)(5) will in most cases appear on the participants’ quarterly statements. These disclosures must detail the dollar amount of fees or expenses charged to the participant’s account for services during the preceding quarter. These quarterly disclosures must also include a brief description of services to which charges relate — plan administration, recordkeeping, accounting, etc. A separate statement will be required if any of the plan’s administrative expenses for the preceding quarter were paid from the total operating expenses of one or more of the plan’s designated investment alternatives.

In some cases, fees for individual services for participants, such as loan processing fees or distribution fees are also assessed against their account balance. In these cases, the dollar amount charged during the preceding quarter for fees and expenses must be disclosed.

Annual Participant Fee Disclosure/Regulation 404(a)(5)

In addition to participants receiving quarterly fee disclosures, a new annual fee disclosure is also required under Regulation 404(a)(5). In addition to investment and plan expense information, as you might expect, these annual participant disclosures must include a variety of additional information.

The required additional information that must appear in the new annual participant disclosure includes plan related information such as how participants may provide investment direction for their personal participant accounts and a summary of any limitations on instructions for providing this investment direction. The annual disclosure must also provide a summary of any designated investment alternatives offered under the plan along with a description of any brokerage windows, self-directed brokerage accounts or similar programs that allow participants to select investments beyond those designated by the plan.

Under Regulation 404(a)(5), annual participant disclosures must also provide fee and expense information for general plan services which may be charged by the plan to the individual participant accounts that are not reflected in the total annual operating expense of any particular investment alternative available in the plan. This annual participant disclosure must also describe fees and expenses that may be charged against individual participant accounts, including fees for loan processing, investment advice, brokerage windows, etc.

In addition to general plan provisions and plan expense information, a variety of investment related information must be provided to participants in the annual participant disclosures. This includes the name of each investment alternative in the plan along with the investment category for that particular investment. For each investment alternative, a variety of performance related information must be provided, including the average annual return of each investment over 1, 5 and 10 year periods, along with a “past performance is not indicative of future performance” disclaimer. Importantly, each investment options’ performance must also be compared to an appropriate broad-based benchmark over the same 1, 5 and 10 year periods.

The investment related information required under the annual participant disclosure must also include the amount and description of shareholder type fees for each designated investment alternative including commissions, sales loads, sales charges, deferred sales charges, and redemption fees.  It must also include the total annual operating expenses expressed as a percentage for each designated investment alternative.

In a future article, I will provide a more detailed overview of Regulation 404(a)(5) and drill further into the specifics of the quarterly and annual disclosure requirements. Suffice it to say that these disclosures will provide much more information to participants on a systematic and ongoing basis than most participants have ever received regarding plan investments and the cost of plan services passed on to them.

Conclusion

In closing, what is the correct strategy for plan sponsors over the next several months?  HBKS Wealth Advisors is recommending that retirement plan sponsors take a multi-faceted approach to preparing for the coming fee disclosure rules.

Understand what services are currently provided by service providers and why – Build a list of all of the service providers associated with your company’s ERISA qualified retirement plan. Service providers might include recordkeeping firms, third-party administrators, investment advisors, etc. After identifying your service providers, determine the associated cost for the services and consider a fee benchmarking study to determine whether or not those fees are reasonable relative to other retirement plans comparable to yours.

Learn what lower-cost alternatives are available without changing vendors. Working with your current service providers, make certain that you have the most cost-effective solution. Concurrently, consider taking a broader look at other service providers to determine if your current cost is competitive.

Get participant buy-in and participation in the decisions related to what service providers to keep and what service providers to change. Consider encouraging employee participation on selection committees for service providers.  Share the results of any reviews with your employee population.

Consider informing participants of the pending disclosure notices ahead of time. Remember, participants will receive annual standalone notices as well as notices embedded in their quarterly statements. You may want to consider training in a group setting and distributing an explanatory guide for these notices. Make certain that you are prepared to respond to concerns that may be expressed by your employees and retirement plan participants.

As you can see, the Department of Labor’s three-pronged approach to fee disclosure is coming full circle in 2012.  These disclosures have the potential to be game changers for retirement plan sponsors and industry players, as well as retirement plan participants. These rules also have the potential to play a significant role in enhancing retirement plan design and administration as plan sponsors review disclosures and work with participants to reduce cost and enhance service.

Disclosure:

Dean Piccirillo offers insurance products through HBK Sorce Insurance LLC. Investment advisory services are offered through HBK Sorce Advisory LLC d/b/a HBKS Wealth Advisors. Mr. Piccirillo is not able to transact business in a state that he is not licensed or registered.

NOT FDIC INSURED. NOT BANK GUARANTEED. MAY LOSE VALUE, INCLUDING LOSS OF PRINCIPLE. NOT INSURED BY ANY STATE OR FEDERAL AGENCY.

The CFDD’s 2010 Advisor Conference themed “New Age Marketing: What Worked In The Past Is No Longer Effective”, is an all business event designed to help retirement plan specialists adapt to new trends, increase activity and grow their business.  This year’s conference is expected to draw more than 1,000 retirement plan experts, including over 500 advisors.

Piccirillo is one of four panelists for the session entitled “The Intersection of Inbound Marketing, New Media and SALES” which will address social media strategy, blogging, compliance issues, and practical tools for managing online efforts.  Piccirillo is one of a handful of financial advisor bloggers embracing the use of social media for business.  He is a steering committee member and co-founder of the Social Media Club of Southwest Florida, and is a member of the Southwest Florida Regional Technology Partnership.  His blog deanpiccirillo.com was featured in the March 26, 2010 edition of The Internet & Marketing Report as an example of how the lines are blurring between blogs and traditional web sites. In his Content Marketing Today(.com) review article, Newt Barrett called Piccirillo’s blog, “simultaneously newsy and professional.”

Piccirillo is a Certified Financial Planner (CFP), Chartered Retirement Plans Specialist (CRPS), and Accredited Investment Fiduciary Analyst (AIFA).  He works closely with families helping them plan for their long-term financial objectives, manage their financial assets effectively and preserve their wealth for future generations.  He also leads HBK Sorce’s Retirement Plan Unit working with most of the firm’s corporate and institutional clients sponsoring qualified retirement plans.

Piccirillo is a member of The Financial Planning Association of Southwest Florida, local building industry associations, Cape Coral Chamber of Commerce, and is a Board member of The Greater Fort Myers Chamber of Commerce.

HBK Sorce Financial is an independent, personal financial planning and investment advisory firm with offices in Pennsylvania, Ohio and Florida.  Currently, the firm has over 3,000 personal, corporate and institutional clients with an aggregate total of over $1 billion in financial assets.  HBK Sorce Financial is affiliated with Hill Barth & King, LLC and its family of service firms and organizations.  Established in 1949, Hill, Barth & King is one of the nation’s largest accounting and business consulting firms with over 10,000 clients and all the resources of a large, multidisciplinary firm.

There are some professional advisors working in the retirement plan arena that have a rather strong bias against group variable annuity products when being used as funding vehicles for qualified retirement plans such as 401(k)s. I am not personally one of those who feel that they should never be used. I have seen situations where these solutions have been a good fit for the plan sponsor. With that being said, having investment options that are held within an annuity wrapper does not relieve plan sponsors of their responsibility to monitor the investment options that they are making available to their participants.

Additionally, because of how variable annuity products are packaged, it can be difficult to determine if there is a retail mutual fund being used as the underlying investment vehicle or if the insurance company sponsoring the product has retained an outside sub-advisor to manage the assets. In many cases there are recordkeeping and administrative fees that are also layered into the asset-based charges assessed against the plan. These asset based charges are removed prior to the calculation of the unit price of the separate account investment option, making it tough for most plan sponsors to determine the true cost to their participants.

Again, I want to emphasize that I am not inherently against group variable annuity products but do feel that they require an additional level of diligence from the plan sponsor, particularly as the size of the plan grows. I have observed many situations where a group variable annuity product was justifiable and reasonable for a small or startup 401(k) but over time, as the plan assets increased, was no longer the best solution.

During the recent product review I conducted for our prospective client, I was able to identify the underlying retail mutual fund within most of the group annuity separate accounts. For those retail mutual funds where I could identify the specific fund being used, I matched that fund with the least expensive share class for that same fund on an open architecture platform.

I went on to demonstrate that the plan sponsor could have obtained many of the same investment managers, funds, etc. by using a recordkeeping solution that allowed them to go directly to the fund managers outside of that group annuity shell. The savings available for each fund compared was between 0.05% and 0.55%. In most cases the savings on a per fund basis exceeded 0.25%. These small, incremental savings could add up to a meaningful amount over the course of the participants’ years of investing for their retirement.

Keep in mind, I was not attempting to show the client the best or most cost competitive solution in each asset class. I was simply attempting to demonstrate that the client could have obtained the very same investment option less expensively outside of the annuity wrapper. In many cases, further cost savings would have been available to the client when considering other no-load or institutionally priced investment options in the same asset class. Setting aside any considerations with respect to the fiduciary responsibility of a plan sponsor to make certain that the fees being assessed to their participants are reasonable, as a business person, if you can obtain the same service from the same provider 25 to 50% less expensively, why wouldn’t you?

In conclusion, group variable annuity products are not inherently bad choices as 401(k) investment options. However, the plan sponsor should appreciate that these are packaged products built by insurance companies and the underlying investment options are not considered retail mutual funds, but are annuity separate accounts. Consequently, the underlying fees associated with each separate account should be compared to the fees for the same retail investment option. I have seen cases where the separate account was priced less expensively than the publicly traded mutual fund, but this is not normally the case.

To stay up-to-date on prudent practices as a retirement plan sponsor, or to share this information please register for our newsletter by using the registration form located in the sidebar of this blog, or subscribe to our RSS feed. As always, we appreciate your comments, which can be added below. For compliance reasons, comments are monitored and reviewed as soon as possible before posting.

Disclosure:

Dean Piccirillo offers insurance products through HBK Sorce Insurance LLC. Investment advisory services are offered through HBK Sorce Advisory LLC. Mr. Piccirillo is not able to transact business in a state that he is not licensed or registered.

NOT FDIC INSURED. NOT BANK GUARANTEED. MAY LOSE VALUE, INCLUDING LOSS OF PRINCIPLE. NOT INSURED BY ANY STATE OR FEDERAL AGENCY.

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For example, if a plan has several different large stock growth mutual funds available, how does the average participant determine which large growth fund makes the most sense for them? If a participant selects more than one large growth fund, are they more diversified? The average participant actually has no way of knowing which of the multiple large growth funds available makes the most sense for them to choose, and he or she is very likely less diversified by choosing more than one fund in a given asset class.

One interesting study that examines how investment decision-makers, such as qualified retirement plan participants, are impacted by more choices is, “The Psychological Costs of Ever Increasing Choice: A Fallback to the Sure Bet,” written by Sheena S. Iyengar and Wei Jiang of Columbia University in 2005.  This study drew upon information attained by examining nearly 650 retirement plans with approximately 800,000 participants.

The above referenced Columbia University Study has a number of very interesting observations and conclusions.  One of the most fascinating conclusions drawn from this study was that having a large number of choices from an investment standpoint induced retirement plan participants to refrain from making any choices even when it was costly to do so.

Further, the availability of a significant number of investment choices actually motivated retirement plan participants to choose less risky investment options. The attitude of the typical participant seems to be, “This is not what I do.There are too many choices here. I think I’ll just play it safe.” The selection of less risky investment options, such as money market accounts and stable value funds, may be appropriate for some participants. However, this could be a costly allocation decision for participants with a long time horizon in front of them from an investment standpoint.

One of the most dramatic conclusions made by this particular study was that having too many investment choices actually created a situation where participants were more likely to completely opt out of a pension plan. This tendency to opt out when there are a large number of choices was even proven to be true when there were clear monetary advantages to participate, such as an employer matching contributions.  As options increase, the probability of participation declines.  I personally found this to be an incredible observation.

This recent and rather extensive study provides some compelling observations for plan sponsors to consider when building a fund menu.  Clearly, participants must have a fund menu that enables them to develop an appropriate allocation based on their personal goals, time horizon, and risk tolerance. However, excessive choices actually decrease the likelihood that participants will develop a prudent investment mix.

Another practical administrative challenge for plan sponsors who have a large number of investment choices on their menu is the ongoing need to monitor those investments based on a prudent fiduciary process.  It is reasonable to expect that if you have a significant number of investment choices and have a reasonably high standard for performance of those investment options, that you will need to make rather frequent changes to your investment lineup.  Changing investments on a frequent basis can be costly in a variety of ways including administrative fees associated with changing a fund, the necessity to place the plan into an administrative blackout, and the possible need to communicate the change to retirement plan participants.

In conclusion, having too many choices has proven to actually decrease participation in defined contribution plans such as 401(k)s, even when participants are incented to participate through a matching contribution.  Further, participants that make investment allocation decisions when there are a significant number of choices available are more likely to weight their allocations toward fixed income and cash equivalent investment options. This bias toward less risky investment options when there are a large number of choices occurs even when the end result may not be the most reasonable long-term investment decision for the participants.

A ‘best practice’ for retirement plan sponsors building an investment menu is to first determine which investment categories make the most sense to include in their fund lineup and then select well-managed mutual funds that fit into those asset classes.  These mutual funds can then be monitored carefully, based on a prudent fiduciary standard of care and replaced when necessary.

To stay up-to-date on prudent practices as a retirement plan sponsor, or to share this information, please register for our newsletter by using the registration form located in the sidebar of this blog, or subscribe to our RSS feed. As always, we appreciate your comments, which can be added below. For compliance reasons, comments are monitored and reviewed as soon as possible before posting.

Disclosure:

Dean Piccirillo offers insurance products through HBK Sorce Insurance LLC. Investment advisory services are offered through HBK Sorce Advisory LLC. Mr. Piccirillo is not able to transact business in a state that he is not licensed or registered.

NOT FDIC INSURED. NOT BANK GUARANTEED. MAY LOSE VALUE, INCLUDING LOSS OF PRINCIPLE. NOT INSURED BY ANY STATE OR FEDERAL AGENCY.

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In his article, Chris reminds his readers that the assessed fees associated with servicing a retirement plan need to be reasonable. Chris also points out the current lack of specific regulations on these fees. That being said, retirement plan sponsors are wise to pay attention to the fees being assessed by fund complexes and other professional service providers to their participants.

My intended audience for this blog is not professional advisors, such as myself, who are obsessed with the pension market and monitoring trends on a weekly basis, but rather company owners who are otherwise busy professionals with limited time to dedicate to company sponsored benefits. Because my readers may not be familiar with the details of ERISA (Employee Retirement Income Security Act) and the fiduciary duties that are required of retirement plan sponsors, I thought it would be useful to provide a real world example of the impact these can have on a participant’s future retirement benefits. Realistically, even small variances in asset-based charges assessed to participant account balances can have a significant impact on a participant’s future benefit.

For example, assume that two participants each contribute $250 per month to the same 401(k) investments. The only difference is the net rate of return available to each respective participant. For this example, investor A earns 8% and investor B earns 7.5% because investor B purchased mutual funds that have higher expense ratios. Based on these assumptions, investor A will have $239,342 at the end of a 25 year period of time.  Investor B, who earned 7.5% over the same 25 year period, will have $220,686. As you can see, paying an additional 0.50% over that 25 year period resulted in investor B ending up with $18,656 less than investor A.

You can take this example an additional step forward by examining the difference in future benefits for these two participants due to the difference in their account balances at retirement. Assume, for example, that they each draw down their respective portfolios over a 20 year period at a 7% rate of return. Investor A could draw almost $150 per month more than investor B. Over this 20 year retirement the total difference in benefit is more than $30,000. For many retirees this is a meaningful number.

If you start to apply this thought process across multiple participant accounts, you can begin to appreciate why it is so important for plan sponsors to pay attention to the underlying expenses assessed against their participants. Clearly, not all investment expenses are bad or imprudent. However, if the same or comparable investment options are available less expensively, then plan sponsors should take action to reduce those costs.

In conclusion, the “401(k) Fee War” is likely to rage on. Unfortunately for plan sponsors, remaining neutral will not be an option. Fees impact participant performance and subsequent retirement benefits. Consequently, plan sponsors need to pay careful attention to the cost associated with providing investments and other services to participants.

To stay up-to-date on prudent practices as a retirement plan sponsor, or to share this information, please register for our newsletter by using the newsletter registration form in the sidebar of this blog, or subscribe to our RSS feed. As always, we appreciate your comments, which can be added below. For compliance reasons, comments are monitored and reviewed as soon as possible before posted.

Disclosure:

Dean Piccirillo offers insurance products through HBK Sorce Insurance LLC. Investment advisory services are offered through HBK Sorce Advisory LLC. Mr. Piccirillo is not able to transact business in a state that he is not licensed or registered.

NOT FDIC INSURED. NOT BANK GUARANTEED. MAY LOSE VALUE, INCLUDING LOSS OF PRINCIPLE. NOT INSURED BY ANY STATE OR FEDERAL AGENCY.

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A Real Impact on Productivity

If asked, most employers can think of situations in which the financial difficulties of their employees directly and adversely affected workplace productivity. On a personal level, any of us can certainly appreciate the stress that would be created in our own lives in the event of a spouse’s job loss or other reduction of family finances.  Worry over looming debt, mortgage payments, and providing for our children’s needs could easily overtake our thoughts, causing a dramatic drop in the amount of time spent on productive business operations.

Numerous studies conducted within a variety of industries and fields indicate a direct connection between financial duress, work performance and overall productivity of employees. The Personal Finance Employee Education Foundation estimates that at any given time between 15 and 30% of the American workforce is under significant financial stress.

Increased “Presenteeism”

The financial stress suffered by employees is thought to lead to increased “presenteeism”.  Presenteeism refers to time spent during regular work hours dealing with personal matters that are not directly related to the individual’s job. According to April 2009’s Human Resources Magazine, over 53% of employees experiencing financial stress spend time during work hours to attend to their financial issues. This time may be spent dealing with creditors, discussing personal financial situations with colleagues, and worrying about financial matters.  It is not difficult to imagine how employees faced with significant financial challenges and the need to deal with them during the work day will have lower productivity.

Workplace Financial Education

One of the ways that many employers have chosen to address lost productivity from employee financial stress is by incorporating a financial literacy or financial education program as part of their training calendar.  Many employers provide personal development education and training not directly related to their industry because they feel it is the right thing to do for their valued team members.  After examining the studies related to lost workplace productivity due to employee financial stress, employers can also make an excellent business case for enhancing employee financial literacy.

Due, in part, to advances in technology that make communicating with employees much easier, financial literacy training can now take many forms.  Employers who have embraced workplace financial education are making use of tools such as online training programs that employees can attend on their own time, providing books, and other materials on personal finance. They are also offering seminars and workshops on personal financial planning, both on and off company time.

There are other benefits associated with an employee financial literacy program including increased employee morale, more effective use of the benefits that are available to a company’s workforce, and even increased employee health.  In future articles on this subject, we will explore these and other benefits along with the most effective methods employers are using in their financial education programs.

If you work for a company that has a financial education program in place or have responsibility for administering an employer sponsored financial literacy program, we would appreciate the opportunity to hear from you.  Please tell us about your experiences with workplace financial education and its subsequent impact on your organization.  You can find our contact information here on this blog.

Stay Connected With Us

To stay up-to-date on workplace financial education and other employer sponsored benefit matters, or to share this information, please consider registering for our newsletter.  You can find the newsletter registration form in the sidebar of this blog. Another option to stay connected with our updates is by subscribing to our RSS feed. As always, we appreciate your comments, which can be added below. For compliance reasons, comments on this blog must be monitored, however, we will approve and post your comments as soon as administratively possible.

Disclosure:

Dean Piccirillo offers insurance products through HBK Sorce Insurance, LLC. Investment advisory services are offered through HBK Sorce Advisory LLC. Mr. Piccirillo is not able to transact business in a state that he is not licensed or registered.

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Retirement plan fiduciaries not periodically reviewing the cost associated with their qualified retirement plan

It has always been important for retirement plan sponsors to pay close attention to the cost associated with servicing and administering their qualified retirement plans.  Plan sponsors should periodically survey the marketplace to make certain that the fees that the plan is paying for various services are still competitive.  Many times, a plan sponsor will carefully compare fees when the plan is initially established but will not include fees and other plan level costs as part of their ongoing monitoring process.

For example, overall plan assets will typically increase over time due to both participant and employer contributions as well as market performance.  Many times when plan assets increase, so does buying power.  Consequently, there may be options available to reduce the net cost of servicing the plan.

Another reason that plan sponsors should carefully monitor fees and expenses is that in the very near future, thanks to actions taken by legislative bodies and regulators, plan sponsors may be required to publicly disclose all fees paid to all service providers.  With this increased level of transparency across the entire retirement plan space, participants will be in a better position to challenge the fees associated with servicing their employer’s retirement plan.  In many cases, these fees related to servicing a retirement plan have a direct impact on a participant’s returns.

The fees that should be examined by the plan sponsor on a periodic basis include fees associated with the product provider such as the fees for mutual funds included as investment options in the plan, investment advisory fees assessed by an investment consultant associated with the plan, fees charged by the plan’s record-keeping firm as well as retirement plan’s administrative firm and perhaps other service providers such as plan custodians.  Generally, plan sponsors should determine if the fees assessed are reasonable and appropriate.

Retirement plan fiduciaries not being clearly identified and briefed on their responsibility and liability

Another common fiduciary challenge, and perhaps the most frequent issue that I encounter, is plan level fiduciaries not being clearly identified within the sponsoring organization and those same fiduciaries not being fully briefed on both their responsibility and their liability.  Frankly, this particular issue should have been one of the first common fiduciary challenges that I referenced in this series.  If those individuals who are considered fiduciaries in an organization sponsoring a retirement plan are not aware that they are responsible parties, they will be less likely to address some of the other challenges referenced in this series of articles.

Generally complacent attitude relative to retirement plan monitoring and administration

Small business people are exceedingly busy individuals with many demands on both their time and their attention.  Demands on an organization’s leadership have increased significantly in recent years as the pace of business has quickened due to advances in technology.  Further, leaders in all types of organizations including for-profit companies, municipalities and nonprofit organizations are under tremendous stress due to the need to respond to the recent economic downturn.  Consequently, the responsibilities related to employee benefit packages such as qualified retirement plans can easily be pushed to the back burner.

Regrettably, this responsibility and liability associated with servicing a qualified retirement plan is not relieved because plan sponsors are otherwise occupied with the demands of clients, customers, employees and suppliers.  Due to increased transparency requirements imposed by legislators and regulators coupled with increased participant scrutiny of plan investments and expenses, retirement plan administration must be moved up on a decision maker’s priority list.

Conclusion

In this series we have discussed a number of common future challenges faced by sponsors of qualified retirement plans.  Although considering these issues may at first seem overwhelming for an otherwise busy leader in business or nonprofit, having a sound process can make addressing these matters much easier.

For your reference we have built an online quiz that a plan sponsor can take to provide them with a simple assessment of their overall fiduciary monitoring process.  The link to this online questionnaire can be found here and can be taken in about five minutes.  We have also added a sample Investment Policy Statement and sample investment due diligence created based on that investment policy for your review.

To stay up-to-date on prudent practices as a retirement plan fiduciary, or to share this information please consider registering for our newsletter, you can find the newsletter registration form in the sidebar of this blog. Another option to stay connected with our updates would be to subscribe to our RSS feed. As always, we appreciate your comments which can be added below. For compliance reasons, comments on this blog must be monitored however; we will approve and post your comments as soon as administratively possible.

Disclosure:

Dean Piccirillo offers insurance products through HBK Sorce Insurance LLC, investment advisory services are offered through HBK Sorce Advisory LLC and securities are offered through Purshe Kaplan Sterling Investments (PKS), Member FINRA/SIPC. PKS is headquartered at 18 Corporate Woods Blvd., Albany, NY 12211. HBK Sorce Insurance LLC and HBK Sorce Advisory LLC are not affiliated with Purshe Kaplan Sterling Investments. Mr. Piccirillo is not able to transact business in a state that he is not licensed or registered.

In my capacity as a professional advisor who consults regularly with plan sponsors, there are some common challenges with plan administration that I frequently encounter when a new client is referred to me. In this article, I will attempt to outline some of the most common deficiencies and what a plan sponsor can do to address them in the most effective manner.

Not having a prudent process to select and monitor investment options

Plan sponsors have a responsibility to ensure that their employees have a competitive mix of investment options to choose from in a defined contribution plan. In order to make certain that plan sponsors are able to meet this requirement in an efficient manner, it is useful to have a written process outlining how investment options will be chosen and monitored. An excellent tool with which plan sponsors can use to detail this prudent process is an Investments Policy Statement (IPS).

An Investments Policy Statement details how the plan will select and monitor the investment options that are available for participants to choose from. The IPS will typically detail the criteria with which these investment options will be reviewed. A typical selection criterion may include:

• Performance relative to a manager’s peer group over a certain period of time
• Performance relative to an appropriate index
• A fund’s expense ratio relative to it’s peer group
• Various methods of evaluating a funds risk adjusted returns such as Sharpe Ratio or Alpha
• The tenure of the manager or team of managers for the fund
• Style consistency – do the underlying holdings of the fund match the stated investment style of that portfolio?

There are many other criteria that are reasonable and could be used to evaluate a particular investment option. Some criteria that plan sponsors may want to consider included in their evaluation process can be found in another article on this blog – Selecting and Monitoring Mutual Funds. The key is to have a reasonable or prudent process and to follow that process.

Not following your stated process for evaluating investment options

Sometimes plan sponsors will have a reasonable, prudent process outlined for selecting and monitoring investment options. Many times, plan sponsors have even prepared detailed Investment Policy Statements when their retirement plan was established. However, if you’re going to have a written process for evaluating managers, it’s important that you follow the stated process and , are able to document that you’ve done so.

Plan fiduciaries must monitor their plans investment options on a regular and ongoing basis. This can be challenging for plan sponsors simply because of how busy the typical executive in a small or midsized company is. Regrettably, being busy does not eliminate the responsibility.

Not documenting that you have followed your stated process for evaluating money managers

As with many things in business, particularly from a regulatory standpoint, if it’s not written down it didn’t happen. As a plan sponsor, you may at some point be challenged about an investment decision that you made. If that time ever comes, being able to demonstrate in writing, that you have followed a prudent process may be critical.

Unfortunately many times, plans sponsors who have carefully monitored the performance of their plans investment options have no evidence that they have in fact done so. Retirement plan fiduciaries are therefore encouraged to maintain records confirming decisions that they made with respect to plan investment options. Records could include due diligence reports prepared for investment options in the plan or minutes from investment committee meetings.

The key is, being able to prove that you did what you said you were going to do from an investment monitoring standpoint? Are you able to prove that you followed your prudent process?

In part two of this series, we will continue to explore some common fiduciary challenges and how plan sponsors can most easily address them. A sample of an Investment Policy Statement, which we use in our practice, can be found at this link on our Resources page. We have also provided a link to a sample Due Diligence Report that has been designed to coordinate with our sample Investment Policy Statement.

To stay up-to-date on prudent practices as a retirement plan fiduciary, or to share this information please consider registering for our newsletter, you can find the newsletter registration form in the sidebar of this blog.  Another option to stay connected with our updates would be to subscribe to our RSS feed.  As always, we appreciate your comments which can be added below.  For compliance reasons, comments on this blog must be monitored however; we will approve and post your comments as soon as administratively possible.

Disclosure:

Dean Piccirillo offers insurance products through HBK Sorce Insurance LLC, investment advisory services are offered through HBK Sorce Advisory LLC and securities are offered through Purshe Kaplan Sterling Investments (PKS), Member FINRA/SIPC. PKS is headquartered at 18 Corporate Woods Blvd., Albany, NY 12211. HBK Sorce Insurance LLC and HBK Sorce Advisory LLC are not affiliated with Purshe Kaplan Sterling Investments. Mr. Piccirillo is not able to transact business in a state that he is not licensed or registered.

Depending on your marital status, income, and whether or not you’re an active participant in an employer sponsored retirement plan, the $5,000 contribution may also be tax deductible.  Beginning in 2009, the contribution limit will adjust annually for inflation in $500 increments.

There are many types of IRAs: Traditional IRA, Roth IRA, Education IRA (EDIRA), SEP-IRA, SARSEP-IRA, and SIMPLE-IRA. Traditional IRAs are broken down into Regular, and Rollover IRAs.  The SEP-IRA, SARSEP-IRA and the SIMPLE-IRA are designed for use by small business owners and are beyond the scope of this article.  The Education IRA is now called the Coverdale Education Savings Account and has become somewhat less popular with the recent enhancements made to the 529 College Savings Accounts.  Thus, our focus for this discussion will be on the Traditional IRA and the Roth IRA.

Let’s review the differences between the Traditional IRA and the Roth IRA.  The Roth IRA has essentially turned the Traditional IRA formula completely around.  A Traditional IRA enables taxpayers to make tax-deductible contributions, but all contributions to Roth IRAs are after tax (non-deductible).

In addition, withdrawals are treated differently. With a Traditional IRA, contributions are growing tax-deferred and withdrawals are taxed at ordinary income tax rates With a Roth IRA, investments grow tax-deferred but can be withdrawn after age 59½ tax-free.  However, in order to receive this tax-free treatment on a withdrawal, you also must have held the account for at least five years.

This ability to make contributions that can be withdrawn tax-free is a unique and powerful characteristic of the Roth IRA. The good news is that most taxpayers are eligible to make contributions to a Roth IRA.  The ability to use this tool however, is phased out for Americans in higher income tax brackets.  For example, if you’re single, the $5,000 (or $6,000 if you’re over the age of 50) that you can contribute begins to be phased out starting at $105,000 and is completely phased out at $120,000.  For married filers, the phase out begins at $166,000.  Married couples earning $176,000 or more can no longer contribute to a Roth IRA.  Unlike the Traditional IRA however, contributions can still be made after age 70 ½ as long as you have earned income.

For investors who have existing Traditional IRAs, one consideration is whether or not to convert the Traditional IRA to a Roth IRA.  Conversion from Traditional to Roth is allowed for taxpayers if they and their spouses earn less than $100,000 per year.  The biggest benefit to conversion is that all future earnings grow tax-free.  This certainly sounds attractive, but investors should consider conversion with caution. Currently, all contributions and earnings moved to the Roth IRA from the Traditional IRA are taxable.

This conversion becomes a little more complex when you consider that you cannot use any of the dollars being converted to help pay the tax due without being subject to a 10% early withdrawal penalty if you’re under the age of 59 ½.  Many experts warn that if you do not have other money on hand to pay the taxes due upon conversion, you’re probably better off maintaining the Traditional IRA.

The decision to use either the Traditional IRA or the Roth IRA for new contributions, and the decision whether or not to convert from a Traditional to a Roth are driven in large part by your expected future tax rate.  In the not too distant past, many retirees entered lower tax brackets during retirement.  This is no longer the case for many, particularly as more people are working (at least part-time) during retirement to support the lifestyle to which they had become accustomed during their working years.  Consequently, many taxpayers should take a hard look at conversion and making new contributions to the Roth IRA, again, proceed with great caution.  A consultation with a Financial Advisor and your tax professional is highly recommended.

To conclude, both the Traditional IRA and the Roth IRA are important tools   to consider in the retirement planning process.  Many in fact will establish IRAs a result of a rollover from an employer sponsored plan.  As you consider which tool will work most effectively for you, many factors play into the decision. Those factors include:  your current income tax bracket, estimate for your future tax rates, your marital status, and your ability to pay the tax upon conversion.  For most of you, these decisions are best made with the assistance of a professional advisor experienced in these matters.  Once made, the decisions can be both irrevocable and taxing.

Sources:

1. Income of the Population 55 or Older, 2004, Social Security Administration, Office of Research, Evaluation, and Statistics (May 2006)

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