[Editor’s Note: This is a guest post from Konstantin Litovsky, a blog advertiser and the founder Litovsky Asset Management, a wealth management firm that offers flat fee retirement plan advisory and investment management services to solo and group medical and dental practices. Konstantin specializes in setting up and managing retirement plans, including 401(k) and Defined Benefit/Cash Balance, and serves in an ERISA 3(38) fiduciary capacity.]
Group Practice Retirement Plans: Fix Problems, Improve Your Plan, Minimize Cost
Even though group practice retirement plans typically have a relatively small number of participants, these plans can be more complex and laden with compliance issues and challenges. Older group practice plans often have serious compliance and fiduciary issues, and unless someone knowledgeable takes the time to examine the plan operation and paperwork, chances are that these issues would only be discovered upon an audit by the Internal Revenue Service or U.S. Department of Labor – in other words, much too late. Compliance errors and fiduciary breaches can potentially lead to hefty IRS and DOL penalties and fines, especially if such breaches have occurred over many years. Therefore, it is preferable and almost always less costly to not only fix them, but also to make sure that your plan is run in such a way as to eliminate the possibility of serious breaches, errors, and liabilities in the first place.
Is Your Plan in Compliance?
As a new practice partner or a current plan trustee, the task of making sure that your plan is in compliance is intricate and may involve a number of professionals, including a Third Party Administrator (“TPA”), an ERISA attorney and an ERISA §3(38) fiduciary. Before you evaluate, hire and/or replace any providers, you will need to have a good understanding of the types of issues your plan may have and how you can fix them cost-effectively. While it is important to address any fiduciary and compliance issues, the ultimate goal is to provide plan participants with a platform to build wealth for retirement. In the process of fixing any issues, you can also improve your plan design and minimize the costs paid by all plan participants.
6 Common Issues Encountered With Group Practice Plans
1) Plan Cost and Fees
Responsible fiduciaries, including individual trustees and other partners within the practice, must make sure that the fees paid by plan participants are reasonable. These determinations, typically done by benchmarking or proposal request and evaluations, must be documented and provable. Most small practice plan sponsors, partners and plan trustees rarely take these steps, and this can subject the plan to excessive fee assertions by DOL, and/or lawsuits by the participants. While such lawsuits are somewhat uncommon for smaller plans, a documented evaluation with an experienced outside expert is important because smaller plans often have other operational aspects that tend to result in higher fees than larger plans. As a result, the determination of reasonableness can be more challenging. A documented evaluation process is critically important to protect against any audit examination or dispute. Because small practice plans often pay significantly higher fees than do larger plans, even if the fees are deemed ‘reasonable’ they may still not be optimal given the alternatives, and there is no reason to accept anything but the lowest fees for the best possible services.
Many older group plans have investment menus with high expense ratio funds. These plans often pay high asset-based fees for plan services, but get very little in terms of service quality to justify these fees. Because many doctors and dentists will accumulate significant assets in their retirement accounts, removing all assets under management (AUM) fees from the plan can potentially save millions in unnecessary expenses for the plan participants. There are a number of ways in which practices can minimize the cost of their plan, and it is the job of your ERISA §3(38) fiduciary to make sure that your plan gets the best services for the lowest possible cost.
If your plan has only self-directed brokerage windows and no fund menu, this can potentially be a significant problem that we’ll address below.
2) Plan Design
Doctor and dentist group practices typically employ high-earning doctors at various stages in their careers with different financial needs. Younger doctors might still be paying off student loans while older doctors might want to accelerate their retirement savings above what’s permitted in a defined contribution 401(k) profit sharing type of plan with a Cash Balance plan. Some plans started by older doctors might not have a design that’s the best fit for younger doctors. The following plan design elements and considerations may be of interest:
Minimizing Employer Contribution
Group plans typically include profit sharing. If the plan has multiple non-partner employees, the right design should be utilized to minimize employer contribution. This does not always happen, resulting in high employer contribution cost which could be lowered with a better design.
Customizing Profit Sharing Contribution Amount
Some plans may not allow different profit sharing contribution amounts for the partners depending on their ability to contribute. This can be easily fixed with a customized design.
Adding a 401(k) Option
Some plans have no 401(k) option that allows participants to make salary deferrals and catch-up contributions. These plans only allow profit sharing contributions, which prevents those over age 50 from utilizing an additional $6k catch-up contribution. Adding the 401(k) option will also enable higher 401(k) contributions for groups that have a Cash Balance plan where the profit sharing is limited to 6%. This is the case with most non-PBGC plans.
Maximizing Profit Sharing Contribution
Some 401(k) plans do not have any profit-sharing because of potentially significant employer contribution cost. While the cost of adding profit sharing can be prohibitive for some plans, there are ways to design plans to allow for an enhanced contribution for the partners. This is especially true for larger practices where there is significant flexibility to use all available plan design tools.
Adding a Cash Balance Plan
For plans where the practice owners are already maximizing their 401(k) contribution, adding a Cash Balance plan should also be considered. This is not a solution that will work for every practice, so plenty of due diligence is necessary. This includes a thorough design study to determine the benefit vs. cost.
3) Legal and Fiduciary Compliance
Many group plans have been around for a long time without any compliance or fiduciary oversight. In these cases, many compliance errors stay hidden until an independent review exposes them. Very often administrative and compliance errors are serious enough to warrant going through the IRS voluntary compliance process under the IRS Employee Plans Compliance Resolution System (EPCRS).
In addition to administrative and compliance errors, there are often serious breaches of fiduciary duty by the plan sponsor. Because many smaller practices do not have knowledgeable HR staff and most doctors are not aware of their group’s duties as the plan sponsor, staff is often left without adequate education or access to guided investment choices. This can cause problems for the plan sponsor if such participants experience significant losses in their plan or if a participant decides to sue.
While excessive fee lawsuits dominate the news, most small practice plans should worry more about administrative and compliance errors as they are a lot easier to detect now that DOL/IRS has automated the process of analyzing form 5500 data. There are also a lot more opportunities for such errors. The pain and difficulties of an IRS or DOL audit should not be underestimated, and any such audit almost always finds errors and issues with the plan.
4) Lack of Plan-Level Fiduciary Oversight and Using Non-Fiduciary Advisers
Many group plans use either a broker or have no investment, fiduciary and compliance advice provided. In such cases, key IRS and DOL fiduciary requirements for participant-directed plans are often not met. These requirements include 404(c) compliance, failure of the plan to operate according to the plan document and various types of discrimination issues related to the benefits, rights and features for employees vs. partners. Group plans might use an adviser who is not a fiduciary and who also provides advice to several of the group’s partners. This is a clear conflict of interest and a breach of fiduciary duty that can result in scrutiny on audit and other liabilities. Oversight over all of the activities of non-fiduciary advisers is essential, especially if the adviser actively solicits business from plan participants. The partners who are plan fiduciaries can be held fully personally responsible for all actions of such advisers.
5) Brokerage-Only Plan Platforms
Many group plans are brokerage-only plans where every participant has their own personal brokerage account with nearly unlimited investment choices. This is often done to allow each individual partner to invest their money using a brokerage of their choice. However, this makes the compliance effort very difficult to implement because of the number and variety of such accounts.
Self-Directed Brokerage Accounts (SDBAs)
There are numerous problems with plans that use SDBAs. For example, if each account is not titled correctly, such mistitled and potentially disconnected individual brokerage accounts may not afford the legal protection of non-assignment and alienation from malpractice claims and creditors. As a result, these accounts can be attached by claimants in malpractice actions. This is likely the case with at least some of the accounts in older plans. Quite often, certain types of investments that are not allowed in 401(k) plans are present and can result in tax and other liabilities. SDBA holders rarely know that the investments in their SDBA are illegal or taxable. Moreover, frequent trading in a retirement account is something that’s frowned upon by the IRS and DOL. Since this information must be disclosed to the government, such plans will receive significant scrutiny from auditors.
SDBA Conflicts of Interest
SDBAs are often managed by outside advisers who charge asset-based fees that are paid out of the accounts. If any of the fees are paid out of SDBA assets, this also creates a big problem for the plan sponsor who is supposed to make sure that any fees paid from plan assets are reasonable. Sometimes the plan sponsor has no idea what fees are charged in SDBAs, so they have no way of knowing whether the fees charged are reasonable.
Addressing SDBA Issues
If your plan is a brokerage-only plan, plan participants can keep their existing brokerage accounts by implementing the right fiduciary process. The first step is to add a fund menu with low cost investments and a number of managed model portfolios, including a qualified default investment alternative (‘QDIA’) portfolio. Adding these items is almost always an attractive option for partners and staff. The next step is to require brokerage account holders and/or service providers to complete a detailed survey. The plan fiduciaries will keep documentation of the brokerage account data, including the fees charged, how the fees are paid and investments used in each account, among other items. The appropriate utilization of your ERISA 3(38) fiduciary adviser and/or ERISA attorney will be very helpful and instrumental in making sure that the responsible and liable parties implement this process appropriately.
New Fiduciary Rule Fallout
Because of the pending implementation of the new Department of Labor ERISA Fiduciary Rule, many SDBA advisers and firms that service SDBAs have dropped or will drop this part of their business altogether. Others are outsourcing SDBA management in ways that are harmful to the plan sponsors by requiring that the practice partners enter into a fiduciary relationship on unfavorable terms.
6) Cash Balance Plan Risk Management Strategies
Cash Balance plans are often mismanaged by not considering actual risks to the practice that might lead to an early plan termination and asset liquidation under less than ideal circumstances. This, in turn, can lead to significant losses for plan participants. These plans may also have too much portfolio volatility and often excessive investment management costs via asset-based fees. With a high volatility portfolio, there is a real risk that assets would be liquidated after a market downturn if one or more participants take significant distributions, forcing the rest of the partners to make additional contributions to fund the plan.
In some cases, there is no fiduciary oversight over the plan. Services are often provided by a non-fiduciary adviser, which essentially makes the plan fiduciaries and partners fully responsible for the actions of the adviser. Because there is no participant direction in a Cash Balance plan, the plan sponsor is thus directly responsible for investment management of participant money, which is a significant fiduciary risk.
What Really Matters for a Group Practice Plan
There are many different types of issues that have to be addressed with group practice retirement plans that require a team of experts including a TPA, ERISA §3(38) fiduciary and possibly even an ERISA attorney. Whether you are starting a new plan or have an existing plan, there are basic things that should be covered to make sure that your plan is run smoothly for the benefit of all plan participants.
Governance and Fiduciary Process
Without a solid framework to make key retirement plan decisions, your plan would always be several steps behind. Do you know your fiduciary duties and obligations as the plan sponsor? Do you have a prudent fiduciary process in place? Is there an appointed committee to oversee and interface with the plan’s administrative and investment service providers? Are you doing everything possible to minimize your plan cost while getting access to the best investments available on the market? Is your plan design optimal for your practice?
Many plans use professionals who simply do not know the rules of ERISA-governed plans, so hiring an ERISA 3(38) fiduciary adviser who is independent and works exclusively for the plan sponsor will ensure that your plan receives a number of key services. These include helping the plan sponsor create and follow a prudent fiduciary process, select the best service providers, minimize plan expenses and provide access to the best low-cost investments available.
Open Architecture Providers
While selecting a good record-keeper is important, having direct access to your own independent TPA and an ERISA §3(38) fiduciary adviser is key. The TPA will take on the administrative and compliance duties so that you don’t have to do it yourself or rely on a record-keeper who might not be able to provide the level of service necessary for your specific plan. Selecting the best independent providers is always better than selecting a single large provider. You will get better results if you use independent providers who are specialists in their respective areas rather than hiring a single company whose employees or affiliates are providing you with services.
Using a single ‘bundled’ provider will not guarantee you the best of everything cost-effectively. In fact, the cost for bundled providers can be significantly higher without any added benefit. In terms of efficiency, having a plan that consists of several open architecture service providers can be just as good as one where everything is under one roof. Independent providers will be working for you and this will also ensure that you have adequate checks and balances. In contrast, a single provider is much less likely to make sure that other parts of the plan are operating properly. It may be appropriate to have a smaller independent provider take ownership of their specific duties rather than rely on a single organization where employees do not provide individualized services and are merely servicing you as they would thousands of other clients. An independent investment adviser (ERISA §3(38) fiduciary) is always better than services provided under the umbrella of the record-keeper because a truly independent adviser will only be working in your best interest, rather than for a third party. You can, therefore, be assured there are no conflicting loyalties. Always make sure your providers are looking at your plan holistically, from all angles. If an issue does arise, it is essential that your providers can recognize it proactively and address it before it becomes a problem.
Fixed Fee Pricing
Small plans pay some of the highest fees for plan services. One way to make sure that you never overpay for your plan services is to use independent providers who only charge flat/fixed fees. It is not necessary to pay any asset-based fees out of your plan’s assets. Asset-based fees will cost all plan participants significant money over time, and you can always find providers who do not charge asset-based fees for their services. When getting proposals from various vendors, always compare the numbers side by side using a calculator that estimates the cost of running your plan over time. Asset-based fees compound, so only a long-term analysis will help you visualize the benefit of minimizing asset-based fees.
What do you think? Have you been in a position to select or evaluate a group practice retirement plan? Share your experience and comment below!