[Editor's Note: This is a guest post I asked a regular poster on the Bogleheads board to submit to the blog. He is an attorney who wishes to remain anonymous who was responding to a question from another poster about revamping his own retirement plan. It's a great addition (with some counterpoints) to the post from Konstantin Litovsky last week on small business retirement plans. We have no financial relationship.]
Q.
I'm an interested employee doing research on options for improving the 401k plan for the company I work for. My primary goals are to reduce cost and improve fund selection (including the introduction of index funds, preferably without any additional asset-based fee imposed on top of the expense ratio).
One thing that's come up in my research is the possibility of paying somebody to advise us on our plan on an hourly or flat-fee basis instead of based on assets under management (as our current advisor is). How (and how much) does your 401K plan pay your advisor? What responsibilities does the advisor have? Are they a 3(21) or 3(38) fiduciary? Does anybody have any suggestions about how to go about finding an advisor who would work this way? Most references I've come across so far seem to expect a fee based on AUM.
I recommended a provider for, and selected the funds for, the 401K plan that my employer now has with Employee Fiduciary (EF). At a prior employer, I researched the issue and proposed moving our plan from a high-fee insurance company provider to EF, but the management refused to switch. When one group of employees left to form a new venture, two bonuses of the move occurred to me: (1) I could roll my 401K account balance into a low-fee IRA, and (2) I would make my feelings about the 401K plan at the new firm known before any provider had been selected.
You Might Not Need An Advisor
I searched for an advisor willing to take on an advisory role on an hourly basis, and couldn't find one. As I recall, I contacted a nearby advisor listed with the Garrett Network. I believe that he offered hourly fees in general, but needed to research the issue of whether he could do so for an entire plan. In the end, we never heard back from him, and proceeded to adopt the plan without using an advisor at all. I have to assume that the fear of liability may drive many advisors away, and that the returns of providing a few hours of service a year to a small firm aren't worth the risk of legal exposure. It's also possible that hourly advice to an entire plan is not a task for which insurers have a ready-made coverage package for.
Minimizing Liability
I convinced our management to proceed without an advisor. The firm undertook various steps to minimize the likelihood of financial misadventure. First, the fund handling was set up so that funds were deposited by default into a low-risk money market fund. Thereafter, the funds are only moved into index funds, or target date funds (the only kinds of funds we have) if the employee himself/herself moves the funds there. To further reduce any potential liability claims, we selected a fund mix that mirrored the Federal Thrift Savings Plan (TSP) fund mix, using all Vanguard funds. As I recall, the single most volatile fund in our offering is the Vanguard S&P 500 index fund (VFINX). I believe that an employee at EF first relayed the logic of this approach to me. In brief, the reasoning is that since the plan parallels the TSP, it could only be considered a violation of fiduciary obligation, if it also found the defined contribution plan available to all federal employees (the TSP) in violation. Since this prospect seemed highly unlikely, it appeared safe to proceed in this manner.
For an employee to sue, he would have to tell the judge/jury that: (1) he or she moved funds from a safe money market fund to the stock index fund on his own; (2) the entire U.S. stock market declined; and (3) the employer should be held responsible for the stock marked declining. The ridiculousness of this claim, coupled with the inability of any of us to find a single case (we're lawyers) where anyone had sued, successfully or not, over this type of issue convinced the management to proceed without an advisor.
Fiduciary Liability May Be A Scare Tactic
I mention the liability issue because addressing it is paramount in avoiding the advisory fees. The large insurance firms offer warranties of coverage against any liability arising from an employee lawsuit (however unlikely). They tend to trumpet this risk as the reason to pay the fees required for the insurance company plans. The sound of this tends to scare most employers into falling in line with the large insurance company plans and their 2% annual AUM fees. The irony is that all the lawsuits I could find when searching on the Internet concerned grievances about high fees, not the performance of the underlying investments. [Such as this one mentioned by Litovsky last week-ed] The insurance companies also divide and conquer by imposing their high fees mostly on the plan participants while offering the plan decision makers (law firm partners, or managers in a corporation) far superior arrangements with higher contribution limits and limiting the fees paid directly by the employer.
In my experience, fear of lawsuits was the crux of the matter. It was comparatively easy to convince people of the benefit of passive investing with low fees over active management with high fees. However, convincing owners of small firms to ignore the disingenuous warnings about liability from high-fee providers proved to be much more difficult. One advisor specifically warned our management that they were proceeding dangerously. Luckily, in our case, we overcame his fear mongering. The advisor now hates my guts of course. But, I’m ok with that. I regard the hatred of a financial advisor as a surefire indication that we did the right thing.
What do you think? Would you implement a retirement plan without an adviser? What have you done to keep costs down in your practice retirement plan? Comment below!
Thanks for this post as the last one on small business 401k’s had scared us about the liability. We have a small practice and offer a 401K through Schwab with NO advisory fees. We pay a separate firm a fixed annual fee to run all the paperwork. The money goes into a money market monthly in each account which can be invested in anything Schwab offers with the only fees being trading fees or expense ratios. As we choose low cost funds and ETFs our fees are very low. I was not even aware Schwab offered options for more active advising until I read a post on this site. I confirmed that we were not somehow “accidentally” signed up for one of these plans which we weren’t. We have been very pleased with our investment options and service over the years. I looked into switching to Vanguard but it didn’t save us anything.
Congratulations! In your efforts to revamp your 401k and cut some costs, you’ve opened your practice (and potentially yourself) to the fiduciary liability you are so concerned about.
The Department of Labor declares the use of money market funds (and other stable value investments) as a default investment is no longer OK (October 2007). I understand the desire to save costs and “do it yourself”. ….So, some search terms you may find interesting would be “QDIA”, “ERISA section 404(c)(5)”, “annual participant notification” , “DOL Field Assistance Bulletin No. 2008-03”.
In your efforts to cut some costs & protect participants from investment loss by “going it alone”, your plan fiduciaries may find themselves out on a limb. …especially in this year when the US stock market is up some 20% year to date.
Nice try on the fear-mongering. You wouldn’t happen to be a “Wealth Adviser” who sells some life insurance products on the side, would you?
To the substance of the matter: The 2007 DoL rule doesn’t actually say that “the use of money market funds (and other stable value investments) as a default investment is no longer OK.”
Rather, it says that for those instances where money is deposited automatically in a 401(k) plan (e.g. auto-enrollment and profit-sharing), the use of a stable value investment as the default option is no longer covered by the DoL “safe harbor” to the fiduciary rule.
First, it’s not clear to me that the author’s 401(k) plan involved either auto-enrollment or profit sharing, as opposed to simple opt-in employee salary deferrals (whether or not matching was granted) which is not within the scope of the cited rule.
Second, and more importantly, loss of a safe harbor does not equal a guaranteed lawsuit, much less a guaranteed lawsuit that the employer is bound to lose.
The whole point of the safe harbor, originally, was to allow an employer to provide a framework under which an employee can invest his retirement savings in volatile assets (e.g. equities) without the employer or plan sponsor getting sued if the employee experiences losses on his investment. I.e., set up a 401(k) plan as we know it today. As extended by the 2007 rules, the safe harbor also allows the employer automatically to start deducting money from the employee’s paycheck to invest on the employee’s behalf in risky assets (all without the employee’s affirmative consent), without fear of being sued for any losses from such investment. The opt-out enrollment 401(k) plans we saw starting in 2006.
But back up for a moment: money market funds tend not to lose money, so there is very little risk of losses over which to get sued. A suit over foregone gains? From an employee who couldn’t even be bothered to move his money into a target date fund? Get real!
There is a balance of risks here, and frankly the risk of going with a high-cost adviser who is guaranteed to extract excessive fees, and at a remote chance will get you sued over it (which does happen every blue moon), is might higher than the risk of going it alone, saving all those fees, and risking a meaningless foot-fault in a DoL safe-harbor rule that’s never been tested in court in this way and likely never will be.
I, for one, choose to cross the street in the morning even though there is some chance I’ll get hit by a cement truck. Beats the certainty of losing my job if I stay in bed, plus the risk that a more sedentary lifestyle will give me an early heart attack.
These are great, thanks!
While some people say that the 401k plan expense disclosures introduced by the DOL last year have not achieved anything, they certainly made me look at our plan’s expenses (less than 10 participants, includes safe harbor and profit sharing). I found out that the insurance company managing the plan had funds with expense ratios of 2.0-2.5%, plus a $1500 record keeping fee, plus another $1500 for profit-sharing calculations at the end of the plan year. Of course, there was a revenue-sharing arrangement with the ‘Wealth Advisor’. I found the Vanguard Small Business plan offered in conjunction with Ascensus to offer the right balance of service while minimizing costs. Did I mention that I was the fiduciary under the old plan? (not the insurance company or the wealth manager). I’m now a more informed fiduciary, and was required to purchase a fiduciary bond to cover against any liabilities that arise. So, when your deserving-to-be-fired wealth advisor brings up the subject of fiduciary liability, realize that it just a scare tactic. Move on.
I agree with the post completely. Based on the fact that broad indexing (US or world equities) is widely accepted as a very prudent, if not the best way to invest, especially if combined into an age-adjusted bond mix as is the case with many of the target-dated retirement funds (ie Vanguard retirement 2040, etc), I have a very hard time believing that there is any bite behind the bark of the financial advisors’ warning of fudiciary liability as long as you set it up with mainly target dated funds or broad index funds. I wish we could fire our advisor and do it ourselves, but I can’t convince my partners to do it. Fortunately, our total costs aren’t as high as some have mentioned in this post (our total average expense is 0.95%, our plan is mostly made up of indexed target dated funds–good thing we’re paying an advisor for that depth of knowledge in choosing our funds for us!) FYI, 0.40% goes to the advisor, roughly 0.40% goes to Transamerica with a small portion of this going to accounting fees, and the rest goes to actual fund fees).
However, my father is the owner of a 75 employee business, they have run their own 401k for decades without any problems and have saved a significant amount of money for themselves and their employees in the process. They pay a small amount per year for accounting purposes. They are routinely approached by advisors who try to scare them with liability concerns so that they will sign up with them, but they have held strong. I’ll post and let you all know as soon as they get sued so Mark can claim victory, but I’m not sure if we’ll even be living on planet earth by that time. Nanu-nanu.
Another great article. Pleas tell me that Mark Wimmer was being sarcastic
There are Garrett Planning Network (GPN) advisors that will advise individual employees including owners on an individual basis. Employers or employees can pay for this kind of service on an hourly or flat fees basis. The author is correct that current liability coverage, in our case, excludes advising plan trustees, and would require additional costs to enter this part of the financial service arena which most GPN members have chosen to avoid. (11 year GPN member).
A stable and reliable investment strategy for the Thrift Savings Plan is key.
This is a great post – and for the most part, I agree with most of it. A couple of comments:
1) Fiduciary Liability is basically the fear of being sued by plan participants. Probably not the overarching reasons to fix up the plan. For bigger companies it is definitely a bigger problem than for smaller ones.
2) High volume TPAs like EF might be great for larger companies who have the right advice, but smaller practices do not know whether they need a cross-tested or a triple-match plan design, or whether they should get a Cash Balance plan. For this a knowledgeable adviser is key. And yes, they have to be able to charge hourly or a flat fee for their advice.
3) In my book, the value of the adviser is to help manage plan investments. Everything else goes without saying – if an adviser uses low cost index funds and knows how to manage portfolios, then there isn’t much of a liability for plan sponsors. In addition, the adviser has to help employees get better investment results through a combination of personalized advice and professionally managed model portfolios (using low cost index funds). And if done for a flat fee, this is all that’s necessary to not worry much about fiduciary liability.
Hey WCI.. Im trying to figure out if its worth it to pay my CPA an additional $125 quarterly to do payroll? I have a small side consulting business and wishing to employ my wife to maximize her employee 401k contribution. I am making an assumption that all I need to do is…
1. Submit payroll online through the SSA website to be done within 2 weeks after the payroll period assuming at the end of the month or quarterly? (for 2015.. was going to do a lump sum $20k for the last period)
2. Pay the self employment taxes of $3060
3. Contribute 100% of her earnings to the ROTH employee 401k
4. In addition.. she and I can each take an employer contribution tax deferred on the net earnings
Is there anything else to do this or is more complicated enough to warrant the $125 quarterly payment to my CPA to do this? Im not sure how complicated the SSA website really is? Did you already do a post on how to employ wife and kids to maximize 401k and ROTH contributions respectively?
Thought about forming an LLC and having both of you be members instead of her being your employee? Then all you have to do is file a 1040 SE for her along with yours at the end of the year. You’ll still owe the same taxes and have same retirement fund options, of course, but might be less hassle.
I doubt your CPA views the $500 per year charge as particularly high. I have not yet done that post and I have not done much through the SSA website.