By Konstantin Litovsky, Guest Writer
When we talk about retirement plans, specifically the 401(k) plans, we always have in mind participant-directed plans in which all plan participants get their own personal account and are responsible for managing their own investments. It turns out that participant-directed plans aren’t the only 401k plans available. A common type of plan that was popular back in the 80s – called trustee directed or ‘pooled’ 401k plan – is staging a comeback, and for some very good reasons. In this article, we’ll discuss pooled 401k plans and explain why they might be a better choice for smaller practices than participant-directed 401k plans.
Participant-Directed vs. Pooled Plans
In participant-directed plans, every plan participant gets their own account and is responsible for managing their own investments. In participant-directed plans, the plan sponsor is ultimately liable for plan performance, as well as for investment selection and participant education. Participant-directed plans require the services of a Third Party Administrator (TPA), a custodian and an investment advisor (either a 3(21) or a 3(38) fiduciary).
Pooled plans have a single trust account managed by the plan sponsor (the trustee). All plan contributions are co-mingled and are tracked by the TPA. A discount brokerage such as Ameritrade or Vanguard is typically used as a custodian. Plan participants do not get to manage their accounts and have no say in the investment direction of the plan investments. The investments in a pooled account can be managed by an investment manager (a 3(38) fiduciary), and no other services that are typically provided by participant-directed plans (such as enrollment meetings, participant education, and individualized advice) are necessary.
Why Use a Pooled Plan?
Since 2008, participants are able to sue (and are increasingly suing) plan sponsors for fiduciary breaches due to high investment costs, lack of education, bad investment choices and investment losses. Because smaller plans rarely get the benefit of quality fiduciary advice, they are exposed to liability due to fiduciary breaches. A pooled 401k plan can be a great way to reduce your fiduciary liability. As long as you have a 3(38) investment manager taking care of the investments, your own liability for managing investments is eliminated, and because there are no participant-directed accounts, there is no other liability for you as a plan sponsor (other than prudent selection of the investment manager). There is no need to worry about 408(b)(2) fee disclosures, QDIA selection and disclosures, fee benchmarking, participant education and advice – services that a plan sponsor for a typical participant-directed 401(k) plan has to provide for the benefit of the plan participants. Please note that not all 3(38) investment managers will want to have discretionary control over your pooled plan investments, and anything less than an investment manager who is a 3(38) fiduciary will not eliminate your fiduciary liability for investment selection and management.
In addition, having a plan with a professionally managed investment portfolio can help you and your employees achieve better investment results, especially if you do not want to worry about managing your own investments. In a participant-directed plan every participant has their own account, so they have to manage their own investments. Even with the best advice provided to participants, each participant still has to follow through and make the right choices. Having a single managed account eliminates this problem, and all plan participants will benefit from getting their investments professionally managed.
Comparing Costs
It costs less to manage and maintain such a plan. Because there are no participant services to provide, a pooled plan will save you time, paperwork and money – there are no asset-based fees for custodians (Employee Fiduciary charges 0.08%), you can use a stand-alone low cost TPA for administration, and a discount brokerage such as Vanguard can be used as a custodian/record-keeper. Vanguard has one of the best selections of low cost index funds available, so that alone will ensure that your investment expenses are low. Investment management in such plans can be offered for a flat fee (rather than an asset-based fee), and because the money is in a single account, the cost of managing assets in pooled plans is lower than in participant-directed plans.
A Pooled Plan in My Practice?
Pooled plans will not work for everyone, but a practice with one owner may be a good candidate for this type of plan. All plan participants will get the highest level portfolio management services (the next best thing to hiring a wealth manager), and since there is only one account, your employees will be thrilled because most of them have no idea how to manage their investments. A pooled plan is a better deal than simply having a 3(38) fiduciary oversee plan investments in participant-directed plans. A typical 3(38) fiduciary might pick investments within a plan, but they rarely offer discretionary portfolio management (or managed model portfolios) inside participant-directed plans, and if discretionary investment management is offered, the cost is usually high (typically via an asset-based fee). While there are some 3(38) investment managers who can provide competitively priced investment management services for participant-directed plans including investment selection and model portfolio management, most advisors offering 3(38) fiduciary services will not provide individualized advice to plan participants, which is one of the best ways to limit your fiduciary liability while helping your employees achieve better investment performance inside a participant-directed plan, Thus a pooled plan is probably the best and the most cost-effective way for a small practice to get the benefit of a professionally managed retirement plan with the highest fiduciary liability protection possible.
All Participants Have the Same Portfolio
It turns out that having the same portfolio for a 30-year-old and for a 60-year-old is not a problem. Having a single conservative allocation for all plan participants can be a good idea over the long term, and it is not necessary to be overexposed to stocks or to have an aggressive portfolio for younger employees. This counter-intuitive result comes from the fact that a conservative portfolio might provide better risk-adjusted return than a very aggressive one. While the actual outcome depends on many factors, we can demonstrate this effect with the Vanguard Monte Carlo simulator that uses actual historical data. (Try using a 100% stock allocation portfolio and comparing it to a 50% stock allocation portfolio.)
Over the past 30 years, a 50% stock/50% bond allocation turned out to be as good (or better) than a 100% stock allocation assuming periodic withdrawals, so if someone retired 30 years ago, a 50:50 portfolio would have done as well (and possibly even better) than a 100% stock portfolio, and with significantly less risk. While a 100% stock portfolio might have done better if no withdrawals were made, periodic withdrawals make all the difference because 100% stock portfolio is much more volatile, so making withdrawals during market crashes would have taken away from future returns. A pooled plan is likely to see continuous contributions, which can help rebalance during the down years, but over time those contributions will be rather small compared to the value of the overall portfolio. In a pooled plan, withdrawals might be made from the portfolio for various reasons (and at various times), such as when an employee is terminated or when making hardship withdrawals, so another reason to keep a more conservative allocation is to avoid a situation where large withdrawals are made from a portfolio that lost value during a market crash (which can happen when a long-time or a highly compensated employee leaves).
One way to think about conservative vs. aggressive portfolios is that it is better to get close to ‘market’ return (represented by an index such as S&P500) with much less volatility than having the potential for a higher than market return but also for a much bigger loss, which can be a significant disadvantage when making withdrawals, especially during prolonged periods of market underperformance. While you might see higher returns with a 100% allocation, you will also see bigger losses, so a conservative allocation might actually do better because you don't have to worry about getting out of the market at the wrong time as much as you would with an overly aggressive allocation. While it may seem that getting out of the market is simple, doing so at the wrong time can lead to large losses over a prolonged period of time because recoveries can often take a decade or longer. Thus, a single conservative allocation can be a good solution for a pooled plan from both the plan operation and investment management perspectives.
Pooled Plans Aren't New
These plans have been around for a long time, but fell out of favor because in the 90s plan participants started to demand more control over their individual accounts. Market gains in the 90s created unrealistic expectations that anyone could manage their own portfolio like a pro, but the two recent bear markets have proven otherwise. A small number of dedicated and knowledgeable advisors including some CPAs and TPAs are using pooled plans with their clients, so pooled plans remain an open secret. Unfortunately, some advisors, including CPAs who provide investment management services, are using pooled plans as a way to charge high asset-based fees, which is not a good deal for the practice owners. This is not an ideal type of plan for larger companies where the owners prefer to manage their own accounts and can afford to hire the right fiduciary to oversee the plan, but smaller companies, especially medical and dental practices, can benefit immensely from what pooled plans have to offer.
[Editor's Note: Pooled plans are not that different from the defined benefit/cash balance plan my practice uses, except it is a type of 401(k). We put in $2500-$15K per year, in it invested in a set asset allocation we have no control over (52% stock in our case), and upon leaving the group, it can be rolled over to an IRA. One of the biggest downsides is that it is hard to mix and match a plan like this with the rest of your retirement accounts. I prefer having more control over my own asset allocation, but most investors, probably including your employees, honestly don't know what to do with that control. It sounds paternalistic, but if they aren't willing to take the time to learn a bit about investing, they're better off handing the reins to somewhat else who will do something reasonable, especially if that asset management comes at a very low price.]
[Editor's Note: Konstantin Litovsky, owner of Litovsky Asset Management, is a long-time WCI partner and an expert in designing low-cost small practice retirement plans, however, this is not a sponsored post. This article was submitted and approved according to our Guest Post Policy.]
What do you think? Do you have a pooled 401(k)? Would you consider one? Comment below!
The assumptions used to justify the more conservative portfolio for the younger investor aren’t appropriate. As noted above, one has to assume periodic withdrawals and that just isn’t a valid assumption. If one is going to allow inappropriate assumptions then its a lot easier to prove whatever you want to prove. These plans could be considered based on cost especially if such costs allow a better match/more pay or benefits elsewhere but if one wants to use a high bond allocation then to believe that its a good fit for the younger people is a stretch. You probably would be opening yourself up to the same concerns and liabilities but of course I’m not a lawyer.
Unfortunately I was not able to find a good Monte Carlo simulation of accumulation phase, but even that wouldn’t be accurate because of potential large withdrawals at random times during the accumulation phase. Maybe someday I’ll write one of these myself, but for now, let’s just look at the implication of what we have.
The Vanguard simulation is limited to withdrawals, that is correct. The point of the simulation is to show the risk-adjusted performance over the long term. The primary reason for a 50:50 allocation is the risk-adjusted performance over 30 years or longer. I have ample research (not shown in this article) that demonstrates that a 50:50 allocation (during crashes) can achieve the same annualized return as 100:0 allocation, even over a long term (30 years or longer). While the 100:0 allocation will beat a 50:50 during market ups, it is the downs that we worry about, and that makes all the difference.
The secondary reason is withdrawals, though not periodic. Because they often can not be timed, the allocation has to be more conservative.
By the way, a ‘conservative’ 50:50 allocation still returned as much as 10% over 30+ years (getting close to S&P500 return with less volatility). That’s because the allocation I’m using is overweight in ‘value’ and small cap stocks. No reason this outperformance will continue into the future though, but this is to dispel a myth that a 50:50 allocation is not adequate for younger employees. The longer the horizon, the more likely we are to experience crashes. Lower volatility will lead to more consistent returns (which is also a fact – with a more aggressive allocation returns are all over the map, which is less than ideal for planning purposes).
Again you have added an assumption this time during crashes.
Bottom line is that if you consider this an IRA for a 30 year old instead of a pooled 401k then no the 50:50 bond isn’t as good for normal retirement.
There is a reason why advice for a 30 year old isn’t 50:50 period.
We are talking about a plan where an average turn over of employees is 5-6 years, so after 6 years maybe half of the employees will be gone, along with their plan balances and a good portion of the matching contributions. All of them will simply want their balance immediately, which can be much more than 4% withdrawal. A more conservative allocation is a must, since we don’t want to sell at a loss if all of a sudden several employees leave all at once.
Recessions can last for many years, even decades. I’m planning for the worst case scenario, not the best one, and one can not time the market (or get out of the market at the right time) with a very aggressive allocation unless you get lucky.
If a 50:50 portfolio is inadequate for retirement, how come the 50:50 allocation I’m using has a 10% annualized 30+-year return? And why does Vanguard calculator show that a 50:50 allocation has a better chance of success than 100:0 allocation? They are using their allocation, not mine, so the results might be even more dramatic.
I’m sorry but you are adding in now new assumptions yet again. I don’t mean to be too rude but unfortunately you have a conclusion you want to come to and keep trying to put stuff out here until it sticks. This is common when someone wants to sell something. If that is such a problem then they shouldn’t use the pooled at all. I can see how a pooled situation is simpler and cheaper and for some this might be worth the reduced performance but any way you slice it, the younger person is taking a hit in this situation if they are going to a high bond percentage. That might be okay and it might not.
I think you’re painting with too broad of a brush. A young person isn’t necessarily “taking a hit” here. If he desires a more aggressive asset allocation, then he can go 100% stocks in his Roth and taxable account so that his overall allocation is as he desires. This is no different than the problem I have with my defined benefit plan (52% stock). If I want to fold that into the rest of my asset allocation, I just adjust the other accounts so that overall I get to 75% stock (or whatever.) Yes, one downside of a pooled plan is that every participant doesn’t get to do what he wants. But it seems to me a rather small problem to work around in exchange for fewer expenses and most of the employees avoiding stupid investment decisions. Remember most “investors” (aka 401(k) participants) don’t read blogs like this one or books like you have. They’re probably better off with a reasonable asset allocation (and 50/50 is certainly reasonable, even for a 30 year old) than doing it themselves.
I agree. If we go by the conventional wisdom that people in different age groups should have a different allocation, then obviously one-size-fits-all compromises the young and the old. Defaulting to a target date fund for each age group would be much better. Research shows that people tend to stay with the default.
Kon,
What you are describing is actually a big shortcoming of a pooled vs. non-pooled plan. In a participant directed plan, no other plan participant is affected should a staff member leave. In the pooled account, funds must be liquidated to meet the distribution request, possibly at the wrong time.
Once more, instead of “planning for the worst case scenario” the prudent thing to do is more likely to plan for the most probabilistic outcome.
These plans are ideal for very small practices with a single owner and a handful employees. The great thing with pooled plans is the flexibility. Because there is only a single account, it can be managed as necessary to accommodate any changes. So at the very beginning when the asset level is low, the plan can be managed more conservatively. When the asset level is higher, the allocation can be more aggressive. As long as the assets are managed prudently, that’s all that is needed, since most plans which are participant-directed will not get the same benefit without providing personalized advice. Also, for small practices, planning ahead is fairly simple and turnover is controlled via vesting schedules.
I find that those docs who don’t want to worry about managing their own account (and who care even less about what their employees are doing) find pooled plans to be exactly what the doctor ordered.
Sorry Kon, there is no 30 year period in our past where a 50/50 allocation had the same annualized return as a 100% stock allocation. While it “can” happen, it is highly unlikely. I’m not saying 50/50 isn’t right for a pooled fund, but it’s a pipe dream to think you can invest in safe assets and have the same return as risky assets. It doesn’t pass the sniff test, nor is it consistent with the historical data.
Now, there are a few ways to dance around that- for example by using a lower percentage equity but using riskier stocks (small, value EM) and then comparing it to a higher percentage of safer stocks. You can also “risk-adjust” the returns. But you don’t get to spend risk adjusted returns, and both expected returns and historical returns are lower with bonds than stocks. The higher the percentage of bonds, the lower the returns. Show me “ample research” that says I’m wrong, and I’ll point out why said research doesn’t demonstrate what you state it does in your comment.
Unfortunately, MPT is not correct – higher risk does not always equal higher return. This data comes from using a portfolio overweight in small caps, so this might not be typical for an average portfolio:
Annualized Return Since 1970
Notes As of bonds (government) 50/50 100/0 S&P
After crash 2002* 8.7 10 10.6* 10.7
2006 8.1 12 15.4 11.2
After crash 2008* 8.3 9.2 9.5* 9.5
2012 7.7 10.5 12.7 9.9
*Only a 90% stock value was provided (so results might be even lower)
So as far as retirement goes, I’d say that the allocation I’m using (50:50) is more than adequate as far as return and risk for anybody. We know what investor returns are, and most don’t come anywhere close.
So if we compare to 100:0 portfolio using the same asset classes, there are times when we come close with a 50:50. The future will produce similar results, worse so if the crashes are deeper/longer (which is only a matter of time). The amazing thing is that even after 40+ years, having a bad crash can easily skew the annualized returns over decades. This is consistent with the fact that markets are described by fat tails, and not a Normal distribution, so a bad crash can significantly impact the average annualized returns.
I didn’t publish an article on this yet, but I’m getting together more materials. This is exactly why Vanguard’s historical data calculator shows that a 50:50 allocation might produce better results than 100:0 one when withdrawals are factored in. The reality is that the crashes can be large and last for a while, and so being more conservative might actually be not such a bad idea for an average person. I know I don’t mind getting 10% average returns with a ‘conservative’ 50:50 allocation. Do you?
Sorry, my table got garbled up. Let’s try again:
Annualized Return Since 1970
As of bonds 50/50 100/0 S&P
2002* 8.7 10 10.6* 10.7
2006 8.1 12 15.4 11.2
2008* 8.3 9.2 9.5* 9.5
2012 7.7 10.5 12.7 9.9
*Only a 90% stock value was provided (so results might be even lower)
I think I see what you’re doing/saying here Kon, but I don’t think it’s a good way to do an analysis. You are purposely cherry-picking 30+ year periods that end in a massive bear market.
I’m not arguing whether a 50/50 plan is adequate for retirement or not (with the right savings rate, any asset allocation can be adequate, of course.) What I’m arguing is that any reasonable analysis of long-term returns shows that a 100% stock portfolio has a historical and expected long term greater return than a 50/50 portfolio using the same stocks and any reasonable bond allocation. Use your 2006 and 2012 numbers and that becomes quite obvious. Heck, even if you use your 2002 and 2008 numbers the stocks still come out ahead, just not by as much.
In addition, that cherry-picked period happens to coincide with one of the longest bull markets in bonds in history. I’ve tried to have this conversation with Kon in the past and just gone around and around. A more sensible thing to do is look at rolling historical periods of 20 or 30 years and see that in the overwhelming majority of the time, more aggressive allocations outperform more conservative allocations.
And the biggest crashes. In fact, Vanguard’s calculator does just that, and of course, it turns out that with periodic withdrawals a conservative allocation can and does win over an aggressive one. It would be nice to add contributions along with withdrawals, but I think this wouldn’t change the results because presumably at retirement there will be no more contributions, so this portfolio has to last 20+ years, and at some point an aggressive portfolio has to be realigned to be more conservative – bad timing (and bad luck) can be very damaging.
Did win you mean. That “calculator” is simply a function of what worked in the past. And remember what “winning” means here. It doesn’t mean the highest amount of money in the end, on average. It means probability it survives 30 years.
Thank you for the clarification. Thinking probabilistically is hard work – our language is so deterministic, and we don’t like it when people start using ‘might, may, could’, as it sounds like someone is trying to sell something.
I have to be more careful here. Let me state something that I’ll demonstrate in an article I’m writing right now), actually two statements:
1) If I use a 50:50 bond/S&P portfolio, there are times (during the past 2 recessions) when the 50:50 allocation 30+ year return ‘touched’ the 100% S&P return (rather, the 100% S&P return dipped low enough to touch the 50:50 return). The 100% S&P portfolio still smoked the 50:50 portfolio on the total return basis. This is of course if one held for 30+ years with no withdrawals or contributions – not a good assumption. With withdrawals, the 50:50 might actually beat 100% portfolio (esp. during prolonged recessions) – this is what Vanguard calculator shows (and I believe it might use 80+ years worth of data – I only have data since 1970 because that’s how long these funds have been available for, sorry!)
2) If I use a 50:50 overweight with value/small caps, this portfolio actually beat S&P on the total return basis over 40+ years. Not by a whole ton (I’d call the results even), but with a lot less volatility.
However, given withdrawals and contributions (uneven ones at that), timing is everything, so all of this analysis (and any other analysis for that matter) is strictly hypothetical. All I wanted to demonstrate is that a 50:50 portfolio (if constructed correctly and if managed correctly) can work very well in the pooled plan setting.
Hard to argue with that.
Having a 3(38) fiduciary does not eliminate liability — it just shares it. The plan sponsor can still be sued for failing to do due diligence and exercise good judgement in choosing the 3(38) fiduciary if they perform poorly.
Exactly! That’s why the 3(38) fiduciary has to do everything right.
http://litovskymanagement.com/2014/01/hiring-fiduciary-adviser
There are too many 3(38) fiduciaries who charge asset-based fees and use the 3(38) as a marketing gimmick. Also, it goes without saying that using low cost index funds and passively managed portfolios will go a long way.
That assumes the 30 year old has additional resources to use in a Roth beyond the 401 k. Even if the young employee leaves in a downturn, he/ she can immediately reinvest that money in another 401k or Ira for trivial costs so no real loss. The high bond scenario favors the likely older and richer physician in this potential example. Those percentage differences over decades do mean a lot even if the 50 50 got 10% and the higher got 11% or whatever number u want to use. Small numbers compounded really add up which is why we focus on reducing or eliminating them.
You are right, but my point is that a properly constructed 50:50 can produce S&P-like 30- and 40- year returns, which will be more than enough for 99% of all docs. This might be counter-intuitive, but the numbers don’t lie. Of course, going forward, nobody knows whether this will hold. Like I said before, I’ll have to demonstrate this with some numbers. Very few people come anywhere close to getting S&P return over several decades, so it is difficult to complain about getting ‘only’ 10% return.
I love how people who sell stuff will put forth an inferior plan and be okay about it by saying that very few people get the avg or its okay to get less then they can if you get whatever 10%. The reason they don’t get the avg is bc they get bad advice. I’d complain bitterly if I were the younger person in this pooled scenario but that’s bc those returns aren’t as similar as you like to pretend.
I actually don’t ‘sell’ plans. My primary role is that of a flat-fee financial planner/wealth manager, and I help small practices get custom-designed and reasonably priced plans, whether pooled or participant directed. So if a SIMPLE IRA is a better choice, that’s what I recommend. If someone wants a participant-directed plan, so be it – my job is to find the lowest cost/highest quality solution for my clients. I also offer managed solutions for retirement plans (pooled or participant directed), so that plan participants either get full discretionary management or investment selection/model portfolios that they can select themselves. This is in due to the fact that most plans don’t offer anything like that, and most docs will not be reading this blog or doing their own research.
A pooled plan is specifically for those who DO NOT want to manage their own money, and who DO NOT want to pay asset-based fees for investment advice. We haven’t even discussed the fact that small practices are not getting properly designed plans for them and that an average small plan owner is paying huge asset-based fees and getting no service in return.
The reason that I came up with this type of plan for small practices is exactly because it allows me the opportunity to provide the highest level and the lowest cost advice to my clients. I’m fed up with plans where nobody knows what they are doing, and where there are terrible choices and the AUM fees are through the roof. This is not an IRA where you can simply get the best of the best (at Vanguard or Ameritrade) and be done with it (as long as you can manage it properly).
Getting a 10% return over 30+ years is probably the 99th percentile as far as most investors (including financial advisers) can offer. I’m not saying I can offer this type of return, but historically, most investors don’t get anywhere near that. Many docs will have the majority of their money in retirement plans, so they will benefit from good advice.
Unfortunately some seem to believe that the rules for asset allocation and returns are written in stone – I used to believe this too until I started running the numbers, and noticed that things are not as linear as they appear. I personally invest in the same 50:50 allocation I use for retirement plans, so I put my money where my mouth is. I’m always happy to share my research with anyone that is interested.
I pay zero AUM fees in either my 401 k or my defined benefit plan. If I wanted advice, I could pay for a consultation at any time. I happen to use Schwab investing in index funds and etfs. The reality is physician owned small businesses could do the same.
I guess this means you’re not going to hire Konstantin to set up a pooled plan for your practice, huh? 🙂
Schwab and Vanguard both have small business retirement plans, but the cost (last time I checked) is around $3,500 per year. Vanguard only offers their plans through advisers though. One issue with both Schwab and Vanguard is that they do not specialize in custom-designed 401k plans. The $3,500 might cover a basic Safe Harbor design, but if you want something a lot more customized (such as when you have older employees and you want to max out your contribution at $52k), chances are that the cost is higher, and that they might not even offer this type of design to you unless you ask. Both Schwab and Vanguard in fact outsource the TPA work to third party TPAs, who may or may not be good at what they do. And in case something changes in your practice, a plan design might have to be tweaked or changed, so that’s not something they look out for.
A retirement plan is not there just for you – it is there also for the benefit of plan participants, including all of your employees, and as far as I know, Schwab and Vanguard don’t offer any special services such as investment selection, model portfolio creation and employee education. How many physicians would be comfortable managing their own plan investments, selecting investment lineup for the plan and providing advice to their employees?
Whether using a pooled or participant directed plan, I believe there is a bare minimum that’s necessary to have a successful plan:
1) A high quality, responsive TPA who can help design the best plan for a practice and respond quickly to any changes.
2) An open architecture platform that provides access to the lowest cost Vanguard index funds.
3) A 3(38) fiduciary who takes responsibility for investment selection, portfolio design and plan participant education.
Costs me around 1.5 k per year for each so 3k total. Every doctor is way smart enough to do it and easily can feel comfortable. They handle life and death issues all the time. If they don’t want to then that’s fine but it’s not like the advisors are guaranteed to offer much more than additional costs. My tpa via schwab is alliance pensions and haven’t found any issues.
I may have mentioned this before, but most high volume TPAs will not do special plan design for you. They won’t work with you to optimize your K1 distribution vs. W2 income, or to maximize your plan contributions using one of several types of designs (such as cross tested or triple match). Also, some practices might benefit from an upgrade to a Cash Balance plan, and most high volume TPAs simply won’t care to do this analysis. This alone can save many times what you pay in TPA fees.
I’m currently working with several clients (some came from White Coat Investor and some from Dentaltown) whose plan designs are anything but cookie cutter, so they require special attention that most small practices won’t get (and I assure you that you won’t be able to find any problems with the designs you get from your TPA, unless you are a TPA yourself). Sometimes the TPAs screw up the design so much that they put the plan sponsor in danger of IRS fines and penalties, and it takes another, knowledgeable TPA to spot the problem and to fix it quickly.
It is not a good idea to pretend that retirement plans are simple and just because you haven’t had problems that everything is done perfectly fine. This is precisely why I do what I do – as a fiduciary I not only help the docs with investment management to improve their investment results vs. what they would have been able to do themselves, but also I work with a quality TPA which can provide a second opinion on plan design. If everyone was able to manage their investments themselves, we would not be having studies done by DALBAR that show that average investors (and yes, docs are not all above average) underperform both the S&P500 and their own investments by so much that they can benefit financially (to the tune of 3% annually, according to Vanguard) from quality professional investment advice.
Well the group I work with converted a 412i and thus seem to have some experience. Of course everyone’s mileage might vary.
Since you are a fiduciary, do you tell the younger employees that they may be missing out on higher returns over their lifetime or do you pretend there is really no difference for them? I’m just trying to see the value in the word fiduciary in this situation.
Bottom line is that there is a cost to doing pooled and pretending nobody takes any hit isn’t accurate. This cost might be completely acceptable to some but not others. I know if I were a younger employee, id consider the cost of having a too conservative an approach.
Who can predict what type of returns one is missing out on? Would you know what returns will be in the future? I surely don’t. All I can do is make sure that they get BETTER returns than they would have been able to get on their own. For 99% of people who don’t know much about investing this is good enough. Besides, as Jim mentioned, a 401k plan is only a part of the employee’s financial situation, so without looking at their entire situation, it is impossible to decide which allocation will work best. As I’ve shown above, the ‘conservative’ allocation I use beat S&P over 30+ years, so that’s good enough in my book.
Any allocation that beat the S&P 500 over 30+ years (which by definition would have 9-11% annualized returns) probably shouldn’t be called conservative. Didn’t we already have this discussion in this thread? More bonds = lower returns over any 30 year period in US history that I am aware of. Doesn’t mean that will happen in the future, but that’s the way the past has been.
Exactly. That’s why ‘conservative’ is in quotes. It is a fairly aggressive allocation, but the fact that it has 50% in treasuries puts many people off, and they immediately assume it has to be conservative and that it has to under-perform some imaginary benchmark. But we can’t be too hard on DIY investors like Rex – this is not something that is clear from reading any investment book that I know of. Very few make this distinction, and it does take a lot of experience to realize that not all 50:50 portfolios are alike. But explaining this point is difficult because most books are written with the assumption there is only one allocation, and that 50% bonds is automatically an extremely conservative one.
If 50% is in treasuries, you must be taking significantly more equity risk than the S&P 500 in order to have overall higher returns.
Exactly. Everything has to balance out, there is no secret.
Along with our 3(38) investment manager, we’ve helped nearly 3500 companies establish a new or improved retirement plan, including over 80 on Dentaltown. Less than a dozen of our entire client base is pooled, and Not on the 401k side, only in regards to profit sharing contributions for plans we took over. Having also worked with hundreds of advisors in support of their clientele since 2002, there just was not a demand and not enough good enough reasons to try and “sell” this scenario. And unless the solution requires a combo plan (using a CB or DB plan) on top of the 401k, there may be no real reason to absorb unnecessary costs using an outside TPA. There are plenty of fine full service providers, who have acquired TPA’s along the years and integrated their expertise internally that can offer a singular point of contact to manage the entire plan or plans at lessor cost, often with advanced technology to offer the participants.
A retirement plan actually can and should be easy to maintain, and simple for the plan sponsor, all the more so if they do not select a DIY solution. 401k plans are a long tail solution, and participants having an advisor try to beat the market using a pooled plan’s assets is folly at best. Pooled plans actually add layers of complexity, for no reason. If someone wants to debate an opposing position, evidence would best be presented if there is a long history of setting up many pooled plans directly. However in no plan size or sector are pooled plans having any degree of increased popularity.
There are several questions that have to be answered:
1) Which solution (pooled or participant directed) is the best for smaller practices?
2) Is one solution (participant-directed plans) oversold by plan providers?
3) What are the reasons why pooled plans are almost never offered to small practices?
One type of plan is not always better than the other, but pooled plans are more appropriate for smaller practices than participant-directed ones.
There are many companies that sell 401k plan platforms. The primary way in which they are compensated are asset-based fees that are often hidden under TPA fees. Pooled plans would be a departure for such companies, because they want larger plans with more assets, and such plans tend to be participant-directed.
Pooled plans pose a direct competition to such companies because they are much simpler to run and implement and they don’t require a complex recordkeeping/custodial infrastructure, and they can be implemented much cheaper without any asset-based fees whatsoever. Also, most companies that sell 401k platforms use a bundled approach and they use a one-size-fits all design. They make money by grabbing as much assets as possible, so working with small practices is not something that is cost effective for them.
Thus, ‘popularity’ is a bad measure for something that may be a better solution than the majority of plan providers are offering. It is more of a testament to the fact that the best is not always the most popular.
The previous comment literally is all over the place. There has to be a distinction made between what you describe as companies, that sell 401k platforms. MANY recordkeepers have No asset based fees, aside from say 6-8 basis points for custody of the assets. And while flat fees have their place, do you feel a $2500 or a $4500 annual Flat fee for a startup or small plan is better than 25 basis points that are only charged if there ARE assets?
Having worked with retirement plans of thousand’s of companies, the statement that pooled plans are simpler to run and implement is 100% without merit. It literally makes no sense to suggest that, unless the thought is being driven by a small or regional TPA that promotes a biased view of pooled plans. When the investments of a 401k plans’s participants reside on a recordkeeping platform, there is no more or less work for Anyone, the platform manages all transactions. once the plan sponsor uploads or enters the deferrals for a given period.
And if you are the plan sponsor, you darn well better hope the advisor you have chosen to manage your pooled plan is doing so for many many clients, and many millions of dollars, a defined track record, and is a 3(38) fiduciary. 3(38) or not, a modestly talented attorney will have a slam dunk case on behalf of the participants for not being able to direct their Personal deferral dollars in bad markets. I’ll say it again, unless you have personally setup or have been part of hundreds of a given thing and maintain a client base using that giving thing, its merely an opinion that should be extremely well researched by any plan sponsor.
From my experience, large TPAs are not that interested in working with smaller plans, and the quality of service is inferior. The TPAs I use see no difference between pooled and participant-directed plans as far as administration. Also, I find that larger firms that try to grab as much assets as they can don’t spend the time working with smaller clients, while not necessarily charging lower fees. TPAs I use for pooled plans charge about $1200 + $20 per person, no basis points of any kind. This is about as low as one can go. Even 8 basis points start adding up once plan assets go over $1M or so.
Let’s not confuse TPA fees and investment management fees. When discussing investment management fees, we have to compare apples to apples. For pooled plans my firm offers discretionary portfolio management services, and for participant-directed plans (which I also like), my firm offers investment selection and discretionary model portfolio management as well as investor education and individualized advice. Most so-called 3(38) firms offer nothing more than a list of investments, and not even managed portfolios. So that’s not really helpful at all as far as getting plan participants better investment results (which is what matters most).
There is a lot more than just selecting a bunch of investments and leaving it at that, but this is exactly what most firms do, while charging pretty high asset-based fees for this ‘service’. And since we are on the topic of fees, your firm’s 3(38) (and other) asset-based fees (according to your own illustration) are 0.58% for services that are far inferior. And you think that 0.58% is lower than say $5k a year? Not by a long shot. After 25 years a typical plan will lose $600k to a 0.58% asset-based fee vs. a flat $5k fee (as an example). So no, asset-based fees in any shape or form are bad for retirement plans, whether pooled or participant directed.
A detailed investment policy statement (that is followed) is all that a good 3(38) fiduciary needs to make sure that the plan sponsor is protected from liability. This is a high level service that we offer to smaller plans because we take discretionary control over plan assets, which are managed conservatively and prudently. This is a lot more than participant-directed plans where every investor does stupid things such as selling at the bottom and buying at the top. Which plan do you think will get better investment results over time?
I have a question, and this discussion is the best I’ve yet found in terms of possibly getting my answer. In September of 2013 I left a job that had a pooled 401k. They provided me with a year-end statement (ie 12/31/13) and a couple of days ago processed my paperwork for a rollover to an IRA. They distributed the amount indicated on 12/31 statement, and did not distribute any additional gains from January 1 through May. That doesn’t seem right to me. Is that how it works in a pooled 401k? Or did they inappropriately deprive me of any interest/gains over that period? Thanks in advance.
Hi Dan. Here’s what my TPA says:
“That’s how it works in a pooled plan. It’s stated in the document that gains and losses are allocated annually as of 12/31. It was not illegal how the distribution was made. Such arrangements can be good or bad, depending on your point of view, but you have to remember back when you first became eligible for the plan, the annual allocation of earnings probably helped you in that you were probably allocated a full years worth of earnings on your beginning contribution, which was probably not in the plan for a full year. So you benefit from annual earnings in the beginning and may not benefit as much at the back end, but it averages out.”
I hope this helps.
That sounds like my defined benefit plan. I make my contributions in April of the next year and they basically treat it just the same as if I contributed it in January of the current year, for better or for worse.
Doesn’t seem fair to me at all. Of course, if you had gotten a loss YTD, you would be very happy right now. Why not make a phone call and ask them? I’d also read the plan document to see how this sort of thing is supposed to be handled in the plan. If nothing else, have your attorney send them a letter.
This sort of thing is a mark against pooled plan accounting. Imagine putting part of your paycheck in this type of plan as an employee and getting no accounting for the value of your investment until you get a once-a-year report from the TPA. This doesn’t do much to instill confidence or encourage plan participation.
These are generally cross-tested plans, so employees will get a higher matching contribution than in a typical Safe Harbor 401k plans. However, participation does not depend on the type of plan but rather on the salary and financial situation of the employees. Most small practice plans have a high participation rate for full-time staff, but if the salaries are on the low side, participation will not be very high regardless of the type of plan.
Even for participant-directed plans, studies show that the more often employees see their account balance, the less rational their investment decisions can be. Thankfully for a pooled plan investment decisions are out of the hands of employees. In any case, most unsophisticated participants don’t care to see their account balance more often than once a year, and that’s how it should be.
Let’s be clear here – these are ERISA plans. Plan adviser has to be a bonded fiduciary, and if there are any issues with the plan, plan adviser is responsible. So if anything, that should provide a very high level of confidence vs. most other where there is no plan fiduciary watching out for the best interest of plan participants.
Of course plan participation depends on plan type. If I myself or my wife was presented with a pooled plan I would be pretty disappointed. And getting no regular accounting of the portfolio would make me rather uncomfortable.
Cross tested or not has nothing to do with it, you can have a cross-tested plan design with a participant directed plan. All 401(k) plans are ERISA plans, whether it is a 3(38) manager or the plan sponsor being held to ERISA Fiduciary requirements.
Well, if you don’t like this type of plan, nobody is forcing you to use it. This is a free country after all 😉 I also mentioned in the article that it is not for everyone, and some practices fit better than others.
A 3(38) for a participant-directed plan has a very limited role. They simply select investments and most of the time they don’t provide education to plan participants, and a typical 3(38) is even less likely to provide individualized education. One is lucky to have a 3(38) as a person – many companies are now using software. Without individualized advice, any ‘education’ participants get is less than useless, so as far as plan participants are concerned, pooled plans are the best type of plan that can help plan participants significantly improve their investment performance. This is not just my opinion – this is the opinion of some well-respected ERISA attorneys:
http://www.seethebenefits.com/showarticle.aspx?Show=837
“Because the likelihood of investment success increases as the plan participant’s involvement in investment decisions decreases, we propose an alternative to the participant-directed 401(k) investment model. Our proposal, the non-participant-directed 401(k) plan, helps satisfy two important objectives at once: (1) increase the odds that the retirement investment and savings needs of plan participants will be met; and (2) reduce the fiduciary responsibility of fiduciaries”
I’m simply of the opinion that professional fiduciaries should help their clients see all sides of an issue and evaluate the merits and shortcomings of any plan design or structure. Nothing is perfect, and one plan structure doesn’t fit all.
I totally agree. A quote from the article: “This is not an ideal type of plan for larger companies where the owners prefer to manage their own accounts and can afford to hire the right fiduciary to oversee the plan, but smaller companies, especially medical and dental practices, can benefit immensely from what pooled plans have to offer.”
This article and the subsequent replies have provided me with some insight as I have been a participant in a pooled 401k plan for nearly two years. The problem I’m having is, despite multiple requests for a statement, my firm’s administrator will not produce one. The last time I requested a statemnent, it was pointed out to me that the money was being withdrawn from my check, implying that the money was being invested. This was an insufficient response as the firm supposedly has been matching my contributions,and it doesn’t account for the market’s effect on my funds. My research indicates that ERISA requires, at minimum, an annual statement for all 401k plans. Is this accurate?
That’s indeed correct. Are you the owner? If you are the practice owner, you should immediately get them to provide you with a statement. If not, you should get the owner to give you a statement as they should have access to the pooled account. If you are the owner and you don’t have access to the account, I think that you should move your plan to anther provider that uses transparent practices that comply with all of the ERISA laws and that is managed in your best interest.
I prefer that the account is opened in the owners’ name and the owner is the trustee (with the spouse usually having access as well), so at most, I get to be a limited agent. This way the owner has full access to the account, so they know exactly what is going on and which transactions are taking place. The problem with what you are experiencing is that not only are they breaking the law, you have no idea what’s going on with the money in the account. At the very least you should know what investment strategy is being used by the plan’s investment manager (who should be an ERISA 3(38) fiduciary).
If you are the owner, the course of action is very clear. They should also provide you very detailed annual report on the plan’s transactions, contribution, etc. As a participant you should also have copy of the summary plan description with your options.
In our annual 401k updates, I noticed a page that shows the total number of employees in the plan, and the total balance. I usually max out my contribution every year , when most participating employees contribute less than $2000 a year.does this have any effect on my personal balance, now or in the future??? Should I not contribute so much annually???
No. Max it out. Their contributions don’t affect how much you can put in unless you’re the owner.
I’ve noticed the same, even among my partners. But over the last few years they’ve all started contributing more!
If you have a pooled plan, my only fear is that if it is managed by someone who’s
1) Not using a buy and hold strategy
2) Not using index funds
3) Charges high asset-based fees
then I would also worry about contributing anything into such a plan. I’ve seen plans that were so mismanaged that they were lawsuits waiting to happen with the owner daytrading individual stocks with plan’s assets. So it is always a good idea to get a handle of the Investment Policy Statement for the plan (if one exists) or to get in touch with the person responsible for handling the money inside the plan, and to make sure that there are no concerns about mismanagement of assets.