401K Plans
Access to a 401K is critical to both employers and employees. For the employee the opportunity is to defer taxes, collect some kind of match from the employer and invest sheltered from taxes. Investing in a tax shelter is a benefit that compounds over time into a huge advantage. If you are young and you do not contribute into your 401K, you are a fool. If your employer’s 401K has a generous match and you do not contribute, you are a fool. Furthermore a 401K allows you to save periodically, to deduct from your paycheck, in my experience this is by far the best way to save, automatically. Structurally, a 401K is so great that it must be a priority. So great that the investment options it offers matter very much.
For the employer the 401K is critical too. Because it is important for the employees, if you don’t offer it to them they won’t like you. Besides, if the decision to adopt a 401K is in your hands, you are an employee yourself, probably the highest paid one, you might have the most to gain by starting a 401K. But for an employer a 401K is a source of liability. Often the employer has full fiduciary duty over the plan, he is responsible for doing what is in the interest of the employees first. A rather common scenario goes like this: a disgruntled employee who just got fired sues his former employer for breach of fiduciary duty in handling the 401K, the breach could be for excessive costs, lack of employee guidance, poor choice of investments inside the plan. You would be stunned by the very recognizable companies that have lost such lawsuits. Having a plan provider with a respectable name like Fidelity or the Principal Group is absolutely NOT a protection.
So what can an employer do to safely provide this critically important 401K? You are in luck, the 401K industry is in a state of rapid and competitive evolution. You can do a lot.
- Hire a “338 adviser”, you will effectively unload a large share of your fiduciary duty on that adviser. A 338 adviser will endorse the liability of choosing the fund lineup and checking that their costs are reasonable. So specifically ask the adviser if he is 338. If the adviser is only a 321 then the liability isn’t shifted on him.
- Ask for a one page full cost of ownership for the 401K plan. You want to know clearly how much is paid, to whom, for record keeping, testing, trustee fee, adviser fee and all operational costs of all funds. Ask for your total cost of ownership to be benchmarked against the industry average.
- Beware of conflicts of interests!!!! If a plan provider is pocketing 12b1 fees from the funds he chooses for the plan, that fee is corrupting his choice. Just say no to 12b1 fees, they are a relic from the conflict full past. Similarly if a plan provider tells you that he provides an all in one solution, watch out !!! When (ahem…) Fidelity tells you that they do record keeping and administration “for free” at the condition that so many percents of the funds be their own, they are skewing their choice of funds to fit their own interest at the expense of the interest of the employees. In general make sure that no money flows from the operating costs of the funds chosen to any other service provider for the plan. That choice of funds absolutely must be done in an unbiased fashion.
- Make sure the employees are provided with a few preset portfolios fitting a variety of risk profile. Most 401K’s totally baffle employees with a list of about 20 funds and a “now you pick yourself” approach. Allocation over these funds is the most important factor for performance and volatility, yet the employee often is not offered any clue as to how he should compose a portfolio that fits him. There must be preset compositions for which there is reasonably long performance history and for which the risk profile is explained clearly. This way the employee can recognize himself into one of the described risk profiles and then invest in that portfolio pressing one button only.
- Include environmentally sustainable investment options. Young employees everywhere are very sensitive about having that option, older employees are becoming that way too. Offering that is an important corporate statement.
The 401K plan industry is being shaken up. Last year the department of labor imposed cost clarity measures. If you are an employer you owe it to yourself and to your employees to take a good look at your plan. Competitive evolution of plan providers has brought a new generation of high tech providers for record keeping, testing and trusteeship with a high level of service at low cost. These open platforms allow for a vast and open fund choice and can be used by 338 advisers. It is time to move to a 401K platform that is cost efficient, conflict free, providing effective guidance to employees and fiduciary release for the employer.
If you are an employer with a plan I will be happy look at it and even do a cost benchmark analysis for you, that you can keep, that is part of your fiduciary duty anyway.
Cheers
Marc Anselme
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Originally published at anselmecapitalblog.com on April 18, 2013.
