401(k) Aggregators – What You Need to Know

Today’s advisors must meet the ever-changing demands of regulations and technology, while facing growing competition from traditional firms and start-ups.

But in recent years, a new breed of 401(k) “aggregators” have emerged in the retirement space, attracting 401(k) plan advisors to partner up, refer, or sell their entire book of business.

Known for their expertise, aggregators primarily offer economies of scale to small-to medium-sized registered investment advisor (RIA) firms. However, if you’ve been curious about, or considered working with such entities, consider the the pros and cons of doing so.

What is a 401(k) Aggregator?

Aggregator firms work one of two ways: They either purchase RIA firms outright, or offer an affiliation model where they compensate firms with referral fees or equity in the holding company. Acquisition typically occurs for firms with more than $1 million in revenues, while those with less than $1 million tend to become affiliates.

Partnership has its Perks

For solo advisors and small- to medium-sized firms, there are benefits  to working with aggregators:

Credibility

You may enjoy the credibility and brand recognition that come with partnering with a larger or well-known entity.

Resources

As aggregator firms grow and gather assets, they may offer expertise that small RIA firms perhaps couldn’t access or afford to develop in-house. For example, most aggregators offer support in the form of lead generation, practice management, technology, client onboarding, marketing, and other areas that are perhaps beyond the scope of a small advisory firm’s capabilities.

Competitive Edge

Aggregators may allow advisors to offer more competitive pricing and a greater menu of plan funds to prospective plan sponsor clients. These advantages are often due to not only an aggregator’s larger asset base, but also from distribution deals they are often able to negotiate with asset managers. Additionally, you may be able to expand your product and service offerings.

Before You Hand Over the Reins

Before joining forces with an aggregator, consider that your firm’s smaller size may actually be to your benefit. After all, partnering with an aggregator means that you will likely be held to their rules and approach to 401(k) plan management. It’s important to assess your firm’s  strengths and weaknesses,. If you go the aggregator route, make sure the sum is greater than its parts for you and your partners.  

Structure

If part of your motivation for becoming an RIA was entrepreneurial drive and the freedom to manage your clientele and plans your way, this may not work well within the bounds of the aggregator’s rules and procedures. However, this isn’t to say that your talents and drive won’t fit with an aggregator environment; some aggregators want RIAs who will continue to diligently oversee and build their book.

Identity

Consider your branding and investment philosophies and whether you’re willing to compromise, especially if you will soon be identified as being part of, or belonging to, the aggregator firm.

Also, understand that by allowing aggregators to control your book, you are contributing to the “institutionalization” of the industry, where a home office takes the lead role in determining what investments 401(k) advisors can use.

Technology

Firms may be able to address many of the reasons to sell or partner up with aggregators by embracing a robust 401(k) technology plan management platform.  Today, 401(k) platforms exist that enable firms to scale more adeptly when it comes to everything from lead management to 401(k) plan management.

If you decide to go the aggregator route, do your homework. As in any business arrangement, consider the best route: selling your firm outright, accepting an affiliate arrangement, or continue growing the business that you’ve already built.

Let’s not make orange the new black: Keeping your clients compliant amidst tax code changes

Mid-year is a great time to review your company’s retirement plan to make sure it complies with all legal and operational requirements. This is especially true given the Tax Cuts and Jobs Act (TCJA) that was signed into law in late 2017, which changed the tax code in several ways that may impact your plan. We’ve identified a few key areas we believe deserve a second look.

Ensure you’re complying with new fringe benefit provisions

Usually plan sponsors have a generous remedial period in which to make any necessary plan amendments to comply with changes to the tax code, but not so in the case of employer-provided transportation fringe benefits and loans. Several of TCJA’s changes took effect January 1, 2018.

* Employees must include moving expenses paid for by the employer in gross income unless the employee is a member of the Armed Forces on active duty or needs to move pursuant to military order.

* Employer-sponsored commuting benefits must now be included in gross income, except for some “de minimis” fringe benefits like transit pass or parking benefits of $21 or less. This may be an especially important issue for employers in Washington, DC, New York, or other states that require employers to offer these benefits. Employees can exclude from gross income occasional overtime transportation and some transportation costs for safety concerns that are paid by the employer.

* The TCJA also expands the time period for an employee who terminates employment or separates from service with an outstanding loan to repay the loan or roll over any distribution to the due date for filing the employee’s tax return for that year (including extensions).

* For employers based in Puerto Rico and other hurricane-affected areas, the TCJA also includes disaster relief on plan distributions.

Make necessary plan amendments now to avoid operational errors in the future

The TCJA changes may necessitate plan amendments so that plans align with current legal requirements. For instance, if your plan defines compensation to exclude employer provided transportation benefits in gross income, those provisions need to be changed to comply with the TCJA. Retirement plans that do not provide hurricane relief will also need to be amended by December 31st. You may need to make similar changes to any loan provisions of your plan.

Once you’ve made the necessary changes, it’s important to ensure your payroll system is coded consistently with the plan document. If not, the result is an operational error that could be very expensive and time consuming for the employer to fix. It is also a common finding in a DOL or IRS audit, which could have other implications for your plan.

Consider reviewing plan design to best support employees

With the TCJA bringing corporate tax rates to unprecedented low levels, some employers are using their windfalls to reward employees with salary increases, matches, and bonuses. This is great news for retirement plans since these benefits translate into more efficient retirement savings.

Now that the TCJA has been in effect for about six months, it may be a good time for sponsors to review their plan designs to make sure the plan serves your goals such as helping employees boost their retirement savings, attracting and retaining talent, or maximizing tax savings. Now may be the right time to implement automatic enrollment or escalation features, start or increase the default savings rate, or allow Roth contributions. Sponsors should also consider revising the plan’s eligibility rules to encourage employees to start saving sooner. Employers can also reduce turnover through an attractive employer match programs.  You can benchmark your matching program against peers and evaluate whether the match or the scope of employee deferrals matched needs to be changed to meet your financial or cash flow needs.

There will be more legislative activity in the coming year that could affect your retirement plan, with everything from requiring after-tax contributions to expanding availability of multiple employer plans.  It is a good idea to get into the habit now of making sure your plan is ready for even more changes ahead.

ESG Offerings Benefit Both Investors and Providers

As Environmental, Social, and Governance (ESG) investing becomes more popular, the wealth management and 401(k) industry is taking notice.

In fact, more than $1 of every $5 invested in the U.S., a total of $8.72 trillion, goes to socially-responsible investing (SRI). And in 2017, 75% of investors — and a whopping 86% of millennials — were interested in sustainable investing.

While the opportunity to invest in companies that align with an investor’s ethical standards, beliefs, and values sounds appealing, the ultimate question is whether ESG is good for the investors and funds involved.

We believe it is, and here’s why.

Good for investors: ESG investments perform competitively

ESG-screened investments perform as well as their non-screened peers 90% of the time, according to more than 2,000 academic studies of ESG performance.

These investments can reflect the values of those who are passionate toward issues such as environmental conservation, gender equality, gun control, and social justice.

2015 study also found that over a 10-year period, companies with the highest ESG scores (those that focused on ESG issues most important to their businesses) more than doubled the performance of those with lower ESG scores.

With results such as these, investors can be optimistic about the positive impact such investments may have not only toward their supported causes and companies, but also toward their financial portfolios.

Source: Khan, Mozaffer, and Serafeim. “The Accounting Review.”

Good for the industry: Attract more investors and business

SRI funds may also offer advisors and plan sponsors an advantage in competitive markets.

In fact, advisors in a 2017 study reported a 32% increase in interest in ESG investing than in the prior year.

Fifty-three percent of millennials, 42% of Gen Xers, 41% of baby boomers, and 39% of seniors also made investment decisions based on social responsibility factors.

A survey of Fortune 1,000 employees revealed that 74% of 401(k) plan participants would like their companies to offer socially-responsible funds in their plan investment menus.

Plan sponsors who offer such options can appeal to an increasing number of socially-engaged employees.

The DOL looks well upon SRI in retirement portfolios

In its latest Field Assistance Bulletin, the Department of Labor (DOL) confirmed that defined contribution plans can include SRI options, as long as they perform as well as and cost no more than traditional unscreened investment options.

Plans can even include ESG-screened target date funds as qualified default investment assets (QDIAs), as long as they don’t have lower-return or higher-risk potential than comparable non-ESG alternatives.

The tipping point

Increasing demand, competitive performance, and the DOL support combine to make SRI funds more attractive than ever for plan sponsors and participants. It’s time for fund managers to consider offering ESG target date funds and ESG exclusive retirement plan options and platforms.

 

A “Reasonable” Approach to Who Pays Plan Fees

Written by Allison Brecher, Vestwell’s General Counsel

The recent barrage of litigation and emerging regulations about retirement plan fees have put plan sponsors on heightened alert to make sure the fees incurred by the plan are reasonable and that they are paid properly. It’s a difficult assessment to make, complicated by the broad array of administrative expenses, with confusing terms like back-end load fees, revenue sharing, and 12b-1 fees.  It’s hard enough for plan sponsors to understand what fees service providers are charging, much less whether the plan or plan sponsor should pay for them. However, it doesn’t have to be and there are plenty of opportunities for advisors to assist in making things more clear.

Depending on the plan sponsor client’s philosophy, sponsors may want to shift as much of the plan’s costs, like recordkeeping expenses, legal fees, and mutual fund expenses, to the plan and participants. Unfortunately, a plan sponsor can significantly harm the plan, and itself, by doing so without careful analysis.

Where to start?

The plan document may specify whether administrative expenses can be paid by the retirement plan assets. If the document says only the plan sponsor can pay, then the plan must reflect that. Some plans require the plan sponsor to advance the payment and get reimbursed by the plan later, in which case the payment and reimbursement should be made within 60 days in order to avoid a Department of Labor requirement for a loan agreement between the plan and sponsor.  If the plan is silent, then analyze DOL regulations to determine if payment by the plan is permissible. Costs relating to plan formation, termination, and design are typically paid by the plan sponsor whereas recordkeeping and investment consulting expenses can be paid by the plan.

The plan can only pay for reasonable expenses – but what is “reasonable”?

This is the central issue in dozens of lawsuits. Participants rely on their plan sponsor to negotiate the best deal with service providers and it therefore becomes the sponsor’s fiduciary duty to make sure the plan is only paying reasonable fees.

Unfortunately, it can be hard to understand all of the direct and indirect compensation paid to plan providers. Sponsors need advisors’ help to ask the right questions. Some expenses, like sales commissions and back-end load fees on mutual funds, are paid out of the assets’ investment returns and therefore charged indirectly to participants. Those charges may not be apparent on participants’ benefit statements. Worse yet, there is no single benchmark for retirement plans to use as a baseline comparison. For this reason, some sponsors prefer to pay for expenses themselves since only plan assets, not corporate assets, are within a regulator’s purview.

Advisors can help sponsors by reviewing the expenses paid by similar plans. All ERISA plans file Form 5500s annually, which are public and should disclose all fees paid by the plan. Making an apples-to-apples comparison can be difficult because some sponsors do not know, and therefore cannot disclose, all indirect compensation. Advisors can also help clients prepare requests for proposals to understand available pricing options, such as flat fees or per participant fees that are more transparent and easier to understand. They can also help evaluate the quality of services, since the DOL acknowledges that cost alone should not be the only determinative factor.

Monitor, monitor, monitor

Sponsors should periodically reevaluate the plan’s fees. Even though a sponsor hires consultants to assist, they remain a fiduciary and must regularly evaluate the changing marketplace. As always, documenting their decision making process is critical. Sponsors must also remember to check whether services are being provided by a party-in-interest and satisfy the prohibited transactions rules.

Understanding the Risks of Being a 3(38) Fiduciary

Retirement plan sponsors often turn to their financial advisors to help them handle key responsibilities. Since navigating the legalities and complexities of retirement plans is typically not their core competency, it’s natural for plan sponsors to offload many of the associated tasks required for proper plan administration.

Enter your role as a 3(38) fiduciary.

While you may welcome the business relationship of being assigned as the 3(38) fiduciary, it’s also important to understand the legal implications and risks involved with performing the role.

What’s a 3(38)?

In a retirement plan, 3(38) fiduciaries are given discretion over most decisions regarding investment choices, such as implementing the lineup of suitable and appropriate investment options to be offered in the plan.. While plan sponsors are still responsible for overseeing these fiduciaries, they generally transfer much of the risk and responsibility associated with plan monitoring and selection over to a 3(38) fiduciary.

This is unlike the role of a 3(21) fiduciary, also known as a “co-fiduciary,” who has less authority when it comes to plan decisions. While plan sponsors may rely on the advice of a 3(21) fiduciary’s investment analyses and recommendations, it is ultimately the plan sponsor’s role to make major investment plan selections.

Today, the latter relationship is more common, with 82% of retirement plan advisors serving as 3(21) fiduciaries, despite the the number of 3(38) offerings doubling since 2011, likely due to the rise in litigation targeting 401(k) plan sponsors.

With great power, comes great responsibility

While you may charge a premium for performing the 3(38) role, you may not wish to take on the added risk of fulfilling much of the ERISA plan sponsor’s legal requirements. This is especially true for smaller plans where you may not be able to make the business case for the services involved. It’s worth considering the amount of business you’ll be providing in relation to the responsibility that comes with it.

As a 3(38) fiduciary, you are committing to serve as the formal investment manager for an employer’s plan. As such, you will be required to provide regular fiduciary reports to the plan sponsor, and document your rationale for investment and fund change recommendations as well as any time you execute on said recommendations.

Adherence to IPS

With the addition of full investment discretion, you must document that you are adhering to the plan’s Investment Policy Statement (IPS), and that all investment decisions are made in the plan participants’ best interests. You may even be asked to help develop an IPS. Importantly, as a 3(38) fiduciary, your processes and methods must be that much more detailed and circumspect than those of a 3(21) fiduciary.

Expertise Required

Being a 3(38) fiduciary is a specialized role that requires specialized expertise. Advisors who dabble in the 401(k) space and advise only a few plans may not wish to take on the responsibility – and liability – required. Fortunately, that’s where external providers can help with the heavy lifting. Integrated solutions now offer you the option to offload the certain levels of fiduciary liability while still putting the power in the advisor’s hands to personally guide clients with their retirement decisions. We recommend exploring how these options ease the fiduciary liability you carry while giving your sponsors and participants the customized plans and advice they value most from their trusted advisor.

 

Helping Your Clients with Required Minimum Distributions

 

Among the many compliance requirements for a 401(k) plan is the obligation to make required minimum distributions (RMDs) to participants each year. Although the distribution need not be made until April of the year after the participant turns age 70 1/2, advisors should check in with their plan sponsor clients throughout the year to make sure they are their service providers are prepared. Participants and employers face stiff penalties – including plan disqualification – if distributions are missed or aren’t large enough. Advisors can also help sponsors now avoid those penalties by checking for and quickly correcting missed RMDs.

Some background: What is a RMD and how is it calculated?

Participants must start making withdrawals from their tax deferred retirement plans by April of the year after they turn age 70 1/2. Individuals who turned 70 1/2 in 2017 face double pain: the IRS requires them to take a RMD by April 1, 2018 and a second RMD by December 31, 2018. RMDs must then be taken by December 31 each year thereafter. These minimum distribution rules apply to tax-deferred retirement plans, including IRAs, 401(k) plans, 403(b) plans, profit sharing plans, and other defined contribution plans.

 Advisors should help plan sponsor clients throughout the year

The IRS assesses large penalties for missed RMDs. While the major crunch time for making RMDs has now passed, don’t let your client forget to check for any missed distributions. Ask the recordkeeper to confirm that all appropriate participants were identified and review the plan language to double check. If a RMD is missed, but detected and corrected quickly, you can save the plan and participants a big headache. Advisors should also understand the demographics of their plan sponsor client’s tax-deferred retirement plans and caution them to pay special attention to aging participants who turned or are nearing age 70 1/2. Advisors can also help sponsors locate missing participants, which the IRS also requires in order to maintain tax qualified status.

Opportunities for advisors to ease the pain and help with planning

The RMD is included in taxable income. Therefore, the RMD can push a participant into a higher tax bracket and become subject to additional state and local taxes as well as a 50% excise tax for missed or inadequate RMDs.

Ensuring clients plan early for RMDs is key. For example, advisors can help clients avoid having both RMDs taxed as income for the same year by encouraging them to make the first withdrawal in the year the participant turns 70½. Advisors should also help clients evaluate whether they missed taking a RMD or received a RMD that wasn’t large enough. The participant may be taxed an additional 50% penalty on a missed or insufficient RMD. If there was a reasonable error, the advisor can help the client request a tax waiver by filing Form 5329 and preparing a good faith explanation.

Advisors can also help reduce a client’s tax burden by making a “qualified charitable contribution” that will count towards the RMD and can be excluded from taxable income.  Advisors should also help participants review their benefit plan document, since that might allow them to wait until the year they actually retire to take the first RMD. Individuals who own more than 5% of the business sponsoring the plan must take the distribution, regardless of whether or not they are actually retired.

For individuals with multiple tax-deferred accounts or inherited tax-deferred accounts, the advisor may be able to help a participant select which accounts to take the withdrawal. For example, investors who make IRA and 401(k) contributions with after-tax money do not receive any tax deductions on their contributions. Therefore, it can be less expensive for them to make RMDs from those after-tax accounts.

Advisors should also help clients who contributed only on a pre-tax basis to carefully examine their retirement plans. For individuals with multiple IRAs, RMDs may be aggregated. In other words, the IRA owner calculates the RMD separately for each IRA account, but may take a distribution from only one of them to satisfy the total RMD requirements for all of them. A client with a 401(k) (or other defined contribution plan) and a traditional IRA cannot aggregate and must take a separate RMD from each plan. Advisors can also assist clients with reinvesting their distributions and estate planning strategies by advising how to pass their distributions onto their heirs.

Education is key…for everyone

Be it plan sponsors, their participants, or your private wealth clients, it’s helpful to know your demographic and who might be affected by RMDs. But most importantly, it’s important to continue to educate yourself, and your clients, to ensure everyone is prepared for what’s in store.

Your Clients’ Plan Audit Qs, Answered

 

If your plan sponsors aren’t already, they should be preparing their year-end report. The penalties for failing to conduct an audit can be substantial. Issues can surface during the audit that may be easier and less expensive to correct now versus down the road.

For plans with 100 or more eligible participants at the start of the plan year, the annual report must include an audit report issued by an independent qualified public account stating whether the plan’s financial statements conform with generally accepted accounting principles. An audit should comfort participants, knowing their plan’s operating processes are in good order.

We’ve put together some common questions and answers to help your plan sponsor understand the audit rules – and so you can ensure your clients are taking them seriously.

IS THE PLAN EXEMPT FROM THE AUDIT REQUIREMENTS?  

Governmental plans, church plans, and certain 403(b) plans that qualify under safe harbor are exempt from the audit requirements.

HOW DOES A PLAN SPONSOR FIND AN AUDITOR?

ERISA requires that the auditor be independent. and Sponsors should utilize a firm that is separate from the employer’s accounting firm and does not do any other business with the company or any of its directors or owners.

HOW IS THE NUMBER OF ELIGIBLE PARTICIPANTS CALCULATED?

The eligibility rules can be complicated.  In general, plans with 80 to 120 participants at the beginning of the current plan year may choose to complete the current annual report using the same “large plan” or “small plan” category used for the previous year. If the Plan previously filed as a “small plan” last year, it may wish to again for the following plan year.

WHAT DOCUMENTS DO PLAN SPONSORS NEED TO PROVIDE?

Every audit is different, but the auditor will likely need to review records relating to participant enrollment, plan contributions and distributions, auto-enrollment, and payroll files. Sponsors may need to provide records relating to tax compliance, related party transactions, and the Plan’s benefits committee (if it has one).

HOW LONG WILL THE AUDIT TAKE?

Sponsors should begin the audit process at least 90 days before the Form 5500 deadline to allow enough time to gather documents, follow up on open items, prepare financial statements, and wrap up.

HOW MUCH WILL THE AUDIT COST?

An auditor may charge $2,500 – $10,000, or more, depending on the size and complexity of the plan.

Yes, Plan Sponsors are Still Fiduciaries

 

You may be confused by the recent news about the DOL Fiduciary Rule: Was the rule declared invalid? Will the SEC move ahead with its own Fiduciary Rule?  Will the Supreme Court issue a decision? Your confusion is appropriate as the status and future of the DOL Fiduciary Rule is still in flight. However, one constant remains and that is the Plan Sponsor’s fiduciary duty to the Plan and its participants.

ERISA and the DOL

The DOL’s Fiduciary Rule was finalized in 2016 and was supposed to go into effect at the start of 2018.

This rule was designed to eliminate financial advisor conflicts of interest when dealing with client retirement accounts. While it had provisions relating to 401(k) plans, it’s important to remember that any delay or even the possible nullification of the rule does not impact the fiduciary duties of a 401(k) plan sponsor.

Any financial advisor who works with plan sponsors can help ensure that their clients are aware of this.

A sponsor’s fiduciary role

 ERISA cites five standards of fiduciary care on sponsors of retirement plans. These boil down to the fact that a plan sponsor must make all decisions with the best interests of the plan participants in mind.

One key standard that has received attention in recent years is the responsibility to keep expenses low for plan participants.

While there is no firm standard for this, this issue has been the basis of a number of lawsuits against plan sponsors. Most of these suits have been brought against large employers, however, in recent years, even smaller plans have not been immune.

Reach out to clients now

 Periods of market volatility signal good opportunities to reach out to your current and prospective clients.

Start by confirming that their current plans are low cost and perform relative to their asset class peers. Find out:

  • Are all fees and expenses transparent, both those that are paid from the participant’s accounts and those paid by the sponsor?
  • Is there a process in place to select, monitor, and (when needed) replace investment choices?

Ideally, your client has an Investment Policy Statement in place for the plan. A solid, consistent, and documented investment process is a great way to demonstrate that the sponsor is acting in a responsible fiduciary capacity.

Beyond just meeting their fiduciary obligations, savvy plan sponsors want to provide the best possible retirement vehicle for their employees (and themselves) to ensure that employees can retire on time.

Advisors are also fiduciaries

 As an advisor you have two options as a fiduciary.

A 3(21) fiduciary serves as a co-fiduciary with the plan sponsor making all final decisions as to the plan’s investments and other decisions including the selection of service providers.

A 3(38) fiduciary has the discretion to make all investment and provider decisions; this is delegated to the advisor by the sponsor.