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.
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.
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.
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.
Governmental plans, church plans, and certain 403(b) plans that qualify under safe harbor are exempt from the audit requirements.
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.
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.
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).
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.
An auditor may charge $2,500 – $10,000, or more, depending on the size and complexity of the plan.
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:
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.
Cash balance pension plans aren’t new, but they are gaining in popularity.
Companies that offer their employees a cash balance plan may benefit from cost-savings over a traditional pension plan, as well as significant tax savings versus a 401(k) or other defined contribution plan.
A cash balance plan is a type of pension plan where an employer credits an employee participant’s account with a set percentage of his or her annual salary, plus an interest credit. This interest credit is typically tied to the interest rate of an outside index, such as the one-year U.S. Treasury Bill rate.
Cash balance plans are defined benefit (DB) plans, which means that employees are guaranteed a specific “defined” amount upon retirement.
Like any DB plan, a cash balance plan is subject to pension funding requirements and the company is ultimately responsible for ensuring the plan is funded.
These pensions typically start paying out around age 65, but could be as early as 55 depending on the company. Note that employees don’t invest any of their own money in the plan, and they typically have no input into the investing choices.
But unlike DB plans, cash balance plans do offer transparency; participants can actually keep track of their account balances.
Cash balance plans also differ from traditional pension plans because they offer the benefit of portability. If an employee leaves the company prior to retiring, the balance is portable and can be rolled over to an IRA, if desired.
Each year, a company makes contributions of a specified amount of earnings to each employee participant’s account. Employers who offer cash balance plans typically contribute 5-8% annually, which is generally higher than DB plan contributions.
These levels increase for older workers: The annual contribution limit for a 55-year-old is more than $160,000, and more than $220,000 for a 65-year-old.
Contributions are made by the company, and are a tax-deductible business expense. This means that business owners, professionals, and partners who themselves want to contribute amounts in excess of $50,000 annually, say for their own retirement, can do so easily.
As with any pension plan, companies with stable cash flow and decent earnings are good candidates for offering cash balance plans. These organizations will generally be in a better position to fund plans over the long-term.
Companies that have regularly contributed annually to employee plans should also consider offering such plans.
As mentioned, business owners and professionals who got a later start on retirement savings can use cash balance plans as a means to rapidly accelerate savings, making up the time to eventually reach the lifetime maximum of $2.6 million per account.
Keep in mind that the large contribution limits for older business owners and professionals offer the reciprocal benefit of a potentially significant tax deduction.
Finally, a cash balance plan can also be used in combination with a 401(k) plan to help maximize their retirement savings.
For all of the advantages of a cash balance plan, note that companies converting their traditional DB plan to a cash balance plan usually leave their employees with a lower benefit than before, due to the higher contribution requirements.
Contributing to such accounts each year instead of a fixed payout based on employees’ years of service is a potentially big cost savings to the employer.
A cash balance plan is a great option to add to your toolkit of retirement solutions offerings; such plans may offer significant tax and cost savings when compared to other employee retirement benefit plans.
Be sure to discuss the pros and cons on this type of plan with any business owner or professional clients who are looking to ramp up their retirement plan contributions.
All contribution limits discussed herein are believed to be current at the time of writing, however, Vestwell Holdings, Inc. and its affiliates do not offer tax advice and this information is offered for educational purposes only.
Many plan sponsors are (or should be) starting to think about their Form 5500 filing and annual compliance testing. That means it is also a great time for advisors to help clients conduct a “plan checkup.” A good checkup can reduce future costs, administrative headaches, and fiduciary liability. Here are some steps to help you start the process with your plan sponsors.
Ensure your sponsors have reviewed all plan documents and communications with their participants within the past 12 months. Changes in a business may produce unexpected and unnoticed changes in a plan’s operation, so it’s important to review plan language and features. Consider including the service providers who regularly work with each plan to help spot issues that may have been overlooked. Some questions to ask when meeting with your client for a review include:
Have you had any mergers, acquisitions, or changes in ownership in the past plan year? Structural changes to their organization will warrant updated plan documents and need to be communicated to your retirement service providers.
Are you a part of a Control Group or an Affiliated Service Organization? A controlled group and affiliated service organization are categories used to describe businesses that are related in some way, usually by family ownership. Knowing whether your client falls into one of these groups or if the employer owns multiple business with different retirement plans can have an important effect on the way a sponsor’s plan is set up for their employees.
Do you have a Fidelity Bond? ERISA requires that every fiduciary of an employee benefit plan and every person who handles plan funds be bonded, so ensure your client’s plan is compliant to avoid penalties. These bonds cover the plan from loss of assets due to fraud or dishonesty. The fidelity bond is required to protect the participants and beneficiaries from dishonest acts of a fiduciary who handles the plan assets. The fidelity bond must be at no less than 10% of plan assets with a minimum of $1,000 and a maximum of $500,000.
How are you tracking the accuracy of administrative tasks? Administrative mistakes are common and easy to make, but the sooner the plan sponsor finds them, the easier and less costly they are to fix. Some common errors are late payrolls, loan issues, and improperly communicating with terminated employees who have account balances.
Your clients are the experts on their businesses—but you’re the expert on their plans. As your check in with your plan sponsors, revisit the features of their plans to see what needs to be changed to better suit their goals.
How is enrollment set up? A retirement plan isn’t doing employees any good if they aren’t participating in it. If auto-enroll isn’t set up, speak with your client about its benefits. Without this feature, plan participation averages 63% for 401(k) plans yet jumps to 90% when auto enroll is enacted. Another way to potentially increase employee contributions? Consider adding auto escalation to automatically increase their contributions year over year.
Do the investment offerings still suit the company? Revisit the investment options the plan currently has and how they are being used. Employees’ goals and risk tolerance may have changed over time.
Have you compared costs? Your service provider’s fees should be reasonable. Consider conducting a benchmarking exercise or issuing a request for proposal from multiple service providers to compare their fees. If you’re looking to dig into a 408b(2) disclosure and don’t know where to begin, we can help.
After checking in with your plan sponsors, take the next step and meet with their employees as well. Schedule a time each year to educate participants on the basics of a 401(k) and how they can take advantage of this important savings tool. Here are some key points to cover:
What is the difference between a 401(k) and an IRA?
All it takes is a few simple questions to ensure that your plans are correct, your platform includes the best features, and your participants are getting properly educated. Your clients will be impressed with the thoughtfulness you put into their plan and thankful that they have an expert to lean on.
Tax reform isn’t the only newsworthy event affecting the benefits industry–several bills were introduced in Congress at the end of 2017 that could dramatically impact certain kinds of retirement plans. While these new proposals have an uncertain future, they all signal Congressional interest in improving retirement security. Here are some common trends news that you may see affecting your retirement plans soon.
The Small Businesses Add Value for Employees Act (SAVE Act, HR 4637) removes the “common bond” requirement, thereby making it easier for small businesses to pool together, regardless of industry, and offer retirement plans to their employees while alleviating some burdens of plan administration.
The Retirement Security Act of 2017 (SB 1383) offers employers a tax credit and protects employees from losing their tax benefiits if one employer in a MEP fails to meet the participation criteria. Similarly, the Auto401k Act (HR 4523) provides relief from the “one bad apple” rule of MEPs so that all participating employers are not penalized when one employer violates the qualification rules.
Through tax credits and other incentives, Congress is attempting to make retirement plans more accessible and promoting lifetime income solutions.The Retirement Plan Simplification and Enhancement Act (RPSEA; HR 4524) would increase the current automatic enrollment safe harbor cap and encourage employers to defer more than the automatic deferral floor of 3% of salary in the first year. It would also exempt retirement savings below $250,000 from complicated required minimum distribution rules and make it easier to take advantage of the saver’s credit. The SAVE Act increases the limit on elective deferrals under a simple IRA and permitting employers to make non-elective contributions for their employees of up to 10% of pay.
Congress is also addressing some of the lesser-known, but equally painful administrative burdens of sponsoring retirement plans. Access to a Secure Retirement Act (HR 4604) corrects some of the confusing regulations that often stop employers from including a guaranteed lifetime income product in their benefits package.
The Receiving Electronic Statements to Improve Retiree Earnings Act (RETIRE Act HR 4610) allows plan sponsors to use electronic delivery as the default distribution method for retirement plan notices and documents. A companion Senate bill is expected soon and the timing coincides with an effort by the Employee Benefits Security Administration’s project to address electronic delivery.
Staying on top of these bills can help eliminate the often confusing world of government. As Congress continues to takes steps to help plan sponsors, we will keep you updated on the way new legislation is affecting your clients. That way, as client questions come about surrounding what they hear in the news – their trusted advisor has the answers.
The number one reason for DC plan sponsors to change their investment manager or recordkeeper is high fees.1 Unfortunately, it is very difficult for sponsors to accurately assess fees because they are typically confusing, hidden, and convoluted (often intentionally). This provides a great opportunity for Advisors to add additional value by guiding their plan sponsors through fee comparisons.
While fees have different names throughout the industry, there are standard services that will typically fall into one of three categories: (1) plan administration and recordkeeping, (2) fund expenses, and (3) ancillary transactional fees. This simple framework will help us compare fees and assist clients with making better decisions about plan vendors.2
There are a LOT of players when it comes to managing a 401(k) plan. As a result, they can account for a heifty portion of retirement plan fees. Here are some service provider fees to look for:
Fund Expenses are costs associated with the underlying investment products offered by a plan; there may be any combination of Mutual Funds, Exchange Traded Funds (ETFs), or Collective Investment Trusts (CITs) found in a retirement plan. Fund expenses may like the most obvious fees, yet funds can hide fees charged by other services providers to a plan sponsor and participants. Here are some common expenses you may find wrapped inside a tradition fund expense:
These are one-time fees for individual transactions that a participant may or may not choose to carry out. Below are some common activities that may result in a charge to the participant.
The complexity of retirement plans requires a lot of services – and they can add up. That’s why it is so important to help plan sponsors understand what they are paying for and why. Staying on top of fees helps keep participants from over paying and gives plan sponsors an extra level of trust with their trusted advisor.
1 Moore, Rebecca. “Investment Manager and Recordkeeper Changes Driven by Fees.”PLANSPONSOR, 26 July 2017, www.plansponsor.com/investment-manager-and-recordkeeper-changes-driven-by-fees/.
2 Does not include all possible fees; Fees listed may or may not be included based on individual plans.