How to Know When It’s Time to Switch Your Service Provider

service provider

By Allison Brecher, General Counsel, Vestwell

The new year is a great time to take stock of your company offerings and, for plan sponsors, that should include a thorough review of your retirement plan. With fiduciary duty on the line, not taking the time to carefully review and make any changes can be a costly mistake. But how do you know when it may be time to pull the plug and switch your service provider, rather than just make tweaks to your plan? Here are some things to keep an eye out for.

Your service provider is not proactive about compliance and/or charges extra to keep your plan compliant

Tax savings is often a main driver for offering a retirement plan, but your plan can lose its tax qualified status and fiduciaries can become liable for potentially significant penalties if your service provider falls short on compliance. Is your recordkeeper proactively monitoring your plan and complying with the legal and regulatory requirements? Or does it only get involved after an issue arises, which can be years later and typically more time consuming and costly to correct? Does your provider review your plan documents for compliance with changing regulations and prepare any necessary amendments?  Or do they alert you to regulatory changes and leave the rest in your hands?

Your service provider does not have adequate data security protections

Think about the kind of data your service provider has on your employees and then think about what can happen if that data gets into the wrong hands. A data breach can put your employees’ personal information at risk, create strained relationships with your workforce, and expose company fiduciaries to liability. It’s important to know how your service provider protects your employees’ information and what it will do when something goes wrong. Most importantly, your provider should:

Have information security protocols in place that have been independently tested and verified by outside experts. In particular, your provider should encrypt all of your employees’ data and store it securely at all times.

Stand behind its procedures by agreeing to pay for and handle instances when data becomes compromised.

Be willing to report any data security incidents to you within 24 hours.

Have cyber coverage to make sure your company is protected and that the amount of coverage is sufficient.

Always be able to restore employees’ data and accounts with minimal or no downtime and disruption. Especially in the current volatile market, your employees should be able to access their accounts 24/7.

Your provider’s fees are unreasonable

It is critical to dig into the details of your recordkeeper’s fees, especially in light of the numerous class actions where plan sponsors and fiduciaries are being sued for operating a plan with allegedly excessive fees. You do not need to select the least expensive provider, but you do need to make sure the fees are reasonable for the services provided. Some things to look out for include:

Fees that are disguised by being included with mutual fund expenses  – – sometimes in the proprietary funds offered by affiliates of your recordkeeper – – that are then kicked back to the recordkeeper. Make sure your provider has disclosed all such conflicts of interest.

Services that cost extra, since some providers will charge sponsors for things such as compliance activities and plan document reviews.

Fees that are reasonable in comparison with others. However, you  cannot know for sure whether a service provider’s fees are reasonable until you ask and shop around. You can do that by getting proposals from other providers or benchmarking their fees. If you determine that your provider’s fees are excessive, you have no choice but to get them reduced and, if your provider refuses, you must terminate them in order to avoid violating your fiduciary duties.

Advisors have a golden opportunity to help sponsor clients understand what they’re getting and the reasonableness of the charges. While some plan sponsors may want to avoid change due to the change management associated with switching providers, the implications of staying with the wrong provider are far greater.

Not Knowing Your Plan’s Fees Can Cost You Plenty

By Allison Brecher, General Counsel, Vestwell

In order to make good investment decisions, it’s important to be informed. Yet one of the more impactful components of any retirement plan is also the area where employers and participants tend to feel least clear: plan fees. While fees are not the only consideration when creating your portfolio or selecting service providers to the plan, high fees can erode retirement savings for participants and can create fiduciary – ie: personal – liability for you, the plan sponsors.

Despite the risks, many sponsors don’t take the time to carefully examine their plan fees or, worse yet, needlessly increase their risk by overpaying service providers who may be charging “hidden” fees. What you don’t see can hurt you, but what questions should you ask to prevent these pitfalls?

First, let’s understand what services are being provided to a typical retirement plan. There are three general categories:

Investment advisory – investment advisors select the investment lineup that they believe is suitable for the plan.

Administration  – recordkeepers and other service providers keep track of the transactions in your account, such as payroll deductions and employer contributions, and make sure the plan is operated in compliance with legal and regulatory requirements.

Direct charges – participants and sponsors are charged for services specifically provided to them, such as for loans, hardship withdrawals, or amending the plan.

All of these services are necessary to successfully operate a qualified retirement plan and, while there is nothing wrong with getting paid, the challenge is to understand how these service providers get paid, the reasonableness of the fee in light of the value of the services, and whether the fee has been disclosed. Unfortunately, it is often not as simple as just asking the service providers because these fees can be embedded in the expense ratios of the mutual funds offered in the investment lineup.

Given all this, how can you get to the bottom of what you’re actually paying and what you’re getting in exchange for those fees?

1. Start with the documents

You should have just received year-end fee disclosures that list all of the expenses paid by the plan. Those notices and the plan’s benefits statements will help you understand the total plan-related fees charged to their account. The plan administrator should be able to provide a list of all direct service charges. All of the expenses paid by the plan or individual participants should be clearly itemized; if they are not, you should probably ask why.

2. Understand share class

Very large employers get the benefit of being able to invest in institutional share classes, which often have lower costs. Some mutual funds create a share class specifically for smaller retirement plans, called Sub-TA fees, which include the fees paid to recordkeepers, plan administrators, or other providers. In other words, the providers’ fees are aggregated with the mutual funds’ expenses and therefore make it impossible for plan sponsors to separately identify and benchmark them. However, you can ask for them to be itemized separately. If you don’t know or understand your share class, you should find out. If you are in one with a high cost, you can insist that your plan be placed in one with lower expenses.

3. Understand conflicts of interest

If your plan provider is an insurance company, there is a good chance your plan’s investments are variable annuities and not mutual funds. Variable annuities are mutual funds owned by an insurance company “wrapped” or protected by an insurance policy, thus increasing expenses with “wrap fees,” surrender charges, or sales commissions in the process. Those fees can turn a low cost mutual fund into an expensive and illiquid investment. The same could be true for plans supported by a mutual fund provider, which has a built-in incentive to use its own funds as part of the investment lineup. Conflicts of interest are not inherently wrong; they just must be disclosed so that the plan sponsor can make informed decisions.

4. Ask about revenue sharing

While the word “kickback” could make you cringe, revenue sharing is just that—a payment made by a mutual fund to compensate service providers that use their funds. Salespeople, brokers, and insurance agents may receive finders’ fees for bringing new business to the mutual funds or negotiated loyalty incentive compensation. Regardless of the type of fee, they are all revenue sharing and they increase the investment’s expenses and reduce investor returns. Sometimes these fees are disclosed as 12(b)-1 fees, but sometimes fund companies pay different levels of fees through multiple share classes. You should ask your investment advisor or read the prospectus. Don’t overlook footnotes about how your plan expenses “may notinclude any contract-level or participant recordkeeping charges. Such charges, if applicable, will reduce the value of a participant’s account.” That is likely a red flag telling you there may be hidden fees.Ask your investment advisor whether it is receiving 12(b)-1 fees, the annual value of those fees, and whether your same mutual funds can be purchased for a different share class with lower revenue sharing fees.

5. Investigate transaction fees

These fees can be especially difficult to understand, yet they are one of the largest expenses that a participant can bear. Every time a mutual fund manager buys or sells the underlying securities within a mutual fund, there is a cost to the trade. Actively managed funds have higher transaction costs than passive funds, like index-based funds, and the participants’ investment returns are reduced by the cost of those trades. While transaction costs cannot be avoided entirely in actively managed funds, they can include brokerage commissions and other compensation paid to the service provider that should be scrutinized. Transaction fees can be found (often with some difficulty) in a fund’s Statement of Additional Information and annual report.

So how are the fees justified? There is nothing wrong with compensating service providers; again, they perform necessary services to successfully operate a qualified retirement plan. But sponsors must ask what services justify these fees and whether the provider yielded material results for participants and beneficiaries. In short, the question fiduciaries should be asking is:  Do these fees exist to pay for reasonable, legitimate, and valuable services that benefit participants of qualified retirement plans and enhance their retirement security?  Or do they exist to support the financial services industry at the expense of participants?

You can largely avoid these issues altogether by investing in lower cost mutual funds, like Exchange Traded Funds or Target Date Funds, and consider using service providers that are not financially incentivized to use certain mutual funds as plan investments. You should be asking yourself the ultimate question regularly:  Have I properly investigated and paid only those fees that were appropriate and reasonable? Hopefully after addressing the questions above, your answer will be “yes”.

 

3 year-end must-dos for your clients’ 401(k) plans

clients

Before the busy holiday season kicks in for you and your clients, make time to add even more value as their trusted investment advisor.

Show—don’t just tell—your clients about these three simple actions to take before year-end, which can help them: 1) reduce their tax burden, 2) increase their chances of retiring comfortably, and 3) make sure their investments remain on track.

Over the long haul, these three moves will be their holiday gifts that keep on giving, and they’ll be grateful that you checked in with them.

1. Make an extra contribution to save on taxes

Your clients have until the end of the year to make an additional contribution to their 401(k)s—which will not only boost their account balances, but also help them save on taxes for the year.

In 2017, the maximum 401(k) contribution for individuals is $18,000. You can advise them to add up their contributions to date, and then figure out how close their are to reaching that limit.

If your clients are over 50-years-old, they can make additional catch-up contributions of $6000, for a total of $24,000.

2. Increase contributions for next year

Many people take a “set it and forget it” approach to retirement savings, but it’s smart to revisit the amount deferred to retirement savings at least once a year.

Ask your clients if they received salary raises this year, and inform them that they may wish to raise their 401(k) contribution by the same percentage increase.

If a company offers an automatic escalation feature, advise them on the benefits for signing up, and their contributions will rise every year to get them closer to savings goals.

3. Check on investment performance, fees, and allocations

Advise your clients to review their investment strategies at least once a year to make sure they are on track. You can help them review all the various parts of their investments:

Performance

Show them how and where to check on performance of their investments—find out if they are happy with their investment performance relative to averages and/or benchmarks.

Fees

You should also ensure that your clients know how much they are in paying investment fees. For example, a large cap stock fund should charge no more than about 1.25% in fees; small cap funds charge a little more, averaging 1.4%.* And fees on ETFs or exchange traded funds can be even lower, around 0.53% on average.**

Help them make sure their funds aren’t eating up their returns with unnecessarily high expenses.

Allocations

You can also help your clients review their portfolios against their target asset allocations.

The stock market has done well this year, and they may have more than they expected in their stock funds. If so, help them to transfer some of the money into other asset classes to diversify and rebalance back to their target.

Helping your clients with their year-end check-up should be part of your regular annual service. Most importantly, doing so will help keep your clients’ retirement savings plans on track.

That’s one way to increase the chances that they (and you) will enjoy financially secure holidays for many years to come.

 

*Thuna, K. (2017, February 14).  Average Expense Ratios for Mutual Funds.  Retrieved from https://www.thebalance.com/average-expense-ratios-for-mutual-funds-2466612

**Why Are ETFs So Cheap? Retrieved from http://www.etf.com/etf-education-center/21012-why-are-etfs-so-cheap.html?nopaging=1