Warning, Employers: Liability Lurks in Your 401(k) Plan and the New DOL Rule Won't Protect You
It's your responsibility to protect your team's retirement, not whoever you hired to handle it.
Regardless of the number of employees you have or the amount of assets in your 401(k) plan, you have a legal obligation to ensure that all your plan's administration and investment management decisions are in the best interest of its participants. If they're not, then you can be held liable by the Department of Labor, and find yourself on the hook for major fines—even if you entrust plan oversight to a payroll company, insurance provider or another third-party administrator.
Said another way, a business owner has a legal fiduciary obligation to make sure the plan is set up, monitored and managed for the "sole benefit" of the employees. For most business owners, this is shocking news, as they often think that the provider or local broker is responsible to make sure things run smoothly. Not so.
The biggest providers are focused on making as much money as possible for their shareholders, not their clients. It's this lack of alignment that has led to lawsuits against business owners and disastrous consequences for Americans' financial future.
Conflicts of interest within the retirement services industry lead to excessive and hidden fees which cause Americans to lose, on average, $17 billion every year, according to the White House Council of Economic Advisers.
Companies that sponsor 401(k) plans have a duty to help their employees achieve their desired retirement outcomes. When sponsors don't pay adequate attention to the fees assessed by administrators, and the menu of investment options chosen by those administrators, the plan participants' retirement savings can take a hit over the long term. Even an extra 1% or 2% in unnecessary fees can deplete significant savings from participants' retirement nest eggs. When they find out, they are understandably angry and upset.
U.S. companies have paid almost $400 million to settle 401(k)-fee lawsuits brought by employees since 2006, when the first suits were filed, according to Financial Times and FT Ignites research. The $62 million and $57 million payouts from Lockheed Martin and Boeing, respectively, in 2015 are the largest announced settlements, but small businesses that offer 401(k) plans to employees are not immune. Although they don't often make the news, small and mid-size companies are experiencing more audits and fines by the Department of Labor.
Big companies may have the resources to hire investment committees to manage their plans, but small businesses can't afford that luxury. Building and growing a company requires intense dedication, and small firms don't have the time to studiously manage and monitor a 401(k) plan. They simply trust the broker who sold them the plan and assume that, because they are nice, that the plan is working as sold.
Also, unless a small business is in the financial services industry, its team probably lacks the expertise necessary to fully understand 401(k) plan fee structures and select investment options. More importantly, they don't have the tools to decipher the lengthy and opaque fee disclosures that contain layers of hidden and often excessive fees.
Spodak Dental Group of Delray Beach, Fla., is one such company. They had a plan with a major insurance company to take care of their 40+ employees. They thought they had relatively low expenses on their funds, but upon further examination, they realized there was an additional 1.2% "contract asset charge" that brought their total fees to over 2.4% annually. They ultimately switched to a lower-cost provider that was just 0.65% "all in." This fee savings amounted to over $1.4 million of additional retirement savings for plan participants over the next 20 years.
Unfortunately, brokers and the record-keepers they work for have many incentives to stick it to small business owners and their employees. Fee-sharing agreements, often characterized as "pay to play," create arrangements where the funds offered in the plan are paying hefty annual fees for shelf space. In other words, the funds offered aren't the best performers—they are the ones paying the most. They also have an incentive to steer participants toward more expensive shares classes, many of which have substantial front-end commissions/loads.
The DOL's Fiduciary Rule Won't Solve This Problem
Some record-keepers are already figuring out how to "Swiss cheese" the new Fiduciary Rule, which is supposed to eliminate conflicts of interest from advice on investments in retirement savings accounts. The problem is, by the time the lobbyists were finished, the rule still allows for revenue-sharing with mutual funds, front-loaded sales charges, and proprietary "name brand" funds that are more profitable for the provider.
Some record-keepers have told business owners and their employees that, since they, the record-keepers, are not fiduciaries, the Fiduciary Rule will require them to retain a third-party fiduciary service provider, which will force them to add yet another layer of additional fees. In other words, they will be charging more money to do what they should have been doing all along—making decisions which are in the best interest of plan participants and their retirement savings.
In addition, some record-keepers are taking steps, on the surface, to reduce fees by decreasing expense ratios on the mutual funds that they offer participants, and by adding lower-cost index funds and exchange-traded funds to their list of investment options. However, by lowering one line item of expenses, they still gouge participants by increasing administrative fees and other asset-based charges on these funds. It's like going to a hotel where the room cost is only $150 but the daily mandatory resort fee is $75. It's $225 out of your pocket no matter how you slice it.
The DOL proposed its Fiduciary Rule with the best of intentions, but unfortunately, it won't prevent 401(k) plan record-keepers from depleting the retirement savings of small business owners and their employees with excessive fees.
To truly safeguard your employees' retirement savings, and prevent a costly lawsuit, there are a few steps you can take:
Understand what you are currently paying by asking for a copy of your employer fee disclosure (also called a 408b2). Find a registered investment adviser, a legal fiduciary, to help you assess the actual fees.
Eliminate brokers, commissions and other middlemen. 401(k) brokers are the travel agents of yesterday -- entirely unnecessary.
Add low-cost index funds to your fund lineup and ensure that there are no additional layers of fees (such as contract asset charges) that erode your financial future.
The one great thing about the new DOL rule is that it will force business owners to wake up to the practices that the biggest 401(k) plan providers have gotten away with for far too long. In much the same way that Uber offers a better experience for passengers than taxi cabs, there are next-generation plans available today that put people ahead of profits.
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