By: Thomas W. Batterman, CTFA
A primary objective of 401(k) plans has always been to help employees take charge of their retirement finances. While many employees with 401(k) accounts fail to take advantage of the opportunity to prepare for the future, there are others who are taking personal responsibility seriously. Some employees, for example, feel their employers are too restrictive when it comes to the investment choice they have in their 401(k) plans.
In two separate lawsuits, a group employees of a major U.S. bank have challenged the selection of investment products the company has made available. It wouldn't be surprising to see more attempts to hold employers accountable for the investment options available in their 401(k) plans, particularly as the nation's Baby Boomers, entering the retirement phase of life, look more closely at their financial resources.
It is important that 401(k) plans help employees prepare for a financially secure retirement. The following nine questions can serve as a guide for evaluating a company's 401(k) plan practices:
- Does our plan offer the best possible investment options?
There are many investment options available today. Employees are far better informed and more involved than they may have been in the past.
The employees of First Union Corp., a bank based in Richmond, Virginia, charged in one lawsuit the company did not act in the best interest of the employees in its investment offerings. Any company with a 401(k) plan may be liable if it fails to demonstrate it has performed its due diligence in terms of the investment products that are available to participants in the plan. Such liability may well extend to the other aspects of the products, including charges, fees and commissions.
- Are we offering personalized investment assistance to our employees?
While it's important for employees to assume responsibility for their individual accounts, is it appropriate to assume most people are sufficiently knowledgeable to make informed investment decisions? Informal studies show most employees make their decisions based on what a fellow employee is doing.
Even if an employee spends considerable time attempting to master investment information, it takes considerable experience and expertise to know how to evaluate investment data. Most employees can benefit from having a personalized investment plan to help guide them over the long-term. It is too easy to be persuaded by what's "hot" or to be coerced by someone who has a financial interest in making a sale. A personalized investment plan can help provide the necessary direction.
- Are we resisting pressure to install a "daily evaluation" service?
There are many times when more is better, but daily evaluation is not one of them. These services are expensive, draining investment dollars away from the purpose for which they are intended. One of the attractive appeals of "daily evaluation" is the ease with which investments can be changed. Is this necessary? Is it really in the employee's best interest? Once again, if 401(k) funds are for retirement, then a long-term investment plan is far more critical than being able to make instant portfolio changes that may emotion-based, and not very well thought-through.
At some point, it's quite possible employers may be subject to criticism and even legal action for permitting "daily evaluation" services since this makes it possible to "gamble" with their retirement funds. But a company that cares about doing its best for employees will want to offer proper protection against unnecessary loss.
- Are we using cash or deferred arrangements to reward certain employees based on their performance?
Many employers are surprised to discover that their 401(k) plans offer the opportunity to reward valued workers. While cash often seems more appealing to employees, a 401(k) makes it possible to give a bonus to specific employees as part cash and part of totally deferred compensation. This option allows the employer to enhance employees' retirement finances.
- Do our plan's servicing arrangements separate administrative costs from investment fees?
This is the issue of "what you don't see you don't know about." Almost always, what's hidden is costly. While it can be advantageous to deal with one servicing company, there are good reasons to have administrative and investment costs shown separately. It's becoming popular for providers to indicate they do not charge an administrative fee or one that is low in cost. By bundling the administrative and investment fees together, it can turn out that the total expense is much higher than necessary. This cannot be done when the fees are shown separately.
- Are loans and hardship withdrawals really in the best interest of our employees?
Provisions for including loans and so-called "hardship withdrawals" have been used as techniques for broadening the appeal of 401(k) plans. If the money is really needed, there are ways to get it out. While these provisions may make a plan more attractive to some employees, there are sound reasons for not allowing withdrawals before retirement. A 401(k) plan is a retirement fund. That's its sole purpose.
Loans and other types of withdrawals only serve to subvert this purpose. If an employer has provisions for employee loans separate from a 401(k) plan, that is appropriate. But as an employer, do you want to sit in judgment in terms of what are "hardship situations"? To permit withdrawals before retirement only serves to confuse employees about the purpose of the plan.
- Are we fully aware of our plan's expenses?
It can be quite difficult to compare fees charged by various providers. This is a business where there can be considerable game playing. Some providers charge an "all-inclusive" fee, while others offer what may be a much lower fee but then charge for each new enrollment, tax return preparation, and compliance testing, as well as a separate consulting fee to address other matters relating to the plan. When placing vendor costs side-by-side, it's difficult to make comparisons. The one which may look low may actually be quite high. The best way to determine your plan costs is to add up all the fees charged over a 12-month period and then divide by the number of participants.
- We are considering a 401(k) program, but we are afraid it won't meet our needs. How should we proceed?
There's a perception 401(k) plans are restrictive and do not permit customization to meet the needs of a particular company. This just isn't true. The needs of most employee groups can be met within the current rules governing 401(k) plans if you seek resourceful design assistance. For example, it's not obligatory for an employer to match employee contributions. You can do so one year and not another.
If it seems a regular 401(k) is not appropriate, there is the Simple 401(k) where the employer/owner can put in the maximum permitted, no matter what employees choose to do.
- Are we using annuities as investment vehicles in our plan?
It's surprising how many 401(k) plans are using annuities when there is absolutely no reason to do so. Whether fixed or variable, annuities only add to the cost and do not deliver any added benefits to an employee. A 401(k) plan is a pre-tax, tax-deferred investment so the main investment benefit of an annuitytax deferralis useless for these dollars. The annuity "wrapper" adds to the cost of the investment. The goal of a 401(k) plan is to keep the costs as low as possible for a given level of investment performance to aid the "wealth-building" characteristics of the plan.
Without question, 401(k) plans are an effective way for employees to provide for their own retirement. At the same time, it is becoming clear that employers may be held accountable for the way plans are designed and administered.
While not providing all the answers for maximizing the benefits of a 401(k) plan, these nine questions can be helpful in evaluating current performance and fine-tuning for the future.
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Thomas W. Batterman, a Certified Trust and Financial Adviser and the Senior Relationship Manager for Vigil Trust & Financial Advocacy, Wausau, WI, has 17 years of experience in the financial advisory field. He is a licensed attorney and is a member of the National Association of Personal Financial Advisors. His firm, Vigil Trust & Financial Advocacy, was started in 1988 as the State of Wisconsin's only registered investment adviser with full corporate trust capabilities and is a founding member of the Association of Independent Trust Companies.