When retirement plans first became available, many small and mid-size companies as well as nonprofits had few options. Furthermore, many 401(k) and 403(b) plans had an inherent conflict of interest built into them when financial advisors were paid by the fund companies. This incented advisors to recommend plans with the highest compensation to the advisor rather than lowest cost to the company and employees.
That is changing as the result of a recent Department of Labor ruling, requiring financial advisors to act as a fiduciary on 401(k) plans and to place the interest of retirement plan participants before their own.
While this ruling does not cover 403(b) plans, many nonprofits could set up a 401(k) plan and transfer existing accounts to the new plan.
While you, your company or your nonprofit may have made a sound choice when you established your current retirement plan, you owe it to yourself and your employees to make certain it remains the best choice.
If you are establishing a new plan, or reviewing an existing one, the following are some items to evaluate:
Cost — Consider the total cost associated with the plan — custodial, record keeping, third-party administrators, financial advisor expense and expenses of the investments. Some of these costs you might pay directly while some may be buried within the plan and deducted from participant accounts.
You can determine how much is being paid by the participant and what portion is being paid by the company by reviewing Form 408 B2, the summary sent to you each year by the plan provider. A good plan will make fees and costs transparent, and if your plan does not, that's a red flag.
Even small differences in cost can have significant differences in account balances, over time, for the employees so cost is critical.
Plan administration costs are costs associated with running the program. Many large companies pay them directly, while some small companies have them billed to client accounts. You may be able to have the company pay those costs yet still reduce the overall costs to the company by instituting a low-cost plan.
Investment management fees go to mutual fund management companies for their work. Depending upon your plan, some of these fees are redirected to third-party administrators or financial advisors. Look closely at the expense ratio charged by each fund company to identify good low-cost funds.
Investment options — A good plan should offer low-cost brand name mutual funds, which include a mix of large cap, small cap, international and bond funds. It should have a mix of actively managed, index and target date funds.
User friendly — Employees should have the ability to be automatically enrolled in the plan, make investment selections and access their account on a variety of devices easily. The web site should be easy to navigate and information on funds readily available with balances updated daily.
Provide a Roth 401(k) option — Younger employees will never have to pay taxes on their gains.
Employer contribution — An employer investment match or safe-harbor contribution is a wonderful fringe benefit. While sometimes it may be difficult for smaller employers to afford, this may become affordable if third-party and administration costs are minimized by implementing a low-cost plan.
Provide individual investment advice — An independent advisor is a valuable benefit for employees to consult to help them avoid mistakes.
Automatic enrollment — Enrolls new employees while contributing a specified percentage of their salary to the plan. Employees have the flexibility to "op out" but this feature encourages greater participation.
Automatic escalation — This feature automatically increases employee's contribution each year. This helps ensure that employees are saving an amount sufficient for their retirement.
A plan containing the above features does not have to be expensive. In fact, every effort should be made to create a plan that is cost effective and transparent for both the employer and employee. Be insistent that your financial advisor make all costs abundantly clear.
John W. Eckel is president of Pinnacle Investment Management Inc. of Simsbury. He can be reached at 860-651-1716.