America’s biggest companies have adopted their own model for 401(k) in order to find the best 401(k) service providers and get the help they need to offer a valuable retirement plan. Together, these best practices form an “institutional approach” to 401(k) management that focuses on understanding and controlling four aspects of a retirement plan:
- Risk Management
For many years, small and mid-sized businesses have largely been approached by local brokers and individual investment advisers who offer commoditized, bundled plans. These “retail approach” plans—which offer very little customization or insight into what works and what doesn’t work in a 401(k) plan—get the job done, but are they really representative of what the retirement industry can do for small and mid-sized employers?
By borrowing larger institutions’ best practices, employers can get more help managing their plan—and maybe even save some money for everyone in the plan.
Understanding 401(k) Costs
- Document fees for all service providers every few years
- Benchmark fees against peers
- Negotiate reasonable fees for services provided
Managing your 401(k) risk
- Understand your fiduciary responsibilities
- Seek out and attend fiduciary training
- Document reasonable decisions in a permanent and accessible location
Finding the best 401(k) companies
- Utilize a specialized 401(k) adviser as your lead provider
- Outsource any administrative responsibilities you aren't comfortable with
- Ensure proper levels of service for you, your admin staff, and your employees using the plan
Choosing 401(k) investments
- Review past performance—but only as a starting point
- Examine and compare investment costs
- Evaluate overall quality of investments
Understanding 401(k) Costs
The bundling of services that is common in the retail model can make it difficult for an employer to figure out who is getting paid, and how much. Here’s how to understand 401(k) costs like the pros.
- Regularly document fees. The first step to understanding a plan’s fees is to request thorough documentation from your service providers. Every few years, request a detailed breakdown of all fees paid by you and your employees. You can get this by requesting a copy of your plan’s 408(b)2.
- Benchmark fees against peers. Once you know what you’re paying, it’s important to see what others like you pay. Ask your service provider to use a third-party tool to help you compare the fees you’re paying to those that other, similar plans pay. By comparing your plan to 100 or more similar plans, you can get a sense for how your fees stack up. Be sure to compare all fees individually, including fees for your adviser, recordkeeper, third party administrator, and investment funds. Advisers often help employers benchmark their total fees against similar plans, but a third-party review of all fees will help you spot any individual fees that don’t line up.
- Negotiate reasonable fees. Larger institutions prefer not to pay a dime more than they should for the services they receive, and when they do pay more, they often get into hot water. A cursory web search for “401(k) excessive fee lawsuit” will show what it looks like when institutions allow their service providers to overcharge. If in your benchmarking you find that your fees are unreasonably high, negotiate for more reasonable fees—or find a provider who will offer them to you.
Managing Your 401(k) Risk
Large institutions dedicate lots of resources to manage risk, including the risks associated with offering a 401(k) plan. Fortunately, managing risk doesn’t necessarily require a whole legal department, but an understanding of fiduciary risk and a disciplined documentation process.
- Understand fiduciary responsibilities. Under ERISA, employers who offer a 401(k) plan act as “fiduciaries,” which means they are personally legally responsible to make reasonable decisions and act in the best interests of employees who participate in the plan.
- Attend fiduciary training. Perhaps the best way to fully understand your fiduciary responsibilities is to find and attend training. I myself offer fiduciary training programs through The Plan Sponsor University because I believe employer education is critical. There are also other training options, like the Fi360 Fiduciary Essentials program. Find one that appeals to you and will help you better understand your fiduciary responsibilities.
- Document reasonable decisions. Employers are required by law to make “reasonable” 401(k) decisions on behalf of their employees. Whenever you make a choice about your plan—changing providers, for example, or updating your investment lineup—document your decision and why you made it. File with your documentation any resources you reviewed or comparisons you made and keep a permanent record that’s easily accessible.
Another best practice under the institutional approach is to select the best 401(k) providers to serve your business’s goals. Choosing your 401(k) adviser is the first step, because they can then help assemble your 401(k) dream team, you can ensure high levels of service without needing to make room in your schedule for managing the team—and the 401(k) plan itself—on your own.
- Utilize a specialized 401(k) adviser as lead provider. A specialized 401(k) adviser (who acts as a fiduciary) will enable smaller employers to assemble the right providers for a plan without requiring the employer to do the heavy lifting. An adviser will be experienced in evaluating and working with providers like recordkeepers, third party administrators, or investment managers. Your adviser can help you understand the capabilities of each provider serving your plan, review any potential conflicts of interest, and help evaluate if they’re charging the right fees for the right level of service.
- Outsource administrative responsibilities you aren’t comfortable with. As an employer managing a 401(k), you do not have to do everything yourself. There are certain administrative aspects of plan management that you might not be good at, or might be too risky for you to handle on your own. That’s okay! Speak to your 401(k) adviser and ask how you can outsource part of your administrative burden to them or a provider they’d recommend.
- Ensure proper levels of service at employer and employee levels. Make sure you are getting the support you need to manage your plan well, but don’t neglect the service your employees should be receiving. Request educational resources and support from your 401(k) adviser to help your employees understand and make the most of the plan. This service is absolutely critical, as it can mean the difference between a successful plan and one that struggles. I often find that by identifying ways to lower costs—like the investment costs mentioned below, for example—small and mid-sized employers can fund this service without increasing the overall plan cost by much, or at all.
Choosing 401(k) Investments
For even the largest of institutions with the most resources, one of the most difficult aspects of 401(k) management is often choosing investments for a plan’s lineup. Evaluating mutual funds and other investment choices can be tricky, but there are best practices any employer can follow to make sure they—or their chosen service provider acting as a fiduciary—are being thorough and thoughtful when choosing investments.
- Review past performance. Institutions look at past performance, but that’s not all they look at. The retail model tends to overemphasize an investment’s past performance, but remember that past performance is not an indicator of future performance. To use an analogy, just because a company has made good cell phones for 10 years doesn’t mean they can guarantee that quality for the next 10 years. Look at an investment’s history to see if it has done well, but don’t stop there.
- Examine investment costs. Each investment will have its own fee structure, which is typically paid to the firm that manages the investment. As is the case with many commodities, the price for the same investment might be different depending on where you buy it, or when, or from whom. Think of it like this: Would you rather keep your $150 per month, 1 GB data plan from 2008, or switch to a modern plan with 5 GB for $70 per month? In my experience, many small to medium-sized plans include more expensive investments when lower cost versions of those same investments may be available to them, and employers are often kept in the dark that they could be paying less for the same investment. Review your fees and ask your adviser to help you compare your specific costs to others who have the same investments to see if you’re due for an upgrade.
- Evaluate overall quality. Retirement plans have continued to evolve and improve over time, and it has also become easier to measure the quality of investments. Just as tools like Zillow have made it easier to judge the value of a home, rapidly improving 401(k) evaluation tools are helping give a clear picture of an investment’s overall quality. As you review investment options, document past performance, costs, and other indicators of quality in order to demonstrate the overall quality of any one investment. You may find that what worked for your plan when you first set it up is no longer the best investment option available today.
Every aspect of the institutional model for 401(k) management comes back to one central theme: best practices. By following those practices that have worked so well for the biggest companies, researching all options in the 401(k) market, and documenting every decision, small to mid-sized employers can maintain a 401(k) plan that stacks up with the biggest and best plans out there.