When David Sackett was spearheading the selection of a new 401(k) provider for his employer in 2013, what he knew most clearly was that he didn’t know much.
“My level of confidence that I was taking the right steps was very shaky the whole time,” recalls Sackett, corporate controller at ULVAC Technologies, a 60-employee semiconductor-equipment maker based in Methuen, Massachusetts. “There was conflicting advice all over the place — from the providers themselves, articles I found online, and colleagues talking about their experiences. It seemed there was no set pattern for how you should do it.”
Indeed. While large companies with dedicated benefits staff and deep pockets to pay outside advisers may have relatively few daunting issues when selecting a 401(k) provider, finance executives at smaller companies often feel adrift when charged with the task.
The following guide to plan selection has the latter executives in mind, even though many best practices apply regardless of plan size. While it can’t be considered comprehensive, it’s an attempt to gather the top-drawer considerations in one place, with some more nuanced tidbits sprinkled in.
Take it as a given that with or without the help of a financial adviser, you’re going to prepare and send a request for proposal to several providers. Here are some things to keep in mind while creating the RFP and evaluating the proposals.
Jim Scott likely knows what he’s talking about when he says, “There are a lot of danger points in the fees charged to 401(k) plans or sponsors.” Currently employed by Early Growth Financial Services, a San Jose, California-based firm that offers outsourced CFO services for early-stage technology companies, Scott was finance chief from 2001 to 2007 at ExpertPlan, a low-cost, online 401(k) services provider.
Fees for plan administration, investment management, brokerage services, loan transaction processing, and more can easily add up to several hundred basis points, Scott warns. Fees are not quite as inscrutable as they were before 2012, when the Department of Labor instituted new regulations for the disclosure of fees and expenses by 401(k) services providers. But they’re still a sharp sticking point.
A majority of companies pass on fees to plan participants, but reining them in not only satisfies plan sponsors’ fiduciary duties, it also serves the goal of enabling employees to afford to retire, instead of lingering on and possibly acting as a drag on the company (in the form of higher medical bills, lower productivity, blocking younger co-workers from moving up, and so on).
There are two essential best practices for keeping fees in line. First, have a consultant regularly benchmark your existing fees, every two or three years, so that whenever you conduct a provider search you’ll have some perspective on fee quotes.
Second, understand how a prospective provider — that is, a third-party provider of plan administration services (a “TPA”) which likely also offers an investment platform that either comprises a finite number of funds or is structured to allow nonproprietary funds to be added to the lineup—gets paid.
“Most of a plan’s costs, usually 70% to 80%, are not for plan administration but for investment management,” says Alison Borland, senior vice president of retirement strategy and solutions for consulting firm Aon Hewitt. “So if you have a broad initiative to focus on high-quality investments at low cost, look for a provider that’s going to support that.”
In part that means including in the fund lineup a selection of passively managed index funds and target-date funds carrying management fees of just 5 to 10 basis points. “Over time an S&P 500 index fund is probably the best no-brainer investment a person can make without having to get actively involved in money management,” says Scott.
Costs can be saved on actively managed funds as well, because their fee structures (called “share classes”) vary widely. Some have front-end (“front-load”) sales charges; some charge on the back end when fund shares are sold; some are no-load funds but carry 12b-1 distribution fees of up to 50 basis points. Depending on the size of a plan’s aggregate investment in a particular fund, it may qualify to invest in low-cost institutional share-class funds.
“Get under the covers and look at the fees involved for the funds being provided,” says Scott. “You’ve got to be extremely careful about what share classes you’re buying for the plan.”
One good reason for that, aside from helping employees prepare for retirement: if plan participants only have access to expensive funds, they could sue the plan sponsor.
But plan sponsors should be careful not to make getting the absolute lowest fees a top priority. “There’s no requirement to do that,” notes Borland. “And there’s often a trade-off in the quality of record-keeping, support, desired focus on institutional versus retail funds, and the quality of communications.”
One formerly huge element of picking a provider has lately been receding in importance, but it still bears consideration.
For many years an industry norm was that when hiring a TPA, a company could only select funds from its proprietary platform. Partly because of the fee-disclosure regulations — which led providers to uncouple their investment-management fees and administration fees, rather than have clients pay the latter with a revenue share of the former — that restriction increasingly has eased over the past few years. The new norm is an “open architecture,” meaning plan sponsors can bring in outside investment options.
But some TPAs still require plan sponsors to maintain a certain percentage of plan assets in their funds, or limit the choice in certain investment categories to the proprietary funds. So if you’re going to pick one of those providers, make sure you’re comfortable with that.
“I see open architecture being a must,” says Greg Marsh, executive vice president of Bridgehaven Investment Advisors, part of the Wells Fargo Advisors Financial Network. “Whatever fee you pay for administration should be irrespective of what investments are offered in the plan. For instance, if you have to use a provider’s target-date funds, but they don’t come out best [among a broad range of target-date funds] in your investment analysis, you’re compromising your fiduciary responsibility.”
Open architecture has led TPAs to increasingly offer administration services for a per-head fee. That may be better for plan sponsors than being charged basis points (that is, a percentage of fund assets) or, in the case of revenue-sharing arrangements, whatever the plan sponsor’s share of investment-management revenue amounts to. “We think per-head is the best way,” says Cynthia Zaleta, a principal in the wealth practice at Buck Consultants. “There is no guessing as to what the administrative cost is going to be.”
It’s important to investigate a 401(k) provider’s wherewithal to help you remain compliant with the Employee Retirement Income Security Act. In fact, some see that as the most important element of the selection process.
“For me, compliance has to be the number-one focus, hands down,” says Cori Slade, CFO of Granite City Electric Supply in Quincy, Massachusetts. “You have to know whether the TPA has the skill set and systems in place to maintain compliance. Ask hard questions: Have any compliance issues ever come about because of services you did or didn’t provide? How do you service clients that are audited?”
In particular, satisfy yourself that the provider can do a good job administering loans, Slade advises, noting that when it comes to 401(k) plans, “loan is a four-letter word.”
“The last thing you want is to have a DoL audit examiner come in and find compliance issues with loans,” she says. “They know lots of companies account for them incorrectly, so it’s an area where they can zing a plan right and left. And if the TPA doesn’t have your back on that, it’s ultimately your responsibility.”
A company also must trust its provider to competently perform required discrimination testing to ensure that contributions made by and for rank-and-file employees are proportional to those made by and for highly compensated employees.
According to Marina Edwards, a senior consultant with Towers Watson, if there are repeated issues related to the provider’s competence in the compliance area, that alone is reason to seek a new vendor.
Conducting a Search
How often should you go through a provider search? The Labor Department says only that it should be done “periodically,” but a rule of thumb, according to most observers, is that it should be at least every three to five years.
A good practice is to stagger provider searches and fee benchmarking. For instance, if you do a search in year one, then benchmark fees in year three or four, followed by another search in year five or six, and so on. “That periodic back-and forth helps cover your fiduciary duty, makes sure that you understand the market, and keeps your plan competitive in the marketplace,” says Edwards.
But don’t conduct a search only because you know you’re supposed to, with the intention of staying with your current provider no matter what. Creating an RFP is time consuming and can be costly. And when the time comes that you really want to do a legitimate search, you may find yourself at a disadvantage, according to Zaleta.
“If you’ve done an RFP every 3 years and yet have been with the same provider for 15 years, vendors have a tendency to figure out that you’re not serious about it,” says Zaleta. So they may not take you seriously, either, and may “coast” on the response.
Also, don’t be surprised if your CEO gently twists your arm to send the RFP to the bank that just lent the company $40 million, warns Edwards. “The bank may have a small 401(k) practice that’s not very sophisticated and uses clunky technology,” she says. “That is a fiduciary issue: the search is supposed to be for the exclusive benefit of participants. That’s a banking relationship you want to steer clear of.”
Whenever you plan to conduct a search, make sure to give yourself plenty of time if the goal is to wind up the process before the beginning of your next benefits year. It may take several months to prepare the RFP, several weeks to get proposals back, several more weeks to analyze them, and still more time to see the finalists’ presentations and make a decision. “It’s a misconception that you can start in August and have the new provider in place on January 1,” says Edwards. “Start no later than June.”
At ULVAC, Dave Sackett says he would have saved a lot of time selecting a 401(k) provider if he’d known from the beginning some of what he learned during the process.
“I think a lot of people go into the selection process thinking, ‘Where do I go? Why would I choose this one over that one? Who should I listen to? Who should I believe?’” says Sackett. “Not knowing any better, I was looking at the really big providers, thinking that bigger is better, and that if they’ve been around for a long time they’ll meet our needs. I found that wasn’t the case” (see sidebar below).
Indeed, he says, referring to the article he was interviewed for, “I wish I could have read it before I had to go down my own road.”
David McCann is a deputy editor of CFO.
Here are a few more factors to take into account when selecting a 401(k) plan provider.
Participant Services. The fees you pay to your provider can bring a lot more than just plan administration and access to investments. For some plan sponsors, providing services for participants can be among their top priorities.
In your evaluation process you may want to consider the availability or quality of the plan website, investment advice, financial wellness and retirement readiness counseling, participant training, technology tools enabling decision making, and phone support.
Enhancing such services has been a broad trend among providers in recent years. “Those things have always been important, but market innovation is becoming more apparent every day,” says Alison Borland of Aon Hewitt.
An Integrated Benefits Platform. Some plan sponsors want to deliver a comprehensive, integrated suite of benefits, so they may favor a 401(k) provider that can also administer health benefits and, if applicable, pension plans. Total retirement planning means making sure you have enough money to retire, which should take into account retiree medical costs, Borland notes.
Brand Power. Your participants may simply be more comfortable dealing with a big-name provider like Fidelity or Vanguard. If you think employees will be more likely to participate in the plan or invest more based on brand recognition, it may be a consideration. “We’ve seen that investor confidence is higher when people feel they are with a known brand,” says Greg Marsh of Bridgehaven Investment Advisors.
But greater name recognition, of course, doesn’t necessarily mean a better choice. Foley Carrier Services of Hartford, Connecticut, recently selected the newly renamed Voya, which had been ING U.S. until April 2014, as its new 401(k) provider. “A lot of providers are changing their names,” says Mary Henry, Foley’s CFO. “Fidelity was more expensive but I was still considering it, just because some people will follow a brand regardless of what else is going on.”
ULVAC Technologies controller Dave Sackett says it was hard to get internal agreement on whether to go with Fidelity or Sentinel Benefits, a small, local provider that Sackett says is highly focused on personal service for participants.
“Some people argued that Fidelity is an industry leader for a reason,” he says. “They were convinced before actually listening to what Fidelity was proposing. Different directors wanted their pick to win, and there was a lot of back-and-forth. Fidelity’s tools are great, but in the end we determined that Sentinel would benefit everyone the most.” —D.M.