My family is getting excited about the upcoming Summer Olympics in Rio. I have a 10-year-old daughter who is a year-round competitive swimmer and shares what’s likely a common dream among young athletes to compete on the world stage. A wonderful thing about sports like swimming is that the time standards for Olympic qualification are clearly stated and communicated so every aspiring Olympian knows what it takes to swim for their home country.
Although the standards for 401(k) plans aren’t as clearly stated as the times required to swim at the national or Olympic level, it is very important to periodically benchmark your 401(k) plan. Fiduciary standards for business owners and plan sponsors have a number of requirements that need to be met, and the most effective way to ensure your plan is meeting those standards is to go through the benchmarking process.
In fact, many of the lawsuits against 401(k) plans (large and small) over the last few years have involved the failure of plan sponsors to regularly conduct plan reviews to ensure they are meeting industry standards. A key consideration supporting the benchmarking process is that, while your current 401(k) solution may have been an excellent choice a few years ago, it is important to verify that the investment share classes and internal expenses are still appropriate as the plan grows.
What does it take to meet industry standards for plans of various asset sizes with a wide range of employee populations? I wish the answer were as clear as knowing that my daughter will need to swim the 100 meter butterfly in 1:01.19 to qualify for the Olympics. What is clear, however, is that periodically benchmarking your 401(k) plan is a prudent way to address your fiduciary responsibility while also ensuring your plan will provide employees (including the business owner) with the best possible opportunity to achieve their retirement savings goals.
Here are a few examples of what we look for while conducting plan reviews:
1. Participation Rates: The level of 401(k) plan participation by employees is generally the most effective measuring stick of a successful plan. It summarizes in one statistic everything else on this list, because plan design, investment line-up, employer contribution and education efforts are all reflected in plan participation. According to a recent survey that Vanguard conducted of its small business retirement plans (assets under $20 million), average participation was 72 percent (unless plans used the auto-enrollment feature, which brought participation rates up to 85 percent).
2. Fee Transparency: How many long-term commitments does a business usually have without knowing their prices? I find it hard to believe that a retailer would last very long without knowing how much it costs to transport products to its various store locations. For some reason, 401(k) providers have been able to stay under the radar by offering “free” plans. Even though fee disclosure has been required for a number of years, the information is typically buried in a lengthy document, not clearly expressed in dollar terms and not discussed with the plan sponsor on a regular basis. How can business owners or their employees know if they are getting a good return on their investment without knowing the cost? At a minimum, the benchmarking process will provide a snapshot of plan expenses. Such reviews can be very enlightening, and will hopefully provide the information needed for a complete evaluation of the plan.
3. Investment Policy Statement (IPS): Following the theme of benchmarking, an effective IPS dictates the standards that must be met by the 401(k) plan. The IPS should clearly describe fiduciary standards, establish criteria to select and monitor the investment options in the plan and address what fees are appropriate relative to the services offered to plan participants. Although many plans have by now adopted an IPS, not many devote time to updating this important document or making sure that the plan is continuing to meet the specified standards. Failing to regularly review this document would be like knowing the time standards for your Olympic swimming event but not monitoring your own race times over the course of the year to see if you are on pace to qualify.
4. Plan Design: This is a general label that describes how a 401(k) plan is set up to provide employees the opportunity to meet their retirement goals. It will reflect the employer contribution, whether the plan has a profit-sharing and/or cash balance component, if automatic enrollment (placing participants directly into the 401(k) plan upon eligibility) and automatic escalation (increasing the amount invested by employees up to a stated maximum) will be offered features, what investment option is used as the Qualified Default Investment Account (where the automatic enrollments are invested), and any other elements the employer wants to include. The benchmarking process is an opportunity to determine whether the investment being made by the company on behalf of plan participants is paying off, and what opportunities may exist to enhance the plan.
5. Education Policy Statement (EPS): A more recent feature for some retirement plans is to create a written document establishing standards for employee education. An effective EPS will dictate what the employer and plan advisor need to accomplish each year so plan participants can take advantage of the amazing benefits offered through a properly constructed and managed 401(k) plan. In addition, an EPS provides important continuity for employees, who should have multiple opportunities to receive helpful information about their retirement plan. Proactive education programs are also a great way to increase plan participation and contribution levels, particularly when combined with employer matching programs.
Although it is doubtful my daughter will ever qualify for the Olympics, there is no reason that business owners and executives can’t take the right steps to ensure they achieve a “gold medal” 401(k) plan. The first step toward obtaining such a plan is to conduct a review with an independent third party to get a clear picture of your plan expenses and participation rate. Then you can re-evaluate your IPS, EPS and plan design to clearly identify what your 401(k) can accomplish for its participants.
Ideally, the plan review will be an opportunity to establish a set of fiduciary standards your company can follow for long-term success, even in years without an Olympic games. At a minimum, you have collected important information and data for your fiduciary file.
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The opinions expressed by featured authors are their own and may not accurately reflect those of the BAM ALLIANCE. This article is for general information only and is not intended to serve as specific financial, accounting or tax advice.
© 2016, The BAM ALLIANCE