403(b) Plans Can Follow the 401(k) Plan (ERISA) Model

Nicholas Zaiko

Investment Consultant

Bridgebay Financial, Inc.

www.bridgebay.com

Defined Contribution Plans Converge

In many respects a 403(b) plan is very similar to a 401(k) plan.  They both provide tax advantaged savings vehicles for employees, the major difference being the groups of employees.  403(b) plans are specifically designed for the employees of nonprofit organizations while 401(k) plans apply to employees of for-profit organizations.  Another major difference has been the level of regulation imposed on these two types of plans.  That difference however, is shrinking as recent IRS regulations have been pushing 403(b) sponsors to streamline administrative functions and take a more active fiduciary role in their plan.  A recent survey conducted by the Plan Sponsor Council of America (PSCA) revealed that the number of non-ERISA compliant 403(b) plans is shrinking as plan sponsors adopt ERISA compliance, in light of increased regulation.

Plan Enhancements

403(b) plan sponsors are realizing that a multi-provider, open-ended plan may not be the best type of arrangement for their participants.  While many believed this type of open arrangement absolved the sponsor of fiduciary responsibility, it is now clear that regulators do not believe that participants should be left to fend for themselves.  A 403(b) plan with multiple service providers has no consistency of message, education or investment products.  The IRS and DoL requirements on 403(b) plan sponsors, similar to those that have existed in the 401(k) market for years, provide an integrated retirement plan.   

Fortunately, 403(b) retirement plan sponsors have the ERISA-covered 401(k) plan model to help them comply with ERISA regulations and emulate the best practices and plan features in the 401(k) market.  Some of these enhancements include automatic enrollment, refining the core fund menu, consolidating service providers and improving and unifying the participant education and communication programs.

Fiduciary Responsibility

Evolving 403(b) regulations have required reporting on a plan basis and compelled 403(b) plan sponsors to take on more responsibility as fiduciaries of the plan.  As fiduciaries, employers may retain a retirement plan advisor as co-fiduciary to provide independent advice on the selection of plan providers, operation of the plan, participant education and investments available to participants.   An independent advisor assists the fiduciaries in implementing best practices and developing a prudent due diligence process in overseeing the plan. As in the 401(k) market, the employer negotiates with the plan sponsor on behalf of the participants, minimizing the potential for unsophisticated individuals to be taken advantage of by opaque and costly arrangements.  ERISA compliance also provides that the DoL and IRS with additional authority to oversee 403(b) plans.  The regulators want to see plan sponsors taking a much more active role in monitoring and overseeing the plan.

This additional oversight is similar to the requirements of a 401(k) plan and so an easy way to achieve this level of compliance is simply to establish the same type of due diligence process which is common in the 401(k) plan environment.  The solutions and best practices already exist so 403(b) plan sponsors can source the experience and knowledge of experts in the 401(k) industry and apply best practices to their 403(b) plan. 

Proper Documentation

Many plan sponsors successfully met the December 31, 2009 deadline to draft, approve and adopt a written 403(b) plan document.  This however, is only part of the requirement.  The IRS is also looking to see that the plan is in fact being operated in accordance with the plan document.  As part of their audit, the IRS may seek information from the payroll and human resources department to validate the operation of the plan.  Deviations from the stated plan document could highlight deficiencies with either the plan document or the plan administration.  As part of an annual review, be sure you can produce the 403(b) plan document and that it is consistent with the day-to-day operations of the plan.  Additionally, ensure that the plan document is consistent with the summary plan document (SPD) which is given to the plan participants.  

Focusing on Participants

Many 403(b) plans that have successfully transitioned to ERISA compliance now find themselves in the enviable position of refocusing energy away from compliance and on to participant outcomes.   

Plan sponsors are increasingly adding plan options such as target-date, target-risk and other investment vehicles designed to increase their participants' chances of reaching their retirement goals.  Administrative enhancements achieved by consolidating providers and streamlining operations free up valuable internal resources that can then be redeployed to enhance plan participation and participant education.

Conclusion

Though the challenges of bringing your 403(b) plan up to ERISA standards may seem imposing, take comfort in the knowledge that the solutions already exist and that once the transition has been completed, maintaining a properly documented due diligence process will yield numerous benefits to both the plan sponsor and the participants.  The most obvious benefits include reduced plan costs, enhanced participation, improved participant education and streamlined plan administration.

Selecting and Monitoring Fiduciary Advisors

Nicholas Zaiko

Investment Consultant

Bridgebay Financial, Inc.

www.bridgebay.com

Effective December 27, 2011, the Department of Labor's Employee Benefits Security Administration (EBSA) issued its final rule regarding the provision of investment advice to participants in individual account plans, such as 401(k) and 403(b) plans, and beneficiaries of individual retirement accounts. The final rule affects plan sponsors, fiduciaries, participants, and beneficiaries of participant-directed retirement plans. Essentially, the rule enables providers of investment advice acting as fiduciary advisers to offer investment guidance to participants provided certain conditions set forth in the regulations are satisfied.

The Need for Advice

Recent studies have indicated that participants who receive professional investment advice consistently outperform those who go it alone. Constructing a proper asset allocation is key to the long-term success of any retirement strategy and most participants are ill-equipped to make such a potentially life-altering decision on their own. The DOL's new participant investment advice regulation attempts to offer participants another means of achieving their retirement goals.

Not all investment advice that has been provided in the past has been impartial or in the participant’s best interest. Sometimes there have been conflicts of interest unknown to the plan sponsor. In selecting a fiduciary advisor the plan sponsor still retains fiduciary responsibility in selecting the form of investment advice they offer to their participants.

Best Fit

There are numerous factors to consider when selecting a fiduciary adviser to a plan. The last few years have seen dramatic growth in the independent investment consulting industry and with the passage of the new regulation, more solutions are sure to follow. The first step is to determine what type of investment advisory service is the best fit for the plan participants. Traditionally, plans have relied on an eligible investment advice arrangement ("EIAA") through a fiduciary adviser to help employees make informed investment decisions, but this is no longer the only available option.

Third-Party Advice

Web-based investment guidance services and managed accounts offered through an independent, third party are increasingly popular options. These firms are unaffiliated with any of the plan’s fund providers or managers. According to the new regulation, their methodology for building an asset allocation must not be in any way impacted by the funds selected. In other words, they must not have a vested interest in or receive any additional financial benefit from using one fund over another. The methodology must be fund and share class neutral. In order to determine the best option for their participants, plan sponsors should conduct a thorough analysis based on their company's demographics and plan objectives.

Identifying Fiduciaries

Another important factor which is often overlooked in selecting a fiduciary adviser is determining exactly who can act as a fiduciary adviser. Many brokers may offer investment advice to participants but most are protected by regulations from taking on fiduciary liability. In many cases, if the adviser is not receiving compensation directly from the act of offering advice, they are not considered a fiduciary under the current law. Eligible fiduciaries generally come in four categories: a registered investment adviser (RIA), an advisor for a bank providing services through the trust department, an insurance company representative and a representative of a registered broker-dealer. Plan sponsors should check with the fiduciary adviser to confirm their status as an eligible fiduciary to the plan and receive confirmation in writing that they are acting as a fiduciary.

Establish Evaluation Criteria

The next step in selecting a fiduciary advisor is for the plan sponsor to establish objective criteria for evaluating an adviser that fits the needs of its participants. The retirement plan committee is responsible for creating a documented checklist that can then be used to evaluate fiduciary advisers. Some general criteria should focus on identifying any potential conflicts of interest, fee and compensation arrangements that may cause the adviser to pressure participants into less appropriate products. The firm’s experience and depth of services in providing fiduciary advice and specifically the qualifications of the professionals providing the advice are important. Checking for any disciplinary actions against the fiduciary adviser or the firm should be conducted at the onset and on an annual basis for any potential change in status.

The fiduciary adviser’s professional credentials and investment experience are critical. Many large firms may be impressive marquee names yet the individuals providing the advice may be junior, less skilled advisers than small boutique firms whose advisers may be highly experienced professionals providing high caliber advice.

Ongoing Monitoring

Once a suitable fiduciary adviser has been selected, it is important that the sponsor establish a process for ongoing monitoring of the adviser. Best practices dictate that a plan sponsor review their plan's fiduciary adviser at least once a year. There are a multitude of factors to consider, but a prudent approach would include a deep dive of the adviser and documenting their process. This would include confirming that all required documentation and notifications were provided. Another factor to consider would be determining whether the adviser is actually complying with the new participant investment advice regulation.

Revisiting the relative cost of the investment advice program in relation to participant adoption and utilization is a prudent way to quantify the value added by the fiduciary adviser. If participant adoption is relatively low compared to the cost, perhaps more education is required or the plan sponsor may want to scale back on the services offered . A thorough review should also include inquiring into and following up with participant comments and feedback. Any participant complaints should be addressed immediately. Participant feedback, whether positive or negative is a good way to stay ahead of any potential fiduciary liability issues. Fine-tuning the plan based on participant comments may lead to increased participation rates, if done in a prudent way. Updating the firm’s and fiduciary adviser’s status for any disciplinary actions should be part of the annual evaluation.

The most important fiduciary benefit of conducting this due diligence review is documenting the decision making process and the results. Comprehensive documentation of the information collected to render decisions that impact the plan is the best way to protect the plan sponsor from fiduciary liability. While investment returns may go up and down, a detailed accounting of the due diligence process is the plan sponsors' greatest asset. An annual review of the plan's fiduciary adviser will go a long way to fulfilling a plan sponsor's fiduciary duty.

Conclusion

Most participants lack the skill, training or time to construct a disciplined, asset allocated, long-term investment strategy. Short-term trends often lead them to make mistakes and risk their long-term success. Individual investors are driven by emotion, causing them to make the same investment mistakes over and over. The DOL's new participant investment advice regulation attempts to offer participants another means of achieving their retirement goals. Plan fiduciaries are responsible for evaluating and understanding the advice options they offer to their participants. Realizing the plan sponsor's role in delivering this essential service is an important fiduciary duty. Establishing a defined strategy for implementing participant investment advice is key to fulfilling a plan sponsor's fiduciary obligations.