RSM Resources

While there’s no shortage of retirement plan providers, experts say business owners and human resources executives need to recognize that a poor choice can lead to more than employee discontent.

"Anytime you look at the options to launch a qualified employee retirement program, you need to look at it from the participants’ point-of-view because you have a fiduciary responsibility to act on their behalf," says Jan Jacobson, director of retirement planning for the American Benefits Council in Washington, D.C. "If it turns out that the funds you choose are bad, or the fees are too high, you could find yourself on the wrong end of a lawsuit."

Unlike defined benefit pension plans, which have been declining in popularity because of their higher costs, defined contribution plans such as the 401(k) are widespread in larger firms. In a 2002 survey of 1,000 midsized to large companies, 98 percent of the firms indicated they sponsor pretax retirement options — such as 401(k) plans — for workers. All such plans are governed by the Employee Retirement Income Security Act (ERISA), which makes companies, or selected third-party providers, personally liable if the plan loses money due to negligent or irresponsible management.

For that reason, companies looking to offer a defined contribution retirement option as a new benefit should first determine if they have the in-house expertise to screen, evaluate and select a plan provider. If not, experts suggest retaining an outside firm with experience in retirement plan administration. Jacobson said that process usually begins with matching available plans to a company’s size and needs.

"If you’re a small business, say with less than 10 employees, the most cost-effective approach might be a SIMPLE IRA plan, which doesn’t have the reporting requirements of a 401(k)," she says. "If you’re a larger business, you can typically seek out a prototype plan, say from a big mutual fund provider, or cherry-pick fund choices from a series of different firms."

A prototype plan is an off-the-shelf 401(k) package providing a limited selection of design choices — such as a percentage of pay or matching contributions an employer would make for workers participating in the plan. The document typically includes all of the forms needed to administer the plan. Frequently, service providers will combine prototype documents with a pre-determined set of diversified investment choices. This bundled, relatively low-cost solution is good for businesses seeking to create a basic retirement plan with few or no special features.

An individually designed 401(k) plan, on the other hand, can be customized to address specific needs. For example, when two businesses merge, combining the two existing retirement plans can be extremely difficult. Or, if a company decides that it wants to make higher or lower 401(k) contributions in different work groups or divisions, an individually designed plan is necessary to ensure that the employer does not violate ERISA standards by discriminating in favor of highly compensated workers.

Another consideration in plan development is a careful review of fees for plan administration. Plan providers will often waive such expenses for large employers because of the fee income they make on the plan’s invested assets. However, smaller or midsized companies may need to negotiate the cost of administrative expenses, such as recordkeeping, compliance testing and government reporting.

While fees are an important consideration, Jacobson said human resources leaders need to look beyond the bottom line.

"For instance, a smaller company might be able to find a bundled product somewhere that doesn’t charge per participant, but will assess much higher fees on the asset base," she says. "Or, the fund choices they offer may have lousy track records."

Like fees, investment performance is another key issue. For that reason, a company should review not only the historic performance of a potential investment, but also its rating against peers in similar fund classes, the length of time the fund manager has been in place, and any recent shifts in the fund’s investment strategy. While much of that information is available from mutual fund companies, online services such as Lipper and Morningstar can provide good third-party intelligence.

To diversify risks for both 401(k) participants and the company, many plans offer a broad menu of funds — either from a single large mutual fund provider or selected investment choices from several companies. Typically, fund choices allow participants to invest pre-tax dollars in a range of choices, including domestic or international stock funds, bond funds, and money market accounts.

Over the past few years, the structure of 401(k) plans has also been affected by highly publicized corporate failures. For much of the booming 1990s, many firms raised the percentage of qualified plan investments in company stock. The most visible example of how that strategy can backfire came when former Enron employees sued the firm’s top leaders and board for failing their fiduciary responsibility to protect employees’ retirement assets.

In the wake of the Enron case, Jacobson says there has been a flurry of lawsuits contending that companies should not have company stock as a 401(k) investment — even if it is only one of several options. Because of that charged atmosphere, an increasing number of firms are now retaining outside providers to handle the fiduciary responsibilities of investment selection, monitoring and management.

"Because employer stock has become such a lightning rod for litigation, an outside fiduciary is usually in a much better position to advise a company’s leaders if they should include it in a 401(k) portfolio," says Jacobson. "But, that protection only works if the company selects a qualified fiduciary and turns all of the investment decision-making over to them."

However, at congressional hearings on employer stock in retirement plans, two economists testified that the addition of employer stock was frequently beneficial as it added more risk balance to the employee’s portfolio.

In light of these conflicting notions, employers who choose to offer an employer-stock investment need to make sure they operate under a high standard of fiduciary conduct. The use of an outside fiduciary is one choice. Another alternative is to hire a competent valuation expert to appraise private company stock in the plan, provide that expert with all relevant data and make sure the plan’s fiduciaries review the appraisal report and concur with the process and results.

By taking these steps, you can help ensure that your company takes a prudent, deliberate approach to structuring its new 401(k) plan.