When was the last time you evaluated the quality and cost-effectiveness of your company’s retirement plan? How confident are you in knowing what fees are being charged and to whom, and if they are reasonable? Have you compared your plan’s provisions — things like eligibility, vesting and matching contributions — to see how your plan stacks up to your competition? Are you effectively communicating the benefits of your retirement plan to your employees?
If you’re the sponsor of a retirement plan and are having difficulty answering any of these questions, it may be time to have an independent retirement plan expert review your plan.
How often should a plan sponsor benchmark their plan?
The Department of Labor recommends benchmarking your retirement plan at least every three years, though an industry best practice is to benchmark your plan annually, especially considering the continued high number of fiduciary lawsuits and increasing regulatory requirements. Nearly 90% of companies say they benchmark their plan fees annually as part of a review process, according to a survey from Callan1. Having a formal benchmarking process can mitigate fiduciary risk and result in better retirement outcomes for your employees.
Covering the basics: Evaluating fees and funds
There are many reasons for benchmarking your retirement plan, including protecting your employees’ personal assets. Plan sponsors have a fiduciary responsibility to protect the interests of plan participants by ensuring they only pay reasonable fees and expenses. Employers that fail to meet their responsibility can be held liable for restoring participant losses due to excessive fees.
In a defined contribution plan, more commonly known as a 401(k) or 403(b) plan, an employee’s account balance will determine the amount of retirement income they will generate in retirement. While contributions to their account and the growth of their investments will increase retirement income, fees and expenses required to operate the plan may substantially reduce balances, resulting in a smaller amount of retirement income. Reduced savings may also impact employees’ ability to retire on their own terms. The cost of delayed retirement can impact the employer as well. A study by Prudential2 found that a one-year delay in retirement for an individual can cost an employer $50,000.
Assume that you’re an employee with 35 years until retirement and have a current 401(k) account balance of $25,000. If returns on investments in your account over the next 35 years average 7% and fees and expenses reduce your average returns by 0.5%, your account balance will grow to $226,556 at retirement, even if there are no further contributions to your account. If fees and expenses are 1.5%, however, your account balance will grow to only $162,846. The 1% difference in fees and expenses would reduce your account balance at retirement by 28%.
401(k) plan fees and expenses generally fall into four categories:
Plan administration fees. The day-to-day operation of a 401(k) plan involves expenses for basic and necessary administrative services, such as plan recordkeeping, as well as accounting, legal, compliance and trustee services. In some instances, administrative service costs are covered by investment fees that are deducted directly from investment returns. Otherwise, if administrative costs are separately charged, they will be charged either to the plan sponsor or directly against the assets of the plan.
Investment expenses. Fees for investment management and other investment-related services generally are assessed as a percentage of assets invested and paid by the employees. The net total return of the investment is the return after these fees have been deducted.
Investment advisory fees. Many retirement plan sponsors hire an independent investment advisor or consultant to help with the selection and monitoring of the plan’s investments. Some advisors act in a fiduciary capacity or even take on the role as the plan’s investment manager, insulating the plan sponsor from fiduciary risk. Fees for the investment advisor can be paid as a percentage of plan assets or paid directly by the employer.
Individual service fees. In addition to overall administrative expenses, there may be individual service fees associated with optional features offered under a 401(k) plan. Individual service fees are charged separately to the accounts of participants who choose to take advantage of a particular plan feature. For example, individual service fees may be charged to a participant for taking a loan or a distribution from the plan.
Evaluating investment performance
When it comes to benchmarking a retirement plan’s investment performance, many plan sponsors will delegate some if not all the investment selection and monitoring responsibilities to an advisor or consultant. Having a documented and repeatable process for evaluating your plan’s investment options is critical to meeting your fiduciary obligations. A best practice is to utilize an investment policy statement (IPS) to serve as the blueprint for making decisions. Another option is to work with a 3(38) investment advisor and outsource the investment selection, monitoring and replacement process. Plan sponsors and their advisors should use a “best in class” approach, independently reviewing and identifying the best funds available in each asset class. This will provide the performance that the plan’s participants need and make it easy for them to allocate their investments.
Going beyond the basics
While fees and investment performance are critical components of benchmarking your plan, it’s also important to evaluate other key areas of your retirement program. As part of your assessment, you should look at the following areas:
Plan design refers to the provisions or options that are included in your retirement plan. A plan should be tailored to meet the goals and objectives of the plan sponsor. Some plans are designed to give a company an edge with attracting and retaining employees in a highly competitive job market. Provisions that can help make your plan stand out include generous matching contributions, discretionary profit-sharing opportunities, and immediate eligibility and vesting. Other plans are designed with the goals of allowing owners and key employees the ability to maximize their contributions and tax deductions while still offering a substantial employee benefit to rank and file employees.
Not all service providers are created equal. There are many factors beyond cost that go into evaluating and hiring the right service provider. Some providers put a premium on delivering high-touch service, others focus more on delivering superior technology, while some combine both high-touch service and good technology. Look for services such as a dedicated account manager, on-site enrollment support, the ability to deliver employee notices, payroll integration capabilities and online educational tools, including financial wellbeing resources. Also, changing providers is not always the best solution. Sometimes, hiring the right advisor that has experience working with your current provider can make a big difference in your outcomes. Regardless of your user experience with the service provider, conducting a request for proposal (RFP) process every three to five years is a prudent practice.
Communication and measuring success
A successful retirement plan should include effective communications and education programs focused on driving successful participant outcomes. More than just relaying key plan information, communications should educate and guide participants, ensuring they have a clear understanding of how to reach their long-term financial goals.
It's important to evaluate the effectiveness of your communications as well as your plan overall. According to a survey from the Plan Sponsor Council of America (PSCA)3, 77% of 401(k) plan sponsors evaluate whether their plans are successful. The PSCA also found that the most-used benchmarks for retirement plan success are participation and deferral rates (90.8% and 75.8%, respectively). More than half of all plan sponsors say they use average account balances as a benchmark for plan success. Only 31.4% use participant income replacement ratios as a success measure.
Start benchmarking today for success in the future
Conducted properly, regular benchmarking of your retirement plan will keep you well equipped to determine if your current retirement program is adequately meeting your company’s retirement goals and whether the plan’s expenses are in line with the market. Having a documented, ongoing fiduciary process is an essential component in meeting your fiduciary obligations and operating a successful plan.