In the previous two articles in this series on retirement, I talked about How to Turn Your 401(k) Into a "Super Roth IRA" and Get the Max Out of Your 401(k). In this third part, I take a look at retirement from a different perspective, that of an employer.

How much is this going to cost me?

Asking how much something costs is a normal question any buyer will ask when considering the purchase of a product or service. One notable exception were Mercedes-Benz shoppers back in the 80’s whose salesmen would respond, “If you must ask, you can’t afford it.”

But what if I told you that this perfectly reasonable question can get a seemingly responsible business owner into an overly expensive deal that can be difficult to break free from? Even worse, that it can expose the owner to legal liability if their employees can show that a buying decision was based on the answer?

How can that be? It has to do with an employer's obligations when they sponsor employee benefit plans, such as 401(k)s.

First, it can be helpful to understand that plan sponsors are fiduciaries[i]. In other words, they are required to put the interests of their participants first, even ahead of their own. That, by itself, should be enough to influence behavior, but then came ERISA.

ERISA is the acronym for The Employee Retirement Income Security Act of 1974. This law set many of the standards that govern company retirement plans to this day. While ERISA doesn’t require an employer to offer a retirement plan, it does set minimum standards for some of the benefits offered to employees. It also offers protection to employees when those benefits are mismanaged and cause harm.

The Act provides retirement plan participants recourse if they suffer losses because of the mismanagement. In the last decade, there have been many class action lawsuits regarding breach of fiduciary duty of retirement plan sponsors. One such example was the case of 114 employees of a Minneapolis auto body shop back in 2016 when they filed a lawsuit[ii] (since dismissed) claiming a breach due to: 

• Selecting inappropriate and imprudent mutual fund and separate pooled account share classes when lower expense share classes were available for the same investments,
• Selecting investment options that were unnecessarily expensive as compared to industry benchmarks,
• Failing to actively monitor service provider fees, fund expenses, and broker commissions, and
• Failing to replace existing service providers and mutual funds with the same or similar service providers and investment options at lower fees and expenses, respectively.

While I don’t know the owners of LaMettry’s Collision, Inc., I do have clients like them. Clients that have worked hard to build small businesses by always keeping an eye on the bottom line. One of the most common conversations I have with these clients and their CPA's centers on ways to reduce their taxes. Frequently, we suggest that the client consider establishing a 401(k) plan. The first question the client then asks, “How much is this going to cost ME?”

For a large number of plans sold to small businesses by insurance companies, payroll providers, and banks, the answer may be too good to be true. In fact, many will tell the employer they will design a plan, manage record-keeping, integrate with payroll, handle contributions, process trades, provide education, offer investment guidance, maintain the participants’ records, create statements, perform required testing, and make filings with regulatory agencies, all for little or no cost to the business.

These providers can afford to do that by forcing the participants into high cost investment options that ultimately make them much more money than if they simply charged for the administration and offered low cost investments to the participants. The problem, and the basis for lawsuits such as Damberg et al v. LaMettry’s Collision, Inc., is when the employer makes the decision primarily based on how much it cost them, they may not be putting the participants’ interests first.

The Right Questions

So how can a conscientious business owner avoid such a breach? Ask the right questions. A few to consider when shopping for a 401(k):

1. Will you help draft an Investment Policy Statement (IPS)?
2. How will you insure the IPS is followed?
3. And the question you most want to ask, what are the fees (explicit and implicit) for:

• Investments?
• Advisory?
• Record-keeping?
• Administration?
• Custody?
• Auditing?
• Other?

And if all of this feels complicated and confusing, consider hiring an independent advisor to act as a fiduciary along side you. Click here to get in touch with one.

[i] http://www.dictionary.com/browse/fiduciary - a person to whom property or power is entrusted for the benefit of another.

[ii] https://www.cpajournal.com/2016/08/01/rpa-fiduciaries-small-401k-plan-sued-breaches/