Even though the 401(k) concept has been around for nearly 30 years now, many plan sponsors continue to manage as if it were still 1980, when tax consultant Ted Benna originated the idea. That’s not only unfortunate; it’s frightening, because over time, the 401(k) industry has been impacted by numerous regulations and legal rulings. Plan sponsors that haven’t been paying attention may find their plans and their companies in trouble.
Industry best practices used to involve keeping as many participants as possible on a plan, with no thought given to the ratio of current to former employees or to their relative value. That’s no longer the case, and there are some very sound reasons behind this change of heart.
The Workplace Environment
Today’s workers no longer expect to stay with one company for their entire careers. In fact, a typical 25-year-old is likely to have seven or more jobs before retirement. When these job changers move on, they often leave their retirement accounts behind; recent studies have shown that 30 percent of 401(k) accounts are owned by former employees — people who no longer contribute to the company sponsoring the plan. These accounts, commonly known in the industry as terminated employee accounts, can cause problems for plan sponsors, because they increase:
· Administrative work and overall plan costs. When this happens, plans suffer from a Plan Performance Gap, becoming less efficient and more expensive. For instance, current workers are left subsidizing the upkeep of accounts belonging to terminated employees. Additionally, terminated employee balances drive down the plan’s average balance size. Plans are simply not performing at optimal levels.
· Liability and fiduciary risks. The Supreme Court’s recent decision allowing 401(k) participants to sue plan administrators for breach of fiduciary responsibility is a prime example of this problem area. The ruling specifically addressed the question of whether the Employee Retirement Income Security Act (ERISA) permitted lawsuits by individuals over loses to their own retirement accounts. The case in point concerned a Texas man, James LaRue, who sued his plan administrators after his account lost $150,000. LaRue, a former employee of the plan sponsor, claimed his instructions to move his money to safer investments were ignored. Justice John Paul Stevens ruled on the matter by saying: “Fiduciary misconduct need not threaten the solvency of the entire plan to reduce benefits below the amount that participants would otherwise receive.”
Communication Challenges
That ruling may be the latest reason why plan sponsors should act quickly to move terminated employees off of their plans, but it is by no means the only one. “The fiduciary requirement to provide sufficient information to make informed investment decisions applies to all participants, including those who are no longer employed by the company,” says Benna, who continues as an adviser to Congress and regulatory authorities on matters related to retirement savings.
Inactive participants are entitled to documents such as new Summary Plan Descriptions (SPD), material modifications to the SPD, the Summary Annual Report, notice of all IRS filings, participant statements, and if requested, the Plan document and the entire Form 5500. Every investment and provider change, including fund replacements, additions, or deletions, must also be communicated.
“Successfully managing the liability exposure during a provider change can be very important,” Benna warns. “Providing complete communication regarding such changes, including the black-out notices that are distributed to active employees, is essential. Ex-employees should even be given the opportunity to attend educational meetings that are held for active employees.”
Of course, the necessity of finding and communicating with ex-employees results in more work and additional costs for plan sponsors. Legal issues can also surface as former employees, upset with their ex-employers, have been known to use the non-receipt of plan information as a reason to file suit.
Pension Protection Act Changes
Industry experts believe the 2006 Pension Protection Act will have far-reaching repercussions for plan sponsors. One issue is its endorsement of auto enrollment, a move that will almost certainly increase plan participation. And with turnover averaging between 10 and 20 percent nationally, plan sponsors will find themselves managing more terminated accounts than ever. As a result, the consequences of not dealing with the accounts of former employees will increase exponentially.
The worsening economy brings additional challenges. Retirement plan sponsors should expect a sizeable increase in 401(k) loans, hardship withdrawals, and cash-outs. Robert Pascuzzi, COO of Creative Planning 401(k) in Kansas City, MO, sees this as a worrisome trend, especially in light of the latest ruling. “You have to wonder if these employees who take money out of their accounts will eventually sue their employers for not providing adequate guidance. This new ruling opens the door for that.”
What You Can Do
There are several proven methods of managing the Plan Performance Gap, and all mitigate financial exposures and improve plan profitability.
Automatic and voluntary rollover programs can quickly and easily move terminated accounts off the books. One large, northeastern financial services company decided to let its employees roll-in balances they had left with previous employers. Because of the time and complexity involved, the company outsourced the process. Its goals were to:
· Increase revenue by accumulating assets under management.
· Offer value-added services to current participants.
· Increase plan size to receive more attractive pricing and reduce expenses.
· Introduce roll-in during new hire enrollment, making it easy for employees to consolidate retirement assets.
· Implement an efficient, cost-effective process that would allow the company to approve all roll-ins while contracting out paperwork and fulfillment functions.
This successful experiment allowed the company to grow assets under management by 10 percent, reduce cost-per-participant by $10 for every $100,000 addition to plan assets, and lower its cost-per-transaction by 42 percent.
Provide education and objective, qualified help to employees who are retiring or changing jobs. These people often have no one to turn to for help in moving their retirement funds into appropriate savings vehicles. That fact was recognized by the 2006 Pension Protection Act, which granted participants greater access to professional retirement investment advice.
Arrange for participants to have access to a variety of top-tier, quality IRA products and assistance in the roll-out process. Another large, service industry employer had an out-of-balance plan, with more than 25 percent of its estimated 200,000 accounts belonging to terminated employees. It also had a high percentage of small balance accounts that reduced its average account size. An average annual turnover that topped 20 percent and an acquisition phase that brought multiple plans on board further hampered plan performance.
The company recognized the need to improve plan effectiveness and moved some 50,000 terminated participants to a third-party solution. In doing so, the plan sponsor:
· Cleared the backlog of inactive accounts.
· Developed an efficient process to service an estimated 30,000 annual terminations.
· Saved approximately $850,000 in annual record-keeping fees.
Conclusion
The plan sponsors that thrive in these turbulent times will be the ones who embrace industry best practices and reject the outdated approaches of the past. These pro-active steps can lower plan costs, lessen administrative burdens, and reduce the risk of lawsuits. What’s more, they can help plan participants stay invested in retirement.
Jim Langenwalter is the Chief Marketing Officer of RolloverSystems, Inc., an independent provider of rollover services, headquartered in Charlotte, NC. Jim can be reached at jlangenwalter@rolloversystems.com and 866-827-9608.