Setting up a 401(k) plan

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This article describes easy-to-follow step by step instructions on how to set up a truly low cost 401(k) or 403(b) plan. Read this article and the forum thread at Setting up a 401(K) plan.


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Is your 401(k) or 403(b) plan in compliance with the final rule Reasonable Contract or Arrangement Under Section 408(b)(2)--Fee Disclosure?

By now, employers should know every cost that the company pays for the plan. Also, employees should know every cost that they pay. On or before November 14, 2012, service providers should have given employers a fee disclosure statement. In turn, employers should have given employees a disclosure statement that shows the fees that employees pay for the plan. In addition to the fee disclosure statement, employees are receiving quarterly statements that show the fees that they pay. [1]


Introduction

Wouldn't it be great if every employer that has a 401(k) or 403(b) plan and every employee who participates in the plan would take a few minutes to learn how to set up a truly low cost plan? Just think about it. If you are paying 3.00% (complete including recordkeeping and investments) for a plan, it means that you are paying $300.00 for every $10,000.00 invested. It makes no sense for you to pay thirty times more than you should for a 401(k) or 403(b) plan! Why would you want to pay that much, every year, when you can easily set up a plan that has great service plus low cost index funds for not more than $10.00 for each $10,000.00 invested. If you are an employer or an employee and you believe that your plan is "free" or "low cost", consider the possibility that it may be because you have never been shown where to look to uncover the myriad hidden and camouflaged costs that your plan has. [2]

The ideas you can learn, right here, help employers and employees to get on the same page. That way you will communicate more effectively with each other and pull the wagon (401k plan) in the same direction.

If you are an employee, you will learn how to talk to your employer in a way that is guaranteed to get him or her interested in improving your 401(k) or 403(b) plan. Please keep an open mind, and read the information provided about each of the Five Simple Steps shown below. Then, contact a Third Party Administrator (TPA) who can show your employer a comparison of why it makes sense to switch from your old 401(k) or 403(b) to a new one. Next, arrange a meeting between the TPA and your employer. Also, you can ask to attend the next committee meeting to present your ideas to the plan's fiduciaries. Easy!

If you are an employer, you will learn how to set up, manage, and monitor a truly low cost and optimal plan FAST. Please keep an open mind, and read the information provided about each of the Five Simple Steps shown below. Easy!

Complete the Five Simple Steps shown below, and your plan will have...

  • a core menu of low cost index funds that employees choose their mix of investments from. [3]
  • a low cost self-directed brokerage account option for employees who don't want to use index funds.
  • a truly low cost recordkeeper and administrator.
  • employees who are on the same page as the employer (plan sponsor) because they understand the mission and have learned how to communicate effectively with each other.
  • the flexibility to cut costs fast because one or more of the plan's index funds can be replaced whenever lower cost index funds are available, and any of the plan's service providers can be replaced whenever a lower cost service provider can be hired. The idea is this: You'll be able to fix whatever component needs to be fixed without having to replace the entire plan.

Note: People at your organization should get together and agree on what the word "optimal" means for your 401(k) or 403(b) plan. That way you will see the target and the bulls eye and you can hit it. Remember, we are talking about optimal, not perfect. For instance, a perfect plan would probably have zero cost, its mix of investments would probably outperform the market, and it would require no time to manage and monitor, but no one would be able to set up a perfect plan by that definition. Here is what TheFreeDictionary has to say about the word "optimum": a condition, degree, amount or compromise that produces the best possible result; most desirable possible under a restriction expressed or implied; "an optimum return on capital."

An "optimal" plan matches the return of the market with a minimum of fund costs. With that in mind, below is a definition of the word "optimal" that people at your organization can work with to come up with your own definition:

  1. Participants can choose from a menu of "optimal" investments, such as index funds, that will provide a market return (less fund costs). Index funds are designed to match the market's performance, and a good TPA (Third Party Administrator) can get low cost index funds such as Vanguard's Total Stock Market Index fund (0.07% per year).
  2. The cost for recordkeeping and administration will be not more than the current benchmark for the cost of those services. Most plans can hire a recordkeeper and administrator for not more than $30 per year, per eligible employee.
  3. The plan would have no unnecessary costs. (Do you have the skills to uncover the hidden or camouflaged costs? Don't worry, it's easy to learn how to uncover every cost that your plan has.)
  4. The plan would require minimal time to manage and monitor. If you make your plan simple, which means it has up to eight index funds and a TPA (Third Party Administrator), the named fiduciary can save time in managing and monitoring the plan.

Five simple steps

Regarding 401(k) plans and quality, it's like this...

If you plan to buy a diamond, you need to know about the 4 C's:

  1. Cut
  2. Clarity
  3. Color
  4. Carat Weight

If you plan to buy jewelry, you need to know about the fineness of gold:

  1. 24kt = 100% pure.
  2. 18kt = 75% pure.
  3. 14kt = 58.33% pure.
  4. 10kt = 41.67% pure.

If you plan to set up a 401(k) or 403(b) plan, you need to complete the Five Simple Steps for setting up, managing, and monitoring a plan:

Step 1: Draft a mission statement for your plan. A leader decides on the mission and how the mission will be accomplished, right?
Step 2: Select the plan’s investments.
Step 3: Hire the plan’s vendors.
Step 4: Manage your plan.
Step 5: Monitor your plan.

Step 1: First, draft a mission statement for your plan. A leader decides on the mission and how the mission will be accomplished, right? As the employer, you could adopt the following mission statement:

Our mission is to select a core mix of no-load, low-cost index funds because index funds are designed to match the market’s performance (less their cost). This will allow employees (participants) to choose their mix of investments from the mix of index funds. We will set up a self-directed account for each employee who thinks that he or she can pick funds that will beat the performance of index funds. Next, we will pay no more than the current benchmark for the necessary record keeping and administration. We will not pay any asset-based fees for services such as consulting, investment advice, education, or administration. We will draft a plan document that is compatible with our mission statement, and we will draft a summary plan description.

Step 2: Select the plan’s investments. Your plan’s investment policy statement (IPS) will specify which index funds to pick for the plan. It will also specify why you picked index funds and how you will monitor them. In the IPS you must also explain why you decided not to use managed funds, and/or asset-allocation, target-date, life-cycle, lifestyle, and balanced funds–if you have decided against them. No one will file a legal action against you for not trying to pick funds that will beat index funds (the market) in performance. The IPS will also describe how you will set up the self-directed accounts for employees.

Step 3: Hire the plan’s vendors. Using your mission statement’s guidelines, hire vendors and ensure that they aren’t paid more than the current benchmark of $30 per eligible employee per year for record keeping and administration. Don’t pay any asset-based fees for services such as consulting, investment advice, or employee education.

Step 4: Manage your plan. Guided by your mission statement, so that it has truly low-cost services and a mix of investments that will match the market’s performance.

Step 5: Monitor your plan. Each month, use the guidelines in your mission statement to ensure that you have accomplished your mission of setting up an optimal 401(k) plan.

In addition to your mission statement, plan document, and summary plan description, you need a provider policy statement (PPS), which is composed of the following documents:

  • Mission statement (MS).
  • Investment policy statement (IPS): guidelines for choosing the plan’s investments and monitoring them.
  • Vendor policy statement (VPS): guidelines that will ensure that only vendors who can assist you in making your plan truly optimal are hired.
  • Education policy statement (EPS): guidelines for a program that educates employees about 401(k) plans and trains every employee to be part of an effective system of checks and balances.
  • Communications Policy Statement (CPS): guidelines for a communications program that ensures employees are informed so that they are part of an effective system of checks and balances.
  • Monitoring policy statement (MPS): guidelines for monitoring the plan’s vendors, investments, and education and communication programs.

Keep it simple; your guidelines shouldn’t be more than a few sentences. You may find it handy to use a three-ring binder for your PPS documents.

If you complete this proven process, both you and your employees will reap the benefits.

Employer benefits:

  • The named fiduciary will save time because a plan that is optimal requires less time to manage and monitor.
  • Your company will save money on the plan’s cost.
  • Employees won’t spend excessive time while at work trying to figure how the plan works, how to select their mix of investments, and how to monitor their investments.

Employee benefits:

  • Employees won’t need to spend countless hours trying to figure how the plan works, how to select their mix of investments, and how to monitor their investments.
  • Employees will save money on the plan’s cost.
  • Employees will save money on the cost of their investments.

Revenue sharing:

  • Revenue sharing is money that plan providers receive from many of the 401(k) plan's mutual funds. Typically, the Third Party Administrator (TPA) will decide how the fees that are paid to them by the mutual funds will be used. For instance, the TPA can decide to give certain fees back to the plan's participants who the fees. Or the TPA can use the fees to help lower the cost that the employer pays for the 401(k) plan. Fiduciaries should consider the consequences of failing to disclose how revenue sharing is used. Therefore, it would be a mistake not to ask for a revenue sharing table that shows which funds have revenue sharing and how those fees are being used.

You are learning how to complete all five steps FAST, right here! Remember, it's critical to complete the steps in the right order. It would be a mistake to complete step three before you complete steps one and two.

Request for proposal (RFP)

Put together a list of low cost 401(k) Plan service providers (recordkeepers and administrators) who will include a menu of index funds in your plan: Example: *Who else wants to know how to lobby for a lower cost 401(k) Ask two or more service providers to compare the cost of your plan to the plan that their firm offers. If you are an employer, before you send out an RFP it behooves you to know what a truly low cost 401(k) plan looks like. It would be a mistake if you are thinking this: "I'll know it when I see it." That mindset is how employers do the wrong thing and set up a 401(k) or 403(b) plan that costs more than it should. The point is this: if you believe that you'll know which plan is a "good one" when you see it, you are fooling yourself; instead, the first step is to learn what a truly low cost and optimal plan really looks like. Otherwise, if you just set out to meet with one service provider after another, instead of setting up an optimal 401(k) or 403(b) plan, you'll likely waste your time in meetings with the service providers who have a history of setting up plans that create the illusion that the plan they recommend is low cost and optimal.

Your job as a fiduciary is to hire service providers who can help you set up a truly low cost plan. A low cost plan looks like this:

  • It's menu of investments has a core mix of low cost index funds.
  • It's recordkeeping and administration costs not more than $30.00, per year, per eligible employee with no hidden or camouflaged costs.

Got it? Okay, now let's have a look at an overview of how you can request a formal proposal from a service provider--FAST. Remember, the idea is to keep your initial contact simple. First, here are some common mistakes that employers make.

Request For Proposal (RFP) - Four Common Mistakes

  1. Not knowing what a truly low cost 401(k) or 403(b) plan looks like before you request a proposal from a few vendors.
  2. Not uncovering all of the conflicts of interest and believing that you are too smart for conflicts of interest to hurt YOUR bottom line.
  3. Believing a service provider's sales pitch that IF you hire a competitor who has the lowest cost you are being shortsighted.
  4. Failure to understand your fiduciary duties. (Have you, the named fiduciary, been acting in the company's best interests, not the best interests of the participants?)

Below is a Sample RFP. On your company's letterhead, you can draft the following letter:

Sample RFP
  • Name and phone number of contact person at your company and if your plan is a 401(k) or a 403(b).
  • Basic information about your plan such as how many employees are eligible and how many participate.
  • Ask questions that you want the service provider to answer such as...
    • Will we have access to Vanguard and/or Fidelity index funds? Which funds are they?
    • Are the other brokerage firms or mutual funds that we could use in our plan?
    • Where will our plan's assets be held? at a Bank Trust department? at a Brokerage firm? How much will the custodian charge us? Send us a sample of the reports that the custodian provides us with.
    • Is there a termination fee?
    • How much will you charge us to set the plan up?
    • How much is the cost per eligible participant?
    • Do you offer assistance in designing and drafting the Plan Document and Summary Plan Description?
    • If a few participants want to use a self-directed brokerage account, how much will it cost them to set up? How much will they pay per trade?
    • Are there any other costs involved such as a termination fee, moving assets from old plan to new plan, switching one mutual fund to another, loans, rollover to an IRA, distribution fees, or amending the plan?

How will you enroll the participants?

  • Will you mail materials to participants' home addresses?
  • Do you automatically enroll eligible employees?
  • Do you have automatic annual increases in the participants' contributions?
  • Can you set up the participants' asset allocation and rebalancing on auto-pilot?
  • Do you educate employees about the plan and its investments?
  • Do you do initial enrollment meetings?

Close your letter by saying something like this:

Please send us a sample of a participant statement as well as a sample of the management reports that you prepare for us to use in reviewing our plan. Also, where can we see the tools you provide for the participants? And is there a minimum length of time that we are required to stay with your company for recordkeeping and administration?

Summary: First, select the plan’s investments. Then, hire the plan’s vendors, and educate your employees about the plan and its investments. You can watch a five minute video to see why it's important to complete the Five Simple Steps in the right order: Youtube: Five Simple Steps

Employees, if you have an employer who has refused to improve your 401(k) or 403(b) plan by taking the steps that we discussed here, don't worry. There is still hope that one day you will have a plan that has truly low cost recordkeeping and administration and a mix of investments that will at least match the market's performance--long term. But you'll have to change the plan from the ground up by talking with other employees. Just ask them to read this. Just think about it. Regarding investments, is it smarter to be guaranteed to match the market's performance by owning a diversified mix of index funds or to risk underperforming it by investing in managed mutual funds and packaged products such as target-date funds? Is the answer not obvious, yet?

Education

Education is the key. For example:

  • A fiduciary can manage his risk by selecting a core mix of index funds. Index funds are much easier to select and monitor than managed mutual funds and packaged products such as target-date funds.
  • No one will sue the fiduciary and take him to court for not trying to beat the market by selecting managed mutual funds and packaged products such as asset-allocation, target-date, lifestyle, lifecycle, and balanced funds. Especially when not one expert has ever picked a mix of managed mutual funds and/or packaged products that beat a core mix of index funds in performance--long term.
  • Employers must educate employees by explaining to them exactly what we are discussing in this article. If that fails to convince someone that it's better to match the market with index funds rather than risk underperforming it long term and a few employees still want to try their hand at picking managed mutual funds anyway, let them knock themselves out in a Self-directed Brokerage Account. Sooner or later, they will get it and invest in index funds.
  • The employer is responsible for setting up a low cost self-directed Brokerage Account for employees who want to use it. Then, the employer must monitor its cost to ensure that it is low. Also, restrictions can be placed on which mutual funds can't be included in the universe of funds that will be available in the Self-directed Brokerage Account.

Communication

Five clues that your 401(k) or 403(b) plan is too expensive to keep:
  1. The core menu of investments is managed mutual funds, not low cost index funds.
  2. Recordkeeping and administration costs you more than $30.00, per year, per eligible employee.
  3. The target-date funds are managed mutual funds, not low cost index funds. [4]
  4. The plan consultant and investment adviser believe that managed mutual funds are the way to invest.
  5. Done right, a plan requires minimal time to manage and monitor. If you make your plan simple, which means it has up to eight index funds and a TPA (Third Party Administrator), the named fiduciary can save time in managing and monitoring the plan.

How employers and employees communicate with each other matters to the success of your 401(k) or 403(b) plan. And how families communicate with each other to successfully manage the family money is not that different. Regarding communication between employers and employees, the idea is to get everyone at your company on the same page pulling the wagon (401k plan) in the same direction.

Here is how employers and employees can hear each other out and communicate effectively with each other:

Step 1. Investments are the most important part of a retirement plan. So, you can pick a core mix of investments for the plan's menu by asking each other these questions...

  • Which large-cap blend index fund do you like best? Why?
  • Which mid-cap blend index fund do you like best? Why?
  • Which small-cap blend index fund do you like best? Why?
  • Which foreign large-cap blend index fund do you like best? Why?
  • Which short-term bond fund do you like best? Why?
  • Which intermediate-term bond fund do you like best? Why?
  • Which long-term bond fund do you like best? Why?

Step 2: Ask each other this question: Which recordkeeper and administrator do you like best? Why? How much do they charge per year, per eligible employee? How do you know that they provide timely and accurate statements?

Note: The cost of your plan matters. There is no good reason to pay more than $30.00, per year, per eligible employee, which includes all of the bells and whistles that your plan needs.

Tips

Tip 1: To learn why it's critical to do the Five Simple Steps in the right order, watch this five minute video: (The reason that employers go down the wrong path and set up a plan that costs more than it should is because they complete step three before they complete steps one and two.) Here is the link to the video: Youtube: Five Simple Steps

A free gift: It's a pyramid that will remind you of five steps that, if taken, cannot fail to cut your plan's cost and improve its investment performance. Keep the pyramid on your desktop. To download your gift, Click on one of the two links below:

This three inch tall pyramid will serve you well day-after-day, because when you combine the five easy steps written on it with what you have learned in this article, you'll have a blueprint that you can use to manage and monitor your plan to ensure that it is truly low cost.

Tip 2: Success breeds success. Get a buddy to talk to so that you can encourage each other to ignore the noise that almost always guides people into awful investments that lead you down the wrong path to retirement.

Tip 3: Below are a few of the choices that you have:

  • Top-down change is quick: If the named fiduciary and other decision makers have shown that they are willing hear you out, you can have them request a formal proposal, which would include a comparison between the plan you have and a lower cost plan that you could have--FAST.
  • Bottom-up change is slow: If the decision makers won't hear you out, you can encourage other employees to complain about the plan's cost by signing a letter that requests switching to a truly low cost plan.
  • Do both of the above.

If you have put together a plan of action, please post your plan in the forum because it may very well help others who are tired of paying more than they should for:

  • Services
  • A menu of investments that underperform truly low cost index funds

Tip 4: If your company does not want to switch to a lower cost plan because of surrender charges on the investments or a termination fee to terminate the plan, you can do the following: You can freeze the old plan and transfer money to the new plan as the surrender charges go away, which may be over a period of years. Also, you can avoid the termination fee that way. The new TPA will complete this process of transferring money to the new plan as appropriate. Or it may be in the best interests of your company to pay any surrender charges and the termination fee, now. Remember, it was your company that made a poor decision and created the mess.

Tip 5: When you read this article (which is about How to set up a low cost 401(k) or 403(b) FAST) you'll only take in what you are already familiar with. And those ideas that may be new to you will require reading more than once. But each time you read you'll get great tips that are proven to work and that you can use today--right now. Yes, a proven idea that may seem difficult for you to understand really will become clearer and clearer each time you read it.

Tip 6: What you are up against is dysfunctional buying practices--not one decision maker at your company seems to be willing to consider the possibility that the company's plan costs more than it should. And not one of them wants to hear you out. For instance, your employer may tell you something like this just to put you off:

Fiduciary: "We evaluate our plan every year."
You: "Really? May I attend your next meeting? I'd like to show you what's wrong with our plan as well as some easy and fast ways to improve it. I will get together with you prior to the meeting. That way you can see that these ideas really do work, as promised. By the way, the main reason why we should implement these proven ideas is because they will result in saving time and money for the employees as well as the organization--the results will be immediate. By attending a meeting with the committee, I can answer any questions that they may have."

Note to employees: Remember, a decision maker who sets up a plan that costs more than it should has proved that he or she does not know what a low cost plan looks like. You are there to help the employer because it's YOUR retirement money that is in the plan. The employer must always act in the participants' best interests, not the employer's. See? Look at it this way. If an employer (plan sponsor) does not know what a low cost plan really looks like, it's because he or she does not know how to evaluate the plan's service providers and investments, which can get the company into a lot of trouble as a fiduciary. It's also a big waste of the committee's time to go through the motions of looking like they are doing a real review.

Case studies

The forum contains several examples:

403(b)

W. Scott Simon, who writes a monthly Fiduciary Focus column for Morningstar, has an eight part series on the 403(b) Plan universe. These plans have been affected by recent regulation changes. This series is especially valuable for 403(b) plan providers.

See also

References

  1. For more information, refer to the forum discussion 401(k) and 403(b) fee disclosure
  2. See Hutcheson, Matthew D., "Uncovering and Understanding Hidden Fees in Qualified Retirement Plans-3rd Edition," The Elder Law Journal, (Fall, 2007). Link to PDF
  3. See Elton, Edwin J., Gruber, Martin J. and Blake, Christopher R., "The Adequacy of Investment Choices Offered By 401K Plans" (March 15, 2004). EFA 2004 Maastricht Meetings Paper No. 1176 Available at SSRN or DOI: 10.2139/ssrn.567122
  4. See Bodie, Zvi and Treussard, Jonathan, "Making Investment Choices as Simple as Possible: An Analysis of Target Date Retirement Funds" (January 21, 2007). Available at SSRN

External links

Books

  • Frank R. Cirullo, Cut Your 401(k) Plan Expenses AND Keep More of YOUR Money: Simple steps to cut plan costs, save money, and make monitoring your plan stress free, ISBN 978-1439236291 or Amazon book link
  • Joshua Iztoe, Fixing the 401(k): What Fiduciaries Must Know (And Do) to Help Employees Retire Successfully, ISBN 978-1934937174 or Amazon book link

Papers

Forum discussions

Frequently asked questions

Affiliate links

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