Article

Retirement Plan Pitfalls

By Hannah Wallace March 31, 2008

A nonprofit has built up an $11 million retirement fund and expects it to grow to $89 million over 20 years. But hidden fees charged by the insurance company provider will cost employees $4 million more than the industry standard during that period, negatively impacting their retirement returns.

A professional firm with 30 employees offers a 401(k) with about 15 investment funds to choose from. Yet employees have invested 80 percent of their retirement savings in relatively low-return money markets, when the average plan should have about 20 percent allocated to money markets.

Both are true-life examples, and both employers could be targeted for failing to meet their fiduciary obligations to their employees, according to John Tufaro, retirement plan specialist for Caldwell Trust Company in Venice.

Business owners and nonprofit managers who offer 401(k) or 403(b) retirement plans may bear more liability than they realize. As baby boomers near retirement age, class-action lawsuits targeting employers for ERISA (Employee Retirement Income Security Act) noncompliance are on the rise. “These defined contribution plans are no longer looked upon as a supplement,” says Tufaro. “For many, it’s their primary retirement plan.”

As plan fiduciaries, owners or managers are responsible for evaluating fund performance and fees to see that their employees are getting a reasonable return. Eighty-three percent of employees with 401(k) plans don’t know how much they pay in expenses, according to AARP, and most believe it is up to their employers or their financial service companies to ensure that they understand them. Employers are also legally required to educate their employees about risk tolerance and advise which funds are most appropriate for them.

Tufaro offers the following tips to help employers meet their fiduciary obligations under ERISA and protect themselves from lawsuits.

ERISA Compliance Advice

Have a written investment policy. Have a process to review investment performance, including measurement standards.

Monitor and evaluate investments periodically. Lean on plan providers to help evaluate investments. Once a year, ask providers to present performance of funds in relation to a similar asset class.

Compare performance to investments within the same peer group. With the help of the provider, come up with objective criteria to evaluate investments. “If it’s a large growth fund, such as Fidelity Contrafund, how does it compare to a Vanguard Windsor?” Tufaro says.

Provide participants with information to make informed investment decisions. In the absence of advice, many employees choose money market funds to avoid risk. Help employees make decisions based on their risk tolerance.

Make sure the plan’s investments are evaluated for risk and are solely in the interest of the beneficiaries. “The classic example is Enron,” says Tufaro. But more recently, General Motors settled with employees who sued for being required to hold on to GM stock through their 401(k) as it depreciated.

Check to see that your service provider’s fees are in line with the industry. “Do an RFP and ask for other providers to give a bid so you can compare apples to apples. A reasonable amount of time is every three years,” says Tufaro. “I’ve seen the employer just ask the provider to disclose the fees and the provider drops it 20 basis points.”

Plan fiduciaries should meet regularly, keep minutes and document their decision-making processes. Well-documented oversight that demonstrates an effort to comply with ERISA requirements can help protect fiduciaries in case of a lawsuit.

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