I recently had the opportunity to provide a review to a prospective qualified retirement plan client. The plan assets were between 3 and 5 million and the underlying investments were separate accounts of a group variable annuity product. A variable annuity separate account will typically either invest its assets into a retail mutual fund or retain an outside money manager as a sub-advisor to manage the account’s assets.

There are some professional advisors working in the retirement plan arena that have a rather strong bias against group variable annuity products when being used as funding vehicles for qualified retirement plans such as 401(k)s. I am not personally one of those who feel that they should never be used. I have seen situations where these solutions have been a good fit for the plan sponsor. With that being said, having investment options that are held within an annuity wrapper does not relieve plan sponsors of their responsibility to monitor the investment options that they are making available to their participants.

Additionally, because of how variable annuity products are packaged, it can be difficult to determine if there is a retail mutual fund being used as the underlying investment vehicle or if the insurance company sponsoring the product has retained an outside sub-advisor to manage the assets. In many cases there are recordkeeping and administrative fees that are also layered into the asset-based charges assessed against the plan. These asset based charges are removed prior to the calculation of the unit price of the separate account investment option, making it tough for most plan sponsors to determine the true cost to their participants.

Again, I want to emphasize that I am not inherently against group variable annuity products but do feel that they require an additional level of diligence from the plan sponsor, particularly as the size of the plan grows. I have observed many situations where a group variable annuity product was justifiable and reasonable for a small or startup 401(k) but over time, as the plan assets increased, was no longer the best solution.

During the recent product review I conducted for our prospective client, I was able to identify the underlying retail mutual fund within most of the group annuity separate accounts. For those retail mutual funds where I could identify the specific fund being used, I matched that fund with the least expensive share class for that same fund on an open architecture platform.

I went on to demonstrate that the plan sponsor could have obtained many of the same investment managers, funds, etc. by using a recordkeeping solution that allowed them to go directly to the fund managers outside of that group annuity shell. The savings available for each fund compared was between 0.05% and 0.55%. In most cases the savings on a per fund basis exceeded 0.25%. These small, incremental savings could add up to a meaningful amount over the course of the participants’ years of investing for their retirement.

Keep in mind, I was not attempting to show the client the best or most cost competitive solution in each asset class. I was simply attempting to demonstrate that the client could have obtained the very same investment option less expensively outside of the annuity wrapper. In many cases, further cost savings would have been available to the client when considering other no-load or institutionally priced investment options in the same asset class. Setting aside any considerations with respect to the fiduciary responsibility of a plan sponsor to make certain that the fees being assessed to their participants are reasonable, as a business person, if you can obtain the same service from the same provider 25 to 50% less expensively, why wouldn’t you?

In conclusion, group variable annuity products are not inherently bad choices as 401(k) investment options. However, the plan sponsor should appreciate that these are packaged products built by insurance companies and the underlying investment options are not considered retail mutual funds, but are annuity separate accounts. Consequently, the underlying fees associated with each separate account should be compared to the fees for the same retail investment option. I have seen cases where the separate account was priced less expensively than the publicly traded mutual fund, but this is not normally the case.

To stay up-to-date on prudent practices as a retirement plan sponsor, or to share this information please register for our newsletter by using the registration form located in the sidebar of this blog, or subscribe to our RSS feed. As always, we appreciate your comments, which can be added below. For compliance reasons, comments are monitored and reviewed as soon as possible before posting.

Disclosure:

Dean Piccirillo offers insurance products through HBK Sorce Insurance LLC. Investment advisory services are offered through HBK Sorce Advisory LLC. Mr. Piccirillo is not able to transact business in a state that he is not licensed or registered.

NOT FDIC INSURED. NOT BANK GUARANTEED. MAY LOSE VALUE, INCLUDING LOSS OF PRINCIPLE. NOT INSURED BY ANY STATE OR FEDERAL AGENCY.

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Over the last few weeks, I have had the opportunity to review two different 401(k) retirement plans; each one having over seventy available investment options.  Participants had to develop their own personal allocation by choosing from dozens of different investment options, many of which were in the same investment category or asset class. It seemed to me that this large number of choices for each participant had the potential to become an overwhelming task that could actually create a situation where a participant was likely to become less diversified, rather than more.

For example, if a plan has several different large stock growth mutual funds available, how does the average participant determine which large growth fund makes the most sense for them? If a participant selects more than one large growth fund, are they more diversified? The average participant actually has no way of knowing which of the multiple large growth funds available makes the most sense for them to choose, and he or she is very likely less diversified by choosing more than one fund in a given asset class.

One interesting study that examines how investment decision-makers, such as qualified retirement plan participants, are impacted by more choices is, “The Psychological Costs of Ever Increasing Choice: A Fallback to the Sure Bet,” written by Sheena S. Iyengar and Wei Jiang of Columbia University in 2005.  This study drew upon information attained by examining nearly 650 retirement plans with approximately 800,000 participants.

The above referenced Columbia University Study has a number of very interesting observations and conclusions.  One of the most fascinating conclusions drawn from this study was that having a large number of choices from an investment standpoint induced retirement plan participants to refrain from making any choices even when it was costly to do so.

Further, the availability of a significant number of investment choices actually motivated retirement plan participants to choose less risky investment options. The attitude of the typical participant seems to be, “This is not what I do.There are too many choices here. I think I’ll just play it safe.” The selection of less risky investment options, such as money market accounts and stable value funds, may be appropriate for some participants. However, this could be a costly allocation decision for participants with a long time horizon in front of them from an investment standpoint.

One of the most dramatic conclusions made by this particular study was that having too many investment choices actually created a situation where participants were more likely to completely opt out of a pension plan. This tendency to opt out when there are a large number of choices was even proven to be true when there were clear monetary advantages to participate, such as an employer matching contributions.  As options increase, the probability of participation declines.  I personally found this to be an incredible observation.

This recent and rather extensive study provides some compelling observations for plan sponsors to consider when building a fund menu.  Clearly, participants must have a fund menu that enables them to develop an appropriate allocation based on their personal goals, time horizon, and risk tolerance. However, excessive choices actually decrease the likelihood that participants will develop a prudent investment mix.

Another practical administrative challenge for plan sponsors who have a large number of investment choices on their menu is the ongoing need to monitor those investments based on a prudent fiduciary process.  It is reasonable to expect that if you have a significant number of investment choices and have a reasonably high standard for performance of those investment options, that you will need to make rather frequent changes to your investment lineup.  Changing investments on a frequent basis can be costly in a variety of ways including administrative fees associated with changing a fund, the necessity to place the plan into an administrative blackout, and the possible need to communicate the change to retirement plan participants.

In conclusion, having too many choices has proven to actually decrease participation in defined contribution plans such as 401(k)s, even when participants are incented to participate through a matching contribution.  Further, participants that make investment allocation decisions when there are a significant number of choices available are more likely to weight their allocations toward fixed income and cash equivalent investment options. This bias toward less risky investment options when there are a large number of choices occurs even when the end result may not be the most reasonable long-term investment decision for the participants.

A ‘best practice’ for retirement plan sponsors building an investment menu is to first determine which investment categories make the most sense to include in their fund lineup and then select well-managed mutual funds that fit into those asset classes.  These mutual funds can then be monitored carefully, based on a prudent fiduciary standard of care and replaced when necessary.

To stay up-to-date on prudent practices as a retirement plan sponsor, or to share this information, please register for our newsletter by using the registration form located in the sidebar of this blog, or subscribe to our RSS feed. As always, we appreciate your comments, which can be added below. For compliance reasons, comments are monitored and reviewed as soon as possible before posting.

Disclosure:

Dean Piccirillo offers insurance products through HBK Sorce Insurance LLC. Investment advisory services are offered through HBK Sorce Advisory LLC. Mr. Piccirillo is not able to transact business in a state that he is not licensed or registered.

NOT FDIC INSURED. NOT BANK GUARANTEED. MAY LOSE VALUE, INCLUDING LOSS OF PRINCIPLE. NOT INSURED BY ANY STATE OR FEDERAL AGENCY.

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Chris Carosa, of the Fiduciary News Blog, recently wrote about an ongoing industry conversation that he refers to as a “401(k) Fee War.” In this article, Chris references the significant attention being paid to mutual fund expenses for 401(k) investment options.  As an industry observer, I too have noticed that the attention being paid to mutual funds fees as well as other asset-based charges assessed to participants has increased dramatically in recent months.

In his article, Chris reminds his readers that the assessed fees associated with servicing a retirement plan need to be reasonable. Chris also points out the current lack of specific regulations on these fees. That being said, retirement plan sponsors are wise to pay attention to the fees being assessed by fund complexes and other professional service providers to their participants.

My intended audience for this blog is not professional advisors, such as myself, who are obsessed with the pension market and monitoring trends on a weekly basis, but rather company owners who are otherwise busy professionals with limited time to dedicate to company sponsored benefits. Because my readers may not be familiar with the details of ERISA (Employee Retirement Income Security Act) and the fiduciary duties that are required of retirement plan sponsors, I thought it would be useful to provide a real world example of the impact these can have on a participant’s future retirement benefits. Realistically, even small variances in asset-based charges assessed to participant account balances can have a significant impact on a participant’s future benefit.

For example, assume that two participants each contribute $250 per month to the same 401(k) investments. The only difference is the net rate of return available to each respective participant. For this example, investor A earns 8% and investor B earns 7.5% because investor B purchased mutual funds that have higher expense ratios. Based on these assumptions, investor A will have $239,342 at the end of a 25 year period of time.  Investor B, who earned 7.5% over the same 25 year period, will have $220,686. As you can see, paying an additional 0.50% over that 25 year period resulted in investor B ending up with $18,656 less than investor A.

You can take this example an additional step forward by examining the difference in future benefits for these two participants due to the difference in their account balances at retirement. Assume, for example, that they each draw down their respective portfolios over a 20 year period at a 7% rate of return. Investor A could draw almost $150 per month more than investor B. Over this 20 year retirement the total difference in benefit is more than $30,000. For many retirees this is a meaningful number.

If you start to apply this thought process across multiple participant accounts, you can begin to appreciate why it is so important for plan sponsors to pay attention to the underlying expenses assessed against their participants. Clearly, not all investment expenses are bad or imprudent. However, if the same or comparable investment options are available less expensively, then plan sponsors should take action to reduce those costs.

In conclusion, the “401(k) Fee War” is likely to rage on. Unfortunately for plan sponsors, remaining neutral will not be an option. Fees impact participant performance and subsequent retirement benefits. Consequently, plan sponsors need to pay careful attention to the cost associated with providing investments and other services to participants.

To stay up-to-date on prudent practices as a retirement plan sponsor, or to share this information, please register for our newsletter by using the newsletter registration form in the sidebar of this blog, or subscribe to our RSS feed. As always, we appreciate your comments, which can be added below. For compliance reasons, comments are monitored and reviewed as soon as possible before posted.

Disclosure:

Dean Piccirillo offers insurance products through HBK Sorce Insurance LLC. Investment advisory services are offered through HBK Sorce Advisory LLC. Mr. Piccirillo is not able to transact business in a state that he is not licensed or registered.

NOT FDIC INSURED. NOT BANK GUARANTEED. MAY LOSE VALUE, INCLUDING LOSS OF PRINCIPLE. NOT INSURED BY ANY STATE OR FEDERAL AGENCY.

Download Article-FeeWar (PDF)

Common Fiduciary Challenges – Part 1

In my capacity as a professional advisor who consults regularly with plan sponsors, there are some common challenges with plan administration that I frequently encounter when a new client is referred to me. In this article, I will attempt to outline some of the most common deficiencies and what a plan sponsor can do to address them in the most effective manner.

Not having a prudent process to select and monitor investment options

Plan sponsors have a responsibility to ensure that their employees have a competitive mix of investment options to choose from in a defined contribution plan. In order to make certain that plan sponsors are able to meet this requirement in an efficient manner, it is useful to have a written process outlining how investment options will be chosen and monitored. An excellent tool with which plan sponsors can use to detail this prudent process is an Investments Policy Statement (IPS).

An Investments Policy Statement details how the plan will select and monitor the investment options that are available for participants to choose from. The IPS will typically detail the criteria with which these investment options will be reviewed. A typical selection criterion may include:

• Performance relative to a manager’s peer group over a certain period of time
• Performance relative to an appropriate index
• A fund’s expense ratio relative to it’s peer group
• Various methods of evaluating a funds risk adjusted returns such as Sharpe Ratio or Alpha
• The tenure of the manager or team of managers for the fund
• Style consistency – do the underlying holdings of the fund match the stated investment style of that portfolio?

There are many other criteria that are reasonable and could be used to evaluate a particular investment option. Some criteria that plan sponsors may want to consider included in their evaluation process can be found in another article on this blog – Selecting and Monitoring Mutual Funds. The key is to have a reasonable or prudent process and to follow that process.

Not following your stated process for evaluating investment options

Sometimes plan sponsors will have a reasonable, prudent process outlined for selecting and monitoring investment options. Many times, plan sponsors have even prepared detailed Investment Policy Statements when their retirement plan was established. However, if you’re going to have a written process for evaluating managers, it’s important that you follow the stated process and , are able to document that you’ve done so.

Plan fiduciaries must monitor their plans investment options on a regular and ongoing basis. This can be challenging for plan sponsors simply because of how busy the typical executive in a small or midsized company is. Regrettably, being busy does not eliminate the responsibility.

Not documenting that you have followed your stated process for evaluating money managers

As with many things in business, particularly from a regulatory standpoint, if it’s not written down it didn’t happen. As a plan sponsor, you may at some point be challenged about an investment decision that you made. If that time ever comes, being able to demonstrate in writing, that you have followed a prudent process may be critical.

Unfortunately many times, plans sponsors who have carefully monitored the performance of their plans investment options have no evidence that they have in fact done so. Retirement plan fiduciaries are therefore encouraged to maintain records confirming decisions that they made with respect to plan investment options. Records could include due diligence reports prepared for investment options in the plan or minutes from investment committee meetings.

The key is, being able to prove that you did what you said you were going to do from an investment monitoring standpoint? Are you able to prove that you followed your prudent process?

In part two of this series, we will continue to explore some common fiduciary challenges and how plan sponsors can most easily address them. A sample of an Investment Policy Statement, which we use in our practice, can be found at this link on our Resources page. We have also provided a link to a sample Due Diligence Report that has been designed to coordinate with our sample Investment Policy Statement.

To stay up-to-date on prudent practices as a retirement plan fiduciary, or to share this information please consider registering for our newsletter, you can find the newsletter registration form in the sidebar of this blog.  Another option to stay connected with our updates would be to subscribe to our RSS feed.  As always, we appreciate your comments which can be added below.  For compliance reasons, comments on this blog must be monitored however; we will approve and post your comments as soon as administratively possible.

Disclosure:

Dean Piccirillo offers insurance products through HBK Sorce Insurance LLC, investment advisory services are offered through HBK Sorce Advisory LLC and securities are offered through Purshe Kaplan Sterling Investments (PKS), Member FINRA/SIPC. PKS is headquartered at 18 Corporate Woods Blvd., Albany, NY 12211. HBK Sorce Insurance LLC and HBK Sorce Advisory LLC are not affiliated with Purshe Kaplan Sterling Investments. Mr. Piccirillo is not able to transact business in a state that he is not licensed or registered.

Currently, for Americans living on $45,000 or more per year during retirement, 18% of that income is generated from personal savings and investments¹.  For millions of Americans, the personal savings and investments component of our income consists largely of Individual Retirement Accounts (IRA).  IRAs are tax deferred personal retirement funds that allow you to save up to $5,000 per year ($6,000 if you’re age 50 or older).  Tax deferral means you’re not currently paying income taxes on dollars earned inside of these investment vehicles; instead, the tax is deferred until you withdraw your money.  Consequently, your money is working harder for you during the accumulation phase.

Depending on your marital status, income, and whether or not you’re an active participant in an employer sponsored retirement plan, the $5,000 contribution may also be tax deductible.  Beginning in 2009, the contribution limit will adjust annually for inflation in $500 increments.

There are many types of IRAs: Traditional IRA, Roth IRA, Education IRA (EDIRA), SEP-IRA, SARSEP-IRA, and SIMPLE-IRA. Traditional IRAs are broken down into Regular, and Rollover IRAs.  The SEP-IRA, SARSEP-IRA and the SIMPLE-IRA are designed for use by small business owners and are beyond the scope of this article.  The Education IRA is now called the Coverdale Education Savings Account and has become somewhat less popular with the recent enhancements made to the 529 College Savings Accounts.  Thus, our focus for this discussion will be on the Traditional IRA and the Roth IRA.

Let’s review the differences between the Traditional IRA and the Roth IRA.  The Roth IRA has essentially turned the Traditional IRA formula completely around.  A Traditional IRA enables taxpayers to make tax-deductible contributions, but all contributions to Roth IRAs are after tax (non-deductible).

In addition, withdrawals are treated differently. With a Traditional IRA, contributions are growing tax-deferred and withdrawals are taxed at ordinary income tax rates With a Roth IRA, investments grow tax-deferred but can be withdrawn after age 59½ tax-free.  However, in order to receive this tax-free treatment on a withdrawal, you also must have held the account for at least five years.

This ability to make contributions that can be withdrawn tax-free is a unique and powerful characteristic of the Roth IRA. The good news is that most taxpayers are eligible to make contributions to a Roth IRA.  The ability to use this tool however, is phased out for Americans in higher income tax brackets.  For example, if you’re single, the $5,000 (or $6,000 if you’re over the age of 50) that you can contribute begins to be phased out starting at $105,000 and is completely phased out at $120,000.  For married filers, the phase out begins at $166,000.  Married couples earning $176,000 or more can no longer contribute to a Roth IRA.  Unlike the Traditional IRA however, contributions can still be made after age 70 ½ as long as you have earned income.

For investors who have existing Traditional IRAs, one consideration is whether or not to convert the Traditional IRA to a Roth IRA.  Conversion from Traditional to Roth is allowed for taxpayers if they and their spouses earn less than $100,000 per year.  The biggest benefit to conversion is that all future earnings grow tax-free.  This certainly sounds attractive, but investors should consider conversion with caution. Currently, all contributions and earnings moved to the Roth IRA from the Traditional IRA are taxable.

This conversion becomes a little more complex when you consider that you cannot use any of the dollars being converted to help pay the tax due without being subject to a 10% early withdrawal penalty if you’re under the age of 59 ½.  Many experts warn that if you do not have other money on hand to pay the taxes due upon conversion, you’re probably better off maintaining the Traditional IRA.

The decision to use either the Traditional IRA or the Roth IRA for new contributions, and the decision whether or not to convert from a Traditional to a Roth are driven in large part by your expected future tax rate.  In the not too distant past, many retirees entered lower tax brackets during retirement.  This is no longer the case for many, particularly as more people are working (at least part-time) during retirement to support the lifestyle to which they had become accustomed during their working years.  Consequently, many taxpayers should take a hard look at conversion and making new contributions to the Roth IRA, again, proceed with great caution.  A consultation with a Financial Advisor and your tax professional is highly recommended.

To conclude, both the Traditional IRA and the Roth IRA are important tools   to consider in the retirement planning process.  Many in fact will establish IRAs a result of a rollover from an employer sponsored plan.  As you consider which tool will work most effectively for you, many factors play into the decision. Those factors include:  your current income tax bracket, estimate for your future tax rates, your marital status, and your ability to pay the tax upon conversion.  For most of you, these decisions are best made with the assistance of a professional advisor experienced in these matters.  Once made, the decisions can be both irrevocable and taxing.

Sources:

1. Income of the Population 55 or Older, 2004, Social Security Administration, Office of Research, Evaluation, and Statistics (May 2006)

Download Article-Trad IRA vs Roth IRA (PDF)

As the number of small businesses in the U.S. grows, the number of retirement plan choices seems to grow as well.  Two popular retirement plan options for smaller businesses seek to avoid the complexities that go along with establishing a qualified retirement plan such as the 401(k). These two options are the SEP IRA (Simplified Employee Pension) and the SIMPLE IRA (Savings Incentive Match Plan for Employees).

Each of these choices enables employers to make contributions for participants directly to individual retirement accounts or IRAs. Contributions made to either the SEP IRA or the SIMPLE IRA are always fully vested to the participant. Employers establishing either type of plan are relieved of the more onerous compliance and reporting requirements required by traditional qualified retirement plans.

One of the key differences between the SEP-IRA and the SIMPLE IRA has to do with the type of contribution that can be made to the participant accounts. With the SEP IRA the only type of contributions allowed into participant IRA accounts are those made by the employer.  Contributions to the SEP IRA are made on a percentage of compensation basis.  Contributions made to SIMPLE IRAs include both employee salary deferrals and employer contributions. In the case of the SIMPLE IRA, the employer contributions can be made either as a matching contribution based on the employee’s salary deferral or as a percentage of compensation made to all eligible participants.

Again, regardless of which of these two types of plans employers choose, they will avoid the cumbersome reporting and disclosure requirements associated with qualified retirement plans which fall under IRC Section 401(a).   A careful examination of each option will help businesses make intelligent decisions regarding which plan to choose.

The SEP IRA

As previously  noted, contributions to SEP IRAs are employer only. In other words, there is no employee salary deferrals allowed into participant accounts. Currently, an employer can contribute up to 25% of an employee’s compensation annually to a SEP IRA. This percentage limit is not to exceed $49,000. This differs from profit sharing plans in that employers can contribute up to 100% of a participant’s compensation up to $49,000. Unlike profit sharing plans, contributions made to SEP IRAs cannot be weighted toward a particular class of employee or given to certain employees based on age. SEP contributions must be made in a uniform manner based on each employee’s compensation.

The only opportunity to weight SEP IRA contributions towards certain employees is found in the ability to integrate SEP IRA contributions with social security. This social security integration allows employers to contribute more toward employees that make in excess of the social security wage base, which in 2009 will be $106,800. Individuals earning in excess of this amount may end up with a slightly larger employer contribution amount. Beyond this ability to integrate employer contributions with social security, there are no other opportunities to allocate SEP IRA contributions toward more highly compensated or key employees.

As you would expect, contributions made to SEP IRAs on behalf of each respective participant are not currently taxable income to the participant. Furthermore, the earnings on assets held inside of SEP IRAs grows on a tax-deferred basis. Ultimately, as participants make withdrawals from SEP IRA accounts,   those withdrawals are taxed as ordinary income.  As is the case with a traditional IRA, withdrawals made from SEP IRAs prior to age 59 ½ are subject to a 10% penalty in addition to ordinary income taxes.

As with many types of retirement plans, distributions from SEP IRAs can be rolled to a traditional IRA. Again, employees own and control 100% of contributions made to their participant IRA account immediately after the contribution is made. Consequently, due to this immediate vesting, employees can always leave the business and take 100% of their account balance with them.

Similar to a profit sharing plan, contributions made to a SEP IRA on an annual basis by the employer are completely voluntary.  Although the maximum contribution is 25% of an employee’s compensation, there is no minimum contribution required on an annual basis.  Consequently, employees are well advised not to rely completely on the SEP IRA to fund their personal retirement goal.

Another unique feature of the SEP IRA is the fact that it has the longest waiting period of any retirement plan available to a small employer. Employers electing to do so may prevent employees from being eligible to participate in the SEP IRA until they have completed at least three years of service with the employer. Thus, if an employer is in an industry which possesses  a large number of short-term or seasonal employees with significant turnover, a SEP IRA may be more advantageous.

As is the case with most other  retirement plans, employees participating in collective bargaining units and nonresident aliens do not have to be covered under a SEP IRA. Also, employers establishing a SEP IRA after 2001 may be eligible for a business tax credit of up to $500 if the SEP IRA is a startup retirement plan for that business.

The SIMPLE IRA

SIMPLE IRAs are only available to employers with up to 100 employees. Contributions made to SIMPLE IRA’s can also be either employee salary deferrals or some form of employer contribution. The service requirement for participation in the SIMPLE IRA is two years. In each of those two preceding years, employees must have at least $5,000 of earnings. In the current year, participating employees must be expected to earn at least $5,000 of income.

In the year 2009, employees can make contributions of up to $11,500. If the participant is over the age of 50 there is a catch up contribution available that allows employees over the age of 50 to contribute up to an additional $2,500 on a pretax basis into the plan. Unlike the SEP IRA, the $11,500 maximum contribution is not limited by a percentage of the employee’s compensation. Employees can contribute up to 100% of their compensation with an $11,500 maximum contribution limit. Theoretically then, employees earning $11,500 could contribute 100% of that amount to their SIMPLE IRA participant account.

Employers must make contributions to the SIMPLE IRA on behalf of eligible participants in one of two ways. The first is a matching contribution based on the participant’s salary deferral amount. This match is dollar-for-dollar up to the first 3% of the employee’s contribution. Consequently, if employees contribute 3% of their salary to the SIMPLE IRA, the employer must match that amount.  The employer has no obligation to match any employee salary deferral in excess of the 3% maximum. Employers not wishing to make a matching contribution must make a non-elective contribution of 2% of compensation for all eligible employees. This non-elective contribution must be made to employees meeting the two-year service requirement regardless of whether not they contribute any of their personal compensation to the plan. And employers may not make both a matching contribution and a 2% non-elective contribution. They must choose one of the two options.

Similar to 401(k) retirement plans, employee seller deferrals made to SIMPLE IRAs are made on a pretax basis. Employer contributions, both the match and the non-elective contribution, are not currently taxable to the employee. Businesses adopting a new SIMPLE IRA after 2001 are also eligible for the $500.00 business tax credit mentioned in the previous discussion about the SEP IRA. This tax credit was put in place by Congress in 2001 as an incentive for employers to establish new retirement plans.

Like the SEP IRA, contributions made to participant accounts by the employer in the SIMPLE IRA are fully vested to the employee. Consequently, employees can immediately withdraw contributions made to the SIMPLE IRA on their behalf, both seller deferrals and employer contributions. These distributions, like those made from the SEP IRA, are immediately taxable to the employee as ordinary income.  Also, similar to both the SEP IRA and traditional IRA, if these distributions are made prior to age 59 1/2, the participant will be subject to a 10% IRS penalty on the entire amount withdrawn. The penalty for early withdrawal from SIMPLE IRA is potentially even more severe. If participants choose to withdraw their SIMPLE IRA balance during the first two years, they may incur a 25% penalty tax.

From the employee’s standpoint, one obvious advantage of the SIMPLE IRA versus the SEP IRA is the ability to make salary deferrals on a pretax basis.   This may allow employees to develop a systematic savings program on a payroll deduction basis similar to what they would be able to establish if they had a 401(k) retirement plan available to them.

Small business owners should consider a SIMPLE IRA versus a SEP IRA when the amount of self-employed income available to them to contribute to the plan is comparatively small. For example, if an individual owns a small business and works in that business on a part-time basis, an excellent alternative may be the SIMPLE IRA. If the small business owner earns $11,500 per year or less that entire amount could be contributed to the SIMPLE IRA. If however, this small employer had established a SEP IRA, the maximum contribution would only be $2,300.00. This is because the maximum contribution to the SEP IRA would be 25% of the amount earned or $2,300 ($11,500 X 25% = $2,300).

In conclusion, both the SEP IRA and the SIMPLE IRA can be very effective choices for small employers looking to establish a retirement plan that is simple to administer. SEP IRA works best for employers who are able to generate a higher amount of revenue and who wish to contribute at a higher limit.

SIMPLE IRA, on the other hand, works very effectively for employers who may have less revenue and wish to have more of the total contribution to the plan coming from employee’s salary deferrals. SIMPLE IRA is also an excellent choice for people who manage smaller businesses in addition to their other employment.

Because of the complexities in the retirement plan arena, many times it makes sense to consult a financial adviser or tax professional prior to establishing a retirement plan for the small business owner.

Welcome to part two of our series on the responsibilities of a retirement plan fiduciary.  In part one of this series we cited the five significant responsibilities that a retirement plan fiduciary has.  Previously we spent a considerable amount of time talking about the first two responsibilities – managing the plan for the exclusive benefit of the participants and  act prudently at all times.

In this post we will discuss the remaining three significant responsibilities, which are selecting and monitoring plan investments, selecting and monitoring the services of the plan and finally, abiding by the plan’s provisions.  Let’s begin with what can be a challenging task for a plan sponsor without a significant background in investment management – selecting and monitoring plan investments.

When selecting and monitoring investment options for a retirement plan, a plan fiduciary must make sure that the plan is diversified on two levels; the fund or investment level, and  the acid class level.  As we discussed in part one of this article, fiduciaries are held to a very high standard in the area of investment selection and monitoring for qualified plans under ERISA regulations.  The standard that plan sponsors are held to is that of an expert.  This standard is often referred to as the prudent expert standard, and represents a higher level of prudence than the more traditional person standard that most corporate executives are familiar with.

At the fund level, plan sponsors must make sure that they select investment options that are diversified.  Most mutual funds will meet this requirement however; caution should be exercised when selecting mutual funds that focus on a particular sector of the market such as technology or health care.  Also plan sponsors should remember that not all mutual funds are broadly diversified portfolios.  There are some mutual funds, which have a much more focused objective and investment strategy, and may only own 20 to 40 investment options.

When diversifying plan investment options at the asset class level, plan sponsors must ensure that participants have access to multiple investment categories so  they can adequately diversify their portfolio, based on their personal goals and their personal risk tolerance.  Plan sponsors will therefore want to make certain that they have investment options that represent most of the available capital markets.  A plan sponsor may for example, want to include a variety of equity-based mutual funds providing exposure to the small, mid and large cap sectors, as well as several fixed income mutual funds covering the short, intermediate and long-term fixed income markets.  Companies sponsoring qualified retirement plans may also want to make certain that their participants have the opportunity to invest in stocks of companies based in foreign countries through an international stock mutual fund.

In addition to selecting and monitoring the investment options in the plan, plan sponsors have a responsibility to have a process in place to other service providers.  Processes should be in place to ensure an appropriate level of service, and to document the associated cost of those services is reasonable based on what is available in the marketplace for similar sized plants.  Making certain that the vendor cost is reasonable is particularly important if these costs are being passed on to the plan’s assets, and are reducing the returns available to the plan’s participants.  Some service providers that plan sponsors should periodically monitor include the following:

• The recordkeeping firm – traditionally maintains the books and records of the plan,  performs services such as tracking participant account balances,  transaction history, tracking all plan balances at the plan participant level by source of funds, provides monthly statements and Internet access for participants and the plan sponsor, along with many other related services
• The third-party administrator –  provides a variety of qualified retirement plan services such as maintaining the plan document, performing a variety of required annual tests, completing a signature ready tax return for the plan, performing profit-sharing, and other employer contribution calculations for the plan
• The investment provider – could be a bank, a registered investment advisory firm, an insurance company or a broker.  These providers offer a number of services to plan sponsors including investment menus, assistance with due diligence, monitoring of investment options, education and counseling for participants, as well as investment counseling for the plan sponsor
• The auditor –plans of a certain size require an audit be performed on an annual basis.  Very broadly, the purpose of a plan audit is to confirm that the assets reported by the recordkeeping firm exist and that the transaction history is accurate based on the plans published reports

As you can see, the services needed to establish and maintain a qualified retirement plan such as a 401(k) plan are extensive and complex.  The challenge to the plan sponsor  is that they are responsible for not only the services  the outside vendors are providing their participants, but are responsible for ensuring that these services are being provided to the plan at a reasonable cost.

The last significant responsibility that retirement plan sponsors have is to simply abide by the plan’s provisions.  The only instance where it is acceptable to not comply with a plan provision is if that plan provision does not meet ERISA requirements.  This is another responsibility that may seem comparatively straightforward and easy to meet, however aspects of this requirement can also be challenging.  This is particularly true when trying to determine things such as whether or not a participant is eligible for a hardship distribution or other special request.

In conclusion, a retirement plan fiduciary has a significant set of responsibilities.  They are ultimately responsible for every aspect of the plan, including the services provided by other service providers.  Furthermore, for certain responsibilities such as the selection and monitoring of investment options, the plan sponsor is actually held to a higher standard than the standard that they would be held to as an officer of the company when managing corporate assets.  Finally, as regulators have made plan sponsors personally liable for the concise execution of fiduciary duties, it is paramount for each plan sponsor to pay close attention to their responsibilities.

In a previous blog post, we spent time reviewing who could be considered a retirement plan fiduciary, and what the associated responsibilities and liabilities would be. As we discussed, anyone who has the ability to act with discretion and control, with respect to the management of retirement plan sets or other investments, could be considered a fiduciary under ERISA or the Employee Retirement Income Security Act of 1974.

The question then becomes, what specific responsibilities do I have to add a retirement plan fiduciary? Well, this reaction has a number of specific responsibilities under the law including:

• Managing the plan for the exclusive benefit of the participants
• Acting prudently
• Selecting and monitoring diversified plan investments
• Selecting and monitoring the services of the plan
• Abiding by the plan’s provisions

For this article, we’ll spend some time discussing each of these significant responsibilities, and in future articles discuss several of them in more depth. Let’s then start with the first one – managing the plan for the exclusive benefit of the plan participants.

The qualified retirement plan must be managed for the explicit benefit of the retirement plan participants. This rule is also known as the duty of loyalty. Generally, retirement plan fiduciaries may not place their own interests above those of retirement plan participants or beneficiaries. The primary duty of a pension plan fiduciary is the sound administration of the retirement plan for the exclusive benefit of its participants and beneficiaries.

At first blush, this “duty of loyalty” obligation may seem comparatively easy for retirement plan fiduciaries to meet however, consider the plan that has employee or stock as an investment option. In this particular case, retirement plan trustees must monitor the performance of their own company’s stock as an investment option plan, and make sure that it continues to be an appropriate alternative for their participants. If you spend some time thinking about this, you can quickly envision situations where a manager’s responsibility as a fiduciary for the retirement plan could diverge from responsibilities associated with his or her role as an officer in the company.

Now let’s spend a few moments talking about the second duty noted above – acting prudently. This concept is normally applied when selecting and monitoring investment options for a qualified retirement plan. Interestingly, the definition of prudence with respect to the management of retirement plan investment options differs significantly from the more traditional prudent man rule that most corporate executives will be familiar with. Under the original prudent person standard, a corporate executive must act with the care, and skill that a prudent person acting in a similar situation would demonstrate.

Under ERISA, this traditional prudent person standard has no weight. The prudence that a fiduciary must exercise under ERISA when selecting and monitoring investment options in a qualified retirement plan is that of an expert. When selecting and monitoring investment options for a qualified retirement plan, fiduciaries must act with the care and skill of a knowledgeable long-term investor. There is actually no higher standard of prudence than that imposed under ERISA.

In part two of this post, we will discuss the remaining responsibilities outlined in the regulations. However, even a cursory review of these responsibilities clearly reinforces the importance of retirement plan sponsors having knowledgeable advisers in this area.

Are you currently a qualified retirement plan fiduciary? If so, you may have some responsibility and perhaps liability that you were not previously aware of. Retirement plan sponsors on a national basis are coming under increased scrutiny with respect to how they administer pension plans in their care.

However, before we begin a discussion regarding responsibilities related to the administration of qualified retirement 401(k), 403(b), or defined benefit plans, I think it’s important that we determine if we are in fact fiduciaries. Understanding who at your company has this responsibility is even more important in light of the recent downturn in the capital markets and the bear markets subsequent impact on the future retirement security of qualified plan participants.

Much of what we’ll cover here comes from ERISA or the Employee Retirement Income Security Act of 1974. This Act was actually signed into law on Labor Day of that year, and this piece of legislation imposes certain obligations on those responsible for retirement plans and other employee benefits.

So who then can be considered a retirement plan fiduciary? The first person that can be considered a retirement plan fiduciary is anyone who has the ability to exercise discretionary authority or control over the management of the plan itself or the plans assets. The other type of person or entity that could be considered a retirement plan fiduciary would be a person or company compensated for providing investment advice to a retirement plan or a person or firm that has the responsibility to do so.

All retirement plans must have a fiduciary that is named in the plan document or through an appointment process described in the plan. This person is clearly a retirement plan fiduciary. However, anyone may be considered a pension fiduciary if they act in a fiduciary role. Therefore, there may be many managers and executives with responsibilities related to the company’s qualified retirement plan who are fiduciaries and don’t even realize that they have this responsibility.

For example, you could have a chief financial officer at a company not named in the plan document, who does provide direction to retirement plan service providers related to things such as the selection and monitoring of investment options, or the general administration of the plan who would be considered a fiduciary. In certain situations, even those not directly involved in the administration of the plan, possessed the ability to appoint these decision-makers may also be considered fiduciaries.

An important thing for these fiduciaries to appreciate is that along with this responsibility, is significant liability. For example, retirement plan fiduciaries are responsible to the full extent of their personal assets to ensure that a retirement plan is managed in accordance with appropriate regulations. This personal responsibility and liability was purposely written into ERISA regulations. It was actually the government’s intent when drafting ERISA to use this personal liability as a law’s teeth.

So, you’ve determined you are fiduciary, now what? Fortunately, there are a number of processes you can follow to enhance the overall management of your retirement plan on behalf of your participants that also go a long way to minimizing the personal liability that plan sponsors and other fiduciaries have. Effective fiduciary liability management and mitigation will be the subject of future articles.