403(b) Lawsuits Continue To Spread To More Colleges
In the last 3 years, the number of lawsuits filed against colleges for excessive fees and compliance issues related to their 403(b) plans has increased exponentially. Here is a list of just some of the colleges that have had lawsuit brought against them by their 403(b) plan participants:
In the last 3 years, the number of lawsuits filed against colleges for excessive fees and compliance issues related to their 403(b) plans has increased exponentially. Here is a list of just some of the colleges that have had lawsuit brought against them by their 403(b) plan participants:
Yale
NYU
Duke
John Hopkins
MIT
Columbia
Emory
Cornell
Vanderbilt
Northeastern
USC
The fiduciary landscape has completely changed for organizations, like colleges, that sponsor ERISA 403(b) plans. In 2009, new regulations were passed that brought 403(b) plans up to the compliance standards historically found in the 401(k) market. Instead of slowly phasing in the new regulations, the 403(b) market basically went from zero to 60 mph in a blink of an eye. While some of the basic elements of the new rules were taken care of by the current service providers such as the required written plan documents, contract exchange provisions, and new participant disclosures, we have found that colleges, due to a lack of understanding of what is required to fulfill their fiduciary role to the plan, have fallen very short of putting the policies and procedures in place to protect the college from liabilities that can arise from the 403(b) plan.
Top Violations
Based on the lawsuits that have been filled against the various colleges, here is a list of the most common claims that have been included in these lawsuits:
Excessive fees
Fees associated with multiple recordkeepers
Too many investment options
Improper mutual fund share class
Variable annuity products
Excessive Fees
This is by far number one on the list. As you look at these lawsuits, most of them include a claim that the university breached their fiduciary duty under ERISA by allowing excessive fees to be charged to plan participants.
Here is the most common situation that we see when consulting with colleges that leads to this issue. A college had been with the same 403(b) provider for 60 years. Without naming names, they assume that their 403(b) plan has reasonable fees because all of the other colleges that they know of also use this same provider. So their fees must be reasonable right? Wrong!!
If you are member of the committee that oversees that 403(b) plan at your college, how do you answer this question? How do you know that the fees for your plan are reasonable? Can you show documented proof that you made a reasonable effort to determine whether or not the plan fees are reasonable versus other 403(b) providers?
The only way to answer this question is by going through an RFP process. For colleges that we consult with we typically recommend that they put an RFP out every 3 to 5 years. That is really the only way to be able to adequately answer the question: “Are the plan fees reasonable?” Now if you go through the RFP process and you find that another reputable provider is less expensive than your current provider, you are not required to change to that less expensive provider. However, from a fiduciary standpoint, you should acknowledge at the end of the RFP process that there were lower fee alternatives but the current provider was selected because of reasons X, Y, and Z. Document, document, document!!
Investment Fees / Underperformance / Investment Options
Liability is arising in these 403(b) plans due to
Revenue sharing fees buried in the mutual fund expense rations
Underperformance of the plan investments versus the benchmark / peer group
Too many investment options
Investment options concentrated all in one fund family
Restrictions associate with the plan investment
Investment Policy Statement violations or No IPS
Failure to document quarterly and annual investment reviews
Here is the issue. Typically members of these committees that oversee the 403(b) plan are not investment experts and you need to basically be an investment expert to understand mutual fund share classes, investment revenue sharing, peer group comparisons, asset classes represented within the fund menu, etc. To fill the void, colleges are beginning to hire investment firms to serve as third party consultants to the 403(b) committee. In most cases these firms charge a flat dollar fee to:
Prepare quarterly investment reports
Investment benchmarking
Draft a custom Investment Policy Statement
Coordinate the RFP process
Negotiation plan fees with the current provider
Conduct quarterly and annual reviews with the 403(b) committee
Compliance guidance
Multiple Recordkeepers
While multiple recordkeepers is becoming more common for college 403(b) plans, it requires additional due diligence on the part of the college to verify that it’s in the best interest of the plan participants. Multiple recordkeepers means that your 403(b) plan assets are split between two or more custodians. For example, a college may use both TIAA CREF and Principal for their 403(b) platform. Why two recordkeepers? Most of the older 403(b) accounts are setup as individual annuity contracts. As such, if the college decides to charge their 403(b) provider, unlike the 401(k) industry where all of the plan assets automatically move over to the new platform, each plan participant is required to voluntarily sign forms to move their account balance from the old 403(b) provider to the new 403(b) provider. It’s almost impossible to get all of the employee to make the switch so you end up with two separate recordkeepers.
Why does this create additional liability for the college? Even through the limitation set forth by these individual annuity contracts is out of the control of the college, by splitting the plan assets into two pieces you may be limiting the economies of scale of the total plan assets. In most cases the asset based fees for a 403(b) plan decreases as the plan assets become larger with that 403(b) provider. By splitting the assets between two 403(b) platforms, you are now creating two smaller plans which could result in larger all-in fees for the plan participants.
Now, it may very well be in the best interest of the plan participants to have two separate platforms but the college has to make sure that they have the appropriate documentation to verify that this due diligence is being conducts. This usually happens as a result of an RFP process. Here is an example. A college has been using the same 403(b) provider for the last 50 years but to satisfy their fiduciary obligation to the plan they going through the RFP process to verify that their plan fees are reasonable. Going into the RFP process they had no intention of change provides but as a result of the RFP process they realize that there are other 403(b) providers that offer better technology, more support for the plan sponsor, and lower fees than their current platform. While they are handcuffed by the individual contracts in the current 403(b) plan, they still have control over where the future contributions of the plan will be allocated so they decide that it’s in both the plan participants and the college’s best interest to direct the future contributions to the new 403(b) platform.
Too Many Investment Options
More is not always better in the retirement plan world. The 403(b) oversite committee, as a fiduciary, is responsible for selecting the investments that will be offered in accordance with the plan’s investment menu. Some colleges unfortunately take that approach that if we offer 80+ different mutual funds for the investment that should “cover all of their bases” since plan participants have access to every asset class, mutual fund family, and ten different small cap funds. The plaintiffs in these 403(b) lawsuits alleged that many of the plan’s investment options were duplicates, performed poorly, and featured high fees that are inappropriate for large 403(b) plans.
To make matters worse, if you have 80+ mutual funds on your 403(b) investment menu, you have to conduct regular and on-going due diligence on all 80+ mutual funds in your plan to make sure that they still meet the investment criteria set out in the plan’s IPS. If you have mutual funds in your plan that fall outside of the IPS criteria and those issues have not been addressed and/or documented, if a lawsuit is brought against the college it will be very difficult to defend that the college was fulfilling its fiduciary obligation to the investment menu.
Improper Mutual Fund Share Classes
To piggyback on this issue, what many plan sponsors don’t realize is that by selecting a more limited menu of mutual funds it can lower the overall plan fees. Mutual funds have different share classes and some share classes require a minimum initial investment to gain asset to that share class. For example you may have Mutual Fund A retail share class with a 0.80% internal expense ratio but there is also a Mutual Fund A institutional share class with a 0.30% internal expense ratio. However, the institutional share class requires an initial investment of $100,000 to gain access. If Mutual Fund A is a U.S. Large Cap Stock Fund and your plan offers 10 other U.S. Large Cap Stock Funds, your plan may not meet the institutional share requirement because the assets are spread between 10 different mutual funds within the same asset class. If instead, the committee decided that it was prudent to offer just Mutual Fund A to represent the U.S. Large Cap Stock holding on the investment menu, the plan may be able to meet that $100,000 minimum initial investment and gain access to the lower cost institutional share class.
Variable Annuity Products
While variable annuity products have historically been a common investment option for 403(b) plans, they typically charge fees that are higher than the fees that are charged by most standard mutual funds. In addition, variable annuities can place distribution restrictions on select investment investments which may not be in the plan participants best interest.
The most common issue we come across is with the TIAA Traditional investment. While TIAA touts the investment for its 3% guarantee, we have found that very few plan participants are aware that there is a 10 year distribution restriction associated with that investment. When you go to remove money from the TIAA Traditional fund, TIAA will inform you that you can only move 1/10th of your balance out of that investment each year over the course of the next ten years. You can see how this could be a problem for a plan participant that may have 100% of their balance in the TIAA Traditional investment as they approach retirement. Their intention may have been to retire at age 65 and rollover the balance to their own personal IRA. If they have money in the TIAA Traditional investment that is no longer an option. They would be limited to process a rollover equal to 1/10th of their balance in the TIAA Tradition investment between the age of 65 and 74. Only after age 74 would they completely free from this TIAA withdrawal restriction.
Consider Hiring A Consultant
While this may sound self-serving, colleges are really going to need help with the initial and on-going due diligence associate with keeping their 403(b) plan in compliance. For a reasonable cost, colleges should be able to engage an investment firm that specialized in this type of work to serve as a third party consultant for the 403(b) investment committee. Just make sure the fee is reasonable. The consulting fee should be expressed as a flat dollar amount fee, not an asset based fee, because they are fulfilling that role as a “consultant”, not the “investment advisor” to the 403(b) plan assets.
About Michael……...
Hi, I’m Michael Ruger. I’m the managing partner of Greenbush Financial Group and the creator of the nationally recognized Money Smart Board blog . I created the blog because there are a lot of events in life that require important financial decisions. The goal is to help our readers avoid big financial missteps, discover financial solutions that they were not aware of, and to optimize their financial future.
How Does A Simple IRA Plan Work?
Not every company with employees should have a 401(k) plan. In many cases, a Simple IRA plan may be the best fit for a small business. These plans carry the following benefits
Not every company with employees should have a 401(k) plan. In many cases, a Simple IRA plan may be the best fit for a small business. These plans carry the following benefits
No TPA fees
Easy to setup & operate
Employee attraction and retention tool
Pre-tax contributions for the owners to lower their tax liability
Your company
To be eligible to sponsor a Simple IRA, your company must have less than 100 employees. The contribution limits to these plans are about half that of a 401(k) plan but it still may be the right fit for you company. Here are some of the most common statements that we hear from the owners of the business that would lead you to considering a Simple IRA plan over a 401(k) plan:
"I want to put a retirement plans in place for my employees that has very low fees and is easy to operate."
"We are a start-up, we don't have a lot of money to contribute to the plan as the owners, but we want to put a plan in place to attract and retain employees."
"I plan on contributing $15,000 per year to the plan, even if I sponsored a plan that allowed me to contribute more I wouldn't because I'm socking all of the profits back into the business"
"I have a SEP IRA now but I just hired my first employee. I need to setup a different type of plan since SEP IRA's are 100% employer funded"
Establishment Deadline
The deadline to establish a Simple IRA plan is October 1st. Once you have cross over that date, you would have to wait until the following calendar year to set the plan.
Eligibility
The eligibility requirements for a Simple IRA are different than a SEP IRA or 401(k) plans. Unlike these other plan "1 Year of Service" = $5,000 of compensation earned in a calendar year. If you want to only cover "full-time" employees with your retirement plan, you may need to consider a 401(k) plan which has the 1 year and 1000 hours requirement to obtain a year of service. The most restrictive "wait time" that you can put into place is 2 years. Meaning an employee must obtain 2 years of service before they are eligible to start contributing to the plan. You can also be more lenient that 2 years, such as immediate entry or a 1-year wait, but 2 years is the most restrictive it can be.
Types of Contributions
Like a 401(k) plan, Simple IRA have both employee deferral contributions and employer contributions.
Employee Deferrals
Eligible employees are allowed to make pre-tax contributions to their Simple IRA accounts. The contribution limits are less than a traditional 401(k). Below is a tale comparing the 2021 contribution limits of a Simple IRA vs a 401(k) Plan:
There are not Roth deferrals allows in Simple IRA plans.
Employer Contributions
Unlike other employer sponsored retirement plans, employer contributions are mandatory each year to a Simple IRA plan. The company must choose between two pre-set employer contribution formulas:
2% Non-elective
3$ Matching contribution
With the 2% non-elective contribution, the company must contribute 2% of each eligible employee’s compensation to the plan whether they contribute to the plan or not.
For the 3% matching contribution, it’s a dollar for dollar match up to 3% of compensation that they employee contributes to the plan. The match formula is more popular than the 2% non-elective contribution because the company only must contribute if the employee contributes.
Special 1% Rule
With the employer matching contribution there is also a special rule. In 2 out of any 5 consecutive years, the company can lower the employer match to as low as 1% of pay. We will often see start-up company's take advantage of this rule by putting a 1% employer match in place for the first 2 years of the plan to minimize costs and then they are committed to making the 3% match for years 3, 4, and 5.
100% Vesting
All employer contributions to Simple IRA plans are 100% vested. The company is not allowed to attach a "vesting schedule" to the contributions.
Important Compliance Requirements
Make sure you have a 5304 Simple Form in your files for each year you sponsor the Simple IRA plan. If you are audited by the IRS or DOL, they will ask for these forms. You need to distribute this form to all of your employee each year between Nov 1st and Dec 1st for the upcoming plan year. The documents notifies your employees that:
A retirement plan exists
Plan eligibility requirement
Employer contribution formula
Who they submit their deferral elections to within the company
If you do not have this form on file, the IRS will assume that you have immediate eligibility for your Simple IRA plan, meaning that all of your employees are due employer contributions since day one of employment. Even employee that used to work for you and have since terminated employment. It’s an ugly situation.
Make sure the company is timely when submitting the employee deferrals to the Simple IRA plan. Since you are withholding money from employees pay for the salary deferrals the IRS want you to send that money to their Simple IRA accounts “as soon as administratively feasible”. The suggested time phrase is within a week of the deduction in payroll. But you must be consistent with the timing of your remittances to your Simple IRA plan. If you typically submit contributions to your Simple IRA provider 5 days after a payroll run but one week you randomly submit it 2 days after the payroll run, 2 days just became the rule and all of the other deferral remittances are “late”. The company will be assessed penalties for all of the late deferral remittances. So be consistent.
Cannot Terminate Mid-Year
Unlike other retirement plans, you cannot terminate a Simple IRA plan mid-year. Simple IRA plan termination are most common when a company started with a Simple IRA, has grown in employee head count, and now wishes to put a 401(k) plan in place. You must wait until after December 31st to terminate the Simple IRA plan and implement the new 401(k) plan.
Special 2 Year Rule
If you replace your Simple IRA with a 401(k) plan, the balances in the Simple IRA can usually be rolled over into the new 401(k) if the employee elects to do so. However, be very careful of the special Simple IRA 2 Year Distribution Rule. If you process any type of distribution from a Simple IRA, within a two-year period of the employee depositing their first dollar to the account, and the employee is under 59½, they are hit with a 25% IRS penalty. THIS ALSO APPLIES TO DIRECT ROLLOVERS. Normally when you process a direct rollover from one retirement plan to another, no taxes or penalties are assessed. That is not the case in Simple IRA plan so be care of this rule. If you decide to switch from a Simple IRA to a 401(k), make sure you run a list of all the employees that maintain a balance in the Simple IRA plan to determine which employees are subject to the 2-year withdrawal restriction.
About Michael.........
Hi, I’m Michael Ruger. I’m the managing partner of Greenbush Financial Group and the creator of the nationally recognized Money Smart Board blog . I created the blog because there are a lot of events in life that require important financial decisions. The goal is to help our readers avoid big financial missteps, discover financial solutions that they were not aware of, and to optimize their financial future.
How Does A SEP IRA Work?
SEP stands for “Simplified Employee Pension”. The SEP IRA is one of the most common employer sponsored retirement plans used by sole proprietors and small businesses.
What is a SEP?
SEP stands for “Simplified Employee Pension”. The SEP IRA is one of the most common employer sponsored retirement plans used by sole proprietors and small businesses.
Special Establishment Deadline
SEP are one of the few retirement plans that can be established after December 31st which make them a powerful tax tool. For example, it’s March, you are meeting with your accountant and they deliver the bad news that you have a big tax bill that is due. You can setup the SEP IRA any time to your tax filing date PLUS extension, fund it, and capture the tax deduction.
Easy to Setup & Low Plan Fees
The other advantage of SEP IRA’s is they are easy to setup and you do not have a third-party administrator to run the plan, so the costs are a lot lower than a traditional 401(k) plans. These plans can typically be setup with 24 hours.
Contributions limits
SEP IRA contributions are expressed as a percentage of compensation. The maximum contribution is either 20% of the owners “net earned income” or 25% of the owners W2 wages. It all depends on how your business is incorporated. You have the option to contribution any amount less than the maximum contribution.
100% Employer Funded
SEP IRA plans are 100% employer funded meaning there is no employee deferral piece. Which makes them expense plans to sponsor for a company that eligible employees because the employer contribution is uniform for all employees. Meaning if the owner contributes 20% of their compensation to the plan for themselves they must also make a contribution equal to 20% of compensation for each eligible employee. Typically, once employees begin becoming eligible for the plan, a company will terminate the SEP IRA and replace it with either a Simple IRA or 401(k) plans.
Employee Eligibility Requirements
An employee earns a “year of service” for each calendar year that they earn $500 in compensation. You can see how easy it is to earn a “year of service” in these types of plans. This is where a lot of companies make an error because they only look at their “full time employees” as eligible. The good news for business owners is you can keep employees out of the plan for 3 years and then they become eligible in the 4th year of employment. For example, I am a sole proprietor and I hire my first employee, if my plan document is written correctly, I can keep that employee out of the SEP IRA for 3 years and then they will not be eligible for the employer contribution until the 4th year of employment.
Read This……..Very Important…..
There is a plan document called a 5305 SEP form that is required to sponsor a SEP IRA plan. This form can be printed off the IRS website or is sometimes provide by the investment platform for your plan. Remember, SEP IRA plans are “self-administered” meaning that you as the business owner are responsible for keeping the plan in compliance. Do cannot always rely on your investment advisor or accountant to help you with your SEP IRA plan. You should have a 5305 SEP for in your employer files for each year you have sponsored the plan. This form does not get filed with the IRS or DOL but rather is just kept in your employer files in the case of an audit. You are required to give this form to all employees of the company each year. It’s a way of notifying your employees that the plan exists and it lists the eligibility requirements.
Compliance Issues
The main compliance issues to watch out for with these plan is not having that 5305 SEP Form for each year the plan has been sponsored, not accurately identifying eligible employees, and miscalculating your “net earned income” for the max SEP IRA contribution.
About Michael……...
Hi, I’m Michael Ruger. I’m the managing partner of Greenbush Financial Group and the creator of the nationally recognized Money Smart Board blog . I created the blog because there are a lot of events in life that require important financial decisions. The goal is to help our readers avoid big financial missteps, discover financial solutions that they were not aware of, and to optimize their financial future.
