What’s the real cost savings when plan sponsors select a discount third-party administrator for their 401(k) plans? They may still end up paying for what they don’t get.
The Employee Retirement Income Security Act of 1974 (ERISA), which outlines the standards for private industry retirement plans, mandates that the compensation paid to third-party administrators of an employee benefit plan must be “reasonable.” For many plan sponsors, settling on the right and reasonable service provider option can be a difficult task because ERISA gives no hard and fast definition for the term “reasonable.”
Many times, the requirement for fees to be reasonable drives plan sponsors to choose the third-party administrator that quotes the lowest fee. On one hand, selecting a discount provider provides assurance in complying with the reasonable fee requirement; but on the other hand, those administrators that quote the lowest fees can also often be the least credentialed and have the least amount of technical experience. The trouble with using a third-party administrator that has less experience is that, unfortunately, remedying certain problems with employee benefit plans can cost far more in the long run than avoiding those errors in the first place. That’s why it’s important to thoroughly vet your provider before you make a selection.
But how can you know when you’ve identified the sweet spot of reasonable fees and quality work? How can you be assured that your third-party administrator has the right procedures in place to protect your plan from error? How can you navigate selecting a benefit provider that satisfies the “reasonable” requirement that still offers reliable services that won’t cost you more in remediation in the long run?
QUESTIONS TO ASK YOUR 401(k) PLAN ADMINISTRATOR AND WHY THE ANSWERS MATTER
Below, I’ve outlined five questions that you should ask your 401(k) plan administrator before you commit to selecting a particular vendor—and why it’s important to know the answers.
- What to ask: Do you employ industry-credentialed staff?
Why it matters: Industry credentials by the American Society of Pension Professionals & Actuaries (ASPPA) or the National Institute of Pension Administrators (NIPA) require the candidate to pass a series of exams to show knowledge of the code. In addition, there is continuing education required of these individuals. These credentials demonstrate a commitment to knowledge in the complex field of employee benefit plans, which means that providers that have them are likely to be more experienced and informed.
- What to ask: Do you require copies of W-2 and W-3s, as well as all components of compensation?
Why it matters: Compensation is compensation, right? Not necessarily. Qualified employee benefit plans have multiple definitions of compensation, and these different definitions can be used for different purposes within the plan. There are numerous reasons why a provider should reconcile back to W-2s. For one, it allows a provider to verify all employees are accounted for and that deferrals are properly accounted for. By providing the full details of compensation, your plan can take advantage of appropriate options.
- What to ask: Do you take the time to explain the terms of the plan to ensure our team members fully understand?
Why it matters: In many cases, the task of providing information to a provider falls on an employee who doesn’t have any knowledge of the plan. By educating these employees, it raises awareness within the plan sponsor’s own organization, which creates efficiencies from the inside out. Having a provider that will make the effort to ensure your team understands can benefit your plan in the immediate work, but it’s also an investment in your employees for the future wellbeing of your 401(k) plan.
- What to ask: Are you solely focused on plan administration services?
Why it matters: Finding someone dedicated to the complex rules of retirement plans to assist in the establishment and operation of your plan means that the services that you need are at the core of your provider’s expertise. Engaging a provider that primarily specializes in processing payroll or recordkeeping assets could mean that the task of assisting with the operation of your retirement plan won’t be the main focus.
- What to ask: Do you bundle plan administration services?
Why it matters: Think about your plan administration having checks and balances. Bundled providers typically provide several services, but independent third-party administrators divide plan responsibilities. Selecting an independent third-party administrator assists in holding other providers accountable.
Asking these questions will inform you about your third-party administrator’s priorities, capabilities and expertise so that you can make the best decision for your 401(k) plan and for your employees.
A CASE STUDY OF ONE THIRD-PARTY ADMINISTATOR
As a demonstration of the importance of asking these questions, consider this true scenario from my recent experience with a new client. A company’s 401(k) plan needed to be reviewed for what was described, at the time, as a potential issue with a discretionary match in a safe harbor 401(k) plan.
Terms to Know for this Example
Discretionary match – an optional contribution that an employer makes to a participant’s 401(k) plan
Traditional 401(k) plan – a type of 401(k) plan that is subject to nondiscrimination testing and, therefore, limits the amount highly-compensated employees can contribute
Safe Harbor 401(k) plan – a type of 401(k) plan that, for a set contribution, essentially buys a sponsor’s way out of the limits set in a traditional 401(k) plan
The plan sponsor is a small employer with 38 eligible participants, and plan assets were approximately $1.5 million. The plan is a safe harbor 401(k) plan that uses the 3% nonelective contribution to satisfy the required ADP/ACP nondiscrimination testing. The third-party administrator was a regional discount provider.
From 2013 until the end of the 2016 plan year, the plan sponsor allocated a discretionary match that was in violation of the safe harbor and plan’s limitations. The contribution was pushed out of safe harbor status because the plan sponsor was matching on deferrals greater than 6% of compensation and because the match rate increased as the deferral rate increased. Each of these issues on its own would have been enough to violate safe harbor standards.
As information was gathered, it was determined that since 2009, the plan sponsor was also excluding all part-time employees. The plan document in effect at the time stated that any eligible employee who performed six months of service would be eligible to participate in the plan.
These are issues that many experienced third-party administrators have policies and procedures in place to catch.
Resolution and Results
The IRS has prescribed methods to fix certain operational failures, but those methods are generally limited to the prior two years. This particular case exceeded that timeframe, so ERISA counsel was engaged to assist with bringing the plan back into safe harbor compliance.
In order to correct the errors caused by the discount third-party administrator’s lack of diligence, the employer had to make a large deposit into the plan, not to mention the legal and administrative fees paid to remedy the problems. In the end, it cost this employer over $200,000 to correct the failures that could have been quickly corrected or prevented altogether with the right procedures set in place by the third-party administrator.
You shouldn’t expect any 401(k) administrator to be perfect. There are, after all, humans behind the calculations. With the right procedures and processes, errors should be caught within a short time frame. It’s important to ask what your current 401(k) administrator is doing to prevent an issue from becoming a problem for your 401(k) plan.
HOW TO MOVE FORWARD WITH CHOOSING A THIRD-PARTY ADMINISTRATOR FOR YOUR 401(k) PLAN
At the end of the day, a plan sponsor’s responsibility is to do what is best for the 401(k) plan. Asking the questions outlined above and knowing the answers from your 401(k) administrator can equip you to make an informed decision about your provider and protect your employee benefit plan. Finding the right provider that will meet your needs can undoubtedly save you time, effort and money in the long run.
Warren Averett Benefit Consultants are experts in designing retirement plans, including 401(k) plans, and helping companies streamline plan administration. If you have questions about how to select the right provider or if you want to know what plan may be the best fit for your company, contact Warren Averett Benefit Consultants, or you can contact me directly.