Business owners often hire their personal wealth manager to manage their firm's retirement plan. Here's what to consider before making the same mistake.
If you have a private wealth manager who advises you on personal financial matters, has that advisor asked to run your company’s 401(k)? After all, you already have a relationship with them, and trust is the cornerstone of any business arrangement.
But be careful! While your wealth manager may be doing a good job investing your personal assets or handling your estate planning, that is no guarantee that he or she knows anything about 401(k) management.
Here are nine questions to ask your wealth manager to see how well their firm fits the needs of your company’s retirement plan.
1. What kind of experience do they have with 401(k) plans?
If your advisor is great at managing your personal assets – congratulations! You’ve got a good one. But is this investment manager also an expert at putting together investment lineups for 401(k)s, or recommending default investments for uncertain employees? While your advisor may be able to explain esoteric investment concepts suitable for your portfolio, can this person explain to young, novice investors why they should own stocks?
Some advisors pursue small 401(k) accounts with the idea of attracting the business of the firm’s highest-paid employees. It’s important to know if the advisor’s focus is on attracting high net worth clients, or making sure every employee starts saving for retirement. To get a straight answer, it may be worth asking your financial advisor for the breakdown of the assets they manage — private wealth vs. corporate retirement assets. If they skew too heavily toward private wealth, they very likely aren’t an expert in retirement plan management.
2. What 401(k) services does the wealth manager provide?
There are a lot of moving parts to your company’s 401(k). And depending on the tasks performed by the plan’s providers, a retirement plan can quickly become a giant to-do list for management. So the first order of business is to ask exactly what services the wealth manager’s firm wishes to provide. At a basic level, do they perform administrative work, or are services limited to acting as the plan’s investment advisor? Do they provide payroll integration or verify that employee deferral rates match their elections? Who tracks employee eligibility or approves hardship withdrawals? What about regulatory services? Who completes and signs Form 5500? Who performs and reviews non-discrimination testing?
3. Will they serve as fiduciary?
And if so, what kind of fiduciary? Just as it’s important to understand the services to be provided by your wealth manager, it’s just as important to know what liabilities this provider takes on while servicing the 401(k). When it comes to investments, if you hire a 3(21) ERISA fiduciary, you will get help selecting and maintaining the plan’s investment lineup. But you will ultimately remain responsible for the investment decisions.
If you hire a 3(38) ERISA fiduciary, you pass on the responsibility of selecting and maintaining an investment lineup. And because a 3(38) fiduciary has full discretion, they also take on all the liability for investment selection. When the investment advisor is a 3(38) fiduciary, investment advice is more likely to be impartial given the legal liability associated with the designation.
If you hire a 3(16) fiduciary you will have a provider responsible for day-to-day administration and maintaining documentation of plan compliance. A 3(16) fiduciary can take on a lot of the work associated with running a 401(k), even ensuring that the rules of the plan are administered correctly.
4. What are the 401(k) fees?
Fees are a big reason that 401(k) plans can be so confusing. There are recurring hard dollar costs as well as asset based fees that can cover everything from recordkeeping to mutual fund expenses. Your potential provider should be able to explain the total all-in cost of the services they provide. Since investment costs typically account the bulk of 401(k) expenses, be sure to understand the average fund costs that you could expected to pay. And be sure to compare those costs against industry averages.
5. How are the 401(k) fees paid?
Tracking per account fees and other forms of direct compensation paid from the plan assets or by the plan sponsor can be relatively straightforward. But not all fees are transparent and easy to understand. Consider mutual fund expenses. The investment management fee compensates the investment manager. Easy enough. But total fund expenses can include much more than the investment management fee. These additional expenses are often called revenue sharing fees. They can include 12(b)1 fees which represent a payment to the broker, sub-transfer agency fees, which are paid to a third party for fund accounting activities, and shareholder servicing fees, which are forwarded to other service providers, like recordkeepers.
While mutual fund expenses can be confusing and costly, they don’t have to be. There are plenty of providers who don’t include funds with 12(b)1 fees in the lineup, and that don’t structure the plan with shareholder servicing fees. Revenue sharing fees not only add to the cost of your plan, but they can impugn the integrity of your fund lineup. If your advisor’s firm is paid by the 12(b)1 fees generated by the mutual funds in the lineup, how do you and your employees know those funds are the best ones for your plan?
6. Will your company’s plan get the cheapest share classes?
An investment advisor seeking your business should provide information on the average expense ratio of funds in their typical lineup. But how does that typical lineup compare with the funds that would be in your plan? In particular, would your lineup be loaded with the most expensive share classes offered by the provider?
The term “share class” has nothing to do with the way the portfolio is being managed. The reason a single fund can have half a dozen share classes is because those revenue sharing fees mentioned above can vary customer by customer. Rather than sending a small plan a higher bill for their services, the fund company will pack more fees into a one share class than another. Because the investment advisor can provide input into fund selection – or in the case of a 3(38) fiduciary, have full discretion to pick the funds – it’s important to know if your lineup will include a slew of funds with expensive share classes.
This lack of transparency has not gone unnoticed by the regulators. In a recent speech at a New York conference, the SEC chairman specifically mentioned high cost share classes as “opaque,” along with the practice of using plan assets to cover fees more appropriately paid by the advisory firm. The chairman said he expects the SEC to be “active in pursuing cases where hidden or inappropriate fees are an issue.”
7. What will the wealth manager’s investment lineup look like?
Fund lineups are best when they have a Goldilocks feel to them – not to many funds and not too few. So two key questions for any advisor are:
- Are there enough investment options to meet the needs of our oldest and youngest employees?
- Are there so many options that employees could be paralyzed into inaction and fail to contribute to the plan, or wind up with an inappropriate asset allocation?
It’s also important to know if your prospective fund lineup will be chock full of proprietary or high cost funds. According to research by ICI/Brightscope, nearly two-thirds of 401(k) plans include funds proprietary to the recordkeeper in their lineup.
Alternatively, will the fund lineup include low cost, passive alternatives? What about target date funds? But beware, “target date” does not automatically mean low cost. Watch out for target date funds that bundle high cost, actively managed funds with an additional fee slapped on top for good measure.
8. Is the firm on solid footing?
Active managers have lost assets to passive alternatives in recent years. It’s important to know how this trend has affected your advisor’s 401(k) business, and if the firm is committed to the 401(k) marketplace. And a good way measure that commitment is to ask…
9. What kind of employee education will be provided?
Will employees be able to access this education at their convenience and on mobile devices? Will the education emphasize the simple need to save along with investment concepts like asset allocation and risk? Will the education process help employees understand the investment lineup? How about helping them understand which funds are bond funds and which are stock funds? Will they know the difference between active and passive, and how fund expenses impact returns? Will employees have access to an investment professional able to address personal finance questions involving credit card or student loan debt?
**Key Takeaway: **With all of its moving parts it can be hard to remember that the 401(k) was created to help you and your workers save money for retirement. Leveraging an expert’s advice can ensure that you and your employees do just that, but don’t simply hire the first option that offers their services! Many professionals offering to manage your company’s plan–typically private wealth managers and brokers–aren’t very knowledgeable about retirement plans. Others may even have incentives to load up your plan with expensive funds!