What vendors are required to offer a 401(k) plan?
It all sounds so simple. Every payday you and your employees divert a portion of your paycheck into their 401(k) account. Then, invest. Repeat each payday.
But it takes a surprising number of players to get the money from point A to point B.
First, 401(k) rules are complicated. Running a 401(k) involves IRS filings and abiding by Department of Labor regulations. And plan documents must reflect new rules as they come along. Participation and savings rates must not be skewed in favor of highly paid employees, and the plan must be monitored to make sure it is not “top heavy.”
There is a lot of administrative work that must be kept up with. Someone has to keep track of how much money is being contributed to each participant’s account, and whether the contribution is an employee deferral or an employer contribution, like a match. Someone has to decide what investments will be initially available, and if they remain suitable as the years go by. And someone needs to explain to the employees how the plan works and what those investments in the plan are designed to accomplish.
Who are the different players in your company’s 401(k)?
With all the different components in the 401(k) game, it can be difficult to keep them straight. That’s partly because some service providers play more than one role, and partly because some act behind the scenes. Here’s the low-down on the typical components to a 401(k) plan. But not all of them will necessarily be involved in every 401(k).
The different components and vendors to a 401(k) plan
The 401(k) Recordkeeper
The recordkeeper is the bookkeeper of the plan. This recordkeeper can also be the most and least visible service vendor of them all. The recordkeeper often runs the website where participants make changes to their accounts and view their statements. That’s high visibility. If the participants can name any 401(k) company, it is probably the recordkeeper.
But recordkeepers are also responsible for the nitty-gritty accounting that tracks the portion of a participant’s salary that winds up in the 401(k). The recordkeeper processes plan enrollment, generates plan documents and issues account statements. Paychex and ADP are two of the largest recordkeepers in the business. They are both payroll companies that also offer 401(k) plan services.
Other recordkeepers are part of large financial service companies. These large players include mutual fund and insurance companies. Traditionally, offering recordkeeping services allowed these large firms to generate more fees on their proprietary investment products, or allow them to bundle recordkeeping with other services.
There are also independent recordkeepers unaffiliated with either payroll or financial companies. These independent sorts don’t sell insurance, mutual funds or payroll services. They are all about keeping track of assets.
Recordkeepers may charge an asset based fee or they may charge per participant, perhaps in addition to a platform fee. Recordkeepers can also be paid indirectly through revenue sharing out of the mutual fund fees. Recordkeepers aren’t always the most straightforward when it comes to fee disclosure, yet it’s critical to know how much recordkeepers are charging for that particular service.
Often the term 401(k) provider is used interchangeably with “recordkeeper,” given the importance of tracking contributions and the high visibility of the recordkeeper’s website.
401(k) Third party administrator (TPA)
The TPA helps the plan sponsor comply with the plan documents and 401(k) regulations. The TPA helps with Department of Labor and IRS filings, including helping prepare, but not usually signing, the Form 5500. The TPA would also usually perform non-discrimination testing to make sure the plan is in compliance.
TPA services may be included under a bundled arrangement offered by a fund company or other financial services institution. The selling point of such an arrangement is that when compliance and investment services are performed by the same company, your 401(k) plan may run more efficiently. That could very well be the case, but many times such arrangements could include conflicts of interest, such as including high-cost proprietary funds in the line-up.
The custodian is the money mover and asset holder. The custodian transfers funds from company banks accounts to individual investment accounts. They also receive the investment allocations for each individual and execute those transactions. Often this vendor is paid a small asset based fee that is deducted from participant accounts.
This investment expert provides investment advice to employees and the investment committee. The advisor may also offer employee education so that participants understand the plan and its investments. The advisor usually receives an asset based fee paid from participant accounts. The advisor may also receive revenue sharing payments from mutual funds in the plan.
Some advisors work with a specific recordkeeper or investment company, and may only be able to offer a limited list of investment options on a particular recordkeeping platform. Others are independent advisors, who are able to look across multiple recordkeepers and investment options and help construct a plan that is right for your company and employees.
It’s important to know how you are paying your advisor and how those fees stack up against other arrangements. Make sure you understand if there are mutual fund classes that pay a commission to the advisor, if there is any monthly or quarterly fee paid by the company and if there is an asset based fee charged to participants.
We believe that advisors should offer different services to the company and their participants. These services can include 401(k) investment advice, 401(k) savings rate advice, credit card debt advice, saving for a home, student loans, social security advice, student loan advice, 401(k) rollover advice, and or non-401(k) investment advice. We offer these services as a fiduciary, which means that we are legally (and morally) required to provide advice based on what we believe to be in the best interest of the participant – not because we are motivated to earn more commission or asset based fees.
And make sure to know what fiduciary role your advisor is taking on. If the advisor is acting as a 3(21) fiduciary, you retain the fiduciary responsibility (and liability) for the plan investments. If your advisor is a 3(38) fiduciary, they are taking on all responsibility for selecting, monitoring and changing up plan investments. Finally, a select few 401(k) advisors will bring on an administrative fiduciary, known as a 3(16) fiduciary. You can read more on the different types of fiduciary coverage that advisors offer here.
Brokers are often confused with advisors – after all, they both help plan sponsors pick investment lineups. However, the two financial professionals are quite different. Specifically, brokers are typically commissioned salespeople who are not held to the same fiduciary standards as advisors acting as investment fiduciaries. We’ve created an article that compares brokers vs. advisors. This piece has useful checklists that you can use to help determine which type of a professional your plan has.
Plans with more than 100 eligible participants are required to undergo an annual audit. The auditor will make sure contributions are accounted for appropriately, that the fidelity bond is sufficient, and will review internal controls. For keeping all these ducks in a row, the auditor typically bills the plan sponsor directly.
401(k) Fund Managers
401(k) plans generally offer a set menu of investment options. These investment options are typically mutual funds offered by an investment company, sometimes called a “fund manager.” As described by the SEC, a mutual fund is an “SEC-registered open-end investment company that pools money” from many investors and invests the money in stocks, bonds, or other assets. These funds are managed by an SEC-registered investment adviser – an investment company like Vanguard, Fidelity, Janus and others. As an example, an employee with a 401(k) may log into a Fidelity recordkeeping website and elect to invest in a fund managed by Vanguard.
Some of the better known providers
In January we published an article that listed the top 401(k) providers to small and mid-sized companies, ranked by size. The majority of these vendors are companies running other businesses that they have integrated with recordkeeping. They include payroll companies and financial giants.