Posted on Thu, Aug 19, 2010
What can the Caterpillar settlement tell us about managing fiduciary risk?
Caterpillar, Inc. has a
received final approval on its settlement of a 4-year-old lawsuit in which the plaintiffs’ claimed the company should have offered cheaper investment options to its plan participants. Caterpillar will pay 16.5 million to participants in the companies’ 401(k) plans. More importantly, (at least to those of us who are not employed by Caterpillar) Caterpillar has agreed to substantial changes in their plan structure.
Among these plan structure changes are agreements to exclude “retail mutual funds as core investment options for a period of time”, provide additional fee disclosures, and a commitment to “increase and enhance” communications with employees about 401k investment options and fees.
Additionally, and perhaps most significantly, Caterpillar also agreed not to let investment consultants serve as investment managers and will not allow investment consultants to receive compensation from plan investments ("revenue sharing").
For over ten years, the company offered plan investors a group of mutual funds that were advised by a wholly owned subsidiary, creating an inherent conflict of interest that led to higher fees for participants. While this level of self dealing is rare, it’s not wholly unlike structures where investment advisory firms also offer investment management services, and recommend their own products.
Had Caterpillar hired an independent plan consultant in the first place they would likely not have ended up in their current predicament. An independent consultant would have seen the conflict of interest in using the subsidiary and would have no incentive or reason to offer retail mutual fund options under a plan of this size (institutional mutual funds, collective trusts and separate accounts are more appropriate). A quality independent plan consultant would also take responsibility for plan communication as this is an extremely important fiduciary responsibility component that is often undervalued or overlooked by plan sponsors.
Fiduciary 360, LLC estimates that ERISA litigation has increased 25% per year since 2005. Cases are increasingly moving from the individual to class action level and this case will likely exacerbate this growth, fiduciary issues must be taken seriously.
On its surface this case is one that revolves around fees, but this may be treating the symptom and not the disease. At its core this is a case about hiring quality plan consultants that are objective and will acknowledge their fiduciary responsibility to the plan, only then can you be sure your consultants are working in your best interest and managing your fiduciary risk.
This material has been sourced from case documents found at caterpillarerisasettlement.com and is provided for general information and is subject to change without notice. Every effort has been made to compile this material from reliable sources; however no warranty can be made as to its accuracy or completeness. The opinions expressed are those of the author and not necessarily those of Geneos Wealth Management, Inc.
Posted on Wed, Aug 11, 2010
Employers and participants alike are often left wondering what exactly they are paying in 401k fees. New rules from the Department of Labor (ERISA Section 408(b)(2)) aim to make the fees charged for 401k services more transparent in order to assure that the 401k fees charged are reasonable. But this begs the question:
What is a reasonable fee to pay for your 401k?
A study by the Investment Company Institute gives some solid guidelines as to what fees are reasonable in a 401k plan on a relative basis. The study found that the average fee for all-in 401k services (recordkeeping, administration & investment management) averaged 0.72% of assets.
This figure can be slightly misleading as it includes all plans across all asset levels. The large plan market, plans with assets in excess of $500 million, averaged just under 0.50%. While the “micro” plan market, plans with assets under a $1 million in assets averaged 1.89% in fees.
While there are too many variables to give a range that will work for all plans, the following list attempts to place some ranges on what should be considered reasonable. It is important to keep in mind that the law does not place any financial constraints on the actual fee charged, but only dictates the fee be reasonable for the services provided.
Sample Guidelines for Reasonable 401k Fees-
Departures from these guidelines can vary widely based on the plan dynamics and services provided.
Micro (Under $1 million) -1.40% to 1.80%*
Small ($1 - $5 million) -1.25% to 1.50%*
Lower Middle ($5 - $50 million) -0.72% to 1.25%*
Upper Middle ($50 - $500 million) -0.50% to 0.72%*
Large ($500 and Over) -0.30% to 0.60%*
(*These ranges are not to be considered legal or investment advice.)
The 401k service industry has been increasingly fee focused in recent years and the 408(b)(2) legislation will continue this trend. However, it is important to find a balance between services and fees when selecting a provider. Employee education and communication suffer as a result of the (often misguided) commoditization of the 401k industry. As employers have increasingly singled out fees as their primary decision making criterion employees are left looking for resources. As we move forward under the new regulations it is important to remember reducing cost is important, but it must be balanced with the quality of service provided.
Posted on Tue, Aug 03, 2010
Legislation is being introduced to address longevity risk for retirement savings under 401(k) and other defined contribution plans. The concern is that participants who are saving enough for their retirement through their defined contribution plan (most do not) will still be faced with the challenge of making these assets produce income for their entire lives. As life expectancy increases so too does the risk of outliving your assets, and congress is taking aim at this potential problem.
Retirement Security Needs Lifetime Pay Act of 2009
Sponsored in June of 2009 by Earl Pomeroy [D-ND], the Retirement Security Needs Lifetime Pay Act of 2009 (RSNLPA) seeks to directly address the issues of longevity risk concerning retirement income. RSNLPA encourages lifetime annuity contract purchases for retirees by offering tax incentives on the income produced by these contracts. By allowing the exclusion of up to 50% from gross income of lifetime payments from certain annuity contracts (up to $10,000) the legislation takes direct aim at the longevity risk for retirement investments.
As of the date of this posting the bill has been referred to the House Ways and Means Committee, but no action has been taken by the full House of Representatives.
This proposed legislation is indicative of a transformative mood in Washington when it comes to the operations of the nation’s 401(k) plans. Expect more legislation that attempts to address low plan participation rates, plan fees and longevity risk for retirees.
The insurance lobby will be fighting hard for the inclusion of annuity friendly legislation for both individual annuities and annuity products designed for defined contribution plans. However, providing retirees guaranteed income streams for life is expensive and complicated, adding these contracts will run counter to the push for low fees and full disclosure that is also taking place in Washington. We will keep you posted as the legislation progresses.
Posted on Tue, Aug 03, 2010
Legislation is being introduced to address longevity risk for retirement savings under 401(k) and other defined contribution plans. The concern is that participants who are saving enough for their retirement through their defined contribution plan (most do not) will still be faced with the challenge of making these assets produce income for their entire lives. As life expectancy increases so too does the risk of outliving your assets, and congress is taking aim at this potential problem.
Life Income Disclosure Act
Sponsored by Sen. Jeff Bingaman [D-NM] last December, the Life Income Disclosure Act (LIDA) has been referred to the House Committee on Health, Education, Labor and Pensions. The Act would amend ERISA to require plan sponsors to provide participants information on how their retirement savings would translate into lifetime income in retirement. The income figures would be based on the plan’s existing annuity (if offered) or a modeled formula established by the DOL. Plan sponsors would not be subject to any liability regarding the projections for retirement income under LIDA.
As of this posting no action has been taken on this bill from the full House of Representatives.
Posted on Thu, Jul 22, 2010
Effective July 16th, 2011 covered retirement plan service providers will need to comply with the “interim final regulation” under ERISA Section 408(b)(2) which details the rules under which service providers must disclose their fees. The new rules released last week finalize regulations originally proposed in 2007, and differ in many respects from the requirements that were initially proposed. We will have more details on the requirements of the regulation forthcoming.
The principal concept of the regulation is to help assure the compensation for service providers is reasonable. Any plan entering into an arrangement with a service provider where the compensation is not reasonable is considered to have entered into a prohibited transaction. The new rules add disclosure requirements for determining whether a service provider arrangement is reasonable.
Posted on Tue, Apr 13, 2010
Some voters are in favor of the estate tax repeal because they believe that the tax creates unfair double taxation. Others oppose it because they feel that the potential repeal is yet another example of the rich getting richer.
Many advisors, on the other hand, can’t stand the ambiguity of the current estate planning laws because it can be difficult to create quality estate and financial plans based on indefinite laws that expose clients to unexpected taxes.
There is no way to tell where the estate tax will finally end up once Congress addresses the 2011 “sunset period.” What we do know is that the repeal will not be permanent. This option already has the three-fifths majority it would need in order to pass. So the estate tax looks like it is coming back, but where is it headed?
Although we may see movement as early as this year, conventional wisdom says the congressional response to fixing estate tax problems will not come until 2009. Because of the election year politics, this matter will probably be held up with other tax issues, such as income tax cuts and the alternative minimum tax, and neither party is likely to make any pre-election waves. But after the election, Congress will be under the gun to make a decision — so 2009 looks like the year for answers.
Here and Now
The problem we face as advisors is that we still must counsel our clients despite this uncertainty. Changes in family structures, look-back provisions, and insurability problems all force us to give clients immediate answers about estate tax laws that, in all likelihood, will change substantially by the time our financial recommendations are implemented. That said, sitting on our hands and waiting for Congress to address the situation could prove to be very expensive for clients.
As advisors, we have no choice but to make an educated guess as to where the estate tax is headed. We must take a look at the evidence at hand and deliver a forecast. Luckily, Congress has given us some clues as to where the tax rates and exemption amounts will be once this is solidified.
Left or Right?
Perhaps the most interesting thing about this issue is how similar the proposals are from both the right and left sides of the political landscape. Therefore, we should be able to make a reasonable approximation of where things are headed.
The proposal that garnered the most support in the last Senate debate on the issue was from Sen. Max Baucus, D-MT. His estate tax reform proposal included a 45 percent tax on any amounts over the $3.5 million exemption. This would essentially extend the level of reform that will be in place in 2009 through 2012. Of course, because this only runs through 2012, a few years from now will leave us in the same position we are currently in. If this proposal, however, continues to gain
traction, it is very likely to come to fruition.
Baucus’ proposal may have the most support, but there are also others with some strong backing that may have legs when Congress finally tallies up their legislative votes. A proposal from Sen. Jon Kyl, R-AZ, sets the exemption rate at $5 million and caps the tax rate at 35 percent. His proposal should win favor for consistency since the exemption amount he proposes would be indexed for inflation, once again making estate planning a science rather than an art. Although this proposal has
garnered significant support, its major sticking point is that the exemption amounts are not required to be “deficit neutral.” If this issue can be resolved, there is a real possibility that the exemption amount will end up closer to $5 million.
All the recent proposals for revision (with the exception of the widely unpopular full repeal) came between this $3.5 million to $5 million range. However, the election of a populist presidential candidate might embolden some Democrats to take a harder line on estate tax reform. As such, we should be cautious when looking at the low side of exemption estimates for our clients.
It is, of course, more advantageous to hold off on costly estate planning issues until definitive and
stable laws have been put in place. Funding insurance premiums and setting up trusts can prove
costly and may be unnecessary, depending on how the laws work out. However, many clients do
not have that kind of time when it comes to their estate planning, especially if they have issues with
insurability.
But until Congress nails down the specific numbers, the ambiguous laws cannot preclude us from advising our clients. It is important that we share with them all of the facts to help them make informed decisions. Take your clients through the various possible outcomes for the exemption and taxation amounts. Explain what these scenarios would mean to each individual situation, and offer solutions where applicable. We may not know the outcome, but we should still prepare clients for
the various possibilities — this is the sort of counsel our clients value most.
Posted on Tue, Apr 13, 2010
The Department of Labor's new 403(b) regulations altered the requirements for plan documents, employee transfers, non-discrimination compliance and plan terminations. While the plan document requirements have garnered the most attention, a closer look at the regulations shows that the greatest change for small and midsize non-profit organizations is that most, if not all, 403(b) plans will now fall under the Employee Retirement Income Security Act (ERISA). In July, 2007, DOL issued a Field Assistance Bulletin on the new 403(b) regulations. A quick perusal of this FAB might lead one to question the above assertion, as the FAB lays out specific safe harbor requirements that, if followed, would exempt a plan from ERISA compliance. However, a close reading shows that compliance with these safe harbor regulations is impractical and nearly impossible. After laying out the ERISA safe harbor requirements, the FAB goes on to say "The employer could not, consistent with safe harbor, have responsibility for, or make, discretionary determinations in administering the program." Such discretionary determinations include:
- Authorizing plan to plan transfers
- Processing distributions
- Satisfying applicable qualified joint and survivor annuity requirements
- Determination of hardship withdrawals
- Processing Qualified Domestic Relations Orders (QDROs)
- Determining the eligibility and enforcement of loans
Any of the actions listed above, if completed by the employer, will force the plan to comply with ERISA. The only way to avoid taking on these actions yourself would be to hire a Third Party Administrator to handle these functions. However, no TPA could reasonably be expected to administer a properly compliant non-ERISA 403(b). Here's why. Every 403(b) plan is now required to maintain and adhere to a written plan document. To do so, a TPA must have access to comprehensive plan information in a timely manner. Non-ERISA 403(b) plan investment options are held in the name of the participant. In ERISA plans, the assets are owned by the plan, in trust, for the benefit of the employee. If the employee assets are held in various individual accounts in the employee's name, a TPA cannot be expected to aggregate all the plan information to assure the investments and contracts are compliant with the plan document. The various Tax Sheltered Annuity (TSA) and custodial account providers do not, in most cases, have the employer information; as a result, getting participant information back to an employer or TPA is unfeasible. The IRS realized this flaw and issued new guidance in November in an effort to remedy the issue. In a nutshell, this states that if the employer gives a "reasonable and good faith effort" to include the individual contracts as part of the employer's plan, the contracts will remain tax qualified. In addition, the guidance dictates that the issuer of these individual contracts make the same "reasonable and good faith effort" in providing the employer contract information. If it was realistic and possible to accomplish this information exchange, the IRS would just say do it, rather than ask the plans and contract issuers to make an "effort." The fact that this guidance was issued bolsters the assertion that trying to administer an employer plan with individual contracts is cumbersome, if not impossible. Clearly, this is meant to give plan sponsors some latitude on this issue, but why take the chance? The answer for 403(b) plans must then be to adhere to the ERISA laws, and in doing so transfer the assets of individual investors into plan-level ownership. This is how 401(k) plans function and it makes plan level administration and recordkeeping simple. It also gives better service and pricing to plan participants through economies of scale on their assets. Moving the assets to plan level ownership should satisfy the "reasonable and good faith effort" requirement in that the employer will contact all individual contract issuers to move the assets into plan ownership. Once this is the case and the assets fall under and adhere to the ERISA standards, there will no longer be a question as to their tax-qualified status under the new regulations. Moving 403(b) assets to a model that uses trustee ownership and follows ERISA has a number of advantages to the current structure. This structure has always provided automated recordkeeping, generally lower fees, improved service and more objective investment information. Now you can add one more benefit to this list, compliance with IRS and Department of Labor (DOL) regulations.
Posted on Tue, Apr 13, 2010
Retirement planning has changed dramatically in recent years. If your plan has been around for a while, you may have missed some opportunities to upgrade. It is important to analyze your plan regularly to make sure you are offering the best options available to your employees. Keeping up with these advancements will help your employees prepare for a secure retirement.Small plans - particularly those of professional corporations, medical practices and legal practices - are more likely to have antiquated structures. This is also true for larger companies with pooled profit-sharing accounts.In most instances, these plans utilize an investment adviser who is not a retirement specialist. While these advisers can offer quality investment advice, they may lack the expertise required to properly handle a qualified retirement plan, leaving plan sponsors at risk.Most of these investment advisers will rely on third-party administrators to handle plan compliance and reporting. Problems can occur when the investment adviser or TPA does not encourage the proper recordkeeping functionality.There are several major plan issues that can become cumbersome if not handled properly.Daily ValuationMost plan assets in small and midsize plans should be valued on a daily basis. This is a cornerstone of effective plan communication. It provides both the participant and the investment adviser a much more accurate and effective tool to plan for retirement.The alternative is plans that are valued quarterly or annually, which tend to be inflexible and are not as accurate as daily valued plans. Here's why:Let's say participants in a quarterly valued plan terminated on Jan. 5 and want to be paid out. They would have to wait until March 31, the end of the quarter, before their accounts can even begin to be valued. Then they would have to wait another one to three months, while the TPA compiles all the data needed to value their accounts. During this timeframe, the participants generally do not have access to their accounts and cannot move their money. In other words, they could be at risk if the market fluctuates.To make matters worse, the terminated participant does not receive any of the returns earned while the valuation is being prepared. Rather, they are shared by the remaining plan participants. For a terminated participant with a large balance, this can be a significant loss.Similar delays could occur with fund transfers, loan requests, contribution processing and participant statements. Daily valuation resolves all of these issues. Under the above scenario, with daily valuation, the money would be liquidated on Jan. 6 and wired on Jan. 7 to wherever the participant requested. All distributions and contributions are processed either the same day or the next day, and participant statements are delivered somewhere between five and 10 business days from the end of the quarter.While daily valuation has become the norm, a surprising number of plans continue to function on an old balance-forward structure.
Internet AccessParticipants should be given every opportunity to access their accounts to see balance, deposit and investment information. They also should be allowed to make investment changes in a simple and timely fashion.The recent Supreme Court ruling on the LaRue case, allowing individuals in plans to sue plan sponsors for investment losses, may have been avoided had the plan in question offered Internet access to its participants. Central to the case was the fact the participant was unaware that his trades had not been executed properly. Had the plan allowed participants to login to see account details, this situation could have been avoided.AutomationA common problem with the older plan setups is that there is no master account holding subaccounts for each participant. For each new participant, a new account needs to be created, which requires new account paperwork and a trustee signature. If the plan has a proper recordkeeping structure, only an enrollment form needs to be completed for the new participant.Additionally, modernized recordkeeping systems automate the deposit process. The deposits hit the accounts the day they are made. This decreases the chances of deposit error and results in the funds being invested more quickly.The basic difference between today's retirement plan systems and those of the past is the automation of plan administration tasks. If you are still running deposits, account setup, reporting and distributions on a manual system, you should look into changing your structure.Compliance and ReportingPlan testing and compliance can be challenging. This is especially true of small professional corporations with large disparities in compensation levels. Having all plan information readily available to the plan administrators is integral in order to keep the plan in compliance.If individual, self-directed accounts are used, aggregating plan information can become very labor-intensive. This may increase the chances for errors and can slow down plan compliance and reporting.
Posted on Tue, Apr 13, 2010
Providing a quality retirement plan for employees is a challenge for companies large and small. It is especially difficult for small employers because the resources and buying power they have to offer these plans can be limited.If your company is small, you likely have a low number of participant accounts and, therefore, relatively low plan assets. As a result, you may get less attention from service providers. Finding one that can provide both reasonable fees and quality service might be challenging.While some of these issues are the unavoidable result of economies of scale and the challenges service providers face in turning a profit on smaller plans, there are things you can do to keep up with the larger retirement plans.1. Finagling fees. For service providers to turn a profit, their clients with limited plan assets will have to pay higher fees on a percentage basis. This is especially true of start-up plans. With most start-up plans, typically there is little money to be made on assets in the early years, depending on the amount of deposits.Some employers would be surprised to hear that the bulk of the fees on new plans can come from the recordkeeper. Plans with $1 million or less can easily have 100 basis points in recordkeeping expenses. One way around this is to find a local recordkeeper that will bundle your small plan recordkeeping with the administration. The local provider will make a hard-dollar charge on the administration to offset limited, asset-based revenue on recordkeeping in the early years. Also, local, small recordkeeping shops will not have the high profit margins that larger firms require.Both of these issues can add up to lower expenses for your new plan.As a general rule, you should try to keep your overall plan expenses for recordkeeping, fund expense ratios and adviser services under 200 basis points. This should decrease substantially once the plan nears $1 million in assets.
2. Find the right vendor. Since the revenue that your adviser will generate on your plan might be limited, you may not be getting the attention that your employees deserve and need. Especially with small plans, it is important to make sure the service the plan receives from the vendor is in line with the fees being charged. Employees of small firms need quality counsel to ensure a secure retirement. It is incumbent upon you to find a vendor that can provide quality service for a reasonable price. There are providers out there that can properly serve the smaller market. You just need to take the time to find one that fits your needs.Of all the issues that go into a plan, the two that matter most when it comes to employees building retirement wealth are deferral amounts and asset allocation. Lots of small employers make the mistake of focusing solely on the investment fund lineup in their plans. While this is not something to be ignored, employee contributions and asset allocation have a much greater impact when it comes to the amount of money employees will have when they retire. These are issues that need to be addressed directly with plan participants.It is certainly worth some extra basis points to all members of the plan if the plan adviser is engaged in helping all employees on this front.
Posted on Tue, Apr 13, 2010
Although market losses are a big concern, employees shouldn't forget that being too conservative may result in interest rate and inflationary risks that can erode the value of their retirement savings.
Even the greenest investment adviser will tell investors to be more conservative with their investments as they approach and enter their retirement years. This is solid advice, as a sudden drop in stock prices easily can wipe out a lifetime of savings. However, there are dangers in having a portfolio that is too conservative.
When interest rates rise, the result is downward pressure on bond returns. While retirement plan participants should move toward fixed-income investments in retirement, if they take on too little risk in their portfolios, their investment returns likely will not keep up with the pace of inflation, resulting in a loss of real purchasing power.
The 10-year Treasury bond has a yield of 4.01%, slightly higher than the 3.64% average for one-year bank CDs. According to the latest Government Consumer Price Index Detailed Report, both are well below the current rates of inflation.
After a modest increase in the first quarter, inflation rose 7.9% in the second quarter of 2008 to bring annualized inflation to 5.5%. If this rate becomes stable, employees will need a 5.5% return just to retain current purchasing power in real dollars. Any money invested at current CD rates or treasury yields will result in a real loss.
We've experienced almost 30 years of decreasing interest rates. After a peak in 1981, the steady period of low inflation and decreasing interest rates has made bonds look overly attractive as post-retirement investment vehicles.
It is important to remember that bond returns have been bolstered by decreasing interest rates for many years. If increasing interest rates start to eat away at yields, and inflation continues its upward trend, large bond allocations in employees' retirement portfolios - once considered safe - can jeopardize their financial solvency in retirement. While bonds still belong in portfolios and might continue to make up the bulk ofparticipants' investments, it is important to mitigate the inflationary and interest-rate risks that their portfolios might need to weather.
TIPS to Follow
The well-known methods to mitigate pension risk are to buy inflation-linked assets or put in place inflation-linked swaps. While the average retirement investor will not and should not have access to swap investments, inflation-linked investments can be purchased in the form of Treasury Inflation-Protected Securities (TIPS). Where swaps are not an option, investors must resort to buying assets that are expected to perform relatively well in an inflationary environment.
TIPS principals increase with inflation, as measured by the consumer price index. When TIPS mature, the investor is paid the adjusted principal or original principal, whichever is greater. TIPS pay interest twice a year, at a fixed rate. The rate is applied to the adjusted principal, resulting in interest payments that rise with inflation.
For most investors, it makes the most sense to purchase TIPS in the form of a mutual fund or exchange-traded fund. There are a variety of TIPS investment options in both forms.Blue-chip stocks typically take a short-term hit when inflation spikes. But the annual inflation rate has run at 3.42% since 1913, about 7% under the average annual return for the S&P 500. Investing some assets in large-cap stocks will help investors stay ahead of inflation over time.
While there is some solid evidence of a commodities bubble, investing in commodities is a relatively direct strategy with which to keep pace with inflation.
Essentially, investing in commodities is investing in things that are going up in price. Be forewarned: While commodities are a hedge against inflation risk, they are also prone to long periods of flat returns. Still, their low correlation with the stock market makes commodities another attractive allocation strategy to manage inflation risk. While analyzing portfolios for the risk of direct investment losses is still a primary concern in retirement years, there are other risks that can compromise financial security in retirement. Heavy bond investments can lose substantial value if interest rates spike. Inflation can erode purchasing power. It is important to assess your portfolio for all of the risks you face and invest accordingly.