A ‘Bungled’ Service Proposition
Employers have a choice of different service models to assist with carrying out their fiduciary responsibilities for their 401(k) plan. Rightly done, the selected model can effectively offload all significant plan duties to service providers. There are three main areas of service delivery: investment advisory, record keeping, and compliance services. Think of record keeping as the internet site that allows participants to gain access to their accounts and choose their investments; think of compliance services as all the work necessary to prepare the annual government tax return for the plan, Form 5500.
One common business model is the combination (bundling) of record keeping with compliance services. This is known as a “bundled” service approach; we speak of a “bundled plan” with “bundled services” from a “bundled provider”.
Bundled providers dominate the upper segments of the 401(k) market. There are reasons for this:
• ERISA compliance is less nuanced for larger plans (for example, top-heavy and discrimination issues are not as prevalent);
• Optimizing contribution design is less available for larger plans since required contributions to non-highly compensated employees dilute the tax effectiveness of many plans;
• Providers can afford to support large plans with systems and very talented compliance-trained personnel;
• The independent accountant annual audit acts as a check-and-balance to bundled provider decisions and work product.
The key 401(k) investment platforms agree with this conclusion: wholesalers for these firms are often incentivized to sell very small (micro) 401(k) plans on an unbundled basis. These providers understand that retention is improved in the micro plan market when the compliance work is separated (unbundled) from record keeping and is handled by an independent Third Party Administrator (TPA). The easy extension to make is for advisors. On balance, an unbundled approach will aid an advisor in retaining plan assets in the micro 401(k) market.
What is the micro 401(k) market? Definitions vary: plans smaller than $10M, or certainly $5M, would be considered micro market 401(k) plans. How large is this segment? Upwards of 75% of the $6 trillion 401(k) market is in plans with assets less than $5M. So, the micro market 401(k) plans truly dominate the 401(k) space. Why?
• Design and compliance issues are preeminent in helping the business owners succeed with their own company retirement plan;
• Small plans often suffer from an overly automated approach from a bundled provider;
• Smaller companies don’t have HR departments that can handle the issues that lead to non-compliance;
• Small plans need help with investment company relations: small plans have more influence as a crowd with an independent TPA firm that has many plans with the 401(k) investment provider;
• Often the micro plan is not subject to audit, so there are no checks-and-balances for the record keeper.
This is why some have come to call “bundled” plans by the tongue in cheek “bungled” plans.
Here’s a recent example: a record keeper changed their software to not allow certain make-up contributions to cure a defaulted plan loan. On the phone, the record keeper operations team told the client that it would be illegal to continue to make payments. Since the client was unbundled, we were able to correctly quote the Code sections and fashion a way to allow the participant to continue making the loan payments. The advisor was very appreciative: the participant that the record keeper was harming happened to be one of the owners! This is an example where the service provider, to achieve efficiency, did not allow the plan to do what was clearly legal to do.
What happens in these instances if there is no independent TPA? A bungled mess.
A ‘Bungled’ Service Proposition