On March 15, 2018, the Fifth Circuit Court of Appeals invalidated the Department of Labor’s (“DOL”) Fiduciary Rule in a 2-1 decision. If the DOL does not request a rehearing within 45 days, the regulation will die. If that happens, the rules for 401(k) investment advice that existed before the Fiduciary Rule will return. That means some financial advisors – basically, brokers and insurance agents - will once again be able to give conflicted investment advice by recommending high-priced 401(k) investments that pay them rich commissions over less expensive - but comparable - alternatives on May 7, 2018.
However, regardless of the Fiduciary Rule's fate, I think an important legacy of its debate is that employers are now more conscious than ever of their fiduciary responsibility to evaluate their 401(k) provider’s conflicts of interest – to ensure they don’t impact the provider’s performance or fees. Unfortunately, meeting this important responsibility can be difficult because few conflicts are as obvious as conflicted investment advice. In fact, many can even seem beneficial at first blush! However, if you’re 401(k) plan sponsor, you can’t be fooled – all conflicts of interest incentivize bad 401(k) provider behavior so you must evaluate each to protect participant interests and limit your fiduciary liability. Below are three common conflicts to be on the lookout for.
“Preferred” fund lists
401(k) providers will sometimes limit your plan investment options to a list of “preferred” funds. Because there are thousands of investment funds available to 401(k) plans today, this limitation can seem like a Godsend. However, the funds on these lists are rarely the best – they’re simply the funds that pay enough hidden 401(k) fees to the 401(k) provider. These hidden fees make excessive 401(k) fees and investment expenses more likely.
In short, picking plan investments from a limited list of funds may seem convenient, but the approach can saddle your 401(k) plan with over-priced funds that benefit your 401(k) provider more than plan participants. Two better options are picking a fund lineup modeled after the Federal Thrift Savings Plan or hiring an investment adviser for impartial professional advice.
“Off-the-shelf” 401(k) plan designs
401(k) providers will sometimes limit your 401(k) plan design options to a handful of canned, “off-the-shelf” designs. While this limitation can seem convenient, it’s not meant for your benefit. It’s meant to steer you towards basic plan designs that are cheap for your 401(k) provider to administer.
Don’t fall for it! There is no such thing as a one-size-ﬁts-all 401(k) plan and choosing the wrong plan design can cost your company thousands of dollars in unnecessary contributions or angry executives due to failed testing. If a 401(k) provider is unwilling to custom design a plan for you based on your company’s plan goals and budget – go elsewhere. This process is can often be completed in 30 minutes or less - a small amount of time to spend when you consider the consequences of poor plan design.
“Bundled” 401(k) services
Lots of companies offer 401(k) services in addition to other corporate services - including banks, insurance companies and payroll firms. Often, these companies will discount their services when you “bundle” two or more of them. In my experience, payroll companies and banks bundle their 401(k) services most aggressively. For example, payroll companies will discount their payroll services when you hire their 401(k) services, while banks will offer lower interest rates on loans or raise rates on savings.
The problem? 401(k) participants often pay higher fees when employers bundle 401(k) services with other corporate services. In a 2016 small business 401(k) fee study, we found only insurance companies charged higher 401(k) fees than payroll companies. If you’re considering bundling, you want to be sure 401(k) plan participants aren’t harmed to keep your fiduciary liability in check.
Overlook 401(k) conflicts of interest at your peril!
Given the Trump Administration’s misgivings about the Fiduciary Rule, there is a good bet the DOL will let the regulation die. That’s too bad because it’s an important consumer protection that protects 401(k) participants and sponsors from following conflicted investment advice by brokers and insurance agents.
However, there are lots of other conflicts of interest in the 401(k) industry. While no conflict automatically triggers excessive 401(k) fees - or otherwise lowers participant returns - 100% of the time, you must be able to identify and evaluate each to confirm as much. Otherwise, you risk fiduciary liability.