the impact of irs regulation 408(b)(2) & your 401(k)
TRANSCRIPT
The Impact of 408(b)(2)& Your Company’s Defined Contribution Plan
www.nyhart.com
Presented by Eric Roberts, RIA
Copyright 2011. All Rights Reserved.
Eric RobertsFiduciary Consultant
[email protected] | (317) 845-3511
Qualifications or certifications:Accredited Retirement Plan Consultant through The Society of Professional Asset-Managers and Recordkeepers and Series 63 and 65 designations..
1. How did we get to 408(b)(2)?
2. What is 408(b)(2)?
3. Review an example of how 408(b)(2) creates transparency in costs of a ‘free’ 401(k)
4. Demonstrate how 408(b)(2) unveils how a vendor can reduce plan costs and create income
5. Show impact on plan participants
6. Outline an action plan
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How did we get to 408(b)(2)?
• Hidden payments (a.k.a. indirect compensation) to a plan’s service provider might include 12b-1 and Sub-TA fees paid from the plan’s investment funds.
• A plan sponsor’s lack of knowledge that such hidden payments exist can give a false impression that they’re receiving “free” administrative services.
Hidden Fees and Conflicts of Interest
• This lack of understanding creates a potential conflict of interest for the administrative provider.
• Service providers who steer plan clients to arrangements with the highest level of indirect compensation presumably are able to receive fees in excess of what plan clients would otherwise agree to if they knew the true cost of services.
Hidden Fees and Conflicts of Interest
Without full disclosure of the indirect compensation paid to the plan’s service providers, the plan and its participants might end up paying fees that are unreasonable, resulting in a breach of its fiduciary duties under ERISA.
Hidden Fees and Conflicts of Interest
The Fee Transparency Timeline
Form 5500Effective
1/1/09
Form 5500Effective
1/1/09
408(b)(2)Interim Final
7/10/10
408(b)(2)Interim Final
7/10/10
404(a)(5)Final Reg
10/20/10
404(a)(5)Final Reg
10/20/10
408(b)(2)Takes Affect
4/1/12
408(b)(2)Takes Affect
4/1/12
404(a)(5)Takes Affect
6/1/12
404(a)(5)Takes Affect
6/1/12
ERISA §408(b)(2) is designed to increase fee transparency
What is Regulation 408(b)(2)?
• Amends a prohibited transaction rule under ERISA and the Internal Revenue Code. That rule says that it is a prohibited transaction for a plan to enter into an arrangement with a service provider unless the “arrangement” is reasonable and the compensation being received by the service provider is reasonable.
• The regulation adds disclosure requirements for the service provider so that plan fiduciaries can determine whether a service provider arrangement is reasonable.
ERISA § 408(b)(2)
Defined Contribution (i.e. 401(k), ERISA 403(b)) and Defined Benefit Pension plans. Excluded from this definition:
• IRAs
• Simplified employee pensions, and
• Simple retirement accounts.
Covered Plans
Let’s Run An Analysis for the Broker-Dealer
“Free” Plan
SITUATION ANALYSIS
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COMPANY: XYZ & Son Manufacturing, Inc.
LOCATION: Indianapolis, IN
EMPLOYEES: 234
Plan Assumptions• 401(k) with $10 million in assets• 200 participants with account balances• Company has one location
Services Needed• Administration• Recordkeeping• Investment Related• Employee Communication / Education
SITUATION ANALYSIS
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Current Plan’s Fee Schedule of ServicesCOMPANY: XYZ & Son Manufacturing, Inc.
Annual Administration: No Charge
Annual Recordkeeping Per Participant: No Charge
Broker Fee: Paid from 12b-1 Fee
Mutual Fund Expense: See schedule
SITUATION ANALYSIS
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Current Plan – Example Fund From Portfolio
American Balanced Fund (% as of 6/30/11)
Cash: 8.60% U.S. Stocks: 57.90% Non-U.S. Stocks: 6.40% Bonds: 27.00% Other: 0.10%
100.00%
SITUATION ANALYSIS
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Current Plan – Share Class SelectedAmerican Balanced Fund
Share Class / Target TickerExpense
Ratio
R-1 RLBAX 1.40%R-2 RLBBX 1.40%R-3 RLBCX 0.94%R-4 RLBEX 0.65%R-5 RLBFX 0.35%R-6 RLBGX 0.30%
SITUATION ANALYSIS
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What are the fees and expenses hidden inside
the fund and in this particular share class?
What are the fees and expenses hidden inside
the fund and in this particular share class?
SITUATION ANALYSIS
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Current Plan – Share Class SelectedAmerican Balanced Fund
Included in Expense Ratio
Share Class / Target TickerExpense
RatioMngmnt Fee 12b-1 Fee
Sub-TA Fee
R-1 RLBAX 1.40% 0.24% 0.99% 0.10%R-2 RLBBX 1.40% 0.24% 0.75% 0.25%R-3 RLBCX 0.94% 0.24% 0.50% 0.15%R-4 RLBEX 0.65% 0.24% 0.25% 0.10%R-5 RLBFX 0.35% 0.24% none noneR-6 RLBGX 0.30% 0.24% none none
SITUATION ANALYSIS
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Let’s Reveal The Hidden Costs of the FundAmerican Balanced Fund
Included in Expense RatioShare Class / Target Ticker Expense Ratio Mngmnt Fee 12b-1 Fee Sub-TA Fee
R-3 RLBCX 0.94% 0.24% 0.50% 0.15%
Plan Costs under Broker-Dealer Scenario Costs% of Plan
AssetsAdministration & Recordkeeping $0 0.00%
Investment $94,000 0.94%Total $94,000 0.94%
SITUATION ANALYSIS
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Let’s Reveal The Hidden Costs of the FundAmerican Balanced Fund
Included in Expense RatioShare Class / Target Ticker Expense Ratio Mngmnt Fee 12b-1 Fee Sub-TA Fee
R-3 RLBCX 0.94% 0.24% 0.50% 0.15%
Share Class Ticker Fund Expense Mngmnt Fee 12b-1 FeeSub-TA
FeeR-3 RLBCX $94,000.00 $24,000.00 $50,000.00 $15,000.00
SITUATION ANALYSIS
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Let’s Reveal The Hidden Costs of the FundAmerican Balanced Fund
Included in Expense RatioShare Class / Target Ticker Expense Ratio Mngmnt Fee 12b-1 Fee Sub-TA Fee
R-3 RLBCX 0.94% 0.24% 0.50% 0.15%
Share Class Ticker Fund Expense Mngmnt Fee 12b-1 FeeSub-TA
FeeR-3 RLBCX $94,000.00 $24,000.00 $50,000.00 $15,000.00
Total Cost: $94,000or
$470 per participant
Total Cost: $94,000or
$470 per participant
SITUATION ANALYSIS
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The Broker-Dealer hasNO FIDUCIARY LIABILITY
OR RESPONSIBILITY.
Let’s Run An Analysis When An
Registered Investment Adviser
(As A Fiduciary)
SITUATION ANALYSIS
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RIA’s Fee Schedule of ServicesCOMPANY: XYZ & Son Manufacturing, Inc.
Annual Administration: $3,000
Annual Recordkeeping Per Participant: $50/per
RIA Flat Fee: $25,000
Mutual Fund Expense: See schedule
SITUATION ANALYSIS
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RIA Plan– Proper Share Class SelectedAmerican Balanced Fund
Included in Expense Ratio
Share Class / Target TickerExpense
RatioMngmnt Fee 12b-1 Fee
Sub-TA Fee
R-1 RLBAX 1.40% 0.24% 0.99% 0.10%R-2 RLBBX 1.40% 0.24% 0.75% 0.25%R-3 RLBCX 0.94% 0.24% 0.50% 0.15%
R-4 RLBEX 0.65% 0.24% 0.25% 0.10%R-5 RLBFX 0.35% 0.24% none noneR-6 RLBGX 0.30% 0.24% none none
SITUATION ANALYSIS
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RIA Plan– Proper Share Class SelectedAmerican Balanced Fund
Included in Expense Ratio
Share Class / Target TickerExpense
RatioMngmnt Fee 12b-1 Fee
Sub-TA Fee
R-1 RLBAX 1.40% 0.24% 0.99% 0.10%R-2 RLBBX 1.40% 0.24% 0.75% 0.25%R-3 RLBCX 0.94% 0.24% 0.50% 0.15%
R-4 RLBEX 0.65% 0.24% 0.25% 0.10%R-5 RLBFX 0.35% 0.24% none noneR-6 RLBGX 0.30% 0.24% none none
SITUATION ANALYSIS
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Current Plan – Share Class SelectedAmerican Balanced Fund
Included in Expense Ratio
Share Class / Target TickerExpense
RatioMngmnt Fee 12b-1 Fee
Sub-TA Fee
R-1 RLBAX 1.40% 0.24% 0.99% 0.10%R-2 RLBBX 1.40% 0.24% 0.75% 0.25%R-3 RLBCX 0.94% 0.24% 0.50% 0.15%R-4 RLBEX 0.65% 0.24% 0.25% 0.10%R-5 RLBFX 0.35% 0.24% none noneR-6 RLBGX 0.30% 0.24% none none
No Hidden Fees Plus Lower Costs for Shares.
No Hidden Fees Plus Lower Costs for Shares.
SITUATION ANALYSIS
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Let’s View the Overall Fees with the RIAAmerican Balanced Fund
Plan Costs under RIA Scenario Costs% of Plan
AssetsAdministration $3,000 0.03%
Recordkeeping ($50 x 200) $10,000Recapture Fee used to offset Recordkeeping ($10,000) 0.00%
RIA Fee $25,000Recapture Fee used to offset RIA Fee ($25,000)
Investment $65,000 0.65%Total $68,000 0.68%
SITUATION ANALYSIS
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Let’s View the Overall Fees with the RIAAmerican Balanced Fund
Share Class Ticker Fund Expense Mngmnt Fee 12b-1 Fee Sub-TA FeeR-4 RLBEX $65,000.00 $24,000.00 $25,000.00 $10,000.00
SITUATION ANALYSIS
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Let’s Reveal The Hidden Costs of the FundAmerican Balanced Fund
Included in Expense RatioShare Class / Target Ticker Expense Ratio Mngmnt Fee 12b-1 Fee Sub-TA Fee
R-3 RLBCX 0.94% 0.24% 0.50% 0.15%
Share Class Ticker Fund Expense Mngmnt Fee 12b-1 FeeSub-TA
FeeR-3 RLBCX $94,000.00 $24,000.00 $50,000.00 $15,000.00
Total Cost: $68,000or
$340 per participant
Total Cost: $68,000or
$340 per participant
What difference does this make for
me and my participants?
Let’s Take An Average Employee• $40,000 Salary at Age 28• Initial 401(k) Balance at Age 28:
$10,000• Annual Pay Growth: 2.5%• Deferral Rate: 6%• Employer Match: 3%• Deferrals made Bi-Monthly
How fees impact overall retirement earnings for a participant.
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How fees impact overall retirement earnings for a participant
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Lost Retirement Savings:
$50,750 or 7.81%
Lost Retirement Savings:
$50,750 or 7.81%
Steps You Can Take Now Before 408(b)(2) Takes Affect1. Identify who your “responsible plan fiduciary” is – that person in
your organization who has the authority to enter into, or extend or renew, a contract or arrangement with a service provider
2. Identify who your “covered service providers” are
3. Know all fees – request an ‘all-in’ fee disclosure from your current vendor
4. Get an independent audit of your current fees
5. Get a benchmarking of your total fees against industry standards
6. If in RFP mode this fall, rewrite your RFP to meet upcoming 408(b)(2) Transparency Requirements
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ANY QUESTIONS?This concludes our discussion
Eric RobertsFiduciary Consultant
[email protected] | (317) 845-3511
Qualifications or certifications:Accredited Retirement Plan Consultant through The Society of Professional Asset-Managers and Recordkeepers and Series 63 and 65 designations..
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