It isn't lost on small business 401k trustees that these plans are not for the faint of heart. Endless changes in regulations and increased scrutiny leave some small business owners wondering why they even bother offering a plan at all. Keeping the plan in compliance and maintaining an investment platform can leave any seasoned business owner scratching their head.
While the risks and burdens on the business owner and 401k trustees have increased, so has competition for the 401k business. Recent regulatory changes related to fee and services disclosure have made reviewing and comparing plans easier. If you're frustrated with your plan or haven't taken a good look at it in a while, invest the time in a review and get some competitive quotes. This likely won't cost a thing and at the same time will help fulfill the fiduciary obligations owed to the plan.
Keeping things simple is a good way to start so limiting the review to investments and fees will keep the process manageable. This will ensure that you're up to speed on investment options and fees and costs associated with the plan.
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Investment Analysis for 401k Trustees:
These ratings can form the basis for comparing mutual funds and help sort through the good and the bad. Fund ratings on their own aren't enough to demonstrate a thorough look at the investments. But, it can be a great starting point. With roughly 9,000 mutual funds in the United States alone, where would you even start? Fortunately, most record keepers and 401k platforms will only offer a fraction of those. But, even with a list of 200 available funds, most 401k trustees will need to whittle it down to about 25.
Three stars out of five should be the minimum requirement. However, your best bet is to stick with four or five star funds. When you choose to start with a three star fund, you run the risk of it being downgraded to two stars. If a fund is less than three stars, a replacement should be considered. For example, let's say you select a four star fund. As time passes, Morningstar changes the rating and now gives it a three. You shouldn't necessarily kick it to the curb because its next move could be back up to a four. However, if it drops from a three to a two, you'll want to start looking for a replacement.
Morningstar style box:
401k trustees would be well served to have a basic understanding of the Morningstar style box. It can be used to analyze stock and bond mutual funds.
For stock mutual funds, it can help identify how the fund invests across the market. For example, the box will measure to what degree the fund is invested in various market cap categories (small, medium, or large companies). In addition, it will show to what degree the fund is invested within value, core, or growth stock categories.
For bond mutual funds, the style box demonstrates how the fund invests within the bond market. For example, the box will measure to what degree the fund is invested in various bond rating categories based on credit quality (high, medium, or low). In addition, it will show to what degree the fund is invested in short, intermediate, or long term categories.
The bottom line with style boxes is that you need to know where the fund really invests. If you are reviewing XYZ Large Cap Fund, you need to know if it's focused on growth or value stocks. Taking it a step further, you need to see if it is also drifting into mid and small cap stocks. That could be an indicator as to why the fund either out-performed or under-performed a fund in a similar category.
Becoming familiar with mutual fund operating costs (expressed as a percentage and known as the expense ratio) is critical to understanding true plan costs. If there are two funds with similar risk, investment objective, ratings and performance, the lower expense fund should be considered. According to Morningstar, the average operating expense for US mutual funds is 1.04%.
Funds should be compared over three, five, and ten year periods. The shorter the time period, the less reliable the information. If there are two funds with similar risk, investment objective, ratings and performance, the fund with stronger five and ten year performance should be considered. With that in mind, take caution so as not to chase returns. A classic example is when you drop one fund, only to find the new fund's performance now lags behind the old one.
Fee Analysis for 401k Trustees:
Broker or advisor fees:
It is very important to know what compensation the advisor receives and how they're paid. The fee disclosures from the broker or advisor will show whether they are paid from the funds owned by participants or if they are paid directly from the employer outside of the plan's assets. Because broker and advisor compensation doesn't always show up as a line item or an invoice, it can be easy to forget about this part.
Record keeping and custodian fees:
The company that maintains the accounts and platform for participants to direct their investments will also be charging some sort of fee or receiving some form of compensation either directly from the plan or indirectly from the investments within the plan.
Plan administration and compliance:
Utilizing a pension consultant or Third Party Administrator (TPA) is critical given the complexities involved with compliance and plan testing. However, they are not all equal and costs can vary for these services. This blog from Benefit Resources, Inc. has some great information for business owners.
401k trustees have a fiduciary duty and should document the review of and decisions made with respect to investment options and fees being charged to the plan. Start with a basic review of the items above. Doing so can be done with little time and cost and will help with the review of quotes from other service providers.
What about SIMPLE IRA Plans?
It should also be noted that 401k plans can be overkill and there are other options. SIMPLE IRA plans can be a great way for a small company to provide a low cost retirement benefit as an alternative to a qualified retirement plan like a 401k and profit sharing plan. SIMPLE IRA stands for Savings Incentive Match Plan for Employees.
Do you have questions about 401k trustees and being a fiduciary?
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Your guide to 2020 tax rates, retirement contributions, and Social Security.