Ex-Employees Who Don’t Rollover – Will 401k Fees Increase Plan Sponsor Liability?
There’s often a debate as to what’s in the best interest of ex-employees: to keep their retirement assets in their former company’s 401k or to roll those assets over into an IRA? What’s often overlooked in this calculation is whether this individual decision can inadvertently increase the fiduciary liability of the 401k plan sponsor at the former firm. To determine the extent of their potential added fiduciary liability, 401k plan sponsors must first discover what makes it so convincing for ex-employees to rollover their 401k into a personal IRA – and perhaps learn why this advice is considered controversial.
Whether employees take their money comes down to two compelling themes: control and costs.
On the control side of the equation, regarding their 401k plan assets, the best time for former employees to rollover occurs during the exit interview. Typical corporate practice has the HR staff explain to the exiting employees the several options they may have regarding their 401k funds. In some cases, small amounts are automatically removed with the default being the employee receives a check. Unfortunately, this usually represents a taxable transaction and, unless the plan sponsor clearly delineates the options (specifically, how to avoid making this a taxable transaction), the plan sponsor may assume some liability for providing incomplete advice. In most cases, the employee has three options: 1) Keep the assets with the old employer; 2) Transfer the assets to the new employer; and, 3) Rollover the assets into a personal IRA.
In the first two options, employees cede control of their retirement savings to either their old employer or their new employer. Lack of control means a lack of options. “The old 401k may or may not be performing well – either way, its financial health is out of the control of the former employee,” says Jaime Raskulinecz, CEO of Next Generation Trust Services of Roseland, New Jersey. By keeping old 401k assets in the former employer’s retirement plan, employees restrict their options “to certain mutual funds or other traditional brokerage investments selected by the former employer,” adds Raskulinecz. The same would be true even if the employee transfers his retirement assets to his new employer’s 401k plan.
There’s another issue of control that can represent something much more problematic. Theoretically, former employees have access to their old 401k holdings, but even that access can come with strings attached. It may take several months to extract their assets from a former company’s 401k plan. Over time, as HR personnel change, companies move or get bought out, it may be less clear where former employees should go to get their retirement assets. In the worst case, if the former company gets into financial trouble, ex-employees may find access to their retirement assets tied up in litigation.
The loss of control stands as a strong reason to rollover assets. As the plan sponsor can see, holding the retirement assets of former employees just increases the chances for a fiduciary breach. But the control issue pales in comparison to the fee issue.
“It’s important for outgoing employees to rollover their company 401k mainly because it’s more expensive to leave it with the employer than it is to transfer it,” says Bill Ulivieri, Accredited Investment Fiduciary Analyst (AIFA) at Cenacle Capital Management LLC in Glenview, Illinois. While there are several ways 401k plans add greater fees, the most significant ones deal with expenses relating to administration and regulatory compliance. In many cases, ERISA plans must hire custodians, recordkeepers, third-party administrators, independent auditors, fiduciary advisers and, in some cases, staff, to operate a successful retirement plan. None of these service providers (and their associated costs) are required in an IRA. “The outgoing employee is better served by rolling their retirement plan to an IRA,” says Ulivieri.
One of the service providers not listed above – but the one most often cited in 401k fee related literature – is the investment adviser. That’s because, unless the employee wants to take the time and effort and manage his own portfolio of stocks and bonds, a Rollover IRA will likely entail either hiring a professional investment adviser to manage the private portfolio of stocks and bonds or hiring a professional investment adviser through buying a mutual fund or an ETF. In both of these cases, the cost of hiring a professional is incurred by both the IRA and the 401k plan.
Though the reasoning to rollover is sound, it is also controversial. It’s easy to find sales literature – and even media articles – that promote keeping assets in a former employer’s 401k. Frequently, these writings cite the greater ability to vet professional investment advisers and to negotiate more favorable fee schedules on the part of 401k plan sponsors as the primary reason NOT to rollover retirement assets. Yet, a simple review of the top mutual fund holdings in 401k plans reveals nearly all these holdings are high-cost low-performing mutual funds (see “Should What DOL’s New Regs Reveal about Most Widely Held 401k Mutual Funds Worry Plan Sponsors?” Fiduciary News, January 3, 2011). While some 401k plan sponsors no doubt do receive significant fee concessions, it’s not clear if those breaks can overcome the administrative and compliance expenses. “The maintenance fees on these 401k accounts are typically high and eat into the investor’s long-term earnings potential,” says Raskulinecz.
Even in the case of index mutual funds, employees might be better served by rolling over their assets into an IRA and buying ETFs (at least the more liquid ETFs) of their favorite indices. In most instances ETFs have much lower expense ratios than their mutual fund equivalents. “The annual management fee of a domestic ETF that tracks the S&P 500 can be 80% less than an equivalent mutual fund,” says Ulivieri, who noted in some cases these ETFs can be purchased commission free.
Mike Garry, owner of Yardley Wealth Management in Newtown Pennsylvania, offered this simple summary when he said, “better investment choices, lower and more transparent fees – no hidden revenue sharing fees either” may provide the best blueprint to help 401k plan sponsors determine whether they may be increasing their fiduciary liability when ex-employees opt to keep their assets with their former employer. In a blunt sense, while 401k plan sponsors can (and should) seek fee transparency and avoid revenue sharing fees, they cannot (and should not) offer all investment options and cannot (and should not) remove administrative and compliance expenses. Unfortunately, 401k plan sponsors cannot serve two masters – the existing employees and the former employees. They might consider telling former employees to stop loitering. It’s good for the 401k plan sponsor and it’s good for their former employees.