Atlantic Capital Management

Atlantic Capital Management (83)

If the road to hell is paved with good intentions, perhaps the same could be said about many of today’s 401K plans.  Employers craft benefit packages with the best of intentions, yet, there’s a good chance you may be administering or participating in a retirement plan not in compliance with new Employee Retirement Income Security Act of 1974 (ERISA) regulations.  Last year nearly 75% of plans audited by the Department of Labor (DOL) were either fined, received penalties or had to make reimbursements for errors.  If your 401K plan were audited today, would it pass muster?  Or, would your company face steep fines and possible criminal indictment?

Every employer, also called the plan sponsor, needs a thorough review of their 401K plan to reduce any chances of unnecessary litigation, keep unscrupulous financial services firms out of participants’ pocketbooks, and be up-to-date with current regulations.   It is advisable for plan sponsors; particularly those with small plans, (defined as plans with less than 100 participants) to have their 401K professionally benchmarked to reveal any hidden fees, expenses, and liabilities within it.  Small plans may carry fees as high as 3% per year.  According to Demos.org, over a participant’s lifetime, these fees can rob investors of nearly 35% of their total returns.  Should financial advisors, who put up no capital and take no risks, take over 1/3 of participants’ returns when they put up all of the capital and take on all of the risk?

We don’t think so.  If your company’s 401K plan hasn’t been audited by the government yet, you won’t have to wait long—the DOL brought on nearly 1000 new hires.  Their role is to enforce ERISA rules by serving as watchdogs and issuing government fines (or worse) to offending employers.  An estimated 88 individuals, including: plan officials, corporate officers, and service providers were criminally indicted for offenses related to their benefit plans, according to the DOL.  It’s important to note plan sponsors (that’s every employer!) will assume fiduciary responsibility.  When the government’s rules are not met, substantial fines can accrue.  Last year’s average, as reported by the DOL, was $600,000 per plan—an increase of almost $150K in the past 4 years alone.

So how did this all start—and how did it spin out of control?  The 401K was first created in the late 1970’s as the U.S. government tried to limit the amount of cash-deferred compensation plans being offered.  An enterprising business consultant to Johnson & Johnson discovered a loop hole which allowed highly compensated executives and their employees to save more of their pre-tax dollars for retirement. And the 401K was born.  Today’s plans can be relatively complex, however, the original plans were straightforward and offered only two investment options: a guaranteed fund and a single equity mutual fund.  As executives wanted to add more flavors to the menu, these options got more complicated; two options became fifteen; which in turn became thousands.  As the menu of investment options grew, an opportunity for middlemen to get involved at the expense of the American worker through layer upon layer of fees presented itself.  Institutions offering small plans, largely brokerage firms and insurance companies, knew that plan sponsors would be unlikely to realize their plan participants were bearing unnecessary expenses or that enterprising salesmen had created revenue streams in excess of their annual advisory fee by selecting investment options laden with upfront sales charges, mark-ups, and recurring fees.

Fast-forward to last year when EBSA released a final rule for increased transparency about fees in 401K plans.  While the news didn’t receive much fanfare, ERISA mandates state that fees paid both at the participant level and the plan level be “usual and customary” for what the market dictates.  If your plan was compliant five years ago, it’s not necessarily compliant today; there is a high likelihood it isn’t.  Robert Hiltonsmith’s research in The Retirement Drain: The Hidden and Excessive Costs of 401(k)s, showed excess fees robbing investors of as much as 33% of their returns.  According to a recent piece in Fortune, excessive fees accumulated over 30 years can erode as much as 37% of returns.  Demos, a New York-based think tank, concluded that an ordinary American household will spend nearly $155K in 401(K) fees over their lifetime.

If you are an employer offering a 401K plan, it is unlikely you chose it with the intention of robbing plan participants of their retirement money or putting yourself in the proverbial hot seat by unintentionally breaking the law.  So what do you need to do today to pass muster with the U.S. Government – especially if it has not been reviewed since the new rules took effect last August?  First and foremost, hire a professional to benchmark your 401K plan.  We also recommend:

Build a 404(c) compliant line-up which provides a variety of investment options. 404c compliance allows you, the plan sponsor, to shift responsibility for investment results to plan participants.  Provided your plan allows employees to choose from a menu of varied investment choices, it’s vital that your menu is 404(c) compliant.  Essentially, what this does is relieve your plan fiduciary of the liability arising from your participants individual investment decisions.  Consider a fund line-up that consists of a broad group of low cost passively managed index funds, with little overlap,  that give employees access to multiple asset classes.

Hire a co-fiduciary. As a plan sponsor you have a duty to act in the best interest of your participants.  This means that you need to be a prudent expert.  If you are not, you need to go out and find that expertise. We believe that it’s not only intelligent for that advisor to be a fiduciary, IT IS IMPERATIVE.  The firm that you choose to put your plan together, must share in your risk, not profit from it.  So rather than working with a broker, who may be compensated by steering the plan sponsor towards funds that increase the sponsor’s risks, yet pay the broker a higher commission, we strongly suggest your investment advisor serve as a fiduciary, choosing the investment choices that are best for your employees and the plan sponsor.

Provide participants with education and support.
Any retirement plan provider should provide the plan sponsor with comprehensive enrollment materials, educational content, a website with interactive tools, and access to an investment advisor that participants can access for one-on-one support in order to make better financial decisions.  Educated participants are less likely to make uninformed decisions, and, not offering educational information sessions could put employers at risk.  The investment advisor should also conduct a risk tolerance review with each plan participant.

Adopt a formal, written investment policy. ERISA Section 402(b)(1) requires retirement plans to provide a “procedure for establishing and carting out a funding policy and method consistent with the objectives of the plan.” A formal investment policy identifies: a) the investment goals and objectives of the plan; b) sets the decision-making process for structuring the overall make-up of the portfolio and selecting investments; and c) specifies the measuring tools for ongoing performance assessment. The investment policy should focus on how investment decisions are made, rather than the investments themselves. Adhering to ERISA Section 404(c) guidelines with a formal, written investment policy provides plan sponsors added protection.

Be wary of the “No Cost” plan.  Many group annuity insurance firms understand businesses don’t want to pay anything when beginning a 401K for participants, so, they offer to charge a wrap fee as an alternative.  It essentially marks up the cost of the underlying investments by as much as 1-1.5% per year.  The firms that do this know this fee isn’t enough to cover their administrative and recordkeeping expenses for your plan upfront.  However, after 5 years, when there’s a $2-3M payroll, they know it’s unlikely their rates will be renegotiated.  So plan sponsors continue paying excess fees which line the pockets of plan administrators and their brokers. Reuters recently wrote about one such lawsuit involving Mass Mutual.  The best way to avoid such headaches is to know what you are getting into from the get go; professional benchmarking is valuable here.

Consider adding options to allow contributors to increase annual tax deductible retirement contributions beyond the statutory $17,500 annual pre-tax contribution limits.

A Profit Sharing Plan will enable higher income earners to save as much as $50,000 per year for retirement through tax deferred contributions.

A Defined Benefit Plan, on top of this, may enable some participants to save $200,000 per year in pre-tax contributions.At 5% in annual appreciation, a plan participant would have accumulated over $2M in additional tax deferred savings, assuming only $50,000 in annual pre-tax contributions.

Just because your plan was compliant 5 years ago doesn’t mean it is today.  Prudent plan sponsors will have an independent 3rd party benchmark their plan at least once per year.  Today’s new rules, as well as the DOL’s attention on small businesses, could mean more employers in the hot seat.  Don’t be punished for your good deeds!  Be clear as to what burdens in your 401K plan lie on you—and what do not.

The information contained in this article is provided solely for convenience purposes only and all users thereof should be guided accordingly. The Abernathy Group II does not hold itself out as a legal or tax adviser. If you wish to receive a legal opinion or tax advice on the matter(s) in this report please contact our offices and we will refer you to an appropriate legal practitioner.

Wednesday, 05 November 2014 00:00

Fall Financial Reminders

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The year is coming to a close. Have you thought about these financial ideas yet?

As every calendar year ends, the window slowly closes on a set of financial opportunities. Here are several you might want to explore before 2015 arrives.

Don’t forget that IRA RMD. If you own one or more traditional IRAs, you have to take your annual required minimum distribution (RMD) from one or more of those IRAs by December 31. If you are being asked to take your very first RMD, you actually have until April 15, 2015 to take it – but your 2015 income taxes may be substantially greater as a result. (Note: original owners of Roth IRAs never have to take RMDs from those accounts.)1

Did you recently inherit an IRA? If you have and you weren’t married to the person who started that IRA, you must take the first RMD from that IRA by December 31 of the year after the death of that original IRA owner. You have to do it whether the account is a traditional IRA or a Roth IRA.1

Here’s another thing you might want to do with that newly inherited IRA before New Year’s Eve, though: you might want to divide it into multiple inherited IRAs, thereby promoting a lengthier payout schedule for younger inheritors of those assets. Otherwise, any co-beneficiaries receive distributions per the life expectancy of the oldest beneficiary. If you want to make this move, it must be done by the end of the year that follows the year in which the original IRA owner died.1

Can you max out your contribution to your workplace retirement plan? Your employer likely sponsors a 401(k) or 403(b) plan, and you have until December 31 to boost your 2014 contribution. This year, the contribution limit on both plans is $17,500 for those under 50, $23,000 for those 50 and older.2,3

Can you do the same with your IRA?  This year, the traditional and Roth IRA contribution limit is $5,500 for those under 50, $6,500 for those 50 and older. High earners may face a lower Roth IRA contribution ceiling per their adjusted gross income level – above $129,000 AGI, an individual filing as single or head of household can’t make a Roth contribution for 2014, and neither can joint filers with AGI exceeding $191,000.3

Ever looked into a Solo(k) or a SEP plan? If you have income from self-employment, you can save for the future using a self-directed retirement plan, such as a Simplified Employee Pension (SEP) plan or a one-person 401(k), the so-called Solo(k). You don’t have to be exclusively self-employed to set one of these up – you can work full-time for someone else and contribute to one of these while also deferring some of your salary into the retirement plan sponsored by your employer.2

Contributions to SEPs and Solo(k)s are tax-deductible. December 31 is the deadline to set one up for 2014, and if you meet that deadline, you can make your contributions for 2014 as late as April 15, 2015 (or October 15, 2015 with a federal extension). You can contribute up to $52,000 to SEP for 2014, $57,500 if you are 50 or older. For a Solo(k), the same limits apply but they break down to $17,500 + up to 20% of your net self-employment income and $23,000 + 20% net self-employment income if you are 50 or older. If you contribute to a 401(k) at work, the sum of your employee salary deferrals plus your Solo(k) contributions can’t be greater than the aforementioned $17,500/$23,000 limits – but even so, you can still pour up to 20% of your net self-employment income into a Solo(k).1,2

Do you need to file IRS Form 706? A sad occasion leads to this – the death of a spouse. Form 706, which should be filed no later than nine months after his or her passing, notifies the IRS that some or all of a decedent’s estate tax exemption is being carried over to the surviving spouse per the portability allowance. If your spouse passed in 2011, 2012, or 2013, the IRS is allowing you until December 31, 2014 to file the pertinent Form 706, which will transfer that estate planning portability to your estate if your spouse was a U.S. citizen or resident.1     

Are you feeling generous? You may want to donate appreciated securities to charity before the year ends (you may take a deduction amounting to their current market value at the time of the donation, and you can use it to counterbalance up to 30% of your AGI). Or, you may want to gift a child, relative or friend and take advantage of the annual gift tax exclusion. An individual can gift up to $14,000 this year to as many other individuals as he or she desires; a couple may jointly gift up to $28,000 to as many individuals as you wish. Whether you choose to gift singly or jointly, you’ve probably got a long way to go before using up the current $5.34 million/$10.68 million lifetime exemption. Wealthy grandparents often fund 529 plans this way, so it is worth noting that December 31 is the 529 funding deadline for the 2014 tax year.1     

This material was prepared by MarketingPro, Inc., and does not necessarily represent the views of the presenting party, nor their affiliates. This information has been derived from sources believed to be accurate. Please note - investing involves risk, and past performance is no guarantee of future results. The publisher is not engaged in rendering legal, accounting or other professional services. If assistance is needed, the reader is advised to engage the services of a competent professional. This information should not be construed as investment, tax or legal advice and may not be relied on for the purpose of avoiding any Federal tax penalty. This is neither a solicitation nor recommendation to purchase or sell any investment or insurance product or service, and should not be relied upon as such. All indices are unmanaged and are not illustrative of any particular investment.

Citations.

1 - forbes.com/sites/deborahljacobs/2014/10/08/eight-key-financial-deadlines-to-keep-in-mind-this-fall/ [10/8/14]

2 - tinyurl.com/kjzzbw4 [10/9/14]

3 - irs.gov/uac/IRS-Announces-2014-Pension-Plan-Limitations;-Taxpayers-May-Contribute-up-to-$17,500-to-their-401%28k%29-plans-in-2014 [10/31/13]

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