401k Fiduciary

A 401k fiduciary is a person who occupies a position of trust in relation to someone else such that he is required to act for the latter's benefit within the scope of that relationship. In business or law, it generally means someone with specific duties, such as those that attend a particular profession or role, e.g., financial analyst or trustee.

According to Southern California-based (401k) Enginuity (www.401kenginuity.com), twenty-year veteran in developing and running 401(k) administration and 401(k) software and recordkeeping systems, the Internet will be the primary delivery system for 401(k)s by 2007. Many web-based 401(k) plans will run on administration and recordkeeping platforms that plan providers will outsource to 401k specialists and 401k Application Service Providers (ASP).

The advantages of web-based online 401(k) plans are obvious to today's workers, and include use conveniences, real-time monitoring and reporting, and instant re-allocation of their retirement assets. The internet has also dramatically reduce the cost of 401(k) plan administration, saving plan sponsor 50% or more in ongoing fees and costs when compared to the older traditional labor-intensive plans. Outsourcing of 401(k) functions by plan providers will extend the trend towards lower cost, high-quality 401(k) products.

401(k) plan providers of all types, financial institutions including banks, insurance companies, brokerages, mutual fund companies, credit unions, and third-party administrators, are now actively outsourcing 401(k) administration and recordkeeping tasks to 401(k) ASPs --- vendors such as 401k Enginuity, whose sole function is to maintain, updated and supervise software-based 401(k) administration and recordkeeping systems on behalf of plan providers. 401(k) ASP vendors are responsible for all routine day-to-day 401(k) recordkeeping and administration functions, thus allowing the plan providers to reduce internal staff, eliminate the expense and complications of licensing, housing and running hardware and 401(k) administration software in-house. Plan providers can refocus and concentrate their efforts on to the needs of their plan sponsors and plan participants, and rely upon the outsourced ASP 401(k) vendor for the recordkeeping and technical "backbone" supporting providers' Internet-based plans. It is inevitable that some of this 401(k) outsourcing to ASPs will include secondary outsourcing of certain non-critical low-level routine day-to-day tasks to non-US locations, where labor costs are less yet the expertise is abundant.

Legal considerations

A fiducial relationship does not exist simply because someone places his trust in another person. One must have a reasonable basis for placing his trust in someone, one that arises from the facts that pertain to that relationship. A court ruled, "Mere respect for the judgment of another or trust in his character is not enough to constitute such a relationship. There must be such circumstances as indicate a just foundation for a belief that in giving advice or presenting arguments one is acting not in his own behalf, but in the interests of another party."

Professions

Members of various professions such as physicians, architects, and lawyers, have highly specialized training, and they often possess credentials that enable them to claim expertise in a particular field. This claim would tend to constitute a reasonable basis of trust on the part of others who avail themselves of their services, thereby placing the professional in the position of a 401k fiduciary. Most professions are subject to specific codes of conduct prescribed by law or independent credentialing authorities (e.g., bar associations or universities).

Other Roles

Understood in its broadest terms, one can imagine a number of other 401k fiduciary positions that arise from particular kinds of relationships, for example, the relationship between employers and employees, investment managers and investors, parents and children, and so forth. In each case, there the person who is the 401k fiduciary acts for the benefit of people who have a reasonable basis of placing their trust in them based on the scope of the relationship and the explicit or implict agreement between the parties as to the terms that govern the relationship.

General 401k Fiduciary Duties

The following are encapsulations of duties which would seem to apply to all 401k fiduciary relationships:

Fiduciaries are responsible for ensuring that they have the necessary knowledge to perform in accordance with their capacity.

Fiduciaries must disclose any limitations, conflicts of interest, or barriers to performing their duties.

Fiduciaries must comply with any legal and professional requirements pertaining to their roles, and also with any relevant moral strictures.

Fiduciaries must not take unfair advantage of their relationship (e.g., misuse information) in a way that could have deleterious effects on those who place their confidence in them.

The three primary reasons why 80% of America's small businesses do not offer 401(k) plans to their employees are: (a) perceived cost of employer-sponsored retirement plans, (b) perceived complexity of company-sponsored retirement plans, and (c) limited investment options. Mutual fund companies offering 401(k) plans to small businesses do so by pre-packaging administration with their proprietary fund investments; this pre-packaged approach, called "bundled 401(k)" tends to be pricey for small companies, limited features and limited investment options. Employees who participate in bundled 401(k) plans typically do not have access to investments not offered by the mutual fund company, and do not have access to the most popular investment option today-the individual self-directed discount brokerage account.

401(k) plans must be sponsored by an employer. Millions of American workers can't take advantage of the 401(k)'s many attractive attributes because, for one reason or another - typically high plan costs, plan inflexibility, and/or prohibitive minimum participation standards - their employers do not sponsor a plan. In particular, very small, small, and medium-sized companies have found sponsorship difficult if not impossible. Some 89% of very small companies (10-50 employees), 72% of small companies (50 - 100 employees), and 66% of medium-sized companies (100 - 250 employees) do not have 401(k) plans (Census Bureau figures). These figures do not include the companies that have fewer than 10 employees, what might be called "micro" companies.

The tax deferral of 401k has a huge compounding effect: $150 per month put into a typical taxable savings account paying 8% annual interest will grow to $42,034 by the end of 20 years (assuming a combined federal and state personal income tax rate of 34%). In a 401(k), however, the same deposits earning the same rate of return during the same 20 years will yield $88,353 . Even if that amount is taxed at the 34% rate when the money is withdrawn from the plan, which is unlikely if the participant is retired, the 401(k) participant will walk away with more than $16,000 compared to the equivalent non-401(k) investment return.

401(k) plans have the highest annual contribution ceiling of any of the tax-deferred defined contribution savings programs (IRAs, SEPs, etc.). More money contributed equals more money earning money, equals more money in the account 20 years later. Add to this earning potential the convenience of contributions made through automatic payroll deductions and it's easy to see why 401(k)s are so popular.

The average 401K account balance at the end of 1998 was $47,000 per participant, up 26% from 1996, according to the ICI and the Employee Benefit Research Institute. On average, 78% of eligible employees will participate in a 401(k) plan if one is made available, with the number of participants growing from 19.5 million in 1990 to 53.2 million in 2000. Some of the increase in participation rates is due to the introduction of "negative election," which allows an employer to automatically enroll employees into the 401(k) when they meet the plan's eligibility requirements. The negative election deferral rate and investment(s) must be defined ahead of time, and the employee must be immediately notified of his or her participation status. Automatic enrollment programs are sanctioned by the IRS under ERISA as long as the employee has ample ability to cease enrollment at will.

Traditional 401(k) plan vendors did not think much about approaching smaller companies until recently, and did so then only because they recognized that the larger-company market was pretty well saturated. When they did turn their attention to the smaller and mid-sized plan market, they were well prepared with a library of useful educational materials for potential and actual plan participants. Participation is participation, after all, whether it is in a plan with 50 participants or 50,000

Unfortunately, however, these vendors were not equally well prepared to service the needs of the smaller companies: the plans they designed and the packages they offer are not always appropriate in price, substance, or style, and their pamphlets and publications are often too dry, legalistic, and expensive. Perhaps it is because most of these vendors are large companies themselves that they have difficulty designing 401(k) plans that embody the entrepreneurial, "do-it-yourself" spirit so prevalent in many small and medium-sized companies.

401(k) plans must be sponsored by an employer. Millions of American workers can't take advantage of the 401(k)'s many attractive attributes because, for one reason or another - typically high plan costs, plan inflexibility, and/or prohibitive minimum participation standards - their employers do not sponsor a plan. In particular, very small, small, and medium-sized companies have found sponsorship difficult if not impossible. Some 89% of very small companies (10-50 employees), 72% of small companies (50 - 100 employees), and 66% of medium-sized companies (100 - 250 employees) do not have 401(k) plans (Census Bureau figures). These figures do not include the companies that have fewer than 10 employees, what might be called "micro" companies.

The tax deferral of 401k has a huge compounding effect: $150 per month put into a typical taxable savings account paying 8% annual interest will grow to $42,034 by the end of 20 years (assuming a combined federal and state personal income tax rate of 34%). In a 401(k), however, the same deposits earning the same rate of return during the same 20 years will yield $88,353 . Even if that amount is taxed at the 34% rate when the money is withdrawn from the plan, which is unlikely if the participant is retired, the 401(k) participant will walk away with more than $16,000 compared to the equivalent non-401(k) investment return.

401(k) plans have the highest annual contribution ceiling of any of the tax-deferred defined contribution savings programs (IRAs, SEPs, etc.). More money contributed equals more money earning money, equals more money in the account 20 years later. Add to this earning potential the convenience of contributions made through automatic payroll deductions and it's easy to see why 401(k)s are so popular.

The average 401K account balance at the end of 1998 was $47,000 per participant, up 26% from 1996, according to the ICI and the Employee Benefit Research Institute. On average, 78% of eligible employees will participate in a 401(k) plan if one is made available, with the number of participants growing from 19.5 million in 1990 to 53.2 million in 2000. Some of the increase in participation rates is due to the introduction of "negative election," which allows an employer to automatically enroll employees into the 401(k) when they meet the plan's eligibility requirements. The negative election deferral rate and investment(s) must be defined ahead of time, and the employee must be immediately notified of his or her participation status. Automatic enrollment programs are sanctioned by the IRS under ERISA as long as the employee has ample ability to cease enrollment at will

A constraint on 401(k) growth is the fact that 401(k) plans must be sponsored by an employer and contributions must be subtracted from the employee's pay within the payroll process, before income tax withholding is calculated. Due largely to misinformation about the complexity of running a 401(k), coupled with a general fear of the IRS and the Department of Labor (both of which have regulatory power over the plans), many employers have excluded this popular benefit from their employee benefits package. This is especially true of very small (including micro), small, and medium-sized companies

Many small and medium-sized companies that have 401(k)s have a bleak future: many are being canceled because they are not profitable enough a service for vendors to maintain; in other cases, service is not being canceled but the level of service is so disproportionate to the high fees being charged that employers themselves must pull out or endure the aggravation of continually feeling they are being overcharged. The company estimates there are more than 400,000 very small, small, and medium-sized companies that (a) have no plan, (b) have had their plan canceled or have canceled their plan, or (c) have a plan they are unsatisfied with.

Traditional 401(k) plan vendors did not think much about approaching smaller companies until recently, and did so then only because they recognized that the larger-company market was pretty well saturated. When they did turn their attention to the smaller and mid-sized plan market, they were well prepared with a library of useful educational materials for potential and actual plan participants. Participation is participation, after all, whether it is in a plan with 50 participants or 50,000.

Unfortunately, however, these vendors were not equally well prepared to service the needs of the smaller companies: the plans they designed and the packages they offer are not always appropriate in price, substance, or style, and their pamphlets and publications are often too dry, legalistic, and expensive. Perhaps it is because most of these vendors are large companies themselves that they have difficulty designing 401(k) plans that embody the entrepreneurial, "do-it-yourself" spirit so prevalent in many small and medium-sized companies

The Labor Department is currently auditing 401(k) plans of all sizes because of a trend they think may violate current pension laws. Many companies, especially smaller businesses, are knowingly or unknowingly shifting plan administrative expenses to plan participants. This shift of plan expenses come in the form of excessive "hidden fees" that are deducted directly from participants' savings by certain plan providers and investment providers. Because of lax reporting requirements, no one really knows how much money changes hands behind the scenes, but it is estimated that excessive fees may be as much as $1.5 billion per year, and growing.

401k Fee Disclosure

In the 401(k) provider industry, expense fee disclosure, whether to plan participants or plan sponsors, has been a notoriously murky affair. The impact of excessive hidden fees on plan participants' retirement accounts is very significant over time. As example, consider a hypothetical 401(k) investment, such as a mutual fund, with deducted fees of 1.3 percent versus one with fees of just .02 percent. Applied to an initial $25,000 investment returning 10 percent, and compounded over 20 years, the difference between the "low-fee" investment and the excessively "high-fee" investment adds up to $31, 701.

The number of companies without 401(k) plans is growing, too - due to a less-than-traditional force: vendors who in the past have serviced smaller businesses are finding it unprofitable and are abandoning these clients. According to an article by Harris Collingwood and Janice Koch ("Squeezed Out," in Worth Magazine, Dec/Jan 1999), "All over the country, 401(k) vendors - the companies that perform investment management, record keeping, employee education, and regulatory-compliance testing - are firing their customers. . What this means is that small and midsize companies are being forced, like it or not, back into the 401(k) marketplace." These companies feel betrayed by the large 401(k) vendors and are frustrated in their search for a 401(k) plan that their employees will like and that they can afford.

Recordkeeping-Only Firms [6% of existing 401(k) plans]

This group represents a small and possibly decreasing fraction of the available market. These firms tend to be local and regional, and although they can maintain the "human touch," they cannot compete effectively with the bundled plans offered by mutual fund companies.

Interestingly, 401(k) Pro, Inc. envisions a tremendous marketing opportunity here: licensing fully-hosted 401(k) Enginuity that plan providers can brand with their own names and offer to their customers via the Internet. 401(k) Pro providing server hosting of 401(k) Enginuity is a low-cost, fast and easy entry into the online marketplace, and an attractive alternative to operating their own servers and licensing 401(k) Enginuity or a competitor's administration software

Mutual fund companies make their money by acquiring, holding, and managing inevitable assets in their various fund portfolios. In some cases, the bundled 401(k) administration may offer to small businesses at a loss as a device for attracting and holding new assets, on the assumption that 401(k) investing tends to be long-term, giving the mutual fund company many years to collect management fees

Internet penetration and usage by small businesses is a key component of 401(k). According to a survey conducted by IDC, Internet usage by small businesses reached 62% in 1998. Total small business spending on Internet related applications is expected to increase from $6.6 billion in 1998 to 418.2 billion by 2002, yielding an annual growth rate of 45%.

INFORMATION AND NON-PROFIT PUBLIC WEBSITES CONTAINING CURRENT USEFUL INFORMATION ABOUT 401K PLANS: Small business 401k providers and bundled 401k plans for small businesses that use 401k mutual funds at www.401k-providers.com . 401K ADMINISTRATION REPORTS AND THE IMPORTANCE OF 401K REPORTS FOR RECORDKEEPING AT www.401kclassroom.com . Answers to 401k questions at www.401k-questions-and-answers.com . Small business 401k software administration at www.easytec-systems.com . Retirement savings programs and 401k at www.employer-retirement-savings-account.org . Small business 401k salary deferrals for small businesses 401k plans using automatic enrollment, passive elections and 401k negative elections at www.web-ira.com . Eco-friendly 401k investments at www.green-401k.com .

Financial institutions such as banks, brokerage firms, and trust companies (e.g., Union Bank of California, Wells Fargo Bank, Merrill Lynch, First Trust) offer 401(k) administration services that tend to be less expensive than services offered by benefit consulting firms. The main target of the financial institutions is also the Fortune-500-sized organization; however, they offer the advantage of more closely linking the investment vehicles with plan administration and recordkeeping. They can achieve vertical integration of investments and administration because banks, brokerages, and some trust companies offer a predefined group of proprietary and other mutual funds investments that pay 12b-1 and other asset-based fees to these plan providers, helping offset the cost of providing plan administration. Today these often "hidden" asset-based fees are coming under close scrutiny by government agencies and the press as being unfair to plan participants. As media and governmental investigation pressures mounts, financial institutions will need to find other ways to offset or cut their administration costs-401(k) Enginuity will become a more and more attractive alternative to traditional administration platforms as time goes on.