Three Best Practices 401k Plan Sponsors Should Revisit Right Now

by Richard Bavetz, FRC℠ July 9, 2024

A plan sponsor's paramount responsibility is to ensure the effectiveness and compliance of their 401(k) plan. In light of evolving regulatory landscapes, technological advancements, and participant needs, revisiting best practices can help safeguard the interests of both sponsors and participants. Three key areas that plan sponsors should focus on right now are fiduciary Responsibility and Plan Governance, Participant Education, and Plan Design Optimization.

Fiduciary Responsibility and Plan Governance

Plan sponsors are obligated to put the interests of their plan participants ahead of their own. It is their fiduciary duty. This involves making prudent decisions about plan investments, ensuring fees are reasonable, and managing the plan in alignment with its goals. Regularly reviewing plan investments is essential. Sponsors should conduct periodic evaluations to assess the performance and suitability of investment options, benchmarking them against industry standards. This practice helps in maintaining a diversified and well-performing investment portfolio. Additionally, providing ongoing fiduciary training to committee members and HR personnel is critical. Such training ensures that all fiduciaries are well-versed in their responsibilities, thereby enhancing the standard of plan governance and reducing the risk of fiduciary breaches. Another crucial aspect is thorough documentation. Keeping detailed records of all decisions made by the fiduciary committee, along with the rationale behind these decisions, can protect sponsors in case of audits or legal scrutiny.

Participant Education and Engagement

Educating plan participants about their retirement options and actively engaging them in the planning process can lead to significantly better retirement outcomes. Comprehensive education programs that offer various resources, including webinars, seminars, and personalized financial counseling, are highly beneficial. Topics should cover investment basics, retirement planning strategies, and the importance of consistent contributions. Enhanced communication strategies are also crucial. Utilizing multiple channels such as emails, newsletters, and plan websites ensures that participants are well-informed about plan changes, investment options, and the importance of staying engaged with their retirement planning. Incorporating behavioral finance tools, like automatic enrollment and automatic contribution escalation, can help participants save more effectively. These tools take advantage of behavioral tendencies to encourage better saving habits. The importance of education in fostering a proactive approach to retirement planning cannot be overstated.

Plan Design Optimization

In addition to fiduciary responsibility and participant education, plan design optimization is a crucial best practice for 401(k) plan sponsors. Optimizing plan design involves regularly reviewing and updating the plan's features to ensure they meet the needs of participants and encourage optimal retirement savings behaviors. This can include evaluating the plan's contribution structure, such as matching contributions and automatic escalation features, to enhance participation and savings rates. Implementing features like Roth 401(k) options can provide participants with more flexibility in managing their tax liabilities. Another aspect of plan design optimization is simplifying investment choices to prevent participant overwhelm, often referred to as "choice overload." Providing a curated list of investment options, including target-date funds, can help participants make informed decisions without feeling overwhelmed by too many choices. Additionally, regular benchmarking against industry standards and peer plans can identify areas for improvement and ensure the plan remains competitive and attractive to current and prospective employees. The Society for Human Resource Management (SHRM) emphasizes that thoughtful plan design can significantly impact participation rates, savings behaviors, and overall plan success, ultimately leading to better retirement outcomes for participants.

Why Is It Important to Revisit These Right Now?

The focus on fiduciary responsibility and plan governance is reaching critical mass due to increasing regulatory scrutiny and legal challenges faced by 401(k) plan sponsors. The Department of Labor (DOL) has intensified its oversight of retirement plans, emphasizing the need for prudent management and transparency. Recent lawsuits have highlighted the importance of monitoring investment options and fees to protect against fiduciary breaches. Litigation is likely to increase over time, and by enhancing governance practices, sponsors can mitigate legal risks and ensure compliance with evolving regulations, ultimately safeguarding participants' interests and trust. A common adage used among fiduciaries is, “If you think compliance is expensive, try non-compliance.”

Amid economic uncertainty and changing retirement landscapes, educating and engaging participants is as crucial as it has ever been. The COVID-19 pandemic has heightened financial stress and retirement insecurity for many employees, making it essential to provide comprehensive education and robust engagement strategies. Enhanced communication and educational programs can empower participants to make informed decisions, improve their financial literacy, and increase their retirement savings, ensuring better outcomes. Plus, a well-informed participant is more likely to feel a sense of partnership that extends into the workplace, creating goodwill within an organization.

Optimizing plan design is timely due to recent legislative changes and evolving participant needs. The SECURE Act and subsequent retirement-related legislation have introduced new opportunities and requirements for plan sponsors, such as increased access to annuities and changes in required minimum distributions (RMDs). Adapting plan features to these changes can enhance participant engagement and retirement readiness. Additionally, simplifying investment options and incorporating behavioral finance tools can help participants make better decisions and improve their overall retirement outcomes.

By prioritizing these best practices, 401(k) plan sponsors can address current challenges and opportunities, ensuring their plans are well-governed, participants are well-informed, and the plan design meets evolving needs and legislative requirements. These efforts not only enhance compliance and security but also significantly improve the retirement readiness and satisfaction of participants.

Which 401k Best Practice Do Service Providers Most Often Get Wrong?

Fiduciary responsibility and plan governance are often considered the most challenging areas for service providers. Carrying out one's fiduciary duty is extremely complex, requiring a keen understanding of the legal and regulatory requirements laid out by the Employee Retirement Income Security Act (ERISA). The intricate nature of these requirements can lead to unintentional breaches if not thoroughly understood and meticulously followed.

One significant issue is the insufficient monitoring of plan investments. Regular reviews and benchmarking of investment options are crucial for ensuring they remain suitable and cost-effective for participants. However, many service providers fail to conduct these reviews adequately, leading to the continued offering of underperforming or high-cost investment options. This negligence can erode participants' retirement savings and expose the plan sponsor to legal risks. Government agencies tell us that improved regulation and oversight could help protect participants from these risks, but adding more complexity won't necessarily fix the problem.

Fee transparency and reasonableness are other areas where service providers frequently fall short. Ensuring that all plan fees are reasonable and fully disclosed is a fundamental fiduciary duty. Unfortunately, hidden or excessive fees are common issues that can significantly impact the growth of participants' retirement savings.

Inadequate documentation and record-keeping also pose significant problems. Proper documentation of all fiduciary decisions and actions is essential for demonstrating compliance and protecting against legal challenges. Poor record-keeping practices can leave plan sponsors vulnerable to audits and legal scrutiny. Thorough and systematic documentation is critical for maintaining fiduciary integrity.

The impact of mismanaging fiduciary responsibilities is profound. Legal and financial risks include costly litigation, regulatory penalties, and corrective actions mandated by oversight bodies like the DOL. High-profile cases of fiduciary breaches have resulted in substantial financial penalties and reputational damage for service providers and plan sponsors. Additionally, participants' trust in the retirement plan can be severely undermined when they perceive that their interests are not being prioritized. This distrust can lead to lower participation rates and reduced contributions, ultimately weakening the retirement plan's effectiveness.

Service providers must prioritize understanding and fulfilling their fiduciary responsibilities to mitigate these risks. This involves regular training, comprehensive investment reviews, transparent fee disclosures, and meticulous documentation practices. By focusing on these areas, service providers can enhance compliance, protect plan participants, and maintain the integrity and success of 401(k) retirement plans. Fiduciary responsibility and plan governance are critical areas where 401(k) service providers frequently encounter difficulties. The complexity of fiduciary duties, challenges in monitoring investment options and fees, inadequate documentation, and the potential for significant legal and financial repercussions highlight the importance of getting this aspect right.

Why Do They Get it Wrong?

Service providers often mishandle fiduciary responsibility and plan governance due to several interrelated factors, primarily the complexity and evolving nature of fiduciary duties, insufficient monitoring and benchmarking of investments, challenges in maintaining fee transparency, and inadequate documentation practices.

Fiduciary duties involve a high level of legal and regulatory complexity. ERISA and the Department of Labor (DOL) impose stringent regulations on plan sponsors and fiduciaries. These requirements can be challenging to interpret and implement correctly. The legal landscape of the responsibilities is continually evolving, with frequent changes to the regulations. The complexity alone can lead to unintentional breaches of fiduciary duty, as service providers may not fully understand or keep abreast of all requirements.

Regularly reviewing and benchmarking plan investments is crucial to ensure they remain suitable and cost-effective for participants. However, many service providers lack the rigorous processes needed to conduct thorough and regular reviews. This insufficiency can result in the continued offering of underperforming or overly expensive investment options. Some suspect this is because service providers often do not or cannot adhere to best practices in investment monitoring.

Ensuring that all plan fees are reasonable and fully disclosed is a fundamental fiduciary duty. However, service providers frequently fail to maintain transparency in fee structures. Hidden or excessive fees can significantly erode participants' retirement savings over time. Understanding 401(k) plan fees is important in order to avoid unnecessary costs. Yet, many service providers struggle with clear and complete disclosure, leading to fiduciary breaches.

Proper documentation of all fiduciary decisions and actions is essential for demonstrating compliance and protecting against legal challenges. However, many service providers fall short in maintaining thorough and systematic records. Poor record-keeping practices can leave plan sponsors vulnerable to audits and legal scrutiny. Industry experts consistently stress the importance of meticulous documentation to uphold fiduciary standards, yet many service providers fail to meet expectations in this area.

Service providers often struggle due to the complexity of legal requirements, insufficient monitoring of investments, challenges in maintaining fee transparency, and inadequate documentation practices. These deficiencies can lead to significant legal and financial risks, eroding trust among participants and undermining the effectiveness of retirement plans. Those who stay informed about regulatory changes, implement rigorous review processes, ensure full fee disclosure, and maintain comprehensive records are in the minority. By improving in these areas, service providers can better fulfill their fiduciary duties and protect the interests of plan participants.

What Can They Do to Get it Right?

Continuous fiduciary education is essential. Service providers should implement ongoing training programs to ensure that all fiduciaries, including committee members and HR personnel, are up-to-date with their responsibilities and regulatory changes. Regular workshops and training sessions on fiduciary duties, ERISA requirements, and best practices in plan governance can help achieve this. Utilizing resources from organizations like the Employee Benefit Research Institute (EBRI) and the Society for Human Resource Management (SHRM) can provide comprehensive training materials and support.

Regular investment reviews and benchmarking are critical to maintaining the plan's performance and cost-effectiveness. Service providers should conduct quarterly or bi-annual assessments of all investment options, benchmarking them against industry standards and peer plans to identify underperforming or costly funds. Engaging independent third-party advisors can provide unbiased assessments and recommendations for replacing underperforming investments. This practice ensures that the plan's investment options remain suitable and beneficial for participants.

Meticulous documentation of all fiduciary actions and decisions is essential for demonstrating compliance and protecting against legal challenges. Service providers should maintain detailed minutes of fiduciary meetings, including discussions on investment performance, fee structures, and participant communications. Documenting the rationale behind each decision shows a prudent process and can protect plan sponsors from regulatory scrutiny. Regular audits of records for completeness and accuracy, along with using digital tools for secure storage, can further enhance documentation practices.

By implementing these strategies, service providers can significantly improve their fiduciary responsibility and plan governance and build trust with plan participants. This will ultimately enhance the effectiveness and reliability of 401(k) plans. These improvements are essential for safeguarding the interests of participants and ensuring the success of retirement plans.

What Best Practice Could 401k Plan Participants Do That Would Help Them Most?

401(k) plan participants can take several proactive steps to maximize their retirement savings and ensure financial security. Firstly, contributing regularly and maximizing contributions is crucial. Regular contributions, even small ones, grow significantly due to compound interest. Setting up automatic payroll deductions ensures consistent contributions, and participants should aim to increase their contributions whenever possible, especially when getting a raise or bonus.

Secondly, diversifying investments is another critical best practice. Managing the risk makes for a well-diversified portfolio and improves potential returns by spreading investments across various asset classes. Using target-date funds or diversified portfolios that adjust asset allocation based on retirement dates can be beneficial.

Finally, developing a Tax Strategy based on an individual's real financial circumstances is vital. For individuals planning to earn more money in the future (shouldn’t everyone be planning this way?), switching to a Roth 401(k) or Roth IRA strategy can be a highly advantageous move. Unlike traditional 401(k) contributions, which are made with pre-tax dollars and taxed upon withdrawal, Roth contributions are made after the taxes are paid, allowing for tax-free withdrawals in retirement. The biggest part everyone needs to remember is the growth of the account is Tax-Free. This strategy is particularly powerful for those expecting or planning to be in a higher tax bracket in the future. By paying taxes now at a potentially lower rate, participants can avoid paying higher taxes on their retirement withdrawals if taxes are higher or if the participant winds up in a higher bracket.

Another key advantage of the Roth strategy is the predictability of tax-free income in retirement. Given the uncertainty of future tax rates, locking in the current tax rate on contributions can provide financial peace of mind. Additionally, unlike traditional accounts, Roth accounts do not require mandatory minimum distributions (RMDs) at age 72, allowing savings to grow tax-free for a longer period. This feature offers greater flexibility in retirement and estate planning, as funds can be left to grow or passed on to heirs without immediate tax implications. Moreover, the ability to withdraw contributions (but not earnings) from Roth accounts without penalties can offer added financial flexibility. This can serve as an emergency fund, providing access to funds without incurring taxes or penalties, which is not possible with traditional accounts until age 59½.

For those planning on higher future earnings, a Roth strategy can be a wise choice. It offers significant long-term tax advantages and financial flexibility. By paying taxes now and enjoying tax-free withdrawals later, individuals can maximize their retirement savings and secure their financial future.

Richard Bavetz, FRC℠ is a Federal Retirement Consultant℠ and Investment Advisor with over 25 years of experience. As a Fiduciary, he works with 401k plan sponsors and their participants to provide advisory services and a wide range of compliant investment platforms.