We promised to delve a little deeper into what startups needs to know about 401(k) plans as a follow-up to our piece on MoneyIntel earlier this month. Here we present a few basic steps to help young founders and CFOs avoid any compensation or employee retirement snafus.
Many small businesses are so busy growing that they don’t realize their 401(k) plan could be a regulatory disaster waiting to happen. New rules from the Department of Labor have increased requirements for employers nationwide; there are now much stricter legal and fiduciary requirements for both companies and the finance and human resources executives who serve as plan trustees. Three simple things can prevent your plan from becoming a ticking time bomb.
1.Review Cost Disclosures
The Department of Labor last year began requiring service providers to disclose all fees and expenses to their customers. Plan fiduciaries must record receipt of these disclosures and analyze them to ensure that the company’s retirement plan is priced reasonably based on number of participating employees, the total amount they have contributed, and which features and services are included. Many providers have created either vague expense disclosures with broad ranges or extremely complicated disclosures that make it impossible to determine your plan’s exact expenses.
According to the new DOL rules, if your company does not receive these disclosures or cannot interpret them to disclose exact plan expenses to employees, you must request written clarification from your plan providers. If they don’t clarify those expenses, the company must “terminate the relationship” with its 401(k) provider. If a company fails to act, it is considered to have engaged in a prohibited transaction that could represent a breaching of fiduciary responsibility. Reviewing disclosure statements shouldn’t take more than a few hours. Don’t overlook this critical part of keeping your 401(k) in compliance with the new regulations.
2.Review Fund Selections
One of the core responsibilities of a plan trustee is to select the funds where employees can invest. Naturally, a huge concern for employers is that investments in their fund lineup perform poorly or, worse, “blow-up” and reduce employee 401(k) savings significantly. Many funds offer a wide variety of share classes, so even if the selected funds perform well, there may still be lower expense ratios available to higher account minimums.
Document that you are reviewing investments every six to 12 months. Your company is required to provide a diverse selection of investments, and you must demonstrate what criteria you used for selecting the funds that you have, including relative and absolute performance, the fund’s expense ratio, and the appropriate share class.
Neglecting to review the funds in your company’s 401(k) plan regularly may not cause any immediate problems. But, come the next recession, your company could face huge liabilities if an improperly vetted fund performs poorly and employees lose lots of money. And don’t think this hasn’t happened in the past (we’re looking at you Calpers).
But this is Silicon Valley, where Detroit-style pension defaults rarely happen; in the venture-backed Valley, companies grow headcount extremely fast and as a startup’s 401(k) plan assets grow with all the new employees coming in, the chosen investment options often don’t keep pace.
This brings us back to those new DOL rules. If a fund grows exponentially and its investment options aren’t updated within a reasonable time frame, this can be a breach of the trustee’s fiduciary responsibilities to the employees. No CFO wants this kind of headache looming when they’re trying to piece together deal terms for the next venture round, or even an IPO. Stay up-to-date on this as you grow.
3.Benchmark Plan Costs
Make sure you benchmark your plan costs at least once a year or possibly at the same time you review cost disclosures. Compare what you’re paying now to quotes from other service providers: Is your current provider charging a reasonable amount relative to the services provided? What are your plan costs compared to other businesses in your industry and size? If things seem out of line, use those competing quotes to negotiate with your current vendor before jumping ship. The faster your business is growing, the more often you’ll want to do this, says MoneyIntel CEO Monte Malhotra. “Far too often, small- and medium-sized companies can save thousands, if not tens of thousands of dollars, by doing a simple Request for Proposal with a handful of well-respected vendors.”
While employers want to offer good 401(k) plans, doing so can be time consuming, particularly if the company’s trustee has little professional investing experience. In fact, an inexperienced trustee is obligated to hire an investment advisor to ensure the plan is managed correctly.