American Administration Services Company

Retirement Plan and Investment Funds Basics for Participants

The Participant Employees and our beneficiaries: the spouse and kids. The greatest responsibility of a defined-contribution plan such as a 401(k) falls to the participant. And while participants are the only link in the chain that is absolutely free from any potential conflict of interest, we still manage to inflict plenty of damage to our retirement plans because of a lack of financial literacy.

The Sponsor - The employer who sets up the plan. Most times, the sponsor constitutes two groups: the company itself, which is usually the "named fiduciary," and the people who work in the human resources or Treasury department who oversee the plan for the company, making them the "functional fiduciary." When the employer's 401(k) committee meets, those functional fiduciaries are the ones who should be looking out for the participants' interests first and foremost. In the best of all conflict-free worlds, the sponsor should pay all the expenses of a plan, rather than let other groups "pick up the costs" -- and pass them back to participants. But in many small plans, it's just not doable. Click here to read general DOL information about Your Fiduciary Responsibilities (16 page .dpf) and here specifically related to Mutual Funds (2 page .dpf).

The Attorney - A pension plan is a complicated legal document, so it's prudent to have an ERISA attorney -- one who specializes in laws associated with the Employee Retirement Income Security Act of 1974, that governs 401(k) plans. The attorney provides legal advice, documents and other resources. Many times, the attorney is from a mom-and-pop law firm, but all the big white-shoe firms have ERISA attorneys as well. The potential for conflicts of interest here don't run very high -- if anything, the "old boy" network might play a role in a few instances. In other words, a big law firm suggests that the sponsor to hire a big bank -- maybe they even note that they handle the firm's plan. What the attorney may not mention is that said big Wall Street firm also brings in the most legal business for the firm. Rare instances aside, this isn't a major area of concern for individuals, except to be relieved that your firm has a good ERISA attorney.

The Auditor - The auditor typically is hired by the company -- and they are necessary for plans with more than 100 participants. As with the attorneys, sponsors can retain auditors from the local mom-and-pop CPA firm that has a 401(k) business or get one from one of the big accounting firms. The best-case scenario is an auditor who is an independent party working exclusively for 401(k) plan sponsors -- with no business relationships with the mutual fund firms, for instance.

The Consultant/Adviser - About 50% of 401(k) sponsors have hired an outside consultant to help choose the funds and the makeup of their plans. They fill a vital function: to advise sponsors on how to manage their plan. This is a huge area, and the services vary widely from the good, the bad and the ugly. The consultant may be from a big Wall Street brokerage & they may be inclined to sell you the funds that they offer in-house. They may be divisions of insurance companies. There are also other big consultant firms plus a growing niche segment of boutique firms (like us, American Administration Services Co., a consulting TPA) that specialize employee benefit plans. They are paid many different ways: commissions, a combination of fees and commissions and fee-only policies. With commissions, they often get paid through mutual funds (participants ultimately pay) -- 12b-1 fees and finder's fees. Consultants may also have lucrative business dealings with specific mutual funds (or even be owned by or own a mutual fund advisor company) which raises undeniable potential for conflicts of interest. Participants would be well-served asking their sponsor if their plan has a consultant, and if so, how do they get paid and are they truly independent?  

TPA or Third-Party Administrator - Virtually all 401(k) plan sponsors hire third-party administrators or TPAs (like us, American Administration Services Co.) that to handle compliance, accounting and back-office functions involved with a 401(k) plan. The TPA may be independent or from a big bank or brokerage that is handling other facets of your plan. TPAs often get paid through revenue-sharing arrangements with mutual fund firms -- such as subtransfer agent fees that may be asset-based or flat fees. These fee arrangements, which can range as high as 65 basis points, may not always be clearly disclosed to participants.

The Custodian - Somebody has to handle all the trades the millions of 401(k) investors make. The custodian is a conduit across which thousands of mutual funds are traded. Few employers have ever heard of the custodian who handles their individual trades. But one little-known custodian has received some troubling press recently, Security Trust Company. According to the complaint, Security Trust allowed Canary to late trade hundreds of mutual funds "under the radar," so that neither the mutual funds nor the investors had any idea that a hedge fund was skimming profits off the top by effectively paying yesterday's prices for today's funds. Security Trust has reportedly said it has not done anything wrong, and hasn't been charged. Many custodians, including Security Trust, also serve as the trustee for a 401(k) plan.  

The Trustee - All 401(k) plans, by law, must have a trustee -- the entity that holds participants' money in a trust account that is separate from the employer's assets. The trustee can be a fund company, a broker, a custodian. The trustee's primary function isn't investment advice, but rather to serve as the protector of the participant's money.

The Investment Manager or Fund Company - Investment firms that offer numerous options, usually stock, bond and money-market funds. Typically, these firms offer a large number of their own funds, but increasingly the fund companies also offer options from other investment concerns. They get paid by the expenses their funds charge -- which average about 1.5% a year for actively managed funds. Many times, the big investment company provides a host of other services for your 401(k) plan. Unfortunately, that doesn't mean all the other costs magically disappear to efficiencies -- instead, it typically means participants are simply paying (the same or perhaps even more) to one entity instead of several different vendors.

From the S.E.C  Invest Wisely:  An Introduction to Mutual Funds

Commonly used Employee Benefit Acronyms & Terms and what they actually mean

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