Picking the cheapest provider can be a breach of fiduciary

When it comes to health and fitness, you constantly hear studies about what foods fight or cause cancer. Of course, those studies are then debunked. I remember how oat bran was cited to cut down on cholesterol and how margarine was better than butter. Plus I have heard how coffee can prolong life or kill you. I joked that one study will suggest that constantly eating broccoli will cause cancer too.

I blogged once about how the paranoia in me figures that a plan provider that quickly cuts down their fee might have been overcharging the client, to begin with. People tend to think I have a bias against plan providers such as third-party administration (TPA) firms and I certainly don’t because I see the overwhelming value of a good TPA.

With fee disclosure regulations around for 8 years and constant news articles about 401(k) fees, I think the fascination and concentration on fees could be detrimental if that is the major or sole criteria in selection plan providers.

401(k) plan sponsors, as plan fiduciaries have important responsibilities. These responsibilities include: acting solely in the interest of plan participants and their beneficiaries and with the exclusive purpose of providing benefits to them; carrying out their duties prudently; following the plan documents (unless inconsistent with ERISA); diversifying plan investments, and paying only reasonable plan expenses.

While paying unreasonable plan expenses is a breach of fiduciary duty, picking providers solely or mainly because they are low in fees can also breach a fiduciary duty. Retirement plan sponsors also have a duty of prudence as one of their fiduciary duties. Prudence is about the process of making fiduciary decisions. Prudence requires the plan fiduciaries to document decisions and the basis for those decisions. So in hiring any plan provider, a fiduciary should survey several potential providers. By doing so, a fiduciary can document the process and make a meaningful comparison and selection.

Governmental contracts are typically decided by the lowest bidder. Sometimes it works, but lots of times it doesn’t. The same thing goes with selecting plan providers. There are many low-cost providers out there and some do a very good job and some do not. Some low-cost TPAs may be good if there is a limited amount of work on a 401(k) plan with a safe harbor design and terrible if the plan requires a discrimination test.

Paying only reasonable expenses is not the same as paying low expenses. Plan provider expenses are less about cost and more about value. A financial advisor charging 15 basis points providing no help in the fiduciary process such as developing an investment policy statement, reviewing investment options, and educating participants in a participant-directed 401(k) plan is less reasonable than paying another advisor 50 basis points to serve as an ERISA §3(38) fiduciary. Why? The advisor charging 15 basis points is increasing the plan sponsor’s liability as a fiduciary because they are doing nothing while the ERISA §3(38) fiduciary is assuming almost all of that liability. Reasonableness is not about cost, it’s about the value of the services provided. A TPA that can help develop a plan design that maximizes contribution for highly compensated employees through a safe harbor/new comparability or a cash balance design is a better value than a TPA who only knows a 401(k) plan with comp-to-comp allocation.

Plan sponsors need to focus on the competency of plan providers, the services they offer, and the value they provide. Concentrating on how much a provider charges may cost more in the long run if that provider offers incompetent services. I have seen too many plan sponsors forced into the Internal Revenue Service correction programs to fix the errors of plan providers that were picked solely on cost.

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