In the course of our work for school districts, cities, counties and other governmental entities, we are often called upon to help find a solution for a problem in the 403(b) or 457(b) plan. This gives us a perspective that we believe will be helpful to others in similar situations. Therefore, I will be writing a regular column for this newsletter in which I will discuss two or three of the most common problems we see with plans of tax exempt and governmental entities.
Here are three "Mistakes We See":
In many cases, the compensation for the brokers or advisers to the plan is paid through commissions. (For ease of reference, I will use the term "consultant" rather than repeating "broker or adviser.") Unfortunately, and all too often, those commissions are not fully disclosed (and, in some cases, not at all). Because of the dual failure-that is, the failure of the consultant to disclose and the failure of the plan sponsor to request information about fees and expenses-unscrupulous consultants are able to overcharge for their services. When consultants give in to that temptation, the employees are the victims, since the excessive fees directly reduce their retirement benefits. The excess costs, compounded over many years, can result in a surprisingly large reduction in the employees' benefits.
Plan sponsors and their officials, as fiduciaries, have a responsibility to fully understand and evaluate all of the expenses being charged to the plan, either directly or indirectly, as well as to understand and evaluate all of the revenues being received by the service providers, both directly and indirectly. Changes in reporting requirements for non-governmental plans subject to ERISA will help with this problem, but it is incumbent on the fiduciaries to ask the right questions.
(Note: In some states, like California, public school districts are required, as a matter of law, to accept virtually any 403(b) provider. Obviously, in those states, the school officials cannot be responsible for the level of fees and expenses. That is unfortunate, as it often results in school teachers and other employees being overcharged.)
Surrender charges are often an indication of excessive commissions-but not always. However, unless the plan sponsor is diligent in its review of the investment and program materials-and in asking tough questions, surrender charges can often be completely hidden, inserted inconspicuously in a lengthy document or not disclosed until after the plan has been put into place.
As a word of advice, don't ever enter into an agreement for the establishment or conversion of a plan unless, and until, you have either a written representation that there are no surrender or similar charges (sometimes called CDSCs or contingent deferred sales charges) or a full written description of all such surrender charges and other termination fees.
Of the situations we have seen with large surrender charges lasting many years, most often those charges are imposed by the plan provider or the investment provider because of high commissions paid to the consultant. In effect, the failure to properly evaluate the payments, direct and indirect, to the consultant at the outset can result in the imposition of a large surrender charge.
Government entities that sponsor retirement plans should appoint a plan committee, and that plan committee should meet with its lawyers, advisers, consultants, etc., at least semi-annually (and, for larger plans, preferably quarterly). Unfortunately, many do not.
Our experience is that, where plan committees are appointed, and where they meet regularly, the quality of the retirement plans is improved significantly. That is because the job is assigned to a group of capable people who are diligent in doing their work. Generally speaking, a plan committee will be more critical (and perhaps more demanding) than where a single person is given the job.
As a result, we encourage all of our plan sponsors, both public sector and private sector, to have operating committees for their plans.
These are just three of many problems that we see. In future columns, I will be writing about others. If you would like for me to address any specific issue or concern, just drop me an email at fred.reish dbr.com.
Disclaimer Required by IRS Rules of Practice:
Any discussion of tax matters contained herein is not intended or written to be used, and cannot be used, for the purpose of avoiding any penalties that may be imposed under Federal tax laws.