by: Ted Schumann, II, MBA, MSF, AIF®, CFP®
When many 401(k) and Profit Sharing plans were first adopted by dental practices, the main focus was on sheltering tax. Owner-Doctors would set up these plans to allow for tax-deductible funding and tax-deferred investing for their employees and themselves. This worked very well historically, and still works very well today to allow Doctors and staff to build sizeable retirement nest eggs. In the old days, it was not uncommon for all participant money to be pooled in the 401(k) or Profit Sharing plan. Furthermore, Doctors would often take it upon themselves, as the plan sponsor, to make investment decisions on behalf of the plan. Some plans even run this way today.
While this arrangement did not give the participants much control over their accounts or transparency in their investments, it did not generally create major problems as long as Doctor, or their advisors, invested the funds prudently and responsibly. It was not until some business owners decided to get “creative” with plan investments that problems arose. Consider the business owner that determined real estate would be a good plan investment, so they used the plan assets to finance the purchase of a cottage.
This kind of activity prompted regulators like the Department of Labor (DOL) to hold plan sponsors more accountable for the investments they made available inside retirement plans. To be most compliant with DOL regulations, the plan must demonstrate a documented process for evaluating and screening investments for inclusion or exclusion from the retirement plan. As you can imagine, an evaluation process is generally not friendly to investments that are opaque. There has been a trend toward increased transparency for this reason.
It is not incumbent upon the plan sponsor to choose the best performing investments. However, it is imperative that a plan sponsor shows criteria for selecting the investments they used. For example, it is a best practice for a 401(k) plan to have a signed Investment Policy Statement. This is a document that outlines how plan assets should be managed, identifies any extenuating circumstances, identifies all plan fiduciaries including the investment committee, and the scope of each party’s authority.
A documented evaluation process and a formal Investment Policy Statement are recommended for trustee directed plans, where the investments are pooled and the plan sponsor makes all the investment decisions. They are also recommended for participant-directed plans, where plan participants choose their own investments according to their own risk tolerance, time horizon, and investment expertise.
Plan fees were also overlooked or ignored in the past. Most rational people understand that no one works for free. Yet it was not until relatively recently that 401(k) and Profit Sharing plan fees got any attention. They are now required to be disclosed. Admittedly, disclosures are not necessarily easy for most plan participants to interpret, but it is a step in the right direction.
For years, plan fees, commissions, and revenue sharing arrangements were buried in mutual fund expense ratios and out-of-pocket costs were low or non-existent. Seldom did the practice owner or employee-participants know who they were paying to do what and how much. Worse than that, most investment professionals were held only to the “Suitability Standard”. This meant that as long as an investment’s risk was not inappropriate for the investor’s situation, it was appropriate and acceptable to sell the client the highest commission product available.
This is a far cry from the way most dentists do business. In my experience, most dentists give their patients treatment options based on the patient’s case and circumstances. Treatment options will vary in cost and feasibility, however, the patient has enough information to make an informed decision about their health. The dentist does not offer only the procedure that will generate the most profit for the practice without giving the patient some other options. Sadly, that is exactly what many financial salespeople were doing to their clients.
Fortunately, the Department of Labor is turning this practice upside down. Readers who know me well know that it is seldom in my nature to welcome even more regulation in the industry. In this case, it makes sense. The Department of Labor is now expanding the requirements of financial professionals that service retirement accounts. All advisors will now be held to the “Fiduciary Standard”, which means they must always act in the client’s best interest; unless, and I wish I was making this up, they qualify for an exemption known as the Best Interest Contract Exemption (BICE). Yes, a loophole exists to actually exempt an advisor from acting in the client’s best interest.
The new Fiduciary Standard is nothing new to Registered Investment Advisory firms like DBS Investment Advisers, LLC. We have always been held to the Fiduciary Standard. So for firms like ours, it is business as usual. For the more commission-oriented Broker Dealer-type firms, this is a major paradigm shift. Some of these firms have decided to discontinue managing some types of retirement accounts altogether. For example, Edward Jones has made significant changes to their business model due to the new requirements.
Retirement plan sponsors also have a fiduciary responsibility and liability for monitoring plan fees. Recently, some plan sponsors have been sued by plan participants (employees) because of excessive plan fees. Excessive fees are a result of the plan sponsors breached duty to monitor and benchmark plan fees. This includes mutual fund expense ratios, revenue sharing paid by plan investments, advisory fees, and fees charged by record-keepers (investment companies), and plan administrators.
As you can see, management and maintenance of retirement plans has evolved over time. While dentists were once able to make deposits into their plans, take applicable tax deductions, and invest the money as they wished with little regard to fees or investment process, those days are gone. The bar is now higher and decisions at a plan level must be made more thoughtfully. In addition to portfolio management, support of the fiduciary process is a big part of what we do for our clients. If you have not thoroughly reviewed your retirement plan lately, you need to. If you have never reviewed your retirement plan, I can help. Feel free to contact me at ted.schumann@dbsia.net to schedule a no-obligation fiduciary review.