Upgrading individual annuity contract plans to slash rising costs
Several colleges are joining forces to pool their employee retirement accounts and lower administrative costs. This trend reflects a simple fact: academic and non-profit institutions, like all employers today, are facing workplace pressures due to rising costs, disruptive technology, and the needs of a new generation of employees. To attract and retain talent in this environment, institutions must offer the most attractive benefits programs — without straining their administrative or financial resources.
Yet, many non-profit employers are trying to address the needs of the present employment marketplace with a retirement platform that is rooted in the past: the individual annuity contract (IAC). Over the past several decades, millions of academic and non-profit institution employees have participated in 403(b) plans based on IACs.
Key Disadvantages of IACs
Probably due to a lack of understanding of their current plans’ deficiencies and available alternatives, most schools and non-profits are continuing to offer outdated IAC legacy plans. Such plans have several disadvantages versus newer group platforms.
· Fiduciary Risk: Most IAC plans were created over 10 years ago, before current fiduciary regulations were in force. Under ERISA, plan fiduciaries can be held personally liable for high cost or inappropriate investments in their organization’s retirement plans. This fiduciary liability can be addressed by delegating full fiduciary responsibility to a Registered Investment Advisor who is an ERISA 3(38) fiduciary or by jointly sharing fiduciary responsibility with an investment professional who is a 3(21) fiduciary.
· Excessive Costs: Depending on the investment share class used in the plan, a large majority of IAC plans have separate account fees ranging from as low as 0.75% to as high as 1.40% of participant account balances. New fiduciary regulations require employers to ensure that participants’ costs are reasonable. We suggest you shift to an open architecture platform that can reduce fees to 0.30% to 0.40%, and enable employers to engage more robust support services.
· Administrative Burdens: Each IAC plan participant has an individual account requiring a signed application, which increases HR’s workload. Also, many of the IAC platforms typically have duplicate plans – one for participant contributions and another for employer contributions. This leads to dual Form 5500 filings and audits, and increases employer workload and costs.
· Limited Support and Service: IACs generally do not have a high level of service support, particularly for plans with under $10 million in assets. Employers are often on their own, with limited assistance for plan design, enrollments, distribution of required notices, and other functions.
· Few Investment Options: IACs limit the employee’s investment options to those preselected by the insurance company offering the plan. These limited options typically include illiquid fixed accounts with locked-in distribution periods, heavy use of proprietary funds, and target date/allocation funds that are static. This prevents employees from allocating their assets in a diversified manner that aligns with their risk tolerance.
· Limited Education and Investment Advisory Support: Many IAC retirement plans don’t offer sufficient plan education or individual investment advisory support. Along with more investment choices, today’s employees deserve better plan education and individual investment advice.
Modifying legacy plans or transitioning to open architecture
Fortunately, there are ways to upgrade legacy plans to meet current regulatory, sponsor and participant needs. An institution may be able to keep its IAC plan, while working with a qualified investment advisor to update the plan to align with today’s best practices, regulations and employer/employee needs, while also offering better employee education options. It is wise to choose an advisor who is an ERISA 3(21) co-fiduciary advisor or preferably an ERISA 3(38) full fiduciary, and will therefore be able to provide additional fiduciary protection. This will not solve the central fiduciary issue of participants paying excessive fees.
Some plan sponsors are not content to give their IAC plan a “tune-up,” but want to trade in their plan for one that is competitive with the benefits offered by for-profit companies and larger not-for-profit organizations. For such sponsors, an open architecture platform offers diverse investments, potentially lower costs, enhanced service support, and greater fiduciary protection. There are two routes that institutions can take to migrate to an open architecture plan.
1. Upgrade with your current provider
Your institution may consider moving from an IAC plan to an open architecture platform with your current provider, if this option is available. For example, many academic and non-profit sponsors work with TIAA, which offers an open architecture platform.
Besides offering participants a wider universe of investment options, a switch to open architecture may provide other advantages:
· An overall reduction in plan costs.
◦ Employers are only paying for the services they receive and not subsidizing other, less profitable plans to the provider.
◦ Underlying investment costs such as revenue sharing and broker commissions are reduced because of a shift from retail pricing to institutional pricing.
· Simplified plan administration.
◦ As part of the process of working with a qualified advisor, upgrading to an open architecture platform would include having only one plan document and one Form 5500, which also contributes to cost savings.
Although a move to an open architecture platform can have many benefits, this doesn’t necessarily solve the key problem of these IAC plans, which is that employees are not invested appropriately. They tend to chase returns, are not adequately diversified, and invest either too aggressively or too conservatively. A successful retirement plan should be measured by employee satisfaction and outcomes, which is the result of employees meeting their retirement goals.
2. Move to an independent open architecture platform
An institution may prefer to move away from its current IAC platform and provider and adopt a new group retirement plan developed with the advice of an RIA. In addition to getting a fresh perspective on employees’ needs and investment options, this approach offers the following enhancements:
· Substantial investment and recordkeeping cost savings, compared with the costs of a typical insurance company-sponsored annuity or group platform.
· A higher level of operational and service support from a dedicated representative versus a toll-free call center.
· The potential for a bundled approach allowing for a turnkey, streamlined administrative process as the sponsor may delegate third party administration services to the record keeper.
· Additional ERISA 3(16) operational fiduciary protection available via the plan administrator/custodian.
This is not to suggest that upgrading or transitioning an existing IAC plan will be easy. However, the result clearly will be worth the effort – providing both employers and employees with a more robust, compliant solution that can deliver a wider range of investment choices, potentially lower fees, better support service, enhanced education, and fiduciary protection.