What is open architecture 401k?
Planners helped shed some light on what open architecture involves; it is not just being able to add non-proprietary funds to a plan's lineup. The recordkeeper,
investment manager(s), and custodian/directed trustee are all separate entities. The recordkeeper has the ability to trade virtually any mutual fund or exchange-
traded fund (ETF), and has a stable of custodians/trustees from which to select. There are no proprietary investment requirements. Fees for services are fully
disclosed, and offset by any revenue sharing provided by investment company (sub-TAs or 12-b1 fees for instance).
It is critical to realize that open architecture is not right for every plan sponsor. Before recommending open architecture to a client, there are a few questions
to weigh, said planners. How important is flexibility to the client? How important are total plan fees and fee transparency? And how sophisticated are the
participants? It’s important to know these things because many bundled providers offer significant investment flexibility which you lose with open
architecture; hence, the total cost could be higher. And although decision-makers of the plan might think flexibility is important, participant behavior might
A planner suggests that advisers look at open architecture in five parts. First, there is fiduciary oversight. The sponsor wants the adviser to build a plan he or
she feels is strong, but at the end of the day, the sponsor wants protection. The most important component, according to A planner, is participant education.
He says it needs to really robust and involve more than just directing participants to a Web site. After those first two elements are given an ample amount of
time, the adviser can then consider plan investments, plan costs, and customizing overall plan design. A planner recognizes that it requires a lot of work, but
when done correctly, it can really make a difference in people’s lives.
Pros and Cons
In his experience, Planners has seen several pros and cons of open architecture. The pros include:
* The ability for an adviser to offer any mutual fund option to a plan is a great way to show value.
* The need to change recordkeepers because of poor fund performance disappears.
* The customization is appealing to clients.
* It can signal to a prospective client that you are willing to go that extra mile for them.
The cons of open architecture include:
* Requires the adviser to work only in a fee-based capacity.
* Takes more work and time to service an open architecture plan.
* Technology offered by most open architecture providers is not as robust as most bundled providers.
* The level of revenue sharing provided to the open architecture provider can significantly affect the economics of the plan.
All of these pros and cons came to fruition with one sponsor in particular, said Planners. Planners Financial was hired as the registered investment adviser (RIA) on the plan after the decision was made to leave a bundled provider for an open architecture one. However, when making the decision to leave the bundled provider, the client had assumed that the proprietary requirement was higher than it actually was, he said. Further, the fee disclosure provided by the open architecture provider assumed “mapping” that was "dubious," Planners said. Although the fund menu suggested in the proposal was reasonable, the share classes used by the open architecture provider contained above-average fees given the plan demographics.
However, after Planners recommended a more prudent fund menu to the client, the billable fees came in higher than that of the bundled provider. The recordkeeping fees, which were billed quarterly, were often inconsistent because the revenue sharing from some fund companies lagged. The technology and customer service was not up to par with that of the bundled provider. The plan participants, though adequately diversified, did not appreciate the differences between funds, but did notice when their employer began to pass fees off to them, which they had not seen under the previous provider.
Planners said that after having gone through that process, the client is now considering proposals from other bundled providers
Retirement plans, such as 401(k) plans, comprise a labyrinth of complex rules, accounting procedures, investment options, testing and reporting schemes and, as such, have heretofore been unmanageable to the average person or small business. Because of the above cited complexities, the normal course of action is to retain the services of a professional retirement administrator to setup, operate, test and otherwise supervise the overall retirement plan established for a group of individual employees.
Internal Revenue Code section 401(k) was devised to encourage workers to set aside money for their retirement years by allowing them to defer paying taxes on "retirement money" until retirement, at which time they would likely be in a lower tax bracket and, therefore, pay less total tax on the dollars.
Because 401(k) dollars aren't to sit idle while awaiting withdrawal (such would hardly make individual or national economic sense), an entire industry has formed around helping companies set up their 401(k) plans--and helping participants invest the dollars they defer into them.
Every 401(k) plan requires knowledgeable monitoring to ensure it stays in compliance with IRS regulations. Plans that include many services (loans, hardship withdrawals, automatic IRA rollovers upon distribution, etc.) and that allow a wide selection of investment opportunities can become very complex; their providers (often "third party administrators") charge accordingly. It's a fee that puts the 401(k) out of reach of many businesses. Providers of these plans also commonly assess a fee based on the number of employees eligible to participate in the plan (regardless of the number that actually do participate), and they often require a certain minimum level of actual participation--to ensure a minimum pool of investment dollars which will be earning the administrator fees and, possibly, brokerage commissions. Coming up with the base-fee capital, plus being able to meet the high eligible-employee and participation standards imposed by providers, effectively eliminates most small businesses from setting up a 401(k) plan.
The tremendous population not served by full-service, highly-customized 401(k) plans inspired some providers to create the "turnkey" plan. Turnkey plans are prefabricated and ready-to-use 401(k) s, with IRS-mandated documents, administration and investment options bundled together into one integrated package; participants' assets are pooled to create the commission earning investment minimum desired by the providers. The plans are designed to be simple, easy-to-use and relatively low-cost--to both provider and end-user. Most insurance companies, mutual fund companies, and brokerage houses offer versions of the turnkey plan.
Unfortunately, the simplicity sought in the turnkey has also made it inflexible, presenting many clients with problems over time. For example, the bundled turnkey offered through a mutual fund company, or brokerage firm, makes it virtually impossible for an employer to change from the in-house investment selection-administration pairing chosen at the plan's outset. Another drawback is that many brokers and agents involved with 401(k) plans use the 401(k) as a vehicle for soliciting their clients' employees with additional investment products.
Offering unlimited access to virtually all SEC-regulated investment options--with no restrictions on the number of mutual fund families or their investments that a company can choose for its plan--is a far cry from the practices of typical "turnkey" products, such as those offered by mutual fund companies and insurance companies. In most turnkeys, the host company bundles a few proprietary investments with its in-house 401(k) administration; the result has been inflexible, relatively costly, and investment-sparse plans limited in their suitability to a wide range of participants--and greatly inhibiting to an employer having to change investment or administrative providers.
Conventional 401(k) plans fail to provide the flexibility to track individual investor accounts separately. Individual tracking enables unlimited new employee additions, unlimited investment options and tracking thereof, without modification of the remaining member accounts.
Current 401(k) Software US Patents
The patent of Gilbert (U.S. Pat. No. 6,041,313) provides for a relational database structure to maintain all information required to administer a 401(K) Plan using individual employee-participant accounts as opposed to traditional approaches using pooled 401(K) accounts. In the preferred embodiment, Microsoft Access™ is the database of choice, but equivalent databases may be substituted without departing from the scope of the present invention. The invention makes maximum use of a relational database structure to streamline the administration of the 401(K) Plan and keep manual administrative overhead to a minimum
The patent to Valentino (U.S. Pat. No. 4,648,037) provides for a method and apparatus of a communication system for enabling an employee to access information by a terminal concerning their up-to-date savings plans and the values thereof, withdrawal information, explanations of provisions, employee benefit information (e.g., group life insurance, disability coverage, vested retirement, etc.), explanations of savings plan and benefit options, and benefit news bulletins.
The patent to Halley et al. (U.S. Pat. No. 4,750,121) provides for an improved pension benefits system for enrolled employees of subscriber employers including a master trust institution and a life insurer institution. The master trust institution computes and receives each subscriber employer's periodic payment therein to based primarily upon that employer's number of current employees, their ages and monthly earnings; purchases and retains a life insurance policy from the life insurance institution covering each enrolled employee; invests in available securities to generate interest income; provides specific accurate future projections of periodic benefits for retirement, death, or disability; receives all life insurance policy proceeds upon the death of each enrolled employee; and distributes all periodic payable benefits. Funding a significant portion of payable periodic benefits by life insurance policy proceeds retained within the master trust institution is one truly unique feature of this system; life insurance having prescribed amounts of whole life and progressive one-year term dividend rider components is yet another.
The patent to Durbin et al. (U.S. Pat. No. 4,933,842) provides for an "Automated Investment Fund Accounting System", a computerized investment plan accounting system which manages data for investment plans with multiple participants and multiple investment funds.
The patent to Atkins (U.S. Pat. No. 4,953,085) provides for a "System For The Operation Of A Financial Account". A personal financial management program is disclosed incorporating means of implementing, coordinating, supervising, analyzing, and reporting upon investments in an array of asset accounts and credit facilities within a client account. Through a mathematical programming function, the client specifies his financial objectives, his risk preference, forecast of economic and financial variables, and budgetary constraints. The mathematical programming function suggests to the client a portfolio of investment and credit facilities to best realize his financial objectives over a defined time horizon.
The patent to Halley et al. (U.S. Pat. No. 4,969,094) provides for a self-implementing pension benefits system for subscriber employees (E1, E2, E3 . . . ) including a life insurer institution and a lending institution. A Life insurer trust institution computes and receives each subscriber employee's periodic payment therein to based primarily upon each subscriber employee's age and desired periodic benefits and issuing a life insurance policy covering each subscriber employee (E1, E2, E3 . . . ); providing specific accurate future projections of periodic benefits for retirement, death, or disability; and distributing all life insurance policy proceeds upon the death of each enrolled employee to the lending institution.
The patent to Wolfberg et al. (U.S. Pat. No. 4,994,964) provides a data processing system which monitors a client's business order over time, and based upon predetermined criteria, determines the client's vested interest in funds deposited into special client accounts. The business order data is stored in uniquely formatted client account files. In addition, a vesting account file stores summary data encompassing all the client files.
The patent to Harris et al. (U.S. Pat. No. 5,095,429) provides for a "Method For Prioritizing Data In Financial Information System." A method is disclosed for modifying calculation of predefined procedure in a spread of financial data in a financial information system operative on a digital computer wherein data is manually input into a cell as a value, the value is prioritized above other values dependent thereon by setting a lock flag to indicate that the data is to be secured against change by subsequent recalculation on the cell, and thereafter the data of all other cells which is not locked is recalculated on the basis of the priority values stored in cells designated as locked.
The patent to Fox (U.S. Pat. No. 5,132,899) provides for a "Stock And Cash Portfolio Development System" which combines data gathering and processing methodology with computer apparatus to produce a system whereby a list of stocks and a cash position is generated and purchased for investment and operating accounts.
The patent to Wolfberg et al. (U.S. Pat. No. 5,214,579) provides for a "Goal-Oriented Investment Indexing, Tracking And Monitoring Data Processing System." The data processing system manages, monitors, and reports the growth of a participant's investment base with respect to progress towards achieving a predetermined target amount selected by the participant.
The patent to Bailey (U.S. Pat. No. 5,227,967) provides for a "Security Instrument Data System Without Property Inapplicable Nulls." The patent discloses a system and method for storage and retrieval of investment asset data in a computer system, separates the data into many small files each of limited size and related to a functional attribute of the investment instrument.
Revenue Sharing & Fee Analysis
Imagine a world in which your grocery store sells food at the cost charged by the producer with no markup. The grocery makes its profit by working only with producers who agree to rebate back a portion of their price (e.g., the producer who sells a can of peas to the store for 50 cents rebates 10 cents back to the store when it's sold).
It sounds like an odd arrangement, but it's the foundation of the record-keeping industry. As much as possible, record-keepers eliminate hard-dollar fees by using soft-dollar relationships where the investments rebate a portion of their fees. This creates a powerful incentive for record-keepers to allow access only to those investments that rebate fees, with performance as a secondary consideration. Many firms are reluctant to disclose these soft-dollar arrangements and consider it proprietary information.
As a fiduciary, you have the right - and the responsibility - to understand the fees vendors receive while providing service to your plan. We can help you uncover the hidden fees and learn exactly how much you and your participants are paying.
Record-keeping is not a profitable enterprise. A typical 401(k) record-keeper may spend between $100 - $150 per year, per participant on record-keeping and administration. This includes the daily valuation, internet access, 800 numbers and quarterly statements that most of us have come to take for granted.
In reality, very few employers with 1,000 participants are willing to pay $100,000 to $150,000 per year in administrative fees. Instead, employers routinely benefit from the revenue sharing provided by the plan's investments and pay only a small portion, if any, of the administrative costs of the plan.
Most employers hire record-keepers without investigating the revenue sharing arrangements and with little thought to questions like: Are other investments available that may pay slightly less revenue to the vendor but have significantly better performance? What amount of revenue is reasonable for my vendor to make in light of the services provided?
We understand the numbers behind the scenes, and we help our clients quantify the revenue generated by their plan. We put you in control of the investment selection and fee process.
Did you know?
- When your plan doubles in size it typically doubles your vendor's revenue.
- Vendors can often be persuaded to offer cheaper share classes of the investments as the plan's asset base grows - driving down costs for participants and enhancing their retirement.
- Hard dollar costs billed to the employer can often be reduced or eliminated for plans with average participant account balances of $30,000 or more.
- Some vendors are willing to credit back excess revenue to the employer and plan participants.
- It is possible to get an accurate estimate of revenue sharing dollars even when the vendor chooses not to disclose it.