Ex-Employees Who Don’t Rollover – Will 401k Fees Increase Plan Sponsor Liability?

June 28
01:19 2011

There’s often a debate as to what’s in the best interest of ex-employees: to keep their retirement assets in their former company’s 401k or to roll those assets over into an IRA? What’s often overlooked in this calculation is whether this individual 456662_61060272_no_loitering_stock_xchng_royalty_free_300decision can inadvertently increase the fiduciary liability of the 401k plan sponsor at the former firm. To determine the extent of their potential added fiduciary liability, 401k plan sponsors must first discover what makes it so convincing for ex-employees to rollover their 401k into a personal IRA – and perhaps learn why this advice is considered controversial.

Whether employees take their money comes down to two compelling themes: control and costs.

On the control side of the equation, regarding their 401k plan assets, the best time for former employees to rollover occurs during the exit interview. Typical corporate practice has the HR staff explain to the exiting employees the several options they may have regarding their 401k funds. In some cases, small amounts are automatically removed with the default being the employee receives a check. Unfortunately, this usually represents a taxable transaction and, unless the plan sponsor clearly delineates the options (specifically, how to avoid making this a taxable transaction), the plan sponsor may assume some liability for providing incomplete advice. In most cases, the employee has three options: 1) Keep the assets with the old employer; 2) Transfer the assets to the new employer; and, 3) Rollover the assets into a personal IRA.

In the first two options, employees cede control of their retirement savings to either their old employer or their new employer. Lack of control means a lack of options. “The old 401k may or may not be performing well – either way, its financial health is out of the control of the former employee,” says Jaime Raskulinecz, CEO of Next Generation Trust Services of Roseland, New Jersey. By keeping old 401k assets in the former employer’s retirement plan, employees restrict their options “to certain mutual funds or other traditional brokerage investments selected by the former employer,” adds Raskulinecz. The same would be true even if the employee transfers his retirement assets to his new employer’s 401k plan.

There’s another issue of control that can represent something much more problematic. Theoretically, former employees have access to their old 401k holdings, but even that access can come with strings attached. It may take several months to extract their assets from a former company’s 401k plan. Over time, as HR personnel change, companies move or get bought out, it may be less clear where former employees should go to get their retirement assets. In the worst case, if the former company gets into financial trouble, ex-employees may find access to their retirement assets tied up in litigation.

The loss of control stands as a strong reason to rollover assets. As the plan sponsor can see, holding the retirement assets of former employees just increases the chances for a fiduciary breach. But the control issue pales in comparison to the fee issue.

“It’s important for outgoing employees to rollover their company 401k mainly because it’s more expensive to leave it with the employer than it is to transfer it,” says Bill Ulivieri, Accredited Investment Fiduciary Analyst (AIFA) at Cenacle Capital Management LLC in Glenview, Illinois. While there are several ways 401k plans add greater fees, the most significant ones deal with expenses relating to administration and regulatory compliance. In many cases, ERISA plans must hire custodians, recordkeepers, third-party administrators, independent auditors, fiduciary advisers and, in some cases, staff, to operate a successful retirement plan. None of these service providers (and their associated costs) are required in an IRA. “The outgoing employee is better served by rolling their retirement plan to an IRA,” says Ulivieri.

One of the service providers not listed above – but the one most often cited in 401k fee related literature – is the investment adviser. That’s because, unless the employee wants to take the time and effort and manage his own portfolio of stocks and bonds, a Rollover IRA will likely entail either hiring a professional investment adviser to manage the private portfolio of stocks and bonds or hiring a professional investment adviser through buying a mutual fund or an ETF. In both of these cases, the cost of hiring a professional is incurred by both the IRA and the 401k plan.

Though the reasoning to rollover is sound, it is also controversial. It’s easy to find sales literature – and even media articles – that promote keeping assets in a former employer’s 401k. Frequently, these writings cite the greater ability to vet professional investment advisers and to negotiate more favorable fee schedules on the part of 401k plan sponsors as the primary reason NOT to rollover retirement assets. Yet, a simple review of the top mutual fund holdings in 401k plans reveals nearly all these holdings are high-cost low-performing mutual funds (see “Should What DOL’s New Regs Reveal about Most Widely Held 401k Mutual Funds Worry Plan Sponsors?Fiduciary News, January 3, 2011). While some 401k plan sponsors no doubt do receive significant fee concessions, it’s not clear if those breaks can overcome the administrative and compliance expenses. “The maintenance fees on these 401k accounts are typically high and eat into the investor’s long-term earnings potential,” says Raskulinecz.

Even in the case of index mutual funds, employees might be better served by rolling over their assets into an IRA and buying ETFs (at least the more liquid ETFs) of their favorite indices. In most instances ETFs have much lower expense ratios than their mutual fund equivalents. “The annual management fee of a domestic ETF that tracks the S&P 500 can be 80% less than an equivalent mutual fund,” says Ulivieri, who noted in some cases these ETFs can be purchased commission free.

Mike Garry, owner of Yardley Wealth Management in Newtown Pennsylvania, offered this simple summary when he said, “better investment choices, lower and more transparent fees – no hidden revenue sharing fees either” may provide the best blueprint to help 401k plan sponsors determine whether they may be increasing their fiduciary liability when ex-employees opt to keep their assets with their former employer. In a blunt sense, while 401k plan sponsors can (and should) seek fee transparency and avoid revenue sharing fees, they cannot (and should not) offer all investment options and cannot (and should not) remove administrative and compliance expenses. Unfortunately, 401k plan sponsors cannot serve two masters – the existing employees and the former employees. They might consider telling former employees to stop loitering. It’s good for the 401k plan sponsor and it’s good for their former employees.


About Author

Christopher Carosa, CTFA

Christopher Carosa, CTFA

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  1. Nevinesq
    Nevinesq June 28, 06:48

    I have long been pitched that plan sponsors should WANT to keep those ex-employee balances in the plan, particularly the retirees – it is ostensibly a benefit that reduces costs for the plan, while at the same offering those participants the benefits (cost and otherwise) of remaining in the plan, with investments that they know. That said, I have found that most plan sponsors aren’t really aggressively interested in retaining those balances, because they do add a level of administrative/communications complexity (consider that in my reading of the Enron case, the real communication problem was with ex-participants/retirees who were no longer part of the company intranet/email).

    But this notion – that participants routinely get access to less expensive and “better” options outside the plan than they do in the plan – seems to me to be most pervasive among those who would very much like to separate those participants from their savings.

    I’m not saying that you CAN’T get less expensive options outside a qualified plan, but I’m willing to bet that most who try to figure out what to do after taking their money out of the plan don’t. In my experience, most are sheep heading for the proverbial (financial) slaughter.

  2. Christopher Carosa, CTFA
    Christopher Carosa, CTFA Author June 28, 10:15


    Thanks for the comment. While the article does agree with you that there may be some cases where plans have negotiated lower mutual fund expense ratios than participants can otherwise obtain, it does focus on two things which your comments may be overlooking. First, all ERISA plans have (appropriate) fees to cover administration and compliance expenses and many plans use fund assets (e.g., via 12b-1 fees) to offset these expenses. IRA do not have similar expenses. Currently, it’s not clear if employers tell exiting employees that leaving their retirement assets in their former company’s 401k may include paying fees the employee would not have to pay if the employee chooses to rollover their assets. This is a potential liability for the employer.

    Second, and this is based on the BrightScope data as referenced in the article, it appears the most widely-held funds are not the low cost funds very large 401k plans have been able to negotiate lower expense ratios for.

    Just as you aren’t saying ex-employees could never obtain lower prices outside the 401k say, I’m not saying there aren’t cases where employees can’t find the lowest price by staying in certain old plans.

    One thing we do disagree on: I have more faith in individuals making their own decisions in their own best interests, so I don’t see them as sheep being led to the slaughter. However, this difference just means you’re a realist and I’m an idealist. 🙂

  3. Randall L. Reese
    Randall L. Reese June 28, 13:20

    This is obviously slanted in favor of recommending a rollover to an IRA.

    Regarding fees, employer plans may have better leverage on asset based fees because of asset size. To make the blanket statement that it is more expensive to leave the account with the old employer is not true. Additionally, in some cases, the expenses listed are paid by the company and not the plan. Plan participants, terminated or not terminated, would not bear any of those costs.

    Regarding fund performance, it is also not entirely accurate to state that top mutual fund holdings in 401k plans are high-cost low-performing mutual funds. Small balance rollovers, or any size rollover, to an IRA may be invested in products that generate a high commission…after all, someone needs to get paid.

    Good article but a biased view that may not always be in the best interest of the participant.

  4. Christopher Carosa, CTFA
    Christopher Carosa, CTFA Author June 28, 15:26


    Thanks for the comment. I was hoping someone would offer what you did. You bring up a good point (and “realistic” in the same sense as Nevin was in his earlier comment): There are plenty of opportunities for ex-employees to jump out of the frying pan and into the fire. However, from the point of view of the plan sponsor, fiduciary liability doesn’t extend to this downside, it increases because an upside exists. In other words, yes, some (non-fiduciary) advisors will direct IRA rollovers into high commission products, but the relevant case occurs when other (fiduciary) advisers (notice the difference in spelling) can manage an IRA rollover in a less costly manner (since only management fees are charged as administration and compliance costs are removed from IRAs). The failure to disclose this upside may be what increases the fiduciary liability of 401k plan sponsors – and that is the subject of the article.

    That being said, continue to trumpet the issue of conflicts-of-interest in using non-fiduciary advisors – this pertains to both 401k plans and retail investors. Also, please read the referenced article regarding BrightScope’s listing of the most widely-held 401k mutual funds. It’s difficult to see where, except maybe in one or two cases, any of the funds on the entire list contains aren’t high-cost low-performing funds.

  5. William Ulivieri- AIFA
    William Ulivieri- AIFA June 29, 14:34

    The S&P 500 Exchange Traded Fund (symbol: SPY) has an annual expense fee of .1% and currently yields 1.88%. There is no possible way that a plan sponsor could ever get the annual cost of their plan as low as 0.1%.

    Couple that with $7.95 per trade at a discount brokerage house, I can “outsource” my $100,000 401k to myself in a self-directed rollover IRA for a $107.95 expense the first year and still earn a yield of 1.77%; versus owning a similar mutual fund and yield almost zero.

  6. Michael A. Iley
    Michael A. Iley June 29, 16:57

    Chris – thanks for bring this topic up. I’ll agree that if we look at an industry average as a whole, fund performance may be less than desirable. However, there are well designed plans (thanks to a handful of quality consulting firms) with good quality, low cost plans.

    I hear the fiduciary risk argument, but what really is the risk involved in terminated employees maintaining a balance? In the interest of providing education vs. advise, participants are informed of their options at termination.

    The decision seems to be based more on opinion that fact. I’d welcome information on cases where there was a clear consultant or plan sponsor fiduciary breach based on maintaining termed balances.

    William – VIFSX

    All the best,

  7. DON
    DON August 03, 17:51

    Question regarding ‘ fees” – I am retired- and for certain reasons elected to keep some of my 401k type money ( pre tax) in a company plan. I am over 70 1/2 and must take RMD which is automatic. I recently- by chance- found out that a new separate ” fee” of 50 cents/month was being taken out. Turns out my previous union had agreed to such a charge for online software giving retirement advice to its members. The company – A Dow 30 with about 100,00 employees and about 50,000 union members had decided to charge all of its NON union employees this fee and also to those unions who agreed. But only those unions who agreed would be charged. fees taken from their account, NO option to cancel. In only one case- MY previous union – were ALL who had been previously represented ( member or not) charged this fee. This fee is NOT used for admin or accounting being paid for by the company and probably included in unit or share prices.- but only for access to the software. The software does not work for someone retired.

    It is not deductible per an phone query with IRS- who was quite puzzled by the whole arrangement. Unions cannot bargain for retirees, and I had no vote, no notice, nor was /is it part of the most recent contract.
    MY question is – is the fee taxable such that it shows up on my 1099R . ????

  8. DON
    DON August 03, 17:52

    PS Forgot to mention that I am NOT and cannot be a retiree or retired member, I pay no dues, and cannot pay dues.

  9. marshall cobb
    marshall cobb August 04, 16:32

    I agree with much of what has been said but I’m not sure there’s an answer. The question implies a verdict as to whether or not an account/investment in a 401(k) is better or worse than a similar investment in an IRA. The answer is that it depends — and that answer changes with nearly instance you examine it as the investments and related fees differ. There isn’t a single guideline that dictates what is fair and reasonable under each setting. At some point a plan sponsor has to make the determination that they are offering a 401(k) plan for their employees that is both fair and reasonable. If a plan sponsor feels that their current offering is lacking they should probably lose a little sleep on a variety of fronts — but I don’t think they should lay awake at night pondering all of the ways that a particular ex-employee might be able to craft an IRA account that is potentially better/cheaper. As you state, that decision is up to the employee.

  10. Luther
    Luther December 21, 11:17

    Thanks for the article. It’s very helpful.

    As an HR associate, I have been giving the task of “encouraging” former employees to leave our 401k plan to lower the plan’s cost. If they don’t leave, I have been instrusted to kick the out of the plan.
    I am a little unsure how to go about this. The article mentions the possible liability of just handing over the funds to the former employee without giving proper guidance. My HR manager suggested that I do exactly that…determine who the former employees and and kick them out of the plan, if they don’t leave on their own.

    What information and guidance do I need to accompany this action with? Do I only need to point out the possible tax consequences associated with not depositing these funds into another 401k or IRA?
    Should other information be passed on to the former employee?


  11. Christopher Carosa, CTFA
    Christopher Carosa, CTFA Author December 21, 19:47

    Luther: Sounds like a good idea for a story. I’ll see what I can do.

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