Financial Opinion and Insights

The Retirement Plan `Shell Game’

Jim Lorenzen, CFP®, AIF®

Jim Lorenzen, CFP®, AIF®

I thought you might like hearing about an actual case history related to me by another advisor.  The names are unimportant because the practice is so widespread, you could probably substitute any number of the usual suspects.

A rep from a well-known, big-name insurance company called on an employer and talked him into transferring his plan and allowing the company to bundle everything for him.   `Bundling’ means the three main plan functions could all be packaged together by the insurance company:  Recordkeeping, administration, and investments.   In an unbundled plan, the three functions are performed by independent providers, usually under the watchful eye of an independent plan consultant, which provides the employer – our plan sponsor – with a system of ‘checks and balances’.

The reason for the change?  Well-known investment options and it would be cheaper!  In fact, for the employer, it was practically free!

The tooth fairy lives.

How did they do it?  The funds in the investment line-up were all ‘load’ funds and carried 12b-1 fees.   This is where the lack of oversight reveals itself.  The insurance company rep is the investment salesman as well as a salesman for the record keeper and administrator.  There’s an incentive to choose funds that charge 12b-1s because they traditionally pay revenue-sharing out of those 12b-1 fees back to the administrator, reducing the amount that the administrator has to charge the company or the plan!   

But, there’s more.  Quite often, as was the case here, the insurance company also charged a wrap fee, which is not part of the 12b-1 and almost always hidden.  Even though not all the 12b-1 fees went to revenue sharing, most of it did, as well as the wrap-fee!   What’s worse, the amount of the 12b-1s that didn’t go to revenue sharing was not being returned to the participants in the plan!

All of this was accomplished so that:

  • The representative could make greater commissions without having to charge the employer or the plan,
  • The employer could move to a `cheaper’ plan – it actually turned out to be more expensive, and
  • The insurance company could make more money since the revenue-sharing hid the true cost of providing needed services, at the expense of participant’s retirement returns

Okay, what’s wrong with this picture?   Back in my management consulting days, if I chose a client solution based on the amount of hidden compensation a third party paid me, that would be called a ‘kick-back’.   Even disk jockeys know what payola is… and choosing investments based on the kick-back to service providers isn’t much different.

How about our employer!  He made an investment line-up decision affecting the participants’ retirement returns simply in order to reduce his own costs.   I’m no lawyer, but that smells like self-dealing to me and could be regarded as a prohibited transaction!

Our employer, by virtue of his decision to choose the insurance company and their funds, was acting as a fiduciary; and, under ERISA is required to act solely in the best interest of the plan participants and for the exclusive purpose of providing retirement plan benefits.  The key words are ‘solely’ and ‘exclusive purpose’.  That means just what it sounds like. 

Do you suppose that employer’s documentation will stand-up under fire?  

Does what our employer did sound like he fulfilled his fiduciary duty to you?

You know he’s trusting his vendor to `take care of everything’.  Wait ‘til he finds out the insurance company’s ERISA attorney works for the insurance company and not him.

No wonder brokers and agents don’t want fiduciary status; and, despite all the marketing material, are actively fighting the DOL and in congress to remain free of it.

Wait ‘til the employer finds out:  He’s a fiduciary.  His vendor isn’t.  And, he’s the one who will have to produce his own documented process for choosing the provider.

Wait ‘til he finds out he actually had the low cost solution before the change!  All the appropriate expenses were being paid by plan participants and the plan, anyway – and without the added drain of all the ‘kick-backs’.

How do you think your plan would ‘score’ on the fiduciary scale? 

When was the last time you had your plan benchmarked for all three main plan concerns:  (1)  fees and expenses, (2) services, and (3) investment line-up?

Smart plan sponsors are looking into this now – before the disclosure rules take effect and employees begin banging on the door.



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Jim Lorenzen is a CERTIFIED FINANCIAL PLANNER™ and an Accredited Investment Fiduciary®  in his 20th year of private practice as Founding Principal of The Independent Financial Group, a fee-only registered investment advisor with clients located in New York, Florida, and California.   IFG provides investment and fiduciary consulting to retirement plan sponsors and selected individual investors.  IFG does not sell products, earn commissions, or accept any third-party compensation or incentives of any description.  Nothing contained in this material is intended to constitute legal, tax, securities, or investment advice, nor an opinion regarding the appropriateness of any investment to the individual reader.  The general information provided should not be acted upon without obtaining specific legal, tax, and investment advice from an appropriate licensed professional.