This is Gizmo.
For those of you who are children of the eighties, you probably recognize this cuddly little fella as the star of the classic comedy horror film, Gremlins. If you are a business owner, you may struggle to realize the relevance of Gizmo to your company’s 401K plan, but your ability to do so could be a matter of life and death for your business. Since we’re in a cinematic mood today, let’s address The Good, The Bad and The Ugly, in that order.
Like Gizmo (and his other Mogwai brethren), your 401K plan often times starts out as a cute and cuddly creature. Perhaps your financial advisor or HR director mentioned that this would be an effective way to provide additional benefits to your employees. A vehicle that can 1) help you retain good talent 2) lower your tax bill and also 3) provide significant protection from creditors? Not even the DeLorean or the Millenium Falcon can do that! The benefits of 401K plans can certainly have us dancing like Kevin Bacon in Footloose.
Mogwai, like all pets, require careful maintenance. The three big rules for the proper care of a Mogwai are as follows:
- Do not expose it to bright lights or sunlight – this will kill the Mogwai;
- Do not get it wet; and
- Do not feed it after midnight.
Similarly, business owners are required to take good care of their 401K plans. In fact, there is a Federal Law called ERISA which imposes a fiduciary duty on business owners to carry out certain responsibilities. Some of the most important responsibilities include:
- Prudently select and monitor investments – this means that you have to choose appropriate investments for your employees and monitor them regularly to make sure they remain appropriate;
- Ensure that fees are reasonable – this means you have to pay attention to the marketplace and assess on a regular basis as to whether the fees are reasonable;
- Operate the plan in accordance with the plan terms – this means that you can’t just stick your plan in a drawer and forget it about it. You actually have to read, understand, and accurately carry out the terms of the plan; and
- Act in the best interest of the employees and avoid conflicts of interest.
Most business owners aren’t professional investors and most of them aren’t lawyers. Given their lack of expertise or knowledge, they often fail to respect the rules imposed upon them. “C’mon … how bad could it be?” you ask? Just like with Gizmo, if you don’t follow the rules, that adorable 401K plan can turn into a nasty batch of Gremlins that can wreak havoc on your company. The courts are full of recent judgments of tens of millions of dollars against businesses that failed to give these rules the proper respect. Even for seemingly small “mom-and-pop” businesses, minor mistakes can cost the business hundreds of thousands or even millions of dollars.
Reading this far has probably made you sadder than Steel Magnolias. However, there is a New Hope. With knowledge there is power, and now that we know the risks, we can address them.
Hire a Caretaker for Your Mogwai or 401K plan
It is possible for a business owner to outsource much of the risk associated with operating a 401K plan by hiring an independent, conflict-free advisor to review the plan, select the investments and monitor them going forward. When selecting such an advisor, it is not enough to choose your golf buddy or your father’s brother’s nephew’s cousin’s former roommate (a la “Spaceballs”), some due diligence is required in order for you to fulfill your fiduciary duty. Generally, it is best to hire advisory firms or consultants who are registered under the Investment Advisor’s Act of 1940, otherwise known as Registered Investment Advisors (“RIAs”). These RIAs are also required to act as fiduciaries in their dealings with the employer and the plan administrator. Having independent, product-agnostic advisors also eliminates the potential conflict where a captive agent might be tempted to recommend proprietary investments. Often times, these advisors will assist and educate employees on financial planning to maximize their chances of fiscal success, further reducing the risk of litigation. Similarly, independent Mogwai caretakers offer comparable benefits.
Hire An Expert When Your Mogwai or 401K Plan Requires an Audit
To paraphrase Ronald Reagan, it is not enough to trust but you should also verify. To that end, it is prudent to enlist the help of an accounting firm that is experienced in 401K audits to make sure that the plan is being administered appropriately. This is critically important when your plan has over 120 eligible participants or when the plan otherwise requires an audit.
As with finding a good caretaker for your Mogwai, spending some time and energy upfront to select the right accounting firm is key to success. There are many accountants out there who are willing to conduct these audits but according to a recent study by the Department of Labor, there were serious problems found with nearly 40% of all employee benefit plan audits. Here are some things to look for when interviewing accountants:
- The number of 401K plan audits conducted each year;
- The extent of specific annual training the accountant has received in auditing plans;
- Whether or not the accountant’s audits have recently been peer reviewed by another CPA, and if so, whether such review resulted in negative findings.
In conclusion, your 401K is a fickle beast. It requires time, attention, and care so that it can remain healthy and bring you all of its wonderful benefits. While maintaining your 401K plan properly can be a daunting task, the good news is that you don’t have to go it alone. By finding good wingmen to run and audit your plan, you can free yourself up to attend to your core competencies while still acting in the best interest of your employees. After all, even Maverick had Goose.