Design a Good Group Retirement Plan Part 3: Unbundle and Save

Bundled retirement plans may be the most common and most convenient for small businesses, but medical practices can save money by unbundling, which means having multiple separate parties for each aspect of the plan.

You see a patient with strep throat so you write him a prescription for antibiotics, but he can only get it filled at the store you own across the street. Your store only stocks limited medications by drug companies that pay you for writing their prescriptions instead of lower cost generics. The patient is happy because he likes the convenience of one-stop shopping and thinks he received all of this care for free, and your wallet is thicker so you can buy your next plasma TV.

That’s not the way we practice medicine, but in group retirement plans it’s the status quo. According to an AARP survey, over 70% of 401(k) plan participants think that they are not paying any fees in their 401(k) plan! I can assure you that there is no such thing as a “financial” EMTALA law that forces advisors and investment firms to provide services for free. But if you’re savvy about group retirement plans, you could save money and increase the size of your retirement portfolio.

In my last two articles I discussed the first steps you need to take to design a good group retirement plan. This time we’ll focus on the second step.

Bundled vs. unbundled plans

Roughly two-thirds of small business retirement plans are bundled. In this plan you deal with one service provider that handles recordkeeping, administration, custodial services and investments. This setup appears to be ideal because it’s a one-stop shop and relieves your plan’s trustee of coordinating these functions with different outside parties.

Contrast that with an unbundled plan in which there are multiple separate parties: an independent third-party administrator (TPA), an independent investment adviser, an independent custodian and an independent record keeper (though oftentimes the TPA handles this function). On the surface this setup looks painful, especially for physician plan trustees. If you’ve got an administrative question you call the TPA, but if you’ve got an investment question you call the investment adviser.

While the bundled plan has convenience, remember that convenience has a price — and for group retirement plans that price is usually big.

Revenue sharing

It has to do with revenue sharing. Every mutual fund has management fees reflected in its annual expense ratio. For example, investing $500,000 in a 401(k), which has funds with an average expense ratio of 1% translates to $5,000 in mutual fund expenses. In bundled plans part of this money pays the service provider of the plan. This creates a direct conflict of interest because the bundled service provider has an incentive to offer only those mutual funds that participate in revenue-sharing arrangements and pay the service provider the highest fees.

Other problems also arise with revenue sharing funds in bundled retirement plans such as:

• The plan participants think they aren’t paying any fees because they don’t see any line item of fees being deducted in their account statements. In reality the expenses are paid via lower investment returns.

• Since the service provider has an incentive to provide only revenue-sharing funds in the list of investment options available to the plan, the total costs may be higher than using an unbundled approach and the choice of investment options may be limited.

For example one bundled group retirement plan I looked at specifically states that the majority of plan assets must be invested in “affiliated funds,” which are funds that pay revenue-sharing fees to the service provider. Many of these funds have annual expenses of 1.5% or more and some approaching 2% — far too high in my opinion.

• Part of the expense ratio in revenue sharing mutual funds goes to the brokerage firm and financial advisor, thus creating another conflict of interest. The financial advisor’s investment recommendations no longer remain objective, he is not acting in a fiduciary capacity, and the plan trustee now has to justify why such an arrangement benefits plan participants.

Next time I’ll discuss the benefits of having a bundled retirement plan.