Check The Fine Print In Picking A 401 (k) Plan

It all looked so easy at the beginning. One vendor would manage the money invested in the 401(k) plan at Continental Industries Group Inc., and another would oversee the plans administration. All that would be left to be done by the firm's controller, Rhoda Cuthill, would be a bit of minor paperwork as she and her 12 fellow employees began to amass their retirement nest eggs.

Alas, instituting a 401(k) plan for Continental, a New York City-based international trader of industrial chemicals, has proved anything but easy for Cuthill. Several younger employees don't want to parti ipate in the threeyear- old plan because it levies a sales charge of 5 percent on any assets withdrawn within five years of the contribution. (Assets withdrawn between five and 10 years after a contribution are subject to a sales charge that gradually declines from 5 percent.) That would hurt them if they wanted to withdraw money for, say, a down payment on a house.

With modest participation by lowerearning workers, Continental discovered in 1995 that for the previous year its plan was top-heavy (skewed in favor of higherwage employees, which is against Internal Revenue Service regulations). To correct the imbalance, Continental's owners were obliged to make additional contributions to the plan on behalf of all employees, even those who weren't participating, prior to filing the plan's Form 5500 with the IRS for 1994.

Now the owners aren't making contributions to their own accounts in the plan, fearful that it could become top-heavy again. Cuthill, meanwhile, is doing calculations on her own throughout the year to monitor the plan's status, something she thought—before the top-heavy mix-up—that she could rely on the plan administrator to do.

"Unless you're really a 401(k) expert and know exactly where to look for the information, putting in one of these plans is not an easy process," Cuthill concludes.

Sorting It All Out
Fortunately, there is help. Many vendors, from mutual-fund and insurance companies to brokerage firms, now offer turnkey 401(k) services that include plan design and documentation, record keeping and administration, investment management, and employee communication and education.

For a company with only a handful of employees, these plans often cost the employer as little as $1,000 to set up and $2,500 a year to maintain. Even as companies grow, costs are seldom prohibitive. Pension Dynamics Corp., a pension-administration firm in Lafayette, Calif, recently compared the annual costs of operating 12 different 401'k) plans from 11 different vendors. Each plan had a hypothetical $1 million in assets and 50 participating employees; the average cost was found to be $18,912.

The benefits of such plans can be significant. Employees, including the company's owners, can contribute up to $9,500 of their pre-tax salary to a 401(k) plan (to a maximum 20 percent of their gross salary, including any matching contributions made by their employer).

An employee who salts away $5,000 a year in a 401(k) account earning 10 percent a year would have $606,160 after 30 years, even after paying taxes upon withdrawal at a 33 percent rate. In comparison, an employee who made an identical contribution to a taxable account earning 10 percent would end up with $319,960—or about $286,000 less—at the end of 30 years.

What's more, employers can make matching contributions to their employees' 40Kk) accounts if they like, a feature that many employees find attractive. But even if the employer chooses not to make a matching contribution, a 40Kk) plan can help it retain valued workers.

Where Can You Turn?
To find the right plan for your company, you could turn to a third-party administrator such as Pension Dynamics; there are thousands of such firms throughout the country Butler typically charges $500 to do a cost-comparison survey tailored to a company's size and the overall investment style of its employees.

Some companies consult certified public accountants or financial advisers before selecting a plan, but the quality of the advice you receive may vary greatly, as it may with a pension consultant. Continental Industries used an adviser to help it select its plan, for example, and still wound up dissatisfied, although Cuthill doesn't blame the consultant for the subsequent problems. In the end, there's no substitute for becoming an educated consumer. When shopping for a 401(k) plan, here's what you should do:

Compare costs, including those borne by the employer and those borne by the plan's participants. If you think your company can't afford to implement a plan, remember that most vendors will allow you to shift virtually all of the expense onto the employees. While this may not be ideal, the tax advantages of a 401(k) are so compelling that even a plan with that type of arrangement would be better than no plan at all.

Review each plan's past investment performance. Although it's no guarantee of future results, this is the only practical way to forecast how the plan will perform. Since all plans offer various investment options—typically a half-dozen or so mutual funds, each investing in a different type of asset—youll have to compare each of those with similar funds available elsewhere. If a plan is a performance dog, it may not be a bargain at any price. One gimmick to watch out for: a moneymarket option that pays a below-market rate of return.

Review the number of investment options offered by each plan. Employees generally prefer more options rather than fewer, although a plan with dozens of choices may prove overwhelming. Also, find out if the plan includes investment options other than the vendors own; some employees might appreciate the chance to include their favorite fund in their 401(k) account.

Determine if the mutual funds or other investment options offered through the plan cany sales fees. A mutual fund with a 5 percent front-end load (a sales fee deducted from the initial investment) would have to earn 9.11 percent a year for five years just to match the results of a noload fund earning only 8 percent a year over the same period.

Even if a fund is touted as no-load, be wary of hidden costs. Some no-load funds have expense ratios (operating expenses, including investment-management fees, expressed as a percentage of the fund's assets) that are twice the roughly 1.1 percent average for domestic-stock funds. If you choose a plan with load-bearing funds or with no-load funds that have high expense ratios, be sure their performance justifies this higher cost.

Try to ascertain each vendor's reputation for designing and administering plans that comply with tax laws, and determine the extent to which the vendors take responsibility for ensuring that their plans are in compliance. "Look at their service contract," Butler advises. "If it is laced with language that holds them harmless in any way, you should be immediately suspicious. Also ask if they have errors-and-omissions insurance to pay for mistakes."

Butler recalls a plan in which the bank administering it made mistakes that led to $60,000 in penalties for the plan's sponsor. The bank offered only to split the payment of the penalties.

Another plan vendor specifies in its contract that if it is found liable for a mistake, it will not reimburse the plan sponsor any more than the sponsor has paid to it in administration fees.

Finally, compare the bells and whistles in each plan. All can be structured to permit employees to make withdrawals from their account, for example, but fees for doing so can vary.

Some plans offer daily valuations, so that participants can always know the current value of their account, and most that offer daily valuations also allow participants to transfer assets among the various investment options on a daily basis. By contrast, some plans provide only quarterly valuations and allow participants to change their investment allocations only quarterly.

And don't forget to ask your business colleagues to recommend 401(k) vendors or third-party administrators that have won their confidence. Most plan vendors will unbundle their services if requested, allowing you, for example, to use them to manage your plan's assets and a thirdpa lty administrator to handle the paperwork. Choose wisely, and your 401(k) plan will prove to be one of the best additions youll ever make to your employee benefits package.

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