Payroll Providers Should Not Serve as 401(k) Plan Administrators
In The Outlaw Josey Wales, Josey, played by Clint Eastwood, approaches a man in a bar and asks if he is a bounty hunter there to kill him. The bounty hunter replies that a man has to do something for a living, and Josey replies, “Dying ain’t much of a living, boy.”
I have been an ERISA attorney for 12 years, and I am often asked whether I give financial advice as an advisor or whether I handle plan administration as a third-party record keeper. I tell people that I do neither; I stick to what I know as an ERISA attorney. While some may say that being a financial advisor or record keeper is a natural segue from being an ERISA attorney, I believe these roles are so vastly different that I couldn’t effectively wear more than one hat. I follow a major rule in business: I stick to what I know.
Too often in the retirement plan industry, we have people who claim to be experts but are really hacks in disguise. Inferior work is frequently done, making it extremely difficult for experts to clean up the mess. The retirement plan industry is highly specialized; it’s the amateurs who cause problems. While people may have to work as third-party plan administrators for a living, being incompetent ain’t much of a living.
The Misconception of Payroll Providers as TPAs
In the 401(k) world, the two largest payroll providers in the country feel that retirement plan administration is a natural segue from doing payroll. I respectfully disagree.
Differences Between Payroll and 401(k) Administration
Providing payroll service is an automated, computerized system dependent on getting the correct tax rates from federal, state, and local governments. As long as the employer provides the weekly payroll, the numbers should be consistent. Mistakes in payroll can usually be easily rectified without consulting attorneys, the IRS, or the Department of Labor.
Retirement plans, however, are highly structured, tax-exempt entities. They must continuously abide by:
- The Internal Revenue Code
- ERISA regulations
- Department of Treasury regulations
- Department of Labor regulations
- The terms of the plan document
Errors can occur in various areas, including contribution deposits, trade processing, eligibility and vesting determinations, discrimination testing, and Form 5500 preparation. These errors can lead to plan disqualification, causing significant financial consequences for both employers and participants. This is why plan sponsors should carefully select their third-party administrator (TPA).
The Importance of Specialized Expertise
Except for the withholding of salary deferrals, 401(k) plan administration has nothing to do with payroll. It is a highly specialized field, dependent on receiving correct data from the plan sponsor and making accurate calculations on the administrator’s side. A large part of what a 401(k) administrator must do is verify the accuracy of the data provided by the client.
Common Issues with Payroll Provider TPAs
Too often, payroll providers acting as TPAs run retirement plans the way they run payroll. I’ve seen numerous instances where clients provide incorrect key and highly compensated employee information, and the payroll provider TPA runs tests with this wrong data.
“I remember one case where an employer didn’t understand the definition of a key employee and marked everyone as key because they were ‘key’ to the company’s operations. Employees making $30,000 were considered key. Unsurprisingly, the payroll provider TPA found the plan to be top-heavy, even though a skilled TPA would have questioned the correctness of the data.”
I’ve had a client for the last eight years because their plan consistently failed ADP (Actual Deferral Percentage) and ACP (Actual Contribution Percentage) testing for salary deferrals and matching contributions. The payroll provider TPA never explained the benefits of a 401(k) safe harbor design or that a $7,000 qualified non-elective contribution could avoid a $10,500 ADP deferral refund. Perhaps this was because the plan was small enough that the payroll provider TPA offered a “team” approach without a dedicated administrator. Regardless, the best TPAs go above and beyond in correcting plan design and data defects, offering a highly experienced, dedicated plan administrator to each client.
I have another client who typically experiences a plan error every six months with their payroll provider TPA, usually dealing with eligibility. The company changed their eligibility requirements to immediate, but the human resources director at a subsidiary still treated the eligibility as three months. If the TPA is a payroll provider, shouldn’t they have asked whether newly hired employees should be treated as participants once they appeared on payroll?
The Illusion of Seamless Integration
Payroll provider TPAs often tout the “seamless” integration of 401(k) plan administration with payroll as a strong selling point. However, discussions with many of their unhappy clients reveal that this integration may not be as seamless as claimed. As previously stated, 401(k) plan administration has very little to do with payroll, allowing many errors to slip through the cracks.
Lack of Comprehensive Plan Design
A major component of setting up a retirement plan is maximizing retirement savings for participants. This can be achieved through proper selection among different plan types and designs. Highly regarded TPAs, along with an ERISA attorney, can analyze participant data to determine the best fit, whether it’s a standard 401(k) plan, a safe harbor plan, a new comparability design, or adding a defined benefit plan like a cash balance plan.
Payroll providers tend to administer only 401(k) plans and are unlikely to discuss the merits of more complex arrangements. They often offer cookie-cutter plan designs using prototype plan documents that may not meet all the sponsor’s needs, especially if there are provisions outside the prototype’s scope. A good TPA can service all the sponsor’s retirement plan needs; a payroll provider TPA can only service needs that fit within a standard 401(k) framework.
Overstepping Boundaries: The Role of Financial Advisors
Another issue with payroll provider TPAs is that they sometimes encroach too closely on the role of financial advisors or co-fiduciaries. Many of these plans do not have an advisor or broker to provide a level of protection for a participant-directed ERISA 404(c) 401(k) plan. While payroll provider TPAs may offer financial experts who select mutual fund menus and meet with clients, they do not offer financial advice nor assume any co-fiduciary role.
“I had a client with one of these payroll providers with $10 million in assets. While this plan was large enough to have its own dedicated plan administrator, they had no financial advisor. During a meeting with the client, their payroll provider TPA administrator, and one of the TPA’s financial ‘advisors,’ the advisor suggested adding a small-cap fund to the lineup but insisted he was not offering any advice. It was just a suggestion because he could not legally give advice. I jokingly called it a wink and a promise because, while the advisor was offering a suggestion, the client could not legally rely on it.”
In today’s regulatory environment, no participant-directed 401(k) plan should operate without a broker or financial advisor, and no TPA should take on any role that could be misconstrued as offering financial advice.
Conclusion
Having your 401(k) plan administered by a payroll provider is like having a proctological exam performed by a pediatrician. Payroll providers have limited background and capability in administering retirement plans. It’s crucial to hire retirement plan experts as your TPA and ERISA attorney.
Payroll providers offer a necessary service at an affordable price. However, I have yet to be convinced that they can do the same job as a specialized 401(k) TPA. While they may be the largest 401(k) TPAs in terms of the number of plans serviced, this has more to do with their standing as payroll providers than their skill at administration. As we know in business, bigger is not always better.