Exposed: Payroll Company’s Excessive Costs as a 401k Provider
There are a few services businesses need to save time and costs. Payroll 401k providers are great for automating and buying more time on tasks that can be handled in a cost effective way. One of the areas you shouldn’t be using a payroll company for is third party administration for retirement plans.
Is it a bad idea to have your payroll provider as the third party admin for your 401k? Let’s just say it’s basically not one of the best decisions a business owner can make to handle and administer a company 401k.
Why? Simply because a payroll 401k providers have very little to do with 401k plans.
The only thing that a 401k plan and payroll have in common is the salary deferrals and W-2 compensations. Other than salary deferrals, there is nothing in common between a 401k plan and payroll.
A third-party administrator or TPA has a direct connection with retirement plan administration. They offer services such as investment advisory, insurance, and legal documents. Derived from this services is where producing TPAs become in hand. This type of third-party administrator are the connection between additional plan services and the administration of retirement plans.
Who sets the rules on qualified plans?
Qualified retirement plans must comply with rules and guidelines that are set by the Internal Revenue Code and the Employee Retirement Income Security Act of 1974 (ERISA). The reason these plans have rules is for it to be fair for employees of private companies (non-government).
What do we mean by fair? This means that the plan has a set of rules in which participants earn their right and fill the requirements to be in the plan. Also, that contributions are fairly distributed to the participating individuals. This avoids that there is no discrimination and that the highly compensated employees receive fair benefits as the non-highly compensated employees.
Additionally, these plans have as a requirement to report the distributions to participants with an annual Form 5500* and the Form 1099*.
*The Form 5500 used to have information from an individual’s benefit plans, such as health and pension plans.
*Form 1099 used to report information returns (tax returns) and give information from various types of incomes such as wages, salaries, and tips coming from self-employed individual’s earnings.
Importance of TPAs on a 401k
401k plan sponsors need an efficient and qualified TPA to direct their plan. A third-party administrator has the responsibility of reporting and controlling gains, losses, dividends, and/or capital gains coming from contributions on the plan. Also, the plan must always be up-to date at all time, administering it according to the plan document’s terms.
Qualified plans are very carefully supervised by the Internal Revenue Service and the United States Department of Labor. They impose audits to the plan sponsors in case errors are found on this plans. High penalties can be given, in which the sponsor of the plan is the one who gets mostly affected.
Reasons on why you shouldn’t choose your Payroll Company as your 401k provider for retirement plans
Third-party administrators should always be close to his/her client’s business and plan. Payroll has now become computerized and more organized; errors can still occur but they have become less common.
At the end of each year a data request form will be sent to the plan sponsor. This form needs to be fill in order to pass the discrimination tests. Information must be provided such as:
- Ownership of the employer
- Affiliations with other entities
- Identification of employer’s officers
- Dates of hiring
- Employee’s hours if service
- Terminated employees
- Dates of termination
- Dates of birth
This information is important since it needs to be correct to avoid failing the discrimination test and receiving penalties.
Payroll Providers don’t give any kind of assistance with third-party administration matters. They leave all information to be done only by the plan sponsor. This creates leaps and faulty information to be on the 401k plans, affecting the employer and employees once the report is given and doesn’t pass the test.
Issues with communication between Payroll Provider Third-Party Administration
It’s difficult to communicate with your TPA Payroll Provider. Other administrators usually assign you a dedicated administrative representative, but with Payroll company, you only get assigned one if the client has a large plan.
Payroll Company’s that are 401k providers give you what is more comfortable for them
Payroll company’s tends to be very simple and none pro-active when it comes to a 401k plan. Third-party administration companies have the obligation on maximizing retirement plan savings for participants, so more benefits and a better secure future can be achieved. Payroll 401k providers who administer plans give a plain vanilla 401k plan, instead of looking among the other options that could maximize a company’s or individual’s plan.
If they choose a simple plan, this means they are not going to discuss things such as:
- New comparability
- Floor-offset arrangements
- Cash Balance Plans
Payroll companies will never discuss or administrate a plan design for a cash balance plan or benefit plan. In case the sponsor wants either of those plans, then a change of TPA will needed.
Payroll Providers Non-fiduciaries capability and no investment advisers
Must plan sponsors that have a Payroll Provider as a TPA, but usually don’t have a financial advisor.
Payroll Providers TPAs can get to offer an investment option. This options are usually from a mutual fund menus that they offer to the rest of their clients.
A fiduciary is an important factor to a 401k plan. They are the ones that work in good faith and for the best interest of a plan sponsor. When having a Payroll Provider as TPA, they don’t act as fiduciary, so when something goes wrong, losses affect only the participant.
Investment options provided by this TPAs are usually beneficial for them. They can get back a lot of revenue sharing and they are still not responsible from it. A Payroll company does not to take into consideration the selection of investment options. Since they are not legally culpable of providing a terrible investment, then only the plan sponsor and other fiduciaries might be vulnerable to liabilities.
Most of the time Payroll 401k providers give referrals to certain investment advisors, which end being for their own benefit. It is beneficial for them because afterwards this other investment advisors, recommend them back to other clients, so it is a win-win situation from both areas.
Firing your payroll provider
Many times, clients are comfortable working with their Payroll Providers, but they don’t like them as TPA.
You have all the legal right of firing them. However, the problem is that often this Payroll Providers take it personal when you fire them. They end up renouncing from being your TPA, and no longer want to be your Payroll Provider from your business. Leaving you without a TPA and a Payroll 401k Provider for your company.
Payroll Provider Turnover rates
The turnover rate of Payroll Provider Third Party Administrators are high. Most clients don’t acknowledge that a lot of problems occur as time goes on with one of these payroll companies administering their 401k plan. Each year company who sponsor a 401k plan with employees enrolled in it feel the need to work with a good third party administrator, mainly to mitigate the legal risk and company tax filings.