Group Annuity Contracts in a 401k

[Guest pon66]

What are the advantages/disadvantages of using a group annuity contract that has underlying mutual funds for a 401k paln with 50 participants ?

[MWeddell]

The main differentiator of having mutual funds within an annuity product rather than having the plan invest directly in mutual funds is that it allows for an extra layer of fees, beyond the mutual fund's own expense ratio, to be charged against plan assets in a manner that is not readily visible to participants. Whether that's an advantage or disadvantage depends whether you're a participant, employer, broker, etc. For a plan with only 50 participants, annuity products are fairly common. If you're a participant or plan sponsor, I'd be more concerned about what are the total fees instead of what form they take, but when you hear that the funds are in an annuity product, you've got to be more diligent in searching for all the fees.

Second item to look for: with annuity products one's investments tend to be less liquid. In other words, there's a greater chance of surrender charges, redemption fees, market value adjustments, etc. if the employer wants to switch providers or, in some cases, when participants take distributions before retirement.

It's tough to answer your question without editorializing, as you can see.

[KJohnson]

I think MWeddell hit it on the head. Using a group annuity product does add another level of fees. The fees are usually based as a percentage of assets held in the plan. Also, with a group annuity product, fees regarding the administration of the plan are much more likely to be "charged back" to participants accounts where in other contexts the employer may pick up these fees.

Where I have seen these products used most often is with "start up" plans where an employer does not want to bear much in the way of inital costs for establishing and administering a plan. In this situation, since fees are based on a percentage of assets and since assets for a start up plan tend to be smaller in the first few years, the actual dollars paid for establishing and maintaining the plan may be competitive in comparison with other alternatives available to the employer.

However, as MWeddell mentioned, the "kicker" is the surrender charges, market value adjustmets etc. Often the surrender charge is simply a method for the insurance company to recoup any commission it has paid if you decide to leave the annuity arrangment "early." You should pay careful attention to these charges because once the $$ of a plan rise to a level where other administrative/investment vehicles may be more attractive, the surrender charges may still be a major roadblock.

Obviously, the adoption agreement for the plan itself is an important document that needs to be gone over carefully. However, when you go with an group annuity contract to "fund" the plan, you need to pay just as much attention to the terms of that GAC and all of the various levels of charges. You may see things like "net investment factor", "general expense charge", "annual administration fee" "plan services fee", "surrender charge" "direct expense charge" "market value adjustment" etc. in the document. It is often not easy to understand what each of these charges are and when they will be levied.

[Wessex]

I wholeheartedly agree with the comments by MWeddell and KJohnson. Anyone who wishes to use annuity contracts needs to do high level of due diligence and be certain that they understand the fee structure and limitatins. I am constantly surpised by the number of plan sponsors who had no idea of the fees that would be charged until they wished to transfer to another provider or participants were entitled to distributions.

[Bill Berke]

I agree with the comments above. Unless an employer wishes to pass off as much of the start up fees as it can to the employees (a still unaddressed fiduciary issue), an annuity is rarely the best way to go. And, sadly and commonly and despite the disclosure regulations, the insurance agent does not and will not disclose all the fees, charges, costs and restrictions. The emplyer must ask and better ask.

Because the contracts are written obscurely, it is always difficult to figure out all the ways the insurance company makes a profit. Which is the point to remember - these products are very lucrative for the insurance companies and their sales people. Considering that the profit must come from somewhere, it is the participants who always suffer. Furthermore, there is no way to check to see if the insurance company is crediting investment earinings correctly. They are not under the mutual fund distribution rules so the insurance companies do not have to pay out all the investment earnings. They only have to pay the portion of the investment earnings that the company determines is appropriate under the contract. And the performance, generally, stinks.

It should be obvious that I am opposed to these contracts because all I have ever seen in 30 years of being a TPA is the massive rip-off insurance companies get away with. The DOL won't touch this because of the lobbying power of the insurance industry. And the new Ass't Secy of DOL PWBA comes from the insurance industry. The Florida insurance commissioner fined Met and Pru millions for their deceptive sales practices, no other state or federal agency I know has ever repeated the courage Fla. showed.

There are better alternatives (fees and performance) - Schwab and MFS - are two examples of investment companies that compete with the insurance companies in the small market. Many insurance companies will provide more of a paperwork turnkey operation for the employer - but that does not overcome the negatives. I believe that soon we will see a fiduciary suit against an employer who doesn't (and probably can't) understand what the employer bought. I'm also waiting for some insurance company to invoke the "six month hold" provision that is in annuity contracts. Boy will that be a fiduciary case - most likely stopping at the employer's door because the employer fulfilled its fiduciary obligation of complete investigation and understanding. Yeah, right!!

[Kristina]

Sorry. I can't resist providing another side to the Group Annuity Contract issue.

I will preface by saying that fees are a big, big issue and, yes, you should use much diligence in assuring that all of the fees are disclosed. (Get it in writing as to how much is being charged and how the fees are calculated. A company sponsoring a group annuity product should be forthcoming. If not, keep looking.) I will also say that any surrender charges may be directly associated to the amount of commission paid to the broker, but there are companies where you, as the plan sponsor, can go direct and eliminate those issues.

On the positive side, a group annuity contract allows participants to invest in numerous fund families with a same-day-transaction. My experience with the program was that the participants received much more investment information than would have been possible without the contract. They also had telephone transfer capability. These features would be very expensive for a small employer to provide for their participants. Because of the recordkeeping under the group annuity contract, the annual administration performed by the TPA was limited.

Unfortunately, in the past the greatest transgressions had to do with the broker being greedy and wanting a large front end commission. Be aware that not all mutual fund families are free of this problem.

I was able to compare the fees and expenses paid under the GA contracts my clients used in the past and determined that they were comparable to some mutual fund companies and less than others.

[Guest pon66]

Can someone tell me what the typical commission structure is for most of these Group annuity contracts from Principal, New England, Manulife etc ? Takeover and trailing ? How do they pay the broker when ther is not much disclosed ?

[Bill Berke]

Some companies have to publish their fee structure if they are licensed in N.Y. because that insurance dep't has a legal rule regarding how much commission can de paid. Few other states have this rule, and in N.Y. the companies get around the legal commission limits by then paying an admin allowance (or some other label) which relates to the premium. And almost every company is different. The insurance industry is notorious in their abiliy to create euphemismsm to disguise truths from buyers. That said, there are usually comissions, awards and allowances that get paid to agents. The amounts vary per company (sometimes per agent), but in all cases it is a percentage of the premium (the awards are ususally for meeting production quotas). So that is what you can ask about. In adition to the agent's commission, there are general agent commissions, which the DOL does require to be disclosed (because the DOL has little knowledge of reality). You can ask about these G.A. comisions or, sometimes called, overrides. Some campanies will let their agents lower the commissions and charge a corresponding lower fees.

You need to ask for all the direct and indirect charges, fees, costs, penalties and restrictions in writing. Then you have to hope that you will be told the whole truth -and get it in writing. Ask for these amounts as a dollar amount and as a percentage of contribution (e.g.10,000). Also make sure they disclose if there is a surrender charge (a penalty for terminating the contract within 5 or 10 years) Do not let the responses be limited to investment charges, they must also include administrative charges and whatever other label the insurance company can think of for other fees. Some companies charge processing fees for loans and/or distributions. I hope this helps. Obviously this is a quagmire - caused by the greedy insurance campanies who must and want to hide their ripping off.

[Scott]

Reviving an old topic.

Any reason why an employer couldn't pay the early termination fee when an annuity contract is canceled early, rather than charging the fee to the 401(k) plan accounts? Would this somehow be a prohibited transaction?

[KJohnson]

For an extensive discussion look here:

http://www.benefitslink.com/boards/index.php?showtopic=16129