401(k) vendors

[Guest benefitslady]

I don't work with 401(k)'s but a client of mine recently had an interesting question for me. They currently have a 401(k) where the employees can select from a dozen mutual funds. To sell this, their broker must be NASD licensed only -- it is not an annuity contract. They are considering moving to a new 401(k) that is labeled as a group annuity contract. Can anyone explain to me the major difference (or why someone would want to change) or point me to a website where I can become educated on differences?

Thank you!

[Demosthenes]

Group Annuity Contracts (GACs) are issued exclusively by insurance companies. They receive their name from the fact that all GACs contain annuity provisions and tables for payout of benefits at separation from service. It should be noted that these provisions are rarely excercised by participants.

GAC's generally included a fixed income fund which is often an investment option where the rate is set by the insurance company and the asset is reported/maintained at book value until the contract is terminated.

Also included are Separate Investment Accounts (SIA) which are pooled investments that operate in a fashion which is similar to a a mutual fund but which are not publically traded.

Many insurance companies have added mutual funds to their offering either as the fund itself or as a SIA that purchases only shares of a particular fund, a wrapped SIA.

Another important difference is that a qualified plan with 100% of its assets in a GAC does not require a trustee with the exception of assets loaned out to participants. This insurance comany exemption has its roots in the lobbying effort by insurance companies at the time that ERISA was first drafted.

Additional information on GACs can be found at FLMI.org, and LIMRA.org.

For your friend, the best advice I can offer is to develop a side by side comparison of the services and charges in the GAC versus mutual fund approach. Pay special attention to the costs of having a trustee, the surrender charges in the GIC and SIA funds, the comfort level of the plans auditors with non-trusteed plans and intangibles such as the amount of investment info available to participants on Mutual funds vs SIAs.

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The surrender charges are usually very high. If the client becomes unhappy, it can be very costly to switch to a new provider.

[Guest consultant]

GAC's or SIA's can be sold in most states by anyone with a variable insurance license. Many states do not require a securities license to sell these types of conracts thus participants pay a "wrap" fee which is the annuity charge taken as a percent of assets. It looks something like this -- Fund expense ratio + wrap charge equal the net cost - 1.00%+1.25% = 2.25%.

It creates an expense you do not need, for instance, if you hire a Registered Investment Advisor and pay him 1.00%, that is a seen value by the participants. Paying 1.25% to an insurance broker is not value added since he can not provide ANY investment advice to the business owner or employees without being an RIA.

Many of these SIA's use proprietary investment options with very little fee disclosure or alliances which signal a rebating program from the fund manager to the insurance company (revenue sharing). Nationwide Life is being sued in Conneticut as we speak over the practice of non-disclosure of fees.

Why would someone change from a mutual fund to an annuity contract? They can actually be more cost efficient for smaller plans. As for cost, spreadsheeting is the only way to calculate costs. Be sure to ask the right questions such as annuity and contract charges, per participant costs and 12b1, Sub Transfer Agency, Shareholder Servicing and any Finders Fees. This should give you a good place to start.

my advice, my opinion

consultant

[Guest benefitslady]

Thanks to all for your responses!