401(k)/Profit-Sharing Plan with Group Annuity Contracts

[NewBieHere]

A dentist friend has his and his employees' money all invested in group annuity contracts. Although he and his employees get annual statements from the TPA, he is not able to check the balances more frequently. He would like to have a more typical 401(k)/profit-sharing plan where he could invest money in mutual funds. Here are some questions I have:

1. Because there are surrender charges, if he were to surrender those policies and move the funds to a new recordkeeper, would that be considered violating the ERISA fiduciary rules because the participants would take large losses?

2. Assuming that the answer to Q1 is "No", meaning that he is allowed to surrender his policies and does not violate ERISA, how does the new TPA calculate the funds allocated to the owner vs. the rest of his employees? Given that the employees have been receiving the annual statements, there must be a way or a method that the TPA follows to allocate these funds on a participant-level.

There has to be many more questions I should be asking. Unfortunately, I do not know enough to ask the right questions.

[CuseFan]

Pooled funds I assume? Surrender in and of itself is not a violation, but could a disgruntled participant sue the fiduciary and claim a breach or even multiple breaches - the decision to get in and then the decision to get out? Possible, yes - probable?

I think this has come up here before where it was asked whether employer or service provider (new funds or advisor) could make up the surrender charges to the plan to make participants whole, which may have its own ERISA concerns. Employer probably OK, service provider not so sure. I expect others on this forum have dealt with this in the past. 

Owner likely has largest balance so employer making whole might be palatable.

[Artie M]

Question 1.  Depends.  A fiduciary of an ERISA governed plan may eliminate a group annuity contract (GAC) and not breach their fiduciary duties, even if the participants incur large losses.  However, this is a legal question that depends on the facts and circumstances and would only be answered after a participant files suit and there is a determination in court.

Here, where the plan sponsor by its actions is going to create large individual losses, you friend should be taking all actions necessary to minimize the risk of a finding of breach of fiduciary duty.  Your friend needs to be able to show that he fulfilled his ERISA fiduciary duties.  He can’t just say I don’t like the GAC and I want mutual funds.  He has to show that he conducted a prudent and detailed analysis of whether surrendering the GAC and paying the surrender charge is in the best interest of the participants as a whole, taking into consideration the current market and participant needs.  He should do a detailed comparison of the various alternatives, i.e., holding the GAC, a partial surrender, total surrender, costs of other investments, etc..  It is a given that he must show that he followed all the plan provisions and also the GAC provisions to ensure that the minimal surrender charges were paid.   If possible, he should consult with an independent financial advisor/expert (preferably not the advisor he is moving to.. to avoid conflicts of interest) to ensure the decision was prudent and in the best interest of the participants.  As with all fiduciary decisions, but especially here where there may a high risk of litigation (he is in essence creating a loss), he must be certain to document his decision (including detailed records of all the analysis performed, alternatives considered, the decision-making process, and the reasons for the final decision to surrender the GAC, etc.).  Also, he should attempt to effectively communicate the change to the participants showing how it is in their best interest to do this.  Of course, he has to walk a fine law … if he shows the GAC is such a bad deal someone might consider filing suit questioning the initial decision to put all the money in the GAC in the first place.

Another option which many plan sponsors utilize when in this situation is simply freezing the GAC and redirecting new contributions into new investments, e.g., mutual funds.  Here, he simply stops adding any more money to the GAC and in essence starts a new investment plan with the new mutual fund investment slate.  At the point the GAC surrender period expires, he would terminate the GAC without the surrender charges and the GAC money would then flow into the new investments.  Don’t know how long the surrender period is but at least for some of the money the participants will have more control.  He may need to amend the plan for this.

It doesn’t sound like your friend would want to do this but some plan sponsors will pay the surrender charges.  Paying the surrender charges is more complex under the tax code and, if desired, your friend should consult an ERISA benefits attorney. see @CuseFan

Question 2.  This allocation should already be addressed in the plan and the GAC.  All qualified plans must have “definitely determinable” benefits.  Even though the funds are all invested in a single GAC, there should be current terms under which those funds are allocated to each of the participants.  As you state, they are all getting statements now that track the amounts in the GAC allocated to each of the participants.  The surrender charges would be allocated amongst the participants under a formula in the plan/GAC.  There must have been participants who terminated employment and qualified for a distribution from the plan.  How were their benefits determined?  Overall, your friend should stay away from any type of modification or amendment of these provisions.

Just thoughts...

[NewBieHere]

Thank you for your inputs.

I have one more question. If my friend wants to terminate the existing 401(k) (thus pay the surrender charges) and start a new 401(k) plan which allows each participant to make his/her own investment decision, would the answer to Question 1 change if my friend decides to increase this year's contributions to make up for the loss? The plan has been around for 3-4 years, and he has financial means to do so.

[BG5150]

First of all it they terminate the 410(k) plan, the company cannot implement a new 401(k) plan until at least 12 months after the last assets were distributed.  So, there's a detriment right there.

What they could do is stop investment into the funds that have surrender charges and contract with another record keeper to offer a daily-valued, participant-directed platform (like Voya or John Hancock or Empower--just examples, not necessarily recommendations).  They liquidate and transfer the funds from the annuities to the new custodian as the surrender charges expire.

Don't confuse where the assets are held as being 'the plan'.  Assets can be moved from provider to provider, even the types of investments offered, without changing the underlying plan.  

Or, in other words, don't confuse a service termination with an asset custodian with a plan termination.

 

What is your role in this?  Are you in the retirement plan industry or are you just a friend asking on his behalf?