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The Fiduciary How (and Why) 401k Plan Sponsors Change Recordkeepers
by Christopher Carosa August 31, 2024
In some ways, now is the best time for 401k plan sponsors to consider changing service providers. There are practical deadlines that could influence the timing of any change. Those deadlines can be different depending on the nature of the service provider.
“There are many types of service providers that are engaged to support employer-provided retirement plans such as recordkeepers, investment advisors, third party administrators, trustees/custodians, accountants, consultants, and legal advisors,” says Michelle Capezza, Of Counsel at Mintz, Levin, Cohn, Ferris, Glovsky and Popeo, P.C. in New York City. “Among the plan fiduciary responsibilities is the duty to prudently select and monitor the plan service providers and their performance, as well as to assess the reasonableness of their fees in light of the services to be provided. Once a service provider is prudently selected, there often is a desire to maintain that relationship and service arrangement rather than disrupt plan operations. However, it may become necessary to change any service provider if, for example, that selection fails to remain prudent, if the service fees become unreasonable, or if there is a consolidation of plans due to a corporate transaction prompting use of certain service providers over others. In case of an emergency situation, given that it can take several months to engage in a process to compare service providers and onboard them, it would be prudent to always have service provider diligence questions prepared as well as a list of potential options to consider in the event that swift action must be taken to replace a service provider. “
Some service providers are replaced more regularly than others.
“Plan sponsors most frequently change their recordkeeper,” says Samuel Shinn, Wealth Advisor at BMC Wealth Management in Hamilton, New Jersey. “The driving factors are usually dissatisfaction with customer service, high fees, or outdated technology. Since the recordkeeper is central to the plan’s operations and participant experience, it’s often the first area sponsors address when looking to improve their plan.”
This is likely because, since they are involved in so many critical parts, one slip-up can appear magnified to both plan participants and plan sponsors.
“Among the various service providers involved in managing a 401k plan, recordkeepers are the providers that plan sponsors change most often,” says Richard Bavetz, investment advisor at Carington Financial in Westlake Village, California. “Just as air traffic controllers ensure that planes take off, land, and travel safely through crowded airspace without collision or delay, a recordkeeper manages the flow of contributions, distributions, and account activity in a retirement plan, ensuring everything happens smoothly and in compliance with regulations. Key factors that drive a plan sponsor to switch to another recordkeeper include reducing costs, improving service quality, upgrading technology, ensuring compliance, and achieving better integration with other providers. When a recordkeeper falls short in one or more of these areas, a plan sponsor must seek out a new recordkeeper to better meet the needs of the organization and its plan participants.”
Of the several factors that can expose recordkeepers, cost may be their greatest Achilles’ Heel.
“Cost is a significant factor in the decision to change recordkeepers,” says Bavetz. “The fees associated with recordkeeping can be substantial, and plan sponsors have a fiduciary responsibility to ensure that plan expenses are reasonable and competitive. Large plans of 100 participants or more can use leverage to bring fees down, but small plans account for as much as 85% of the 401k plans in America and do not have that same leverage. As a result, they are known to have much higher costs. High administrative fees can erode participants’ retirement savings and are a vital concern for sponsors trying to maximize participant outcomes. If a sponsor identifies that another recordkeeper can provide the same services at a lower cost, it creates a strong incentive to switch. As a principal fiduciary duty, a plan sponsor should regularly benchmark fees every 3 to 5 years and explore options for reducing costs while maintaining or improving service quality. In today’s competitive marketplace, recordkeepers must offer competitive pricing to retain plan sponsor clients, and when sponsors find better value elsewhere, they are inclined to make a change.”
It’s not just fees, it’s also service.
“Service quality is another major factor driving plan sponsors to change recordkeepers,” says Bavetz. “Since recordkeepers handle essential tasks such as processing participant transactions, managing account data, and issuing statements, any shortcomings in service can have immediate and detrimental effects on participants. Errors in account balances, delays in processing contributions, or difficulties accessing account information can lead to participant dissatisfaction and create administrative headaches for plan sponsors. Inadequate customer service, such as long response times or insufficient support in addressing participant concerns, further exacerbates these problems. For plan sponsors, ensuring that participants have a positive experience and that the plan operates smoothly is crucial. When service quality falls short, sponsors often look for a recordkeeper with better reliability and responsiveness.”
Perhaps a leading indicator of a pending service failure is the state of the technology used by the recordkeeper.
“Technology is playing an increasingly important role in determining whether a plan sponsor will stick with their current recordkeeper or seek a new provider,” says Bavetz. “As participants become more engaged with their retirement planning and expect greater convenience in managing their accounts, the technology offered by the recordkeeper becomes a significant differentiator. Recordkeepers that provide modern, user-friendly online platforms and mobile apps make it easier for participants to view their balances, adjust their investments, and access educational resources. Moreover, advanced technology can improve the overall plan management by automating administrative processes, reducing potential errors, and providing plan sponsors with real-time reporting and analytics. If a recordkeeper falls behind in technological innovation, a plan sponsor may switch to a provider offering a more sophisticated and participant-friendly experience.”
There’s another area that recordkeepers play a big part in. Mistakes here can increase the fiduciary liability of plan sponsors.
“Recordkeepers are responsible for helping plan sponsors maintain compliance with complex regulations, including IRS contribution limits and Department of Labor (DOL) guidelines,” says Bavetz. “Failure to accurately manage contributions, administer plan loans, or meet deadlines for required filings can expose plan sponsors to penalties and legal liabilities. Given the complexity of 401k regulations and the potential for costly mistakes, plan sponsors cannot afford to work with a recordkeeper that fails to maintain strict compliance standards. When compliance issues arise—such as missed deadlines for filing required reports, errors in contribution tracking, or failure to conduct required nondiscrimination testing—plan sponsors often change recordkeepers to avoid further risk and ensure their plan remains in good standing with regulators.
Unfortunately, sometimes problems aren’t the recordkeepers’ fault. As the hub of plan operations, it’s easy for other service providers to point the finger at the recordkeeper.
“Integration with other service providers is an important factor influencing the decision to keep or change recordkeepers,” says Bavetz. “Most 401k plans involve several service providers, such as payroll processors, investment advisors, and third-party administrators (TPAs). The recordkeeper must integrate smoothly with these other providers to ensure that plan operations are efficient and accurate. For example, suppose the recordkeeper cannot easily integrate with the payroll provider. In that case, there may be delays in processing contributions or errors in participant data, leading to administrative complications and participant frustration. A lack of integration can increase the administrative burden on the plan sponsor and create unnecessary obstacles in managing the plan. Plan sponsors who encounter difficulties coordinating services between the recordkeeper and other providers may decide to switch to a recordkeeper that offers better integration and seamless coordination.”
But there’s a flip side to many of these factors. This can make changing recordkeepers difficult.
“The recordkeeper is typically the most challenging service provider for a 401k plan sponsor to change,” says Bavetz. “This is due to the recordkeeper’s central role in managing the plan’s day-to-day operations, including participant data, account balances, contributions, and distributions. Recordkeepers are responsible for maintaining detailed records of each participant’s retirement account, processing transactions such as loan requests, rollovers, and withdrawals, and ensuring the plan stays compliant with IRS and Department of Labor regulations. Given the recordkeeper’s integral role in handling administrative and participant-facing tasks, switching providers can be a complex and disruptive process requiring meticulous planning and coordination.”
Again, there’s another coin with two sides when it comes to recordkeepers. Just as poor technology can be the downfall of the recordkeeper, it can also represent an obstacle to replacing the recordkeeper.
“One of the primary reasons changing recordkeepers is so tricky is the vast amount of data that needs to be transferred during the transition,” says Bavetz. “A recordkeeper manages sensitive participant information, including historical contributions, investment elections, loan balances, and transaction histories. This data must be transferred precisely from one recordkeeper to another to ensure that information is recovered and accurately recorded. During this transition, errors can lead to significant issues for the plan sponsor and participants, such as incorrect account balances, delays in processing contributions, and difficulties accessing accounts.”
From the point of view of the plan participant, any hiccup in the employees’ ability to manage their retirement assets can cause problems for plan sponsors.
“Participant disruption is a significant concern when changing recordkeepers,” says Bavetz. “Unlike changes to other service providers, such as investment advisors or third-party administrators (TPAs), where the impact on participants is minimal, a recordkeeper transition directly affects participants’ ability to access and manage their retirement accounts. Participants may need to set up new online accounts, update their login information, and become familiar with a new user interface and account management platform. This set-up period can cause confusion and frustration, especially for participants who need to be more technologically savvy or who rely on regular access to their retirement accounts for loan payments, hardship withdrawals, or routine contributions. Ensuring a seamless participant experience during a recordkeeper change requires significant effort in terms of communication, education, and support.”
Along the same lines, the central role of the recordkeeper can create reverberations with other providers should the plan sponsor attempt to change recordkeepers.
“Integration with other service providers contributes to the difficulty of changing recordkeepers,” says Bavetz. “Recordkeepers work closely with payroll providers, investment managers, and TPAs to ensure that contributions are processed correctly, compliance tests are conducted, and plan documents are maintained. When a plan sponsor switches recordkeepers, changes or reconfigurations may be necessary in how other service providers interact with the plan. For example, the payroll system must be updated to integrate with the new recordkeeper’s platform, and the TPA must ensure that data from the new recordkeeper aligns with compliance requirements. These technical adjustments can be complex and require extensive coordination between multiple service providers, further complicating the transition process.”
There’s even another side of the coin regarding compliance.
“Compliance concerns also add to the difficulty of changing recordkeepers,” says Bavetz. “Recordkeepers are critical in ensuring the plan complies with regulations, including adhering to IRS contribution limits, managing nondiscrimination testing, and filing required documents such as Form 5500. When a recordkeeper changes, the new provider must quickly get up to speed with the plan’s compliance history and requirements. This handoff can be challenging, mainly if there are unresolved compliance issues from the previous recordkeeper. Additionally, the new recordkeeper has different procedures for managing compliance. In that case, the plan sponsor may need to adjust its internal processes to accommodate these changes, which can create additional administrative burdens.”
Finally, don’t underestimate the power of inertia. Remember, running a retirement plan is not the full-time job of plan sponsors. They’ve got their companies to run.
“The time and resources required to execute a recordkeeper change present significant factors that make the process difficult,” says Bavetz. “A typical recordkeeper transition can take several months, requiring the plan sponsor to invest considerable time in managing the process. Issuing a Request for Proposal (RFP), reviewing potential new recordkeepers, conducting due diligence, and negotiating contracts are all needed. Once a new recordkeeper is selected, the transition process involves extensive planning, data reconciliation, and testing to ensure the transfer is successful. Plan sponsors must also develop and execute a robust communication plan to inform participants about the change, provide them with necessary instructions, and address any concerns or questions they may have. This requires time, effort, and careful coordination to ensure that the transition does not negatively impact participant satisfaction or confidence in the plan.”
Bavetz summarizes it by saying, “While it can be necessary to switch recordkeepers to improve service quality or reduce costs, the process requires careful planning, extensive coordination, and significant time and resources to ensure a smooth transition with minimal impact on participants and plan operations.”
In other words, look before you leap.
Christopher Carosa is an award-winning online news producer and journalist. A dynamic speaker, he’s the author of 401(k) Fiduciary Solutions, Hey! What’s My Number? How to Improve the Odds You Will Retire in Comfort, From Cradle to Retirement: The Child IRA, and several other books on innovative retirement solutions.