This
article is available in PDF format.
he
corporate responsibilities of anesthesiology groups’
management are a new topic for the “Practice
Management” column. Among them, not infrequently,
is retirement plan administration. The plan administrator
is a fiduciary whom the law holds to certain standards,
including due diligence in selecting plan advisors.
Jeff Seymour, Managing Director of Triangle Wealth
Management, L.L.C. in Cary, North Carolina, offers
the cautionary information and suggestions below.
Overview
Both anesthesiology practice administrators and
physician owners commonly serve as retirement
plan administrators for their groups. As such,
they must ensure that they select competent and
independent plan advisors. Sometimes plan administrators
rely too heavily on the advisor (or more often,
broker) to provide full disclosure of their own
interests in investments held by the plan. This
can lead to a breach of the plan administrator’s
fiduciary duties. This article will help the retirement
plan administrator become better informed on issues
regarding disclosure of conflicts of interest.
Recall that under the Employee Retirement Income
and Security Act (ERISA), a plan sponsor and plan
administrator must not only identify conflicts
of interest, they must avoid them.
On the Watch List
Hidden fees: Do any
of the plan mutual funds have 12b-1 fees? If so
the advisor may have a potential conflict of interest
and a reduced ability to assume a fiduciary role.
You should ask your advisor why you have funds
with 12b-1 fees. These are ongoing fees paid by
the mutual fund company to a brokerage for marketing
the fund. When the 12b-1 fee was introduced by
the Securities Exchange Commission (SEC) in 1980,
it was supposed to help mutual fund companies
pay for advertising in order to grow their funds
so that some economies of scale could lower the
ongoing management costs. We have seen that many
of the funds charging 12b-1 fees have grown considerably
in size, but we frequently do not see a corresponding
reduction in the size of the 12b-1 fee. Alternatively,
witness the existence of thousands of no-load
funds (with no 12b-1 fees either). Clearly 12b-1
fees are not necessary, and clearly they do nothing
to help the investor. For this reason, the SEC
considered repealing 12b-1 fees in 2004. A bill
was introduced — the Mutual Fund Reform
Act of 2004 — providing for the repeal of
rule 12b-1, but it did not pass.
As an investor, you should know that once a broker
sells a mutual fund with a 12b-1 fee, it continues
to receive 12b-1 fees annually, as long as the
fund is held. Over the years, this will have an
impact on returns because you are charged the
12b-1 fee directly by the mutual fund company.
Make sure you include the 12b-1 fee in your comparisons
of mutual funds — or better still, avoid
mutual funds with 12b-1 fees, since there is no
evidence to support the claim that funds with
12b-1 fees produce higher returns. Similar issues
affect mutual funds with class A, B or C, which
means that the plan participants are paying sales
loads (commissions) without necessarily performing
better than or as well as no-load funds.
Setting yourself up to pay a higher tax rate:
Both physician leaders and professional practice
managers may have great breadth and depth of business
knowledge, but they are probably not tax experts.
The plan administrator does need to be mindful
of some basic tax considerations for retirement
plans, and to hire an advisor to educate the plan
participants about the impact of tax planning
on the investments in their plan. Here is a rudimentary
fact that is often overlooked: federal personal
income tax rates on long-term capital gains, and
on dividends, are only 15 percent. Yet the same
investments (those that are equity-based, i.e.,
stocks and mutual funds holding stocks) held inside
your company retirement plan will be taxed at
personal income tax rates when withdrawn. Most
anesthesiologists are in the 33-percent federal
personal income tax bracket or higher. Would you
rather pay 33 percent or 15 percent in taxes?
Some would reject this argument because the purpose
of the retirement plan is to defer income tax
to the future, when personal tax rates are assumed
to be lower. Good point. Now consider this: If
the anesthesiologist is planning on living comfortably
in retirement, he or she is still going to be
drawing enough from his or her retirement plan
to pay more tax than 15 percent. In addition,
the current status of the nation’s fiscal
situation (ballooning debt, aging population,
plummeting national savings rate, lowest personal
income tax structure in decades, Medicare and
Social Security solvency crises in 2018 and 2040,
respectively, according to the trustees’
May 2006 report) mean there is considerable chance
we will see higher marginal income tax rates in
the future. We are not saying that you should
not hold any equities in your retirement plan
(read: deferred savings plan), but you need to
be aware of the tax implications of your asset
allocation decisions. Certainly your advisor needs
to educate plan members about this and other facts.
Preferred funds: Ask your advisors
if they or their company receive any remuneration
in any form (trips to Maui, BMWs and Rolexes,
etc.) from fund companies. There are brokerages
that have charged mutual fund companies for the
privilege of being called a preferred fund company.
This status may lead to improved access to the
sales force (brokers). Failure to disclose this
or any similar arrangement leads to a clear conflict
of interest. One national brokerage actually made
most of the firm’s annual profits from these
undisclosed fees alone in 2005.
Trading costs: When a plan participant
sells mutual fund shares (redeems them back to
the fund company), that participant does not directly
incur a fee/cost for the trades required to sell
the stocks that make up the fund. Instead the
remaining fundholders pay. In this manner, any
short-term trading of the fund hurts returns of
the long-term fundholders. For mutual funds with
high turnover (a great deal of buying and selling),
fundholders may see up to 1 percent of the value
of the fund lost annually to trading costs. Trading
costs are not disclosed in the fund prospectus,
so the investor cannot know in advance what will
be lost to trading costs. The plan administrator
may, however, ask for the “Statement of
Additional Information” (SAI). Sometimes
the SAI will disclose trading costs for the fund
in a previous year. Look for funds with trading
costs as low as possible, ideally less than 0.4
percent of the fund’s value per year. This
should be something your advisor analyzes and
discusses with you.
Broker or advisor: You must know
whether the persons you are working with at the
investment firm are brokers or advisors. Ask them
to disclose their role in writing. Brokers will
vehemently deny any fiduciary responsibility among
themselves, but some have been known to muddy
the specific nature of their role when they are
in front of clients. The Financial Planning Association
has brought suit against the SEC for allowing
Merrill Lynch to continue to call its brokers
“advisors.” A Registered Investment
Advisor is an individual licensed to provide investment
advice, and advisors have a legal obligation to
act in the best interest of their client (1940
Investment Advisor Act). Brokers do not.
Other sources of conflict: ERISA
requires that you have an advisor that is independent
and will validate the product providers’
(mutual funds companies’) performance results.
This means your advisor must not be in any way
affiliated with the mutual fund companies represented
in the plan (unless you hire a separate independent
advisor).
If the advisor recommends products that are proprietary,
you need to understand the implications for your
fiduciary role. We recommend avoiding proprietary
products because they serve to lock in the client
by preventing them from transferring those assets
elsewhere.
Plan sponsors and plan administrators must not
accept services that are not offered to all participants.
The most obvious example of this clear ERISA violation
is the offer of a free personal retirement plan
analysis for the anesthesiology practice owners,
but not for other practice employees.
Conclusion
Many of the above potential problem areas for
retirement plan administrators are not disclosed
very well — but they should be. The securities
industry is under fire from regulators (Spitzer,
et al.) in part because of poor disclosure and
in part for failure to perform the role of fiduciary.
One hopes that the pressure to reform and provide
improved transparency will continue.
Jeff Seymour may be contacted through Triangle
Wealth Management’s Web site at <www.doctorwealth.com>
or by calling (919) 469-3600.