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When it comes to 401(k) plan administration and payroll, they don’t have much to do with each other beyond salary deferrals and W-2 compensation. Besides those two small elements, retirement plan administration requires a different type of knowledge and expertise.
Payroll providers that offer retirement plan administration to their clients often attempt to create a sort of “synergy” with various services like investment advisory, legal documentation, or insurance. While they claim that these services compliment each other, sounding appealing is all it has going for it, since this “synergy” is actually the downfall of their approach. Not only can it lead to poor plan administration and investment returns, but can create conflicts of interest as well.
Despite these shortcomings, payroll providers are among the country’s most popular TPAs.
Popularity doesn’t equal competence, however. While payroll providers have many clients, they also have a high churn rate, meaning they lose as many clients as they gain.
The success of payroll providers is partially due to many plan sponsors not understanding what a TPA does. As a result, plan sponsors can think, erroneously, that they are getting a bargain by using their payroll provider for both payroll and retirement plan administration.
But payroll providers might not have the expertise or customer focus to ensure retirement plans abide by highly technical IRS and ERISA rules. These rules include complicated testing to gauge if a plan favors highly compensated employees and reporting requirements embedded in IRS Forms 5500 and 1099.
In addition, plan sponsors must have up-to-date plan documents, and participant- directed 401(k) plan funds must be transferred from payroll to the plan’s trust.
More complicated still, after daily mutual fund or exchange traded fund trades, assets must be distributed to plan participant accounts, which also must be updated with any gains, losses, dividends, and capital gains.
Because retirement plans have so many moving parts, plan sponsors should focus on finding TPAs that make few administrative errors. Errors can lead to penalties, or in extreme cases plan disqualification.
While errors in processing of payroll for 401(k) salary deferral contributions can occur, they aren’t likely because payroll is automated.
On the other hand, plan discrimination testing is not automated; rather it’s heavily dependent on data collected by plan sponsors. Because the data is both technical and extensive, good TPAs will work closely with their clients to insure the data is correct.
Most payroll providers don’t walk their clients through data collection, however. The payroll providers assume, often erroneously, that the plan sponsors data is correct. Consequently, discrimination testing errors can frequently occur leaving the plan sponsor more likely to be audited and penalized.
Many TPAs offer plan sponsors a dedicated representative. However, payroll providers only assign a dedicated representative to their largest clients. Other clients have to work with a team. In those cases, when questions or problems arise, it ‘s often difficult for plan sponsors to track down someone who has worked on their plan.
It ‘s far easier to work with one plan contact, because the team approach creates more chances to drop the ball.
One major component of setting up a plan is maximizing participant retirement savings. This can be accomplished by selecting the right plan type and design. Unfortunately, payroll provider TPAs aren’t usually sophisticated plan designers, which means that the ability to maximize savings is beyond their ability. Payroll providers most often administer plain “vanilla” 401(k) plans and won’t likely discuss the merits of new comparability, floor offset arrangements, or cash balance plans.
While some payroll provider TPAs offer a choice of mutual funds, they aren’t fiduciaries, and as a consequence, aren’t liable for losses suffered by plan participants.
Payroll providers may recommend certain mutual funds, but they aren’t considered investment advisors. In other words, they aren’t legally culpable for their recommendations.
Both cases leave plan sponsors and other fiduciaries legally liable.
In sum, using payroll provider TPAs makes sense only in the case of small 401(k) plans that make safe harbor contributions (thus avoiding discrimination testing)