Administration February 25, 2021

Plan Sponsors Have Fiduciary Duties to Follow During Adviser M&As

They should know the right questions to ask as advisory firm merger and acquisition activity continues to increase.
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Art by Scott Bakal

Advisory firm merger and acquisition (M&A) activity is on the rise without any sign of slowing down. But what are plan sponsors to do if their advisory firm is acquired, or if the firm they partner with keeps acquiring others?

Plan sponsors should first find out whether and how the services their financial adviser provides will be impacted, says George Sepsakos, an ERISA [Employee Retirement Income Security Act] attorney and principal at Groom Law Group. “The first questions that our [plan sponsor] clients typically ask is how the direct experience with the adviser is going to change, and if they need to be concerned with the effects of the relationship,” he says.

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Beyond that, plan sponsors will want to understand whether the acquisition will bring on any conflicts of interest that were not a concern before, Sepsakos adds. Plan sponsors should ask, “Is the business strategy of the company that was acquired the same? Will they now have access to proprietary funds that they otherwise haven’t had access to? Are there other streams of revenue that were important to the acquired entity business but could now flow to the adviser?”

One notable question Sepsakos consistently asks his clients is whether the adviser can continue to work on the full investment lineup. “There are instances where there are securities that the adviser is not able to provide advice on,” he explains. “If those securities are in the plan lineup, the question becomes whether the adviser will have to recuse themselves, or will there be another mechanism to oversee that bucket of security?”

Additionally, and oftentimes most importantly, Sepsakos says, ask about potential fee changes. Is there any reason for the fees to change? Would the acquisition affect fees at all, and is the adviser going to have a different process for selecting or recommending investments?

Robert Friedman, an ERISA attorney and partner at Holland & Knight, recommends employers review the contracts they have with the advisory firm if it’s going through an acquisition.

However, he notes that if the acquisition involves an equity-type transaction where the advisory firm is owned by another company or person, then it’s likely little has changed within the firm and its services.

“The advisory firm will still be intact, but it would still make sense to review the contract and see if the sale has any effect on the terms,” he advises. “The plan sponsor may not need to do anything initially, but they will need to pay attention consistently to make sure that the advisory firm is still capable and competent.”

If there is a change in the structure of the advisory firm, then plan sponsors will likely be asked to consent to a new contract. In this case, Friedman strongly encourages plan sponsors to ensure they understand the potential alterations that would occur as a result of the acquisition. “Those changes could be anything. It could be a change in the team that is servicing the plan sponsor, a change in fees or a change in the approach that the advisory firm takes when providing services,” Friedman says.

It’s also important to consider any new services that will be offered through the acquisition. One example is that the entity that is acquired could offer managed accounts, while the new adviser only provides target-dates funds (TDFs). Another example could be that the new advisory firm conducts business with individual participants who leave an employer-sponsored plan. Both of these instances could cause substantial changes to the plan, both Sepsakos and Friedman say.

Friedman emphasizes that employers hold a serious fiduciary duty to ensure the advisory practice can provide advice on prudent investments and avoid conflicts of interest.

“If there is any question about this, then the plan sponsor needs to take action,” he continues. “If the advisory firm is not capable of discharging its duties, the potential liability will roll back on the plan sponsor.”

The core liability that a sponsor holds is recognizing and understanding how the plan adviser’s business has fundamentally changed, Sepsakos adds. He doesn’t anticipate a halt on M&A activity anytime soon, so he recommends that plan sponsors watch out for any new acquisitions with their advisory partner.

“M&A activity has been really hot and I think it’s here to stay—at least in the near-term,” he says. “We can all expect there to be some major changes in that segment of the business that we just need to keep an eye on.”

Participants February 24, 2021

Ways NQDC Plan Participants Use Their Accounts

Section 409A nonqualified plans allow for various payment dates so participants can save for children’s college expenses and other financial needs and wants.
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Art by Grace Park

Section 409A nonqualified deferred compensation (NQDC) plans aren’t just an extra retirement benefit for executives, the plans can help executives with other financial needs as well.

With Section 409A NQDC plans, participants have to make elections for deferrals and distributions ahead of when the deferrals will be made, and a plan sponsor can design the plan to either allow for in-service withdrawals or not, says Steve Marrow, senior vice president of plan sponsor strategy and analytics at Fidelity.

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Participants can defer salary, annual or long-term incentives, restricted stock or restricted stock units, and there are different rules about the timing of those elections, Marrow adds. But with any type of deferral, the plan sponsor can design the plan to specify whether participants’ money is available to them before retirement or a separation of service.

The plan’s design can set plan sponsors apart if they use it to recruit top talent, Marrow notes, so plan sponsors might want to allow the plan to meet executives’ financial needs other than retirement.

Employer money—a match that participants aren’t able to get in qualified plans due to statutory limits or special retention contributions—could also be included in in-service withdrawals for purposes other than retirement, Marrow says. “If the plan is designed so that in-service distributions can be elected for employer money, any vesting schedule attached to that money would have to be considered for distribution timing,” he notes.

Karen Volo, senior vice president of executive services program at Fidelity, says plan design matters in how participants can use their NQDC plan assets. She says about 50% of plan sponsors allow a choice of either in-service or vesting-driven payments.

Mark West, national vice president of business solutions at Principal, says another type of NQDC arrangement, 457(f) plans, are used by plan sponsors more as a retention mechanism and do not offer the various payments dates that nonqualified plans subject to Internal Revenue Code (IRC) Section 409A plans do.

“I suppose if someone was offered a 457(f) plan, they could make a deal. They could say they have a child going to college in eight years so they want part of their payment at that time, but it’s not as clean as with a 409A plan,” he says.

The most common use of NQDC plan accounts is to bridge the gap for participants who want to retire early but don’t want to dip into other savings accounts, West says. For example, an executive might want to retire at age 60 but avoid taking money out of his qualified plan until later to get more tax deferred growth, West explains. He might use what’s in his NQDC plan to cover expenses from age 60 to whenever he wants to start drawing money from other assets. Likewise, a participant can use his NQDC funds to bridge the income gap until age 70 when Social Security is maximized.

According to Volo, the majority of plan participants are taking distributions after age 60 for retirement. The top uses are to create a ladder for payments to bridge the gap between that age and when they start taking distributions from other sources, to bridge the gap for health care expenses or to purchase long-term care insurance.

Using NQDC Plan Assets for Other Needs, and Wants

In addition to retirement, participants can use NQDC plan assets to cover their children’s education expenses. If an executive has a child who will be starting college in 2021, he could elect distributions for 2021, 2022, 2023 and 2024, West explains. He says the use of in-service distributions to pay for a child’s education is the one Principal sees the most.

West says he has also seen participants target buying a vacation home at age 50 or 55. They will elect to take a distribution at the age they need to purchase it or to make a down payment. “I’ve also seen it used for an extended vacation, when the participant plans to be gone for a couple of months,” he adds.

In addition, NQDC plan participants can schedule a distribution to be used for home remodeling. “They are generally thinking they want some things done before they retire,” he says. “I’ve even seen a participant use a distribution to buy a boat. Really, anything a participant is dreaming to do, they can set up a distribution for it.”

Volo says when Fidelity recently surveyed representatives that help with retirement planning, the reps mentioned a wide range of uses for NQDC plan assets—one participant used his plan assets to achieve his dream of buying a farm.

Marrow adds that another individual used his plan assets to buy a plane. “There’s a lot of flexibility,” he says.

“I think now, more than ever, there’s a desire to take advantage of potential tax diversification among retirement accounts, to defer money with no specific goal in mind, but to take out if they do need it for a big expenditure,” he says.

Taxes and when a person needs the assets are factors in the decision about when to take distributions, Marrow says.

Plan Design Considerations

Plan sponsors can allow participants to make a different distribution election each year if they want to, Marrow says. And, if a participant doesn’t want a distribution at the original time he elected it, the plan sponsor can allow him to re-defer it until at least five years beyond the time he was going to use it. Marrow says this is called the 409A push rule.

Although, more often, participants are given the ability to take in-service distributions, NQDC plan sponsors could design the plan to steer participants into certain uses for their accounts, West says. “If the plan sponsor wanted to steer participants to use their accounts just for retirement and didn’t like offering the chance for multiple in-service distributions, it could design it that way,” he says. “Still, the plan sponsor wouldn’t ultimately know what the participant uses the money for.”

He says there are also plans that will distinguish between a separation of service below a certain age or a service requirement before retirement. “For example, if a participant leaves the employer after age 50 with 10 years of service, the plan might allow him to get installment payments over 10 to 20 years,” Marrow explains. “If the participant doesn’t hit that age before leaving the employer, the plan would force him to receive a lump-sum payment.”

Fidelity has found that nonqualified plans can be difficult to understand for participants, so Volo says they should be coupled with financial planning.

“It is so important to have a planning component alongside the plan to help participants to understand the complexities of the plan and the opportunities it offers, and to consider the best use of assets,” Volo says. “That’s one thing Fidelity will focus on going forward.”

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