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Ropes & Gray attorneys provide timely analysis on legal developments, court decisions and changes in legislation and regulations.
David Kirchner: Hi, all—thank you for tuning in to our podcast today. I’m David Kirchner, a principal in the Ropes & Gray benefits consulting group. I am here with my colleagues, Jack Eckart and Elliot Saavedra, who are both benefit consultants in our group. Welcome back Jack and Elliot.
This is the second episode of our podcast series focused on a newcomer to the 401(k)/defined contribution space called pooled employer plans, popularly referred to as “PEPs.” In January, we released our first episode, where Elliot and I provided an updated overview of PEPs and how they work. On that podcast, we:
• explained how PEPs are structured with the pooled plan provider and the other third parties,
• addressed the potential benefits of PEPs as compared to a single-employer retirement plan, and
• discussed the growth we’ve seen in the PEP market since they started rolling out in January 2021 per the SECURE Act.
Today’s transcript provides a link to this first episode in case you missed it or are interested in getting a refresh on the basic concepts and components of PEPs.
Over the last few years, Elliot, Jack, and I had the opportunity to work with many of the new PEP providers bidding and vetting them on behalf of our clients. So, today, we thought we would discuss our experiences with the goal of sharing some of our lessons we have learned through these processes.
With that introduction, Jack, let’s start with a big picture perspective. What are some general observations you have made with respect to this new animal in the defined contribution space since it showed up in 2021?
Jack Eckart: First off, thanks for having me here today. I listened to the first part of the series that you and Elliot did, and I thought it did a great job at laying out the overall structure of PEPs. But I’d like to take a step back to when the SECURE Act was signed into law. On its face, the legislation was intended to improve access to retirement plans for American workers and help them save for retirement. This makes sense, because for years now, we’ve heard how a significant portion of the American workforce lacks access to retirement savings plans and does not have enough savings for their retirement.
So, when the SECURE Act was signed into law in 2019, my initial reaction was that PEPs would be a game-changer for those smaller employers that lacked the wherewithal to sponsor and support their own stand-alone plans. However, over the last few years, the PEP market has played out a bit differently.
Sure, there are PEPs that are marketed to smaller employers who are just starting out and offering their first retirement benefit but, in another emerging facet of the market, there are PEPs that are successfully marketing to relatively large employers who are merging their existing single 401(k)s into a PEP. This is apparent as we’ve started to see some PEPs implement minimum participant entry requirements. For example, we’ve seen PEPs that require 100 or 200 minimum participants in order for an employer to join the PEP. These PEPs are clearly targeting established employers with existing single-employer 401(k)s.
And there’s a multitude of varying PEP products in between, which seems like a good thing. From my vantage point, there’s not currently a single PEP solution that works for all employers. When considering a PEP, an employer needs to evaluate where it is today in terms of its retirement program, or potentially lack thereof, and what it is trying to accomplish by joining a PEP.
David Kirchner: I agree with you, Jack. As we’ve discussed in previous podcasts, there’s a host of reasons why an employer would want to consider a PEP, whether it is looking to:
• achieve better participant pricing,
• reduce its potential fiduciary liability risk under ERISA,
• outsource administrative responsibility because they have a lean internal HR/benefits function, or
• implement a retirement benefit as soon as possible in the context of a merger or other corporate transaction.
Elliot, you’ve really been on top of the PEP market trends as you’ve assisted multiple clients with RFPs and implementations and have been tracking the various PEP offerings available in the market. What are some of your observations about the different structures you’ve seen available?
Elliot Saavedra: Like you and Jack have been saying, there’s a multitude of PEP offerings out there now. Currently, there are over 350 PEPs registered with the DOL, and there are some pretty significant differentiators. As Jack mentioned, there’s a pretty wide range and type of employers who are considering PEPs. We’ve assisted small nonprofits who are joining PEPs as their first retirement plan offering. At the other end of the spectrum, we’ve assisted large employers who are merging their single-employer 401(k)s into PEPs to lower participant fees, gain some additional investment options, and reduce their fiduciary responsibilities and administrative burdens.
Using just these two examples, our starting point for evaluating and determining the success of a PEP would be completely different. There would be minimal, if any, overlap in the PEP providers to whom we would consider issuing an RFP for these two different scenarios. Given the growing marketplace, to Jack’s point, there doesn’t seem to be a one-size-fits-all PEP, so employers thinking about a PEP as an option need to specifically identify what’s important to them when considering which single-employer and PEP options to evaluate.
In terms of which organizations and administrators are registering as pooled plan providers with the DOL, we’ve seen all types. As a reminder, the pooled plan provider replaces the employer as the named fiduciary and plan sponsor for a PEP, and that entity is responsible for fulfilling many of the PEP’s administrative and ERISA fiduciary responsibilities, similar to an employer sponsoring a single-employer plan. Some segment of traditional retirement record-keepers, PEOs, payroll providers and consulting firms have all registered as pooled plan providers. We’ve also seen an emergence in third parties, or TPAs, registering as pooled plan providers and—although, these third parties may not have the same brand recognition as some of the traditional record-keepers and consulting firms—their PEPs are typically structured in a way that does not appear to have conflicts of interest. Again, from the employer’s standpoint, this illustrates the importance of identifying their priorities in advance, when evaluating PEPs.
David Kirchner: That’s a good point, Elliot—employers should determine their goals in advance of going to the PEP market. Shifting gears, even though PEPs have been in existence since 2021, to date, there hasn’t been any formal guidance on how PEPs need to be structured, operated, or administered. As a result, the PEP marketplace is still in a state of flux, and there are a lot of different approaches out there. For instance, some PEPs may have what appear to be conflicts of interest that seem difficult to reconcile with ERISA. Jack, based on your experience, can you elaborate on some of the potential conflicts we’ve seen with some of these PEP structures?
Jack Eckart: Yes—as a quick reminder, though, under ERISA, a fiduciary has to “act prudently and make decisions solely in the interest of plan participants and their beneficiaries.” When participating in a PEP, one of the few ERISA fiduciary responsibilities that remains with the employer is that after prudently selecting the PEP provider, they still need to periodically review and monitor the PEP providers on an ongoing basis—and like any other retirement plan function, they need to meet and document their periodic reviews.
So, let’s consider an example of a PEP where the entity acts as the pooled plan provider, the record-keeper, and the 3(38) investment manager—and in addition, it offers its own target date funds or CITs as part of the PEP’s investment lineup.
David Kirchner: I’d say in that scenario, there’s certainly at least the appearance of a potential conflict of interest, right?
Jack Eckart: “Appearance” is the key word here. When evaluating this type of PEP, the employer would really need to dig in and ask the pooled plan provider some probing questions as part of their diligence evaluation process and analysis in order to conclude that the same entity is best suited to fill more than one or even all of these PEP functions and roles. For example, the PEP may have selected the same provider for each PEP role in order to achieve the best economies of scale for their participants. It’s up to the employer, in its fiduciary capacity, to weigh this assessment to determine if it is reasonable and appropriate as their employee’s retirement benefit program.
When issuing an RFP for PEPs, employers will really want to dig into the compensation each PEP provider is earning and how they are receiving it. They will need to determine whether the providers are being paid directly by participants, receiving any sort of kickback compensation from the investment options, or possibly even benefiting financially outside of fees paid by the participants and participating employers. There are various mechanisms for the PEP providers to receive compensation, and an employer should fully understand these arrangements before joining a PEP.
David Kirchner: And as we are fond of saying to our clients: “Document, document, document your analysis and conclusions.”
Jack Eckart: Indeed. I think another trend that raises some questions is that there are pooled plan providers that offer a magnitude of different PEPs, each with different flavors and colors and service providers involved.
Elliot Saavedra: That’s right, Jack. We’ve seen examples where a single pooled plan provider may provide three different PEPs—the only difference being that each PEP has a different and distinct 3(38) investment manager. As you may recall from our first episode, the 3(38) investment manager is the fiduciary who is responsible for selecting the menu of investment options under the plan. So, one PEP provider might be offering different investment fiduciaries for each distinct PEP it offers to an employer.
Jack Eckart: Yes, and the employer needs to be quite diligent here and ask questions about the differences between the 3(38) managers and understand the underlying fee structure and why the pooled plan provider may be recommending one of their PEPs versus another.
We’ve also seen different providers within the same PEP, whether record-keepers or investment advisors, market the same PEP, which is fine, but the same thing—employers need to ask themselves:
1. Why a record-keeper or investment advisor may be recommending one PEP versus another?
2. Does the record-keeper’s or investment manager’s compensation vary between these PEPs?
Typically, we would suggest that employers work with the pooled plan providers when soliciting bids for PEPs as they are responsible for the entire PEP and bear the burden for the vast majority of the PEP’s fiduciary responsibilities—including the ongoing benchmarking and vetting of these service providers.
David Kirchner: This is giving me flashbacks to our long-running series on emerging issues for retirement fiduciaries and risk management strategies that we produced a year or two back. None of these issues is necessarily a show-stopper, but the main takeaway is that employers, as fiduciaries, should be diligent when reviewing and selecting a PEP and should prepare written documentation of how and why a particular PEP was ultimately selected.
In Jack’s example of the PEP that has the same entity acting in multiple capacities within the same PEP, it might very well be a prudent decision for an employer’s participants, but the reasoning behind that decision needs to be documented.
So, Elliot, given your experience assisting clients with implementing PEPs, what are some of the issues and growing pains that you have seen our clients have to deal with over the last few years?
Elliot Saavedra: First off, I want to be clear that growing pains are pretty much expected for a new offering in the vast world of retirement benefits. That is especially true when considering how there is no formal guidance from the DOL or IRS for PEPs.
The first precaution I would make is to have your ERISA counsel review the PEP agreements and plan documents prior to committing to joining a PEP. It has become apparent that many of the PEP agreements and plan documents have been extracted from old agreements for single-employer plans, multiple-employer plans, and other types of offerings. These old agreements do not reflect some of the many nuances and adjustments in roles and fiduciary responsibilities of the new PEP contract.
Employers will want to review the agreements to ensure the language accurately provides that the relevant fiduciary responsibilities are clearly outsourced to the pooled plan provider, and that the participating employer will maintain a very narrow set of fiduciary responsibilities—and maybe even none—related to the operation of the PEP. Thoroughly vetting the documentation prior to selecting a PEP is critical because some PEPs are not willing to negotiate the language in their agreements, so it’s better to know this before making a decision.
Jack Eckart: Right, and we’re also seeing issues arise when an employer joins a PEP, and it wants to customize some features of the PEP structure. This isn’t to say PEPs won’t customize certain aspects of the structure for certain participating employers, but given how new PEPs are, employers looking to customize the PEP really need to monitor their implementation—especially if the pooled plan provider has limited or no prior experience with PEP customization.
For instance, we have seen situations in which a client who wants to merge their single-employer 401(k) into a PEP might negotiate a few customized features specific to their participants. However, during implementation, if the client is onboarded in a manner that does not recognize their custom features, they immediately find themselves in a situation where corrections are required. This sort of situation can leave both the employer and the plan participants with a poor first impression of the PEP—not to mention the complexity of the corrections.
Elliot Saavedra: Yes, you’re right, Jack. Another aspect of the process where we have seen issues arise has to do with payroll and file feed integration. These two functions are just as important with a PEP as they are for a single-employer plan—for example, payroll-deducted contributions will still need to meet the DOL’s timing standards for deposits into the plan’s trust—and we’ve seen instances where PEPs have not closely monitored and tracked the remittance of payroll contributions into the PEP, which means late contributions that require lost earnings calculations and potential IRS filings.
We believe one basic advantage of PEPs when comparing them to a single-employer plan is that PEPs significantly reduce the employer’s administrative burden. However, if the PEP is not set up correctly with payroll or other file feeds, it’s going to become a huge mess, requiring participant account corrections.
The takeaway here is that during the PEP RFP process, we would highly recommend getting into the weeds with the potential pooled plan providers on how they will take on these administrative functions and ask questions that are specific to each employer’s set-up, whether the employer has multiple payroll systems, different locations, different pay frequency, and the PEP’s ability to work within the employer’s payroll parameters.
David Kirchner: Elliot, this is a good point. It may sound great that a PEP is going to take on the administrative responsibilities, but it needs to be vetted for each employer’s particular situation.
This also reminds me of something Jack touched on earlier, that employers and their advisors need to get under the hood when reviewing the fees of PEPs during the diligence and evaluation process. When it comes to comparing and evaluating the different PEP options, employers need to make sure they have the full picture of each PEP’s fees. Also, employers should understand how the PEP is priced for all participating employers. Many PEPs offer one set of fees for all participating employers or offer pricing based on a scale of how many participants or assets each participating employer brings to the PEP. If a PEP is unwilling to disclose how it provides pricing for its other participating employers, or it offers some type of customized pricing structure, we’d recommend looping in your ERISA counsel.
Switching gears, I want to briefly discuss how an employer that is already participating in a PEP can ensure it has appropriate internal governance in place to prudently review, evaluate, and monitor the PEP on an ongoing basis. Jack, can you dive in here?
Jack Eckart: Sure thing, David. Looking at single-employer retirement plans first, governance is pretty extensive, and it entails:
• setting up a committee,
• adopting a charter and investment policy statement,
• holding regular committee meetings,
• reviewing the plan’s investment line-up,
• evaluating the plan’s service providers,
• ensuring the plan is administered correctly and remains compliant,
• remaining current with the plan’s reporting and disclosure obligations,
• staying informed of relevant legal and other regulatory developments, and so on.
For a participating employer in a PEP, the employer will still want to continue to evaluate and monitor the PEP and its providers in accordance with the SECURE Act. So, how would a participating employer do this?
The PEP’s 3(38) investment manager should be monitoring the PEP’s investment line-up, and the pooled plan provider should be ensuring that the PEP is administered correctly, taking care of the reporting and disclosure requirements and also monitoring the other PEP providers.
The DOL has not released specific guidance on how participating employers should monitor PEP providers who have been selected by an employer, but we would recommend that a participating employer establish a formal committee to oversee the PEP. It may not be necessary for this oversight committee to meet at the same frequency or discuss topics to the same extent as a single-employer plan committee would, but we would recommend this committee meet at least annually and record minutes.
Elliot Saavedra: That’s right. Participating employers should also confirm that the pooled plan provider is providing an annual report for the PEP. If the pooled plan provider is not already doing this, the employer should insist that the pooled plan provider produce a periodic written report that includes:
• investment performance against benchmarks,
• participant demographic information such as participation rates and average deferral rates,
• initial enrollment and ongoing participant education activities,
• the pooled plan provider’s current evaluation of the PEP’s service providers and their fees, and
• any upcoming changes to the PEP’s fees, administration, or operations.
We’d also recommend having a representative from the pooled plan provider attend the employer’s oversight committee meetings to review its report in detail with the committee members.
The employer’s oversight committee would also need to do its own evaluation of the PEP without the assistance of the pooled plan provider. The committee would want to check in
periodically to ensure that the PEP is:
1. still competitively priced,
2. sufficiently meeting the needs of the participants, and
3. accomplishing its objectives by offering a retirement benefit to the employees.
For these types of governance activities, participating employers may consider bringing in a third-party advisor to assist. We would also suggest that the oversight committee stay informed on any new guidance from the DOL on PEPs—again, PEPs are still relatively new, so new guidance can potentially have a significant impact on both PEP providers and participating employers.
David Kirchner: That’s very helpful, gentlemen. For our regular listeners, I believe you all know that on the whole, we think that PEPs are a great new option on the retirement landscape, particularly for smaller employers, and we still believe this. However, I think it’s fair to say that like anything that is new, there are some growing pains associated with PEPs that will need to be ironed out over time. PEPs are really in their infancy stage and the learning curve is just beginning—so, I think there is much more to come on the PEP front in the future.
Jack and Elliot, thank you both for joining me and sharing all of your insights. If listeners have any questions about PEPs, please feel free to reach out to us. Also, as we said at the beginning, this was the second part of a two-part series on PEPs, so be sure to check out our first episode if you missed it.
We really appreciate you joining us today, and for more information, you can visit our website at ropesgray.com. Be sure to also download our overview on PEPs on ropesgray.com to learn more. You can also subscribe and listen to this series wherever you regularly listen to podcasts, including Apple and Spotify. Thanks again for listening and take care.