Pooled Retirement Plans Feeling Annual Audit Regulatory Pinch

Federal audit restrictions on pooled employer retirement plans have cooled what was a simmering market for collective 401(k) arrangements, forcing savvy plan providers to retool their products and adjust market strategies in order to compete.

New pooled employer plan growth has slowed markedly since Congress first authorized PEPs in 2019, and signs of major industry consolidation are on the horizon, benefits advisers and attorneys said. But recordkeepers and administrative service providers who scurried into the market with dozens of small plans three years ago are now refocusing their efforts on achieving a “critical mass” of participants that overcome the new regulatory hurdles.

Congress billed PEPs as a game changer for the retirement industry, allowing groups of employers to shed the fiduciary risks and administrative burdens of sponsoring a workplace plan by consolidating them under a single entity. Federal regulators have since finalized rules that reject industry requests for audit relief that some critics alleged defeated PEPs’ whole purpose.

“I can’t see a lot of providers putting time and effort into combined filings because of these restrictions put on them,” said Leisha Gosling, a plan consultant for Retirement Management Services LLC in Louisville, Ky. “It just isn’t cost effective.”

The number of pooled employer plans newly registered with the US Labor Department grew 76% between 2021 and 2022, but halfway through 2023, growth is down to barely over 16%, according to departmental data. That’s a far cry from the anticipated 3,200 companies the department’s Employee Benefits Security Administration anticipated would initially register when plans first rolled out in 2020.

No Regulatory Relief

The combined DOL, IRS, and Pension Benefit Guaranty Corporation rule (88 Fed Reg. 11984) modifies the annual Form 5500 filings regulators use to measure plans’ financial condition, investments, and operational status. Plan sponsors with more than 100 participants have historically been required to tack on an independent auditor’s report at their own expense, a way to double-check plan math and catch legal loopholes.

Ahead of the rule’s release, PEP sponsors, called pooled plan providers, formed a working group with one mission in mind: to convince regulators to boost that 100-participant threshold to 1,000. Audits with starting costs in the tens of thousands of dollars were too much for small PEPs with a couple of hundred participants.

Regulators wouldn’t play ball. Final rules in February confirmed advisers’ worst fears, keeping the 100-participant threshold firmly in place, and even placing independent audit requirements on individual employers in groups of plans.

In response, PEP sponsors called “pooled plan providers” are launching “open PEPs” that tap interest from registered investment advisers for one-stop-shop retirement solutions to offer their clients. It’s a creative solution to a complicated problem, said Robb Smith, president of RS Fiduciary Solutions, an independent employee benefits law consulting firm.

“Advisers and recordkeepers are looking for a new revenue stream by registering anybody and everybody they can,” Smith said. “What that means is that, despite the setback, the PEP business is healthy.”

Plan Consolidation

The culprit behind the PEP audit woes is the “1,000/100 rule” the 2019 SECURE Act (Pub. L. No. 116-94) envisioned. Wording in the legislation gave the DOL the authority to waive audit requirements for plans with fewer than 1,000 eligible participants and no one employer with 100 workers or more.

In its preamble to the final rule earlier this year, however, the department said the information it gathers from independent auditors is too valuable to give up that easily.

“It has been the DOL’s experience that plan audits lead to increased reporting of prohibited transactions, such as identifying and disclosing delinquent participant contributions,” the rule states. “The DOL has not changed its view in this regard.”

That’s where slowed growth and plan consolidation becomes more relevant, Smith said. Open PEPs offer “enough adopting employers and participants that auditing fees are minimized,” he said.

RIA firms find large PEPs particularly attractive as a means of linking wealth management services with retirement savings, Smith added. There’s a value in small and mid-sized business owners avoiding the start-up costs of a 401(k) or transferring an existing plan into a pooled-plan vehicle.

More Guidance?

The Labor Department isn’t done regulating the pooled plan space. Officials are still meeting with stakeholders on a rulemaking project or legislative recommendation (RIN No. 1210-AC10) that would improve outcomes for PEPs.

Advisers told Bloomberg Law that pooled plan providers need guidance to understand whether they are violating conflict of interest laws when they hire themselves as service providers to a pooled plan they offer.

This is a major concern for registered investment advisers whose exposure to the defined-contribution industry has been limited in scope under Section 3(38) of the Employee Retirement Income Security Act of 1974 (Pub. L. No. 93-406).

“Right now there are gray areas for some of these plans that are ‘conflicted’ because they have billions of dollars invested in them,” said Terry Power, president and CEO of the Platinum 401(k) Inc. “The Department of Labor needs to go on the record and clarify who can do what work for plans.”