From the September 2007 issue of Investment Advisor • Subscribe!

September 1, 2007

Changes Ahead for 403(b)s

New regs will add paperwork and confusion say critics

Retirement plan advisors, distributors, and providers are finding themselves responding on the fly to the trends shaping the 403(b) and 457 markets. The old model of manufacturing and distributing is going away, according to The State of 403(b) and 457 Marketplace: Challenges and Opportunities, a Cerulli report released in March that discusses the key attributes and nuances of that marketplace, and offers a look at the providers and advisors serving plan participants in these markets.

The 403(b) market is one of the few retirement plans that advisors can dabble in, especially if they sell or accommodate a non-ERISA 403(b), the report states. Consequently, 62% of all advisors who work in the retirement plan arena have 403(b) assets, the report found. However, the recent report, based on Cerulli Associates' online surveys of advisors and providers as well as third-party public and nonconfidential sources, reveals that although the current 403(b) model allows advisors into the market, it does not yield much in assets. Advisors with 403(b) assets under management have, on average, total 403(b) assets of $2.3 million. This is 15 times less than the average 401(k) assets under management of $34.7 million. To boot, 85% of advisors who report having 403(b) assets under management have less than $5 million in 403(b) assets, with nearly one-third reporting less than $500,000 in total 403(b) assets. At the same time, 60% of advisors with 401(k) assets have more than $5 million in 401(k) assets, with about one-third reporting between $10 million and $49 million in total 401(k) assets, according to Cerulli research.

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When comparing the 403(b) advisor to the "broader advisor universe," Cerulli research found that the services offered by both are similar, with 60% of all advisors' time spent in client meetings, client acquisitions, or providing services to clients. However, even though 403(b) advisors spend the same amount of time meeting with participants, 403(b) advisors credit a larger portion of their revenue to commissions--an average of 71% compared to only 22% to asset-based (wrap) fees, while the average advisor attributes 51% of his revenues to commissions and 39% to asset-based (wrap) fees, according to the report. Even though payments from 12b-1 fees and mutual fund C-shares provide ongoing compensation based on assets, in its reports Cerulli considers those payments commissions and not fees. "Thus, there is a disparity between 403(b) advisors and the broader universe of advisors," the report reads. "Even though 403(b) advisors display similar characteristics as fee-based financial planners (they use a consultative approach, spend time with their clients, and focus on advising their clients), they still gravitate toward commission-based products." Furthermore, Cerulli believes that 403(b) advisors' revenue streams are on the brink of changing, mainly due to pending 403(b) regulations. Not only would these regulations favor a single/limited vendor and greater employer control, they will also restrict the ability of participants to initiate a 90-24 transfer from one 403(b) plan to any eligible receiving company of their choosing.

"It was scary at first because it sounded like they were trying to limit the number of vendors in the school district, which would limit our exposure there," says Marina Armbruster, registered principal at Brecek & Young Advisors in Folsom, California. Currently, 90-24 transfers represent about one-fifth of advisors' 403(b) revenue (17%), while an additional 13% is from new rollovers. "With the pending regulations it will be more difficult to move the money, which will require agents and advisors to rethink how they will generate consistent, repeatable revenue," Cerulli reports. However, Armbruster believes the new regulations aren't as bad as expected. "It can be favorable to the agent that's in with the right school district because they are going to go to that agent as their contact person. You sort of become a guru of 403(b) and everyone wants to talk to you about it," she says. And the downside? "It just makes the school district more accountable for the 403(b) compliance, which the school districts don't really want," she adds. The other negative is the limited amount of time 403(b) advisors have before the new rules take effect. "Although the regulations don't go into effect until January 1, 2009, we have to comply with the 90-24 transfer rule as of September 24 of this year," notes Armbruster.

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