Fidelity Investments Institutional Brokerage Group (IBG), the second-largest custodian of RIA assets, recently issued a press release saying it had lured about 300 new advisors to its fold in 2001 and that it is committed to supporting the independence of its RIA clients. Normally, a release like this would not be news. But competition has heated up between Fidelity and the number one custodian, Charles Schwab’s Services for Investment Managers unit (CSSIM), and Fidelity’s release sends an important message about that competitive battle.

“While RIA firms of all sizes joined Fidelity in 2001,” Jay Lanigan, who runs Fidelity IBG, is quoted as saying in the release, “the one thing that we heard consistently from those new firms was their need for independence.”

Lanigan, in an interview, refused to speak directly about Schwab. Specifically, he would not talk about Schwab’s recent decision to only sell new licenses of Centerpiece, the popular portfolio reporting software owned by Schwab, to RIAs doing business with Schwab. Nor would he comment on Schwab’s decision to reform its AdvisorSource branch referral system by splitting fees with an advisor in perpetuity when one of its referrals becomes an RIA client.

However, in saying that it is committed to the independence of advisors just as Schwab is being eyed more critically than ever by RIAs, Fidelity is shrewdly exploiting an opportunity to gain ground in the RIA business. This could benefit advisors because it will force all custodians to compete for the right to be called the most enlightened, supportive, and advisor-friendly custodian.

Until Schwab Institutional came along in the early 1990s, there was no platform for independent financial planners and investment advisors who targeted investors with portfolios in the $100,000 to $5 million range. Fidelity IBG followed Schwab’s lead but has been a distant No. 2 to Schwab for many years. In the mid- and late-1990s, Fidelity IBG steadily grew its business but still lagged Schwab. Fidelity seemed almost uninterested in or incapable of mounting a serious threat to Schwab. In the last 18 months, however, Fidelity has gained momentum.

At the end of 2001, Fidelity held $58 billion in assets managed by RIAs compared with $52 billion at the end of 2000. In the same period, Schwab went from $234.1 billion in advisor assets to $235 billion. Assuming advisors at Fidelity are about as talented at managing market risk as they are at Schwab, losses and gains due to market exposure should be about equal at both firms. But Fidelity’s advisor business grew by more than 10% in 2001, while Schwab Institutional basically stood still. Fidelity is gaining traction.

Fidelity is growing because the three big RIA custodians–Schwab, Fidelity, and TD Waterhouse–have become more alike in terms of the services they offer while technology has made it easier to do business with multiple custodians. Fidelity has integrated the Internet into its business process for advisors. Furthermore, advisors’ tech skills are improving, making it easier for RIAs to do business with Fidelity. And, along the way, Fidelity’s offerings and service have become more competitive. My guess is that these trends are likely to continue over the next couple of years.

Lanigan gave me a preview of coming technology and service offerings at Fidelity. Perhaps the most significant technology change that Fidelity is about to implement is an interface with financial planning software giant NaviPlan. In all fairness, NaviPlan deserves most of the credit, but Fido deserves a pat on the back as well for embracing this path and being the first RIA custodian to do so. And the move ties in with Fidelity’s stated commitment supporting the independence of RIAs.

NaviPlan is almost always on the list of top planning programs in trade press reviews and it has by far the largest base of users–some 35,000 of them. Fidelity is the first of the RIA custodians to launch an interface that will let you directly download client account data into a financial planning package. This means that one of the big obstacles to using planning software–the time it takes to manually input data–will be reduced significantly.

Making it easier for advisors to use financial planning software represents a big step for the profession. Money managers might be more willing to provide planning services. Also, since the NaviPlan interface is also being launched through National Clearing Corp., Fidelity’s huge correspondent clearing operation, it will put the same capabilities in the hands of tens of thousands of reps. That’s a big deal for the progress of the financial planning profession. NaviPlan’s Rob Eby says the software company will be rolling out such an interface with other broker/dealer back offices, but Fidelity is the biggest. Its move will undoubtedly trigger other custodians to make similar deals, all of which will support the goal of advisor independence.

Custodians and B/Ds serving independent advisors have two choices in building tec hnology systems. They can build their own and make their advisors use it or they can partner with outside vendors. Partnering with NaviPlan is a decision to do the latter and that could ultimately mean giving the independent advisor more choices.

You each do things your own way. You may like ACT for contact management but don’t want to use it for e-mail. You may like Morningstar’s fund research application but prefer Wiesenberger’s hypothetical modeling function. Or maybe you’d like NaviPlan’s investment planning capabilities but not its Monte Carlo functions. The point is, you want choice. The way to get maximum flexibility is not from a proprietary system but to become the glue that allows advisors to knit together many technology pieces. Fidelity is taking a step in that direction by creating a NaviPlan interface.

“Understanding the nature of the proposition value that advisors build their businesses on, their need is to give unencumbered advice to clients,” says Lanigan. “We think that needs to be demonstrated by allowing advisors to have choice in the products and services that they think best meet their clients’ needs.”

In contrast to Schwab, which is building a proprietary technology platform, Fidelity says it is moving to support an open platform that will let advisors choose the tools they want. “If they [advisors] want a portfolio management software program and tell us they want to build their business in a certain way, we need to be flexible in how we support them,” says Lanigan. He says he is not leaning toward building an in-house portfolio management system.

While NaviPlan is the financial planning interface today, Lanigan says interfaces to other planning software tools could be offered in the future. That means, Lanigan says, giving advisors choices of portfolio management systems, financial planning software, prime brokerage and research, and other tools and services. “We’re serious about making sure our clients have choice,” he says.

If Fidelity promotes an open platform and choice, that will push other custodians to move in the same direction or create differentiation that could be attractive to independent RIAs.

Meanwhile, other technology moves by Fidelity are sure to be welcome. For instance, Fidelity is launching an improvement to its advisor-only Web site that will let RIAs see real-time market data on positions. Apart from the “gee-whiz factor” of being able to tell a client the current prices of his positions, you can tell the client what would happen on an after-tax basis if he or she sells a particular security.

If a client has GM stock and has purchased it in three or four lots over the past five years, you can see what would happen if the client sold the entire position at this second on an after-tax basis. “It brings positions together with live market data,” explains George Baumgarten of Fidelity.

The Fidelity IBG site has also added an account service center where an advisor can go to manage standing instructions on clients. For instance, say you and your client have set it up so that his paycheck hits a Fidelity IBG account on the first day of each month. You can use this area of the site to set up a standing instruction on what funds to invest in after the check hits the brokerage account. You can see all instructions from each client in one place. The service center on the site can also be used to track assets coming in and leaving from sub-accounts. In addition, an advisor can set up e-mail alerts to remind you when a stock has hit a target price or to take other required actions on a client account.

According to Patrick Jancsy, a senior VP at Fidelity IBG, a new account transfer monitoring system aimed at tackling the messiest part of the securities industry’s back-office business will be added to the site. In the fourth quarter, advisors will be able to initiate account transfers from other B/Ds and track the transfers’ progress over the Web.

Furthermore, Fidelity recently implemented a 403(b) technology platform that takes advantage of Fidelity’s positioning as one of the nation’s top sponsors of 403(b) plans.

Managing 403(b) assets is difficult for RIAs because the assets are held separately. You can’t easily download assets from a plan into Centerpiece or Advent or make trades across several accounts if you have a number of clients in the same plan. But RIAs clearing through FIIBS can do that.

If you have a client whose taxable account you manage, for instance, and you want to manage his 403(b) assets as well, you’ll have to go to his 403(b) plan’s Web site and make trades in his account from there for him. If you have several clients in that plan, you’ll have to get each password and ID for the site and do the trades individually. There has been no way to trade several clients at once, download the data into a portfolio management program, and automatically debit fees for ongoing management of that part of a client’s portfolio. However, Fidelity’s Advisor Channel software aggregates 403(b) data in with all other assets managed by an RIA. For RIAs who target plans using Fidelity’s 403(b) products, giving advice on these assets is now scalable and practical, creating a new opportunity for some advisors. Neither Schwab nor Waterhouse Institutional offers a similar capability.

Competition for your business among the custodial firms is heating up, and that can only be good for you.


The News on Pension Plans

Befuddled by the intricacies of defined benefit plans? Bruce Temkin returns to active duty to explain what you should know

It was September 1999, and I was in San Antonio for the IAFP Success Forum. On the way back from the convention center, I noticed a guy wearing a bow tie who looked like a cross between a professor and Groucho Marx. I had not met Bruce Temkin, but I had heard that he was really smart and knew a lot about pensions. So I said hello.

Standing there on the street corner, Temkin confided that his wife, Katie, had died of cancer in December 1998. He was broken with sorrow and he opened up to me. Thus began a friendship.

Since our meeting in San Antonio, Temkin has called me every so often to say he’d like to stop by for a visit. I was flattered when I realized that I was part of a small group of individuals in the financial planning world with whom Temkin had stayed in contact, since he’s been totally committed to raising his now 15-year-old son, Patrick.

Let the financial planning world beware: Bruce is back!

Although Temkin, whose 1999 book, The Terrible Truth About Investing, received rave reviews, has not been a part of the financial planning lecture circuit for the past two years, he has continued to think about the conflict between the statistical finance of Monte Carlo simulation and human behavior, and the human and practical dimensions in assessing investment risk. Best of all, he’s done more thinking about how business owners can sock away money in their retirement plans.

Temkin is an original thinker who’s loaded with contradictions. While he probably has a genius-level IQ, he is dyslexic. He’s authored a great book, but he has trouble writing and dictates everything. Although he is a futurist, Temkin is inept on a computer. He’s one of the most colorful personalities I’ve ever met, but he’s an actuary. Perhaps all this explains why Temkin sees what others do not, and why Temkin is finding opportunities for business owners to use their retirement plans in ways that no one else seems to be talking about.

Many advisors are unfamiliar with the qualified plan area because of its technicalities. In addition, it’s looked at by many as the domain of actuaries and accountants who are usually needed to implement qualified plans. As a result, many advisors focus solely on investing and personal financial planning and don’t pay attention to this area. But business owners are often an advisor’s best clients, and being able to tell a client or a prospect about opportunities available to business owners could be critical to a relationship, as is the ability to work with a team of pension specialists without looking like you’re uninformed. So here’s Temkin’s briefing, a collection of his insights culled over several days of interviews.

The Economic Growth And Tax Relief Reconciliation Act (EGTRRA) is filled with important changes in the area of qualified plans. What do advisors need to know about the pension law changes in EGTRRA? EGTRRA has created more planning opportunities in the design of retirement plans for closely held businesses and personal service organizations than any bill since ERISA in 1974. Profit-sharing plan contributions increased from 15% to 25% of covered payroll. There are new maximum limits in defined benefit plans that will allow owners of businesses to increase contributions by 50% or more. We’ve gotten increased maximums on 401(k) deferrals, including additional contributions for individuals 50 years of age or older, and 401(k) plan deferrals do not count toward the 25% of covered payroll limitations when combining a defined benefit and a defined contribution plan. (See Table 1: Higher Limits for 401(k) Plans) Also, the government increased the maximum contribution limit for an individual in a profit sharing plan or defined contribution plan from 25% to 100% of compensation. Finally, EGTRRA increased maximum compensation that can be used in designing a qualified retirement plan from $170,000 to $200,000. All of these changes became effective at the beginning of 2002.

While you describe EGTRRA as a sea change, there has not been a lot about any of this in the consumer press and it seems like many advisors aren’t aware of the enormity of the opportunities created for business owners by the new law. Do you think many people are asleep at the switch? After any major pension law change, there are two steps that advisors need to go through. The first is getting an understanding of what the changes are, and the second step is taking the reflective time necessary to see what the laws mean when it comes to designing plans. When you consider the sheer enormity of this bill’s changes, this process takes considerable time to assimilate. In addition, prior to the passage of EGTRRA, long-awaited final regulations on required distributions after age 701&Mac218;2 were issued, impacting almost all financial advisors and their clients. Last year, when I was asked to speak at national legal and accounting tax institutes, they wanted me to cover the new IRA required distribution rules rather than qualified plans. This seemed to be a trend at conferences throughout the country. When given a choice of covering an employee benefit topic, distributions were chosen over qualified plans. This delayed the discussion of these radical pension changes.

You’re using the word “radical” in describing these changes. Can you give some examples of why it’s such a big deal? Say a business owner plans to make a $40,000 contribution in his profit-sharing plan in 2002. His spouse works part-time for the business but she has not been put on payroll because his tax advisor tells him the Social Security costs of adding her to the payroll would be prohibitive in relationship to the maximum retirement plan contribution of 25% of compensation. If the spouse was put on payroll in 2002 and paid $11,000, there would be an opportunity to defer the entire $11,000 if the employer has a 401(k) plan, allowing the spouse to defer an amazing 100% of her compensation! This would not have been possible in 2001. Or, if the spouse were paid $20,000, it would be possible to contribute the full $20,000 on a profit- sharing plan with a 401(k) feature. (See Table 2: Maximum Contributions for a Defined Contribution Plan) Another example of a big change: A 50-year-old business owner in 2001 could have conservatively contributed about $60,000 to a defined benefit plan. In 2002, the same business owner could contribute over $100,000. These staggering contribution increases were buried in the bill. People focused on other language in the bill, emphasizing that the maximum benefit went from $140,000 to $160,000. But what actually occurred is that contribution limits went up in most cases 50% or more–the equivalent of having an increase in maximum benefit from $140,000 to $210,000. The accompanying chart (Table 3: Funding of Defined Benefit Plans, Pre- and Post-EGTRRA) gives you a good idea of the increased contribution levels now possible.

What are a few of the important plan design trends that you see resulting from EGTRRA? Please list a few things that would be discussion items for advisors with clients who are business owners. Employers will not have to use money purchase pension plans in combination with profit-sharing plans to contribute 25% of covered payroll. They can now do this with a profit-sharing plan alone. Also, even though Social Security taxes will still have to be paid, many working spouses and children will be put on payroll in order to take advantage of the new 100% contribution limit on defined contribution plans that I mentioned earlier. There will be an increase in the use of Safe Harbor 401(k) plans in combination with cross-tested plans. By making a 3% vested contribution for staff employees to the profit- sharing plan, the owners or highly compensated employees will automatically be able to defer the maximum 401(k) limits. In addition, the 3% contribution in the profit-sharing plan can be utilized for cross-testing purposes, creating in many cases maximum leverage. We’re also going to see a substantially increased use of defined benefit plans for the small business or professional service organization, and more businesses will consider adding supplemental defined benefit plans to existing profit-sharing 401(k) arrangements.

You keep talking about defined benefit plans and how much opportunity they provide. Won’t many employers be concerned about the enormous obligation to fund contributions when they adopt a defined benefit plan? This obligation to fund a defined benefit plan has generally been a myth and has unfortunately caused many sophisticated advisors not to recommend them. However, in most cases, a defined benefit plan can be designed in a way that should there be a down year in the business, the business would have little or no obligation to fund a contribution.

The other big bugaboo in qualified plans is that they cannot discriminate between owners and staff. As a result, the cost of funding staff members in a plan can be prohibitive. You are one of the fathers of cross-tested plans and that’s a great way for controlling staff costs in a plan. How does a cross-tested plan work? Here’s how it works. Let’s assume you have a 30-year-old employee making $30,000 a year. If we contribute 5% of his compensation, or $1,500, to the plan, we test the plan by projecting the $1,500 contribution to grow from his current age of 30 to age 65 and assume an 8.5% return. A $1,500 contribution would then grow to about $20,000. Then, we would convert this theoretical $20,000 account into an annuity for life. An annuity would not actually be purchased, but this is how you make the testing calculation. This would provide an approximate $2,100-a-year benefit for life for the employee. This $2,100-a-year projected benefit replaces 7% of the employee’s $30,000 compensation. Now, in completing the test, let’s look at the 53-year-old business owner whose current compensation is $200,000. Let’s contribute $40,000 to his account. We would then project this contribution to grow at 8.5% annual return to age 65 or approximately $84,000, creating a theoretical $9,000-a-year annuity for life. This replaces only 4.5% of his current compensation. So while the owner is replacing only 4.5% of his current compensation with his plan contribution, the employee is replacing 7%. We have just demonstrated to the government that the plan is non-discriminatory since the employee’s projected benefit is greater than the owner’s. If you have multiple owners or employees, the government allows you to average the projected benefits of the owner in relationship to his staff. If one test fails, there are other tests that could pass. The testing is more liberal than many professional advisors realize. Cross-testing can allow a business owner to maximize his retirement contributions while controlling their staff costs.

What impact will the new law have on cross-tested plans? There will be a significant increase in the use of cross-tested plans as a result of the increased staff costs for many small business owners when they attempt to increase their individual contributions to the new $40,000 defined contribution limit (see Table 4: Maximizing Owners’ Funding). The chart illustrates how an employer using a Safe Harbor 401(k) plan, which automatically will allow a maximum 401(k) deferral for the owner, in combination with a cross-tested plan, was able to control staff costs. If the business owners had used a traditional integrated defined contribution plan in this example, the staff costs would have exceeded $36,000 instead of $13,899 shown here with the cross-tested plan.

But isn’t this plan discriminatory? No. The plan clearly passes the government’s non-discrimination rules and tests. It’s important to keep in mind that the small business owner is contributing an additional 6.2% of each employee’s compensation for Social Security retirement benefits.

Since we’re touching on Social Security, let me ask you about its viability. Many advisors and their clients do not believe Social Security will be around over the long term. Do you think the Social Security problem is fixable? The insolvency of Social Security is more myth than reality. All the government has to do is a couple of things in order to put Social Security on sound footing. The first would be to increase the normal retirement age. Life expectancy has increased over 35 years since 1900 and future medical breakthroughs will accelerate this trend. The current system has not adapted to this enormous longevity shift. This, in combination with slightly limiting or deferring future cost of living increases, will put Social Security on a sound footing for the baby boomers. This is a difficult and complex issue, as many advisors and their clients know from calculating Social Security benefits when doing retirement planning.

Let’s get back to plan design. In the early ’90s, you helped usher in the era of cross-tested plans and it was cutting edge. Do you have any cutting edge designs that you are using? The most important new plan design that I am utilizing can be a remarkable planning opportunity for many small businesses and their professional advisors. It is a cross-tested defined benefit cash balance plan. Many business owners and professionals would like to put away significantly more than the $40,000 individual limit in their defined contribution plans. In looking at the following example (see Table 5: Cross-Tested Cash Balance Plan), we can see that a 55-year-old business owner is able to contribute $120,000 while the contribution level for the staff employees totals $14,850. The contributions for owner and staff could only have been achieved using this new type of defined benefit cross-tested plan design. If a traditional defined benefit plan were used, the staff costs would have been prohibitive. The response to this new type of plan design has been overwhelming and it provides financial advisors with a remarkable new way to help small business clients. For business owners with staff with these kinds of demographics, which is a very common sort of situation, this is the most powerful plan for small business owners that I’ve ever designed.

Your book, The Terrible Truth About Investing, was well received among sophisticated advisors. Are you continuing to write? What role do you see for yourself in the future? I am co-writing a book called How the Internet And Longevity Revolution Will Change Retirement and Investing. It should be available sometime in the spring of 2003. I will be more available to lecture on qualified plans, distributions, and special issues in money management. The last several years have been the richest period of research and introspection that I have ever experienced in my professional career; I am looking forward to bringing to audiences new ways of thinking about planning issues that are important to advisors and their clients. If any of your readers are looking to adopt a widowed single father who enjoys opera, or have any comments on any of the ideas in this article, I can be reached at .