Like a snowball rolling downhill, reasons for Congress to clarify and strengthen the U.S. retirement system have been accumulating for the past decade. Along with relatively low interest rates and a turbulent stock market, the litany of massive corporate bankruptcies, faltering pension plans and outright malfeasance (as exemplified by Enron) has caused employees to lose confidence along with their retirement savings. As a result, baby boomers are both financially unstable and uncertain about the future.
In response, Congress created and ratified the Pension Protection Act of 2006. The Act is a comprehensive reform package that covers both defined benefit plans (i.e. traditional pensions) and defined contribution plans, while dealing with conversions of pension plans to cash balance plans, liberalized payout and rollover rules and many other changes. These changes and enhancements are both important and relevant to the advisory industry, especially when it comes to encouraging employee participation and overseeing employer due diligence.
However, advisors won’t want to miss one specific provision in the 907-page legislation: investment advice to plan participants. In the past, employers have been fearful and uncertain about fiduciary issues surrounding the furnishing of investment advice to plan participants. ERISA has established fiduciary standards and incorporated prohibited transactions rules dealing with this very touchy subject of investment advice. The Pension Protection Act creates a new exemption that will now permit plan fiduciaries to receive compensation for providing participant investment advice, subject to rules limiting the possibility of abuse.
This represents a huge opportunity for advisors. Employers will now be looking for professional advisors who can guide them and their employees when it comes to making employer-sponsored plan decisions.
For ERISA-covered employer-sponsored plans, a fiduciary that is a registered investment company, bank, insurance company or registered broker-dealer will be allowed to give investment advice to participants within a plan as long as the advisor meet two requirements. First, fees charged for advice cannot vary depending on the investment choices that participants make. Second, all recommendations must be based on a computer model certified by an independent third party.
Plan sponsors have their own obligations to live up to. Managers of local employer-sponsored plans will be required to select the best advisors available and monitor their activities. These advisors will disclose (in writing) their relationships with any companies that offer products through the retirement plan, along with fees and compensation that they would receive. This relationship and disclosures required must be established and maintained annually. Employees have the ability to accept or reject any investment advice that the advisor offers.
A Winning Formula
The challenge for employers — and the corresponding opportunity for advisors — comes in a neatly wrapped package. By establishing themselves as fiduciaries that offer financial education for employees, advisors can position themselves to fulfill the Pension Protection Act’s new requirements on employers.
And employers are ready to accept the help. In fact, executives rank financial illiteracy as one of the “most critical unaddressed issues in the workplace today,” and according to data gathered by the Cambridge Resource Group, a full 32 percent of executives also consider the “toll on productivity caused by financial stress” to be a chief concern.
Even before the Pension Protection Act was designed, studies by the Society of Human Resource Management (SHRM) reported that 65 percent of respondents say top management is “somewhat to very interested” in providing financial advice to employees. In fact, in one such study, a full 49 percent of those surveyed were already in the initial research and consideration stage of dealing with the issue of financial illiteracy among their employees.
It is not that employers have not already tried. In the past, employees who participate in employer-sponsored pension plans have had access to some investment advice from their organizations, retirement providers and/or investment advisors. Some employers have even deployed web-based advisory solutions for their workers. Still, according to “Savings and the Effectiveness of Financial Education,” a 2004 paper by economist Annamaria Lusardi (of Dartmouth and the National Bureau of Economic Research), the number of participants taking advantage of advice in these cases indicates a utilization rate of less than 10 percent of the eligible participants.
So here’s the question: If employers were already so concerned about employee financial education and if employees already had some access to important information and knowledge, how is the Pension Protection Act of 2006 really going to increase employee financial literacy, solve employer fiduciary problems and provide an opportunity for advisors?