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Practice Management > Compensation and Fees

Breakaway 401(k)s

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Next spring, 72 million Americans will open their quarterly 401(k) statements and, for the first time, they will see the true cost of their retirement investments spelled out in new fee disclosures. The sound of all those envelopes being torn open—and the collective gasps, screams and confusion likely to ensue—will echo throughout the financial services industry.

It is fair to say that this national case of sticker shock will fundamentally alter the $3-trillion 401(k) industry, putting vast amounts of retirement plan assets in motion and providing fee-based investment advisors with significant new opportunities and challenges.

The trigger for this 401(k) sea of change? Long-awaited Department of Labor rules will go into effect in April 2012 and are designed to improve fee transparency in 401(k) plans. One rule, ERISA 404(a)(5), gives 401(k) participants detailed information about fees and expenses and creates uniform standards for calculating and disclosing investment expense and return information. The result, according to the DOL, allows participants to make “apples-to-apples” comparisons among investment options.

A companion regulation, ERISA section 408(b)(2), focuses on disclosure of direct and indirect compensation service providers receive, including fiduciary or RIA services; recordkeeping or brokerage services related to investment options made available in a plan; or other services for which indirect compensation is received, according to the DOL. It also requires service providers to state explicitly if they are acting in a fiduciary capacity.

While they are a step in the right direction, the rules fall short of full fee disclosure. They do not go far enough to provide plan sponsors and participants with a clear understanding of the true cost of a 401(k) plan. Notably, the disclosure of investment costs actually incurred by participants—typically the single largest plan expense—is not required by DOL regulation.

According to a study by Deloitte and the Investment Company Institute, investment expenses account for 74% of a plan’s “all-in” cost. The DOL only requires the disclosure of the expense ratios and the amount per $1,000 that it would cost participants to be invested in the fund, leaving the burden on the participant to perform the calculations to determine their investment expense.

The Cost of “Free”

Despite their shortcomings, the new rules will nevertheless shatter the old myth, perpetuated by some product providers, that 401(k) plans are “free”—a myth that is especially prevalent in the small to midsized plan market ($1 million to $50 million). According to industry estimates, there are about $900 billion in these plans.

The free 401(k) myth is also a widely held truth among participants. According to an April 2011 AARP survey, 71% of plan participants thought they paid no 401(k) fees, while only 23% knew they paid fees. The survey also found that 61% were unaware of how much they paid in fees for their plan, while only 32% felt knowledgeable about the impact that fees play in overall plan performance.

Many firms that market to the small to midsized plan market have traditionally marketed free 401(k) solutions as another means to get assets into their highly profitable investment products, annuities and mutual funds. They do this by shifting the cost burden onto participants, layering service fees on top of investment expenses and thereby reducing the net returns of the investments. However, since the largest component of 401(k) plan fees is usually attributable to the investment management fees, it is critical that these fees are included in a plan’s all-in fee calculation. It could very well be that a free plan that does not charge recordkeeping and administration fees is actually cheaper than a plan with lower investment expenses and explicit fees. Yet, the converse could be true as well. As long as plan sponsors have all cost information at their fingertips, with the assistance of an experienced advisor they will be able to make an informed decision. While the new regulations will provide most of the information plan sponsors need to determine their total plan cost, an advisor’s value could be added by consolidating these fees and providing benchmarks for comparison.

Money in Motion: Risks and Opportunities for Advisors

How much money will be in play with the introduction of new fee disclosures? At the 2010 SPARK Forum, Robert Wuelfing, president of RG Wuelfing & Associates, projected that about $206.4 billion in 401(k) assets would turn over in 2011. At Lincoln Trust, we believe that plan turnover will likely increase significantly in 2012 as the disclosure rules come into effect, particularly in the small to midsized plan market. Large plans, which have the muscle to negotiate fees and armies of consultants to select investments, will tackle the issues on their own, but small to midsized plan sponsors will be looking in part to advisors to understand the regulations and make smart investment choices.

“I call it the ‘perfect storm’ for advisors,” says Jerry Kalish, president of National Benefit Services Inc., a Chicago-based retirement plan consulting, actuarial and administration firm. Kalish says that with tens of thousands of baby boomers entering retirement, new regulations clouding the waters and market volatility causing concern among participants, plan sponsors will be under pressure to get their 401(k) house in order.

There are both defensive and offensive strategies for advisors. Regardless, advisors in the 401(k) marketplace don’t have a choice but to understand the regulations and find business partners that will help them grow their business.

Positioning advisor practices for success will be a team effort. “You don’t have to know everything about ERISA, but the days of stumbling onto a 401(k) opportunity are over,” says Kalish. “As the industry unbundles, you will need to form a winning team to provide clients with the service and advice that will motivate them to stay put or make a change.”

Watching Your Assets

In the market turmoil of 2008, some advisors were running scared, refusing to answer calls or communicate with clients. Those who thrived during the market collapse—who, in the words of former White House Chief of Staff Rahm Emanuel, didn’t “let a good crisis go to waste”—were servicing clients and finding prospects.

A similar situation is arising in the 401(k) world. With greater fee transparency, advisors need to get out ahead of the change and start talking to clients to help them understand the ERISA rules and prepare them for the potential firestorm from participants who see the full effect of fees on their retirement savings. Having honest discussions now and providing support over the next several months will cement relationships with current plan clients.

Helping plan sponsors aggregate and analyze the multitude of disclosures may be another way to keep clients happy. As an example, ERISA 408(b)(2) does not set a uniform format for service providers to disclose fees. Thus, a plan sponsor could end up with a multitude of disclosures that differ in form from auditor to TPA to recordkeeper. As an advisor, you can play quarterback and help clients gather and consolidate fees and then develop a consistent reporting format.

RIAs who don’t get proactive may be blindsided by the changes. In its report, “ERISA 404(a)(5): A Game Changer,” the Boston-based research firm Dalbar noted that some advisors may face challenges depending on how their relationships and compensation are structured.

“Once the cost is exposed and examined, the critical question will be whether the adviser’s services are both essential and economical,” notes the Dalbar study. “When the plan sponsor is aware and agreeable to the adviser’s compensation there is no real threat. Advisers who provide ongoing support with demonstrable results are not likely to be challenged, even if their compensation is a surprise to the plan sponsor. On the other hand, advisers who receive indirect compensation, but are not providing ongoing support to either the plan sponsor or the participants, will likely be the first casualties in the mission to lower cost.”

The lesson here for advisors is that the onus is on you to be knowledgeable about the regulations. If you are in the 401(k) business, you better not be pushing products, as you will likely be perceived as a conflicted, costly extravagance by plan sponsors.

Snaring “Breakaway” 401(k)s

Armed with knowledge about the new regulations and with a team of recordkeeping, trust, custodial and other service providers as potential resources, advisors have several avenues in pursuit of “breakaway” 401(k) plans.

Opportunities for prospecting new plans can start with online data providers such as, which provides access to all Form 5500s filed with the Department of Labor over the past two years, including data on retirement, health, life and other benefits plans. The Sept. 15 deadline to file plans with a calendar year ending June 30 recently passed, which means advisors can access a plethora of new information on 401(k)s. Data includes plan contact information, renewal dates and financial and service provider information for 2.6 million retirement programs.

Using the 5500 filing, Paula Hendrickson, director of retirement services at Denver-based First Western Trust Bank, is filling the firm’s pipeline with high-quality leads. Data such as fund share classes and high 12b-1 fees can often lead to opportunities and a conversation about fees. “We have been fee-based forever, even when it was a business risk to show fees,” she said. “The new disclosures are helping to level the playing field and they make us more competitive than ever.”

In these situations it may make the most sense to approach potential breakaway plans as an individual advisor rather than as a package of providers. As an independent, RIAs can offer the advice and evaluation that plan sponsors need to identify potential cost and service issues. Once identified, advisors can then tap the network of service providers to offer a comprehensive solution. “It is an easier sell to come in on the side of plan sponsors rather than pushing a total package from the start,” said David Halseth, principal at Strategies LLC, a fee-only investment and plan consulting firm that advises institutional clients, primarily participant-directed defined-contribution plans.

Marketing—in the form of seminars, events and networking with professional referral networks—can also provide an entrée to new business.

Given the complexity of the new regulations and their potential impact on plans, educational seminars have proven to be of great interest to sponsors. A seminar Lincoln Trust co-hosted last spring drew about 50 plan sponsors to a two-hour lunch in which attorneys and consultants drilled down into the details of the DOL regulations. Much of that time was spent in a detailed Q&A with human resources officers and other representatives from small to midsized plan programs eager to understand their roles, responsibilities and options. We expect interest to accelerate as fee disclosure deadlines approach.

Smaller gatherings also can generate good results. Halseth says Strategies hosts a monthly roundtable with two to four clients and an equal number of prospects. The roundtable typically features a speaker addressing a relevant topic such as fiduciary education, disclosure issues and primers on plan fees. Strategies also hosts a monthly happy hour at its offices. Collectively these events keep prospects informed and engaged and have helped lead to new business.

Helping Clients Retire With Dignity

In the end, the success of the new fee disclosure regulations and the ability of advisors to generate new business should be measured by the degree to which we as an industry are helping our clients retire with dignity. To date, the 401(k) industry has failed in this fundamental mission. Too many Americans are not prepared for retirement and too often providers are seeking to maximize profits at the expense of participants.

Fee-based RIAs are the ideal industry players to help lead this industry change. By educating plan sponsors, advocating for plans that don’t layer fees on participants and encouraging plan policies such as auto-enrollment and auto-escalation in 401(k)s, we can increase retirement savings and help companies and employees meet the challenges of the future.


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