Are you a financial advisor with total fee transparency? Then get ready for your share of three trillion dollars!* The largest opportunity in the history of our profession is upon us. As an industry, advisors will have more AUM growth over the next handful of years than any time in history. This revenue growth will be driven by opportunities presented in the 401(k) industry.
Congress and the Department of Labor (DOL) are finally forcing fee transparency in 401(k)s. Their goal is to better prepare employees for retirement and to protect their retirement savings. Unfortunately, too many of the defined contribution plans that workers are dependent upon for their retirement income are poorly managed and entirely too costly.
The Employee Retirement Income Security Act of 1974 (ERISA) requires plan sponsors to act as fiduciaries and operate the plan in the best interests of the participants, including ensuring that the fees are reasonable for the services provided. However, most plan sponsors have neither the knowledge nor tools to carry out this fiduciary obligation and often cannot ferret out the fees as they are often hidden or "baked in".
In addition, most plan sponsors are not fully aware of what their fiduciary obligation to plan participants actually means. Equally troubling, most of them mistakenly believe their existing broker is a fiduciary to the plan. These two misconceptions expose the plan sponsor to potential litigation.
The way the 401(k) industry has typically worked thus far is that most or all of the fees associated with running a 401(k) plan are borne by the individual participants. However, these fees are not required to be disclosed to the participant, and rarely are, even if requested by a diligent participant. In fact, most plan sponsor prospects I have worked with cannot find out for themselves the fees being charged to their participants. It is shocking that we have a system where the person paying the fee has no say in what the fee is and cannot see the fee to determine if it is appropriate given the services provided.
To help both plan sponsors and participants, Congress passed the Pension Protection Act of 2006 (PPA), which mandated, among other things, fee disclosure to plan participants. The 404 (a)(5) participant fee disclosure rules are set to take effect on or around May 31, 2012. This rule mandates that the fees taken out of the participants assets be disclosed to the participant on the quarterly statement in dollars. Once participants, many of whom believe their plan is free, start seeing all the fees being taken out of their pocket, they will pressure plan sponsors for improvements.
I understand that most people do not regularly read their 401(k) statement. But only a few people in each company need to read it and begin asking questions. Even without prodding by employees, the HR professional, business owner, or plan sponsor, may see the fees and start the review process before other participants raise a red flag. Questions regarding expensive fees will be directed at brokers and highly priced insurance contracts.
The broker distribution channel, which has dominated the defined contribution marketplace, will come under fire. Historically, many of them have told plan sponsors that their plan is free. These brokers are now going to field some tough questions from employers.
In addition, insurance companies, who have historically been the primary back-end delivery vehicle for 401(k)s, are going to come under fee scrutiny. These entrenched players are facing significant challenges while adjusting their internal organization, infrastructure and cost structure. This has many players taking a piece of the pie while delivering little to no value to the end client. Given the current litigation, concern for future litigation, their existing structure, and expected fee compression, some of the large firms are questioning if they want to continue to be in this business going forward.
The end result will be that the individual participant will see fees drop, service improve, and their retirement cash flow enhanced - and that is long overdue.
An unintended consequence of the PPA is the significant benefit to you, the transparent financial advisor. While this change has been on the horizon for a handful of years, few advisors have positioned themselves to take advantage of the opportunity that is about to materialize.
To help demonstrate the potential, I will highlight a couple of real world examples.
Wal-Mart. Prior to 2010 and settling a class action lawsuit, Wal-Mart did not negotiate a single discount on fees among the actively managed funds in their lineup. The store famous for putting the screws to suppliers and delivering "everyday low prices," had their 1.2 million participants pay top dollar for investing the over $10 billion in their 401(k) accounts when noticeably less expensive share classes were available.
Unfortunately for employees across America, Wal-Mart is not the exception. It is clear that some of the biggest companies with an army of HR professionals and legal counsel have not understood and adhered to their fiduciary duty. While you and I are not going to win the Wal-Mart plan, countless small and mid-sized companies are even worse off and in the next year will be looking for help.
Acropolis. On over 90% of the plans that Acropolis (my firm) now manages, we have lowered fees from their prior provider by more than 33%. Plan Sponsors have been surprised, and disappointed, to learn that a plan they thought was free was costing their participants so much money. They have also been surprised to learn that their broker, who shows up for one meeting a year, is typically getting paid 25 basis points. Once disclosed, many plan sponsors have not felt like the brokers have earned their keep. Participants, many of whom have never heard of nor met the broker, are about to see the broker being paid and will be asking questions as well.
The 1974 law that brought defined contribution plans into existence was a monumental change from defined benefit plans and brought great opportunity for brokers. The impact of fee disclosure will be even more significant for transparent financial advisors.
This is such a large market that it will take years for a majority of the companies to address their plan and its shortcomings. Therefore, there is still time to get on the train, to lead participants to retirement income security, and to develop a significant revenue stream for your business.
How do you take advantage of this imminent disclosure? To be successful in the defined contribution market, there are a couple of recommendations for advisors.
Hire Experts. The defined contribution business is a different business than private client money management. It is heavily regulated and advisors would be well served to hire someone that knows the industry. You will benefit from having someone on your team who can speak intelligently about plan design, compliance, and the legislative issues surrounding qualified plans.
Start Talking with Owners. Most company owners do not understand their retirement plan. They are unaware that they need help, but will likely start to realize it when disclosure comes. This upcoming "eye opener" will create a great opportunity to start a dialogue.
Ask for Statements. After May 31, 2012, when disclosure takes place, I recommend you request that every client with a 401(k) bring their statement in for you to review. You may find that many of your best clients are paying too much for their 401(k)s. You can help your clients, and yourself, by asking them to introduce you the 401(k) decision maker at their company. (You can look up a potential decision maker by seeing who signed the most recent IRS Form 5500 at www.efast.dol.gov.)
As someone who has been selling 401(k) plans for a handful of years, I understand that most plan sponsors have more pressing things to think about than their 401(k) plan. Getting a plan sponsor to focus on their plan has been a challenge. However, when their eyes are opened to how expensive their plan is and how poorly it has been managed, there will be a one-time chance for you to identify the problem, offer a solution and take over management of the plan. Once the plan has been fixed, however, I think much of the old sense of complacency will return and the grand avalanche of opportunity will have faded.
If you would like your piece of the three trillion dollar pie, now is the time to get ready. This opportunity will only come once.
Michael Lissner is a partner with Acropolis Investment Management LLC, a St. Louis based, fee-only wealth management firm, serving individual investors and 401(k) plan sponsors. Acropolis specializes in retirement planning and currently has over $750 million in AUM. For more information visit www.acrinv.com.
* According to the Society of Professional Asset-Managers and Record Keepers (SPARK), assets in 401(k) plans reached a record $3.075 trillion in 2010.