In the past, the defined contribution plan business was generally regarded as too much work for too little pay. But times have changed.
The naysayers will tell you there are too many good reasons to avoid the qualified plan business:
- The marketplace is too complicated and litigious.
- The marketplace is mature.
- Required fee disclosure has led to compression, and advisor services are undervalued.
- The small plan marketplace (below $5 million) is unprofitable.
- It's too late.
Nevermind that since their introduction in 1978, 401(k) plans have grown at an astonishing pace — both in number of plans and participants. Despite a decrease in assets from the 2008 downturn, the 401(k) marketplace still represents a multitrillion dollar opportunity. These caveats also ignore the growing number of participants who are projected to roll balances out of 401(k) plans — and will be in dire need of income planning.
The trick to succeeding in the qualified plan business lies in understanding the marketplace. Let's look at how it has evolved, dispel the myths, and identify the opportunities.
An Auspicious Beginning
The original 401(k) sales model of the 1980s was built for the traditional broker world. 401(k) plans were typically an ancillary part of one's business; the broker was a generalist, not an expert. That role belonged to the product wholesaler, and the broker received commissions and varying compensation from the funds within the plan.
By law (like today), brokers and service providers were not allowed to provide investment advice to either plan sponsors or participants because of inherent conflicts of interest: brokers and service provider would be paid by the fund companies recommended and some fund companies might pay more than others regardless of their merit for clients. Brokers tended to focus on such areas as education and communication, testing, compliance and plan design, investments, proprietary requirements, enrollment, and the out-of-pocket-cost to the plan. While they were not named fiduciaries, many brokers inadvertently became functional fiduciaries by virtue of their activity and unknowingly engaged in so-called prohibitive transactions.
As the marketplace evolved, so did the sales model. Originally, financial companies provided 401(k) products; it was an asset-based model. But as technology emerged that allowed companies to offer mutliple fund families, asset managers struggled to hold onto their market share. While some opened their gates to additional investments, they implemented self-interested proprietary investment mandates as well. Then annuity players got into the game; while their multifund options were popular, they were also loaded with commissions and expenses that were neither disclosed, nor understood, by plan sponsors — then or now. Essentially, with internal expenses of 2.5 percent to 3 percent going to service providers and brokers, and no out-of-pocket fees to plan sponsors, 401(k) plans appeared to be free — but the hidden fees were ultimately detrimental to plan participants.
Recordkeepers have since emerged as the dominant leaders of the 401(k) industry, and undisclosed, complicated, and indirect expenses such as 12b-1s, sub-transfer agent fees, and soft-dollar transactions continue to be a problem. Many plan sponsors are still in the dark, believing 401(k) plan management is free.
This model has worked to the disadvantage of financial “advisors” — why would companies choose to incur the additional expense of investment advice if they were getting everything for free? Consequently, many advisors feel their services have been undervalued and are thus reluctant to enter this market. They are right about the first part, but wrong about the second. The Pension Protection Act of 2006 (PPA) brought into play some necessary reform that helps validate the need for advisors in the 401(k) marketplace.
Brokers vs. Advisors
The growth of RIAs and independents over the last 10 years has increasingly led investment professionals to answer the following question: Do I want to be a broker and sell products, or do I want to be an advisor and offer consultative advice?
The adoption of fee-based advisory business in both qualified and nonqualified arenas is testimony to the fact that the Gordon Gekko days are over and independent advisors can truly align themselves with clients to provide independent, objective consulting services in line with fiduciary standards.
But where and how investment professionals decide to set up their practices presents another challenge. We've seen compensation issues, product limitations, and myriad potential prohibitive transactions limit the advice investment professionals can offer at the plan sponsor and participant levels. The fact that compliance oversight for registered representatives and advisors falls under two different regulatory bodies presents more obstacles. Many traditional brokerage houses don't protect advisors on this front. In fact, some firms claim it's cheaper for them to handle one-off lawsuits than to go through the expense of redesigning their compliance protocols and paperwork. Other firms, despite the definition of a functional fiduciary, have retreated altogether, claiming that neither they nor their employees who provide plan sponsor services are fiduciaries.
Most traditional brokerage houses do have proprietary fee-based programs, but they come with exclusive sales agreements with captive money managers and mutual funds that aren't necessarily in the best interests of clients. The contracts supporting these relationships sometimes acknowledge a limited fiduciary role. Some of the major wirehouses also have retirement consulting programs for qualified producers who meet criteria like AUM, education (i.e., designations), and years of experience, but these programs are limited in their scope of vendor access, nondiscretionary functions, and contractual fiduciary acknowledgment.
Enter The Hybrid Model — And The Opportunity
The issue with the broker model is clear: A registered representative who sells products and earns commissions cannot provide advice and therefore does not belong in the qualified plan business. And while an RIA-only model enables advisors to act as qualified investment advisors, it limits access to certain products.
That's why we're seeing the greatest growth in “hybrid” independents, which allow advisors to act as either a registered representative or an RIA — and thereby gain access to the entire investment universe and bring the greatest value to client relationships. For example, while a pure fee-based model would be ideal, there are situations when a product with varying compensation, such as an annuity for estate or income planning needs, may be suitable. Hybrid firms enable advisors to work with organizations and individuals in this dual capacity based on suitability, need, and product access, which is what being a fiduciary is all about.
Let's consider this in the context of today's 401(k) marketplace, which has suffered an approximate $2 trillion dollar loss. As the Chinese proverb goes, “Crisis equals opportunity.” According to a 2008 EBRI survey, approximately 77 percent of participants claim to have little, basic, or no level of investment understanding, despite all sorts of 404(c) education requirements and efforts. Participants need advice, not education.
In the past, plan sponsors said, “Go away, Mr./Ms. Broker, we don't want you selling our employees stuff.” Now, because of the magnitude of the credit crisis, and the personal liability that they bear, plan sponsors are welcoming advisors with open arms.
Many plan sponsors don't understand their basic fiduciary duties, and they need advice on everything from forming a committee and basic protocols, to how an IPS management process works, to what the various fees and expenses mean and how to protect themselves. Plan sponsors feel overmatched by their fiduciary responsibilities, and advisors who can bring some perspective and help address their needs will win all day long.
As alluded to previously, the Pension Protection Act brought some necessary reform, but it also muddied some issues — which play to the advantage of advisors.
- Issue one: The provision calling for advice to be provided by independently certified computer models, which seems to benefit large corporations, not individual participants.
- Issue two: The qualified default investment alternative (QDIA) provision, which made asset allocation/target date investments the vehicles of choice. Yet proprietary holdings and management inconsistency among these vehicles make them a poor choice for many investors. Moreover, 67 percent of participants polled assumed asset allocation investments offered some kind of retirement income guarantee.
QDIA evaluation and support is a huge growth area. With money markets breaking the buck and insurance companies downgrading, diligence around money market and stable value investments is in demand. Additionally, with the integrity of many target date investments under attack, advisors have an opportunity to come in with their own models comprising diverse underlying holdings from the plan's investment menu — offering independence and objectivity.
The bottom line is, with the right positioning, advisor opportunities are limitless. Today's paradigm is about objective advice, and it appears the Obama administration is in full support of it. Today's qualified plan advisor is a specialist, not a generalist, handling everything from establishing fiduciary protocols, plan review, and plan design, to investment management, vendor search and selection, fee management, benchmarking, and participant education and advice. Today's qualified plan advisor bears fiduciary accountability.
What was it those naysayers said?
The marketplace is complicated and litigious
While true, it's amazing how simple it is when you do the right thing and can say, “Yes, this is in the best interest of my client every time.” It is easy to find a designation program with a curriculum that will both keep you current and differentiate you from other advisors; consider the PRP, AIF, or CRPS. The AIF program also offers an affordable suite of tools and analytics to support your compliant practice.
The marketplace is mature
Sure, but the new paradigm is about advisor replacement, not product replacement. There are thousands of plans being underserved by brokers who set the plan sponsors up in a product and never came back — and those brokers can't offer advice.
Required fee disclosure has led to compression, and advisor services are undervalued
This works in favor of advisors. For years, advisors have given away their time-consuming advisory services for free, bundling them under asset management fees, yet the changing marketplace is making room for fee-based consultative services.
Fee disclosure requirements are actually forcing advisors to think more like CEOs by substantiating their time. Likewise, plan sponsors are starting to understand and respect the value advisors provide.
The small plan marketplace is unprofitable
Quite the contrary — and RIA and hybrid models, not to mention technology, are creating new opportunities. Previously, the only options for start-up and small businesses were single investment family offerings or multifund offerings through annuity-based providers. As technology has evolved, record-keeping entities such as Ascensus, Expert Plan, and Daily Access have moved down market and can support truly open architecture services in the small marketplace.
As an RIA, you can dial in a minimum fee of, say, $5,000, which can debit from the plan on a prorated basis with full disclosure. There are hundreds of thousands of plans out there with an annuity-based provider paying something like 2.5 percent to 3 percent all in. As an RIA working with an open architecture platform, you can find a lineup of I shares with an average internal operating expense of 0.45 percent, tack on a point for your services, and earn some money. And 90 percent of the time, you will be lowering clients' fees and enhancing their services.
It's too late
Not true. Fee-based practitioners who got into this business early surely have a leg up, but I know of hundreds of teams who made a commitment to get into the 401(k) game — and they've been successful in a big way. It has never been easier to brush up on your skills via designation programs, conferences, study groups, and online and offline subscriptions.
We continue to hope that the current administration will simplify the posture around advice, enabling advisors to serve both plan sponsors and participants. Now is the perfect time to retool your practice and bring viable solutions to a marketplace in crisis.
Amy Glynn is the director of retirement consulting services at Commonwealth Financial Network, an independent broker/dealer and a registered investment advisor, in Waltham, Mass.