The next frontier

401(k) plans present a wealth of opportunities for advisers

Mar 3, 2013 @ 12:01 am

By Darla Mercado

Retirement plans, particularly those at small businesses, are the next frontier for financial advisers — as long as they can find the best way to serve employers and their workers.

Defined-contribution plans are booming as plan sponsors abandon traditional defined-benefit pensions and shift the burden of saving for retirement onto employees. Indeed, assets in 401(k) plans hit $3.6 trillion last year, and they're expected to reach $4.8 trillion by 2017, according to Cerulli Associates Inc.

Service providers' push to encourage workers to raise their contributions to a retirement plan beyond the default 3% of salary, along with market appreciation, likely will be the big drivers of that asset growth, according to Kevin Chisholm, associate director at Cerulli.

“There's a strong desire from the plan sponsor to make sure that the participants have some education and guidance, and advisers can play a role in that, as well as help participants with their questions,” he said.

As the opportunity for advisers to enter this market grows, so too does segmentation in the retirement plan space. Advisers can provide three different levels of service to plan sponsors.

At one end of the spectrum, there is the 3(38) investment manager under the Employee Retirement Income Security Act of 1974, a designation that places full fiduciary liability on advisers and gives them discretion over assets.

In the middle, there's the ERISA 3(21) co-fiduciary, who shares fiduciary responsibilities with the plan sponsor.

And on the opposite side of the spectrum, there's the nonfiduciary broker or insurance agent, who does not handle investment selection but can help select providers and ramp up participation in the plan.


The plan sponsor ultimately has the responsibility for selecting a service provider prudently.

In a rule it plans to re-propose later this year, the Labor Department will seek to expand the scope of retirement plan professionals who must meet a fiduciary standard — a development seen as a mixed blessing for financial advisers.

For one thing, it will drive demand from plan sponsors who prefer that a fiduciary adviser pick out plan investments, choose the appropriate service providers and stay on top of DOL regulations.

“People shouldn't run from [the fiduciary designation] — they should embrace it,” said Pete Kirtland, president of ASPire Financial Services LLC, a web-based record keeper for 401(k) and 403(b) plans. “A plan sale isn't really an investment sale; it's a service sale, and now you have to serve the plan and its participants.”

Not all advisers will be able to step in as a plan fiduciary. Some are precluded from doing so because their broker-dealers limit that capability — as well as the additional resources and liability exposure — to advisers who specialize in retirement, keeping out 401(k) dabblers who have only a handful of plans.

Those who do become fiduciaries, however, have a whole slate of new issues about which to worry.

There are two distinct areas of potential liability exposure that are within the adviser's control, according to Jason C. Roberts, chief executive of the Pension Resource Institute. “You need a prudent investment process, and you must be able to demonstrate [it] with good document retention,” he said. “But the sleeper issue is prohibited transactions.”

Advisers can control some prohibited transactions, such as ensuring that they receive level compensation for the services provided to a plan (ensuring that fees don't rise drastically as assets grow). However, other so-called PTs can come around and bite the adviser, such as a failure to detect a fiduciary breach by another service provider who's working with the plan, Mr. Roberts said.

Each player providing service to the plan accounts for a portion of the overall cost. A third-party administrator handles the plan's record keeping, while an insurance company or fund manager provides the investments. In turn, a trust company, insurer or fund manager can act as a custodian of the plan assets, depending on the service arrangement — namely, whether the plan is “bundled” and serviced by one service provider, or unbundled.

Under newer models, an adviser who shares fiduciary duty with a plan sponsor as a 3(21) adviser can expect to earn 10 to 25 basis points, while an RIA acting as a 3(38) investment manager can earn 25 to 80 basis points, said Reed C. Fraasa, managing director at Highland Financial Advisors LLC. Though nonfiduciary brokers have been able to charge 50 to 100 basis points in the past, he believes these fees will come down as plan sponsors become increasingly aware of the services they're getting for that cost.

“Over time, as more plan sponsors get educated, [401(k) fiduciary] is going to be the new standard,” he said. “I don't see how brokers can justify more than 25 basis points just for putting together a package for someone and once a year meeting with employees. It's unreasonable.”


Though nonfiduciary brokers and agents can't provide investment advice to plan sponsors or handle other fiduciary duties, they still can be valuable to employers.

In these arrangements, popular among plans with less than $10 million in assets, third-party firms such as Morningstar Inc. or Mesirow Financial Holdings Inc. can handle investment management duties and act as fiduciaries, according to Mr. Chisholm. Meanwhile, the broker or agent can maintain his or her relationship with the plan by driving participation rates in the plan, educating workers and answering questions plan sponsors may have.


Mr. Roberts warns, “Don't hang your hat solely on the ability to serve in a co-fiduciary capacity. There are people out there who will prospect your plan based on their ability to provide holistic services.”

Those services include improving outcomes for workers and helping participants maximize their benefits, he said.

The ability to capture rollovers, which some 401(k) advisers view as the ultimate payoff as workers retire, depends largely on whether the adviser is a fiduciary.

Advisers acting as fiduciaries — even those who are “functional” fiduciaries and give advice on investments when they shouldn't — run the risk of triggering prohibited transactions if they try to harvest rollovers from the plans they oversee.

A 2005 advisory opinion from the DOL said if a plan fiduciary advises a participant to take a distribution and invest the money in an IRA overseen by that adviser, he or she is violating the prohibited-transaction rule. Notably, nonfiduciary reps are not held to the same restriction.

A number of major broker-dealers are able to assist advisers in understanding the nuances and can accommodate those from all three service tiers. Commonwealth Financial Network, for instance, has its “occasional” 401(k) advisers — wealth managers with a handful of plan clients — “business builders,” who have 10 to 20 plans and want to expand their book, and “specialists,” whose entire business is based on serving 401(k)s.


Those who are starting out need to understand that there is strength in numbers, said Paul Mahan, director of retirement consulting services at Commonwealth.

“I would suggest that [newcomers] team up with another practice under their broker-dealer or hire a consultant and take advantage of the broker-dealer's resources to ensure they're doing the right thing,” Mr. Mahan said. “The wealth management practice that wants to put a foothold in the 401(k) business will struggle unless they have some additional resources to get them going.”

Plan advisers need help not only with mitigating risk and ensuring their fiduciary process is sound, but also with closing new deals and coming up with employee education materials, Mr. Mahan added.


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