During a recent plan sponsor education program, a professional from a major investment provider was advocating for using annuities for retirement income within 401(k) plans even though the money manager was not an annuity provider. A few plan sponsors voiced concern about annuities because of their lack of transparency, which made it unlikely they would offer these products to their employees.
After being burned by hidden fees and inherent conflicts of interest, defined-contribution plan sponsors are waking up concerned about our industry's lack of transparency. They are less likely to adopt new products, even if they are beneficial, unless the industry can engender trust through transparency and elimination of conflicts.
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The dramatic growth of DC plans was based on a lack of transparency and inherent conflicts of interest.
The first DC plans were started in the 1980s, mostly by large organizations that treated them much like defined-benefit plans — vendors were paid directly in part because there were lots of participants and few assets.
In the 1990s, mutual fund providers started offering free or reduced record-keeping and administrative fees by using retail share classes with significant revenue sharing and only providing proprietary funds. Plan sponsors were mostly oblivious to the lack of transparency and conflicts.
Insurance companies followed suit, offering annuities that allowed them to charge a largely unknown "wrap fee" to pay themselves and the adviser, all the while touting, "It's a free plan." (It's free to the mostly oblivious plan sponsor, but not to the participants.)
This led former Rep. George Miller, D-Calif., to push for fee disclosure and eventually get the Department of Labor's fee disclosure rules in 2012. More significantly, experienced plan advisers were helping plan sponsors better understand fees and reduce record keepers' prices significantly. The move to index funds and collective trusts is reducing investment fees.
So you would think the DC industry would catch on and not try to hide fees from plan sponsors. However, they're still offering products and services like financial wellness for no cost.
Everything costs something — even relatively unsophisticated plan sponsors know that — and the no-cost offer means it's being funded from some other hidden source for who knows how much.
Having attended hundreds of plan sponsor educational programs, I have never met one plan sponsor who understands the complicated web of revenue sharing, in which embedded investment fees subsidize the cost of running a plan. When they do understand, it makes them wonder what else is going on behind the scenes and it certainly does not engender trust.
Clever schemes used recently by record keepers to offer low-cost clean shares and then make it up by charging money managers platform fees are just another attempt by the DC industry to hide the pea while offering only those investments able to pay the freight.
The next wave of innovation is critically important to employers and employees focusing on participants and work-site benefits — advice, wellness and retirement income. Embedding fees within investments to pay for them so plan sponsors or participants don't notice or don't have to write a check is counterproductive; it will only make plan sponsors weary and unlikely to adopt these new services, even though it might seem to make the sale easier.
Plan sponsors are willing to pay for services that help the company and the employees — they do it all the time with human resources, legal and accounting services. Why not retirement and financial planning?