The Department of Labor, 401(k)s and technology

The new Department of Labor rules imposing fiduciary responsibilities for retirement plan advice might impact registered investment advisers, even though they’ve already been held to a fiduciary standard. While this could be interpreted as an unnecessary compliance burden, it could also present an opportunity with regard to 401(k) accounts.
Here’s how the new rules can affect advisers and 401(k)s. If you’re a typical adviser, you don’t manage clients’ 401(k) accounts on an ongoing basis. For the most part, you might look at clients’ 401(k)s once a year and suggest updates to their allocations. The consequences of this approach are:
• There is no real professional oversight for clients’ investments in 401(k)s.
• Retirement 401(k) accounts are generally expected to include a full allocation of investments, even if the 401(k) doesn’t offer all asset classes and even if some of the funds offered are less than ideal.
• Advisers don’t charge for an annual off-the-cuff allocation review.
At some point, when your client retires or separates from service, most advisers will recommend the client roll the 401(k) balance into an IRA under the adviser’s management. This is good news for the adviser, since that will increase assets under management and thereby increase revenue. Now enter the new DOL rules. Advisers must put the interests of their clients first. So, before recommending that a client transfer a 401(k) account to a managed IRA, the adviser must first show that this is the best move for the client. Therein lies the dilemma. Is the 401(k) offering so bad that it is worth moving to an IRA with a 1% management fee?
This can be problematic if the adviser has been operating under the described scenario. We all believe that our services are worth at least what we charge. Yet, can we justify our fees when the alternative is simply leaving retirement funds in the hands of the 401(k) provider?
I’d like to recommend a potential solution to this issue: Manage the 401(k)s while the client is still working for the company. If you are using a sophisticated rebalancing software (like Total Rebalance Expert) as well as account aggregation (like ByAllAccounts) to bring outside account data into your daily downloads, you can cohesively manage 401(k)s as part of each client’s overall portfolio. And you can charge a management fee on the entire amount. You still need to justify that this is in the best interest of the client; however, should the client leave the job, there would be no conflict of interest in moving the 401(k) balance to an IRA.
So, how can you justify that this is in the best interest of the client? There are several reasons:
• The 401(k) will be professionally managed on an ongoing basis.
• Since the 401(k) is no longer required to hold a full allocation (since different pieces can be held in the client’s other accounts), the adviser can cherry pick from fund offerings. In other words, the client will no longer have to hold a sub-par fund in a 401(k) merely because that is the only one offered in a particular asset class.
• The 401(k) can hold investments based on optimal tax location. Thus, the 401(k) can be targeted to hold more bonds (deferring taxation) while the taxable account can hold more equities (getting the benefit of capital gain rates when appreciated securities are sold).
It certainly seems like professional management, avoidance of sub-par funds and tax savings can justify charging a management fee on 401(k) accounts.
Of course, everything involves client education. And, you might be required to spend a little money on software. Doing this can give you the opportunity to increase revenue, avoid fiduciary issues when converting 401(k)s to IRAs and provide increased AUM revenue by simply gaining a larger wallet share from your current clients.
Sheryl Rowling is head of rebalancing solutions at Morningstar Inc. and principal at Rowling & Associates. She considers herself a non-techie user of technology.