For years, experts have predicted the small-plan 401(k) market would have to change. Although prices have come down, they are still high when compared with larger plans, and the market is rife with inefficiencies.
However, a series of dramatic industry changes this year could finally cause fundamental shifts and improvements in the small and perhaps even midsize 401(k) markets.
Today, there are hundreds of thousands of 401(k) plans with less than $10 million in assets, run by insurance company record keepers, sold by inexperienced (or "emerging") advisers and designed by independent third-party administrators. Payroll company record keepers have the next-largest market share after insurers, and many plans suffer from poor service and high turnover. Inefficiencies are rife.
Each plan sponsor is forced to form and run its own plan and create their own investment menus, something they are ill-equipped to do. Most of the plans are sold and managed by emerging plan advisers, who might have a relationship with the company (e.g., the owner's brother-in-law or personal wealth adviser) without having the necessary experience or resources.
Record keepers are forced to employ armies of expensive wholesalers to support these hundreds of thousands of emerging advisers, and maintain an even more expensive infrastructure of internal wholesalers, education specialists and service professionals, all while their fees continue to decline precipitously. Third-party administrators are hired to design and consult on these smaller plans, further adding to the cost.
More experienced advisers have eschewed this market, as they cannot afford to profitably service these smaller 401(k) plans.
Forces that could finally drive change and bring efficiencies — and plain common sense — include the Department of Labor's fiduciary rule and
legislation that would allow unaffiliated companies to join a type of multiple employer plan called a "pooled employer plan." That would make MEPs more attractive to small employers — today, unaffiliated companies in a MEP each must file their own Form 5500 and face the adverse consequences of the "one bad apple" rule, for example.
If the PEP legislation passes, experienced advisers are likely to move down market, since advisory prices are plummeting for midsize and large 401(k) and 403(b) plans.
In addition, broker-dealers
concerned about the increased fiduciary liability under the DOL fiduciary rule, which raises investment-advice standards in retirement accounts, could use PEPs to limit liability by forcing emerging advisers and all small-market plans into these schemes regardless of the experience of the adviser.
And record keepers could use PEPs to improve distribution, design and service efficiencies, thereby increasing margins. The small market would become attractive for more experienced plan advisers.
Further fueling change are the
state-mandated retirement plans. The greatest value emerging plan advisers bring to record keepers is the sale of a retirement plan based on a prior relationship the adviser has with the client; that value may be lessened if companies are forced to provide a retirement plan for their workers.
The
benefits of a PEP for small-market companies, and even larger organizations, include better pricing and investment options, access to more experienced advisers, and less fiduciary liability (because a professional lead sponsor would take control on behalf of all employers in the PEP).
They are the proverbial no-brainer. Entities in a PEP can still customize plan design. Behavioral finance can suggest the plan design that might be most beneficial, depending on the type of company and demographics of the organization.
If fundamental changes to the small 401(k) plan take root, the winners include record keepers and experienced plan advisers that can leverage the shift to cooperative schemes like MEPs and PEPs, managed-account providers that can better leverage plan data to customize investments by using liability-driven investing principles, and TPAs that are substantial enough to step into the role as a lead sponsor of the PEP.
Losers will be record keepers that aren't able to pivot, and are likely to be consolidated out of the market, and advisers that remain up-market and are starved by predatory pricing. Those most at risk are the hordes of record-keeping wholesalers as a result of the distribution efficiencies of PEPs, as well as the thousands of compliance-only TPAs no longer needed to individually design and service these smaller 401(k) plans.
"Triple F" advisers
focused on fees, funds and fiduciary services will be exposed, while advisers that leverage PEPs, focusing on improving outcomes through thoughtful plan design and participant engagement, will benefit.
Fundamental change takes time, and not all inefficiencies will be eliminated. The change also depends on PEP legislation passing, but it seems a strong likelihood in the near future. And even without the PEP legislation, the small 401(k) market will change, leveraging clever schemes such as
81-100 trusts and outsourced administrative fiduciaries, maybe less dramatically and slower but nonetheless inevitably.
Fred Barstein is the founder and CEO of The Retirement Advisor University and The Plan Sponsor University. He is also a contributing editor for InvestmentNews'
Retirement Plan Adviser newsletter.
