The new Pension Protection Act puts stress on traditional pension plans at the same time that it creates big opportunities for the $7 trillion defined contribution plan market.
Automatic enrollments in retirement plans, now permitted under the PPA, will add trillions of dollars to 401(k) and other plans, while new fiduciary advisor provisions legitimize the expansion of financial advice as a worksite marketing product or service.
In the context of retirement plans, a fiduciary advisor is a financial advisor retained by an employer to help guide employees' retirement decisions. The PPA requires that the advisor be retained by the employer only after exercising due diligence, which includes periodic reviews of performance and an annual audit.
The Act includes a provision that for the first time allows a company providing a 401(k) plan to offer investment advice to employees in that plan. Under the PPA, however, the provider can only offer such advice in the form of a computer model, to assure the advice given is objective.
In addition, advisors must provide information to participants describing their fees, rates of return, roles of parties involved and an acknowledgment of the investment advisor's status as a fiduciary.
The new fiduciary advisor provisions legitimize financial advice as a worksite marketing product. Advisors are now required to list all services offered to employees, such as annuities and mutual funds, with the endorsement and support of employers.
Take the case of a benefits advisor, ABC, which has 200 corporate clients that altogether have 20,000 employees. By becoming the fiduciary advisor for just half of these clients, ABC could add $1.5 million to its annual revenues.
Because the PPA requires that the advisor must consider all of the employees' finances when giving advice, that makes every employee a source of business for other household assets, rollovers and referrals.
In exchange, fiduciary advisors must take personal responsibility for the advice they give. Unlike fiduciaries of a retirement plan, fiduciary advisors are responsible only for the advice they give employees and do not become fiduciaries for the entire plan.
From their vantage point, employers have a great incentive to engage a fiduciary advisor because it relieves them of much of the responsibility for their employees' retirement. Employers can pay for fiduciary advisor services from funds in the plan but are required to screen the fiduciary advisors thoroughly.
While it is clearly preferable to have a fiduciary advisor with no conflicts of interest, the PPA now allows plan providers to also become fiduciary advisors, despite a conflict of interest, if they use a computer model to deliver the advice.
For independent fiduciary advisors, this means they will have to convince employers of the benefits of selecting them for their impartial personal advice over the easy decision of using a plan provider using a computer model.
There are 3 critical arguments that independent fiduciary advisors can use to show the benefits of using their services over those offered by plan providers:
Fiduciary relief: Use of computer models by employees is notoriously low, so only a few would actually be served by making such a model available. Since the employer only has fiduciary relief for those employees that use the computer model, there is little advantage to offering one.
Conflict of interest: Advisors who sell a 401(k) plan would have a conflict of interest if they also advised employees on how to invest the money they put in that plan. This is why they must offer a computer model–to give employees the option of using an impartial instrument for choosing their investments. They must also disclose the conflict to employees.
Unproven technology: There is no proven way to establish that computer models will produce satisfactory retirement income. While these models have been backtested (in which the model's predicted results for given investments are weighed against past results), there is no record of actual long-term performance.
