Next spring, 72 million Americans will open their quarterly 401(k) statements and, for the first time, they will see the true cost of their retirement investments spelled out in new fee disclosures. The sound of all those envelopes being torn open—and the collective gasps, screams and confusion likely to ensue—will echo throughout the financial services industry.
It is fair to say that this national case of sticker shock will fundamentally alter the $3-trillion 401(k) industry, putting vast amounts of retirement plan assets in motion and providing fee-based investment advisors with significant new opportunities and challenges.
The trigger for this 401(k) sea of change? Long-awaited Department of Labor rules will go into effect in April 2012 and are designed to improve fee transparency in 401(k) plans. One rule, ERISA 404(a)(5), gives 401(k) participants detailed information about fees and expenses and creates uniform standards for calculating and disclosing investment expense and return information. The result, according to the DOL, allows participants to make "apples-to-apples" comparisons among investment options.
A companion regulation, ERISA section 408(b)(2), focuses on disclosure of direct and indirect compensation service providers receive, including fiduciary or RIA services; recordkeeping or brokerage services related to investment options made available in a plan; or other services for which indirect compensation is received, according to the DOL. It also requires service providers to state explicitly if they are acting in a fiduciary capacity.
While they are a step in the right direction, the rules fall short of full fee disclosure. They do not go far enough to provide plan sponsors and participants with a clear understanding of the true cost of a 401(k) plan. Notably, the disclosure of investment costs actually incurred by participants—typically the single largest plan expense—is not required by DOL regulation.
According to a study by Deloitte and the Investment Company Institute, investment expenses account for 74% of a plan's "all-in" cost. The DOL only requires the disclosure of the expense ratios and the amount per $1,000 that it would cost participants to be invested in the fund, leaving the burden on the participant to perform the calculations to determine their investment expense.
The Cost of "Free"
Despite their shortcomings, the new rules will nevertheless shatter the old myth, perpetuated by some product providers, that 401(k) plans are "free"—a myth that is especially prevalent in the small to midsized plan market ($1 million to $50 million). According to industry estimates, there are about $900 billion in these plans.
The free 401(k) myth is also a widely held truth among participants. According to an April 2011 AARP survey, 71% of plan participants thought they paid no 401(k) fees, while only 23% knew they paid fees. The survey also found that 61% were unaware of how much they paid in fees for their plan, while only 32% felt knowledgeable about the impact that fees play in overall plan performance.
Many firms that market to the small to midsized plan market have traditionally marketed free 401(k) solutions as another means to get assets into their highly profitable investment products, annuities and mutual funds. They do this by shifting the cost burden onto participants, layering service fees on top of investment expenses and thereby reducing the net returns of the investments. However, since the largest component of 401(k) plan fees is usually attributable to the investment management fees, it is critical that these fees are included in a plan's all-in fee calculation. It could very well be that a free plan that does not charge recordkeeping and administration fees is actually cheaper than a plan with lower investment expenses and explicit fees. Yet, the converse could be true as well. As long as plan sponsors have all cost information at their fingertips, with the assistance of an experienced advisor they will be able to make an informed decision. While the new regulations will provide most of the information plan sponsors need to determine their total plan cost, an advisor's value could be added by consolidating these fees and providing benchmarks for comparison.
Money in Motion: Risks and Opportunities for Advisors
How much money will be in play with the introduction of new fee disclosures? At the 2010 SPARK Forum, Robert Wuelfing, president of RG Wuelfing & Associates, projected that about $206.4 billion in 401(k) assets would turn over in 2011. At Lincoln Trust, we believe that plan turnover will likely increase significantly in 2012 as the disclosure rules come into effect, particularly in the small to midsized plan market. Large plans, which have the muscle to negotiate fees and armies of consultants to select investments, will tackle the issues on their own, but small to midsized plan sponsors will be looking in part to advisors to understand the regulations and make smart investment choices.
"I call it the 'perfect storm' for advisors," says Jerry Kalish, president of National Benefit Services Inc., a Chicago-based retirement plan consulting, actuarial and administration firm. Kalish says that with tens of thousands of baby boomers entering retirement, new regulations clouding the waters and market volatility causing concern among participants, plan sponsors will be under pressure to get their 401(k) house in order.
There are both defensive and offensive strategies for advisors. Regardless, advisors in the 401(k) marketplace don't have a choice but to understand the regulations and find business partners that will help them grow their business.
Positioning advisor practices for success will be a team effort. "You don't have to know everything about ERISA, but the days of stumbling onto a 401(k) opportunity are over," says Kalish. "As the industry unbundles, you will need to form a winning team to provide clients with the service and advice that will motivate them to stay put or make a change."
Watching Your Assets
In the market turmoil of 2008, some advisors were running scared, refusing to answer calls or communicate with clients. Those who thrived during the market collapse—who, in the words of former White House Chief of Staff Rahm Emanuel, didn't "let a good crisis go to waste"—were servicing clients and finding prospects.
