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Fund Firms Test Individual 401(k) Waters

More than a decade ago, Fidelity Investments of Boston formed Institutional Retirement Services Co. to target the small-business 401(k) market. Today, with the retirement plan market tighter than ever, fund firms have begun to pursue the ultimate small business: individual 401(k)s.

Earlier this month, Waddell & Reed of Overland Park, Kan., became the third fund company to offer 401(k)s for the self-employed and business owners who have no employees. Pioneer Investment Management of Boston and AIM Funds Management of Houston both launched similar products in January [see MFMN 1/21/02].

BISYS Retirement Services of Little Falls, N.J., was the first company to receive approval from the Internal Revenue Service for its prototype individual 401(k) plan, which it launched at the end of 2001. Pioneer has based its individual 401(k) plan on the BISYS prototype.

Keybank of Cleveland has already signed on with BISYS to administer its own individual 401(k) plan. BISYS is finalizing contracts with 15 other mutual fund and insurance companies to offer their own versions of the product, according to Chris Guarino president of BISYS Retirement Services.

"It would not surprise me if more firms came out with similar products," said Don Cassidy, senior fund analyst at Lipper of New York. "The 401(k) market is in a maturing phase and firms are always looking to find new distribution methods and niches."

Getting Started

Firms are just now starting to create individual 401(k) plans because the tax bill President Bush signed last year, the Economic Growth and Tax Relief Reconciliation Act of 2001, has made individual 401(k)s more viable.

Under the old tax laws, contributions were limited to 15% of compensation, so owner-only companies were better off opening a simple IRA, profit sharing or Keogh plan, according to Patrick White, a vice president in AIM's retirement and education products division. Under the new tax bill, contribution limits have been raised to 25% and asset allocation limits have gone from 25% to 100%, White said.

"Individuals could always set up 401(k)s. It's just that the contribution limits were minimized before the tax bill," White continued. "I don't know if Congress realized it and said, We just created a really nice product for the sole proprietor,' but that's essentially what they did."

Guarino of BISYS said that individual 401(k)s have the potential to grow and become very popular products because they are simply better from a tax standpoint than the options self-employed individuals have currently.

"There are an awful lot of owner-only businesses out there, and from a tax advantage standpoint, this takes the place of Keogh plans," Guarino said. "On the surface, the tax implications seem to make this a very positive product" because individual 401(k)s have higher contribution allowances, he said.

The timing may be fortuitous, but so far, AIM has not had a tremendous amount of success with its product, Solo 401(k). The firm has only opened about 12 accounts, according to White.

AIM has received a lot of requests for literature about the new products, however, and the firm expects a big push in the fourth quarter of this year into the first quarter of 2003, White said. Individual business owners are likely to decide on plans at that time, when they know what their earned income for the year is, White said. When AIM launched its plan in January, White said he expected the firm to open between 1,000 and 3,000 accounts this year.

Pioneer would not disclose how its plans are selling. Pioneer spokeswoman Denise Robbi-Arena only said that its sales have exceeded the firm's expectations.

If Pioneer has had more initial success than AIM, it may be because AIM devoted all of this year's marketing budget to its 529 college savings plan. However, the firm included "highlights" about the individual 401(k) plan and compared it to other retirement vehicles in its quarterly newsletter that it sent out in April. The newsletter is sent to roughly 150,000 financial advisers, according to an AIM spokesman.

Retirement Vehicles Rule

Firms are extremely eager to develop their retirement products because of how important that market is in terms of asset accumulation, said Avi Nachmany, director of research at Strategic Insight, a research firm in New York. About 75% of all mutual fund assets are in retirement vehicles, such as 401(k)s, IRAs and variable annuities, he said.

"That's the primary driver of this business," Nachmany said. "It has been extremely important and will continue to be in the future."

Nachmany added that rolling out these products is a good idea for firms because, even if they do not generate revenue right away, they give potential and current clients another way of dealing with the firm.

Even though the small business 401(k) market may be small, fund companies are offering these products to begin relationships with clients whose assets could grow over time, Nachmany said. He likened the strategy to 529 plans. Even though these plans initially provide very low margins, their assets will grow over time and it is unlikely that clients will move their money out of them, he said. "It's all part of the same thing," Nachmany said. "It provides greater engagement in a good way."