401(k) Administrators Leery of Advice
August 13, 2007
The Pension Protection Act ushered in far-reaching changes to 401(k) plans, including fiduciary protection for providers using automatic enrollment and default investments, and making permanent higher contribution levels and catch-up contributions for older workers.
But one provision that investment advisors are grappling with is whether to take on an expanded fiduciary role by offering investment advice.
The act provides safe harbor under ERISA rules for advisors that provide personalized investment advice to participants in pension plans, 401(k)s, 529s and other tax-saving accounts. It allows for two types of advice, one where the compensation received by the advisor must be a level fee that is not affected by the advice given, and a second where the advice is based solely on a certified, unbiased computer model. It also requires complete fee disclosure, as another way of preventing investment advisors from benefiting themselves by steering investors into their own products.
However, there are advantages and disadvantages to offering advice, according to a report from Principal Financial Group of Des Moines, Iowa, called "Pension Protection Act of 2006: Is An Expanded Fiduciary Role The Right Choice For Financial Professionals?"
"Regrettably, the new rules are complex and, in some cases, difficult to implement," said Fred Reish, an attorney with Reish Luftman Reicher & Cohen, an employee benefits law firm in Los Angeles that reviewed the report for legal accuracy.
Many plan sponsors will view participant investment advice as a valuable asset for their plans.
However, their ultimate objective is that their employees be well invested, regardless of whether it results from investment advice, lifecycle funds or managed accounts, the report states. Investment advisors need to assess whether the best and most effective way of accomplishing that goal is taking on an expanded fiduciary role of providing advice.
One optimistic result of acting as a fiduciary is an expanded book of business. Taking on a fiduciary role can increase an advisor's business from both plan sponsors and participants, said Jack Stewart, a director and defined contribution national practice leader at Principal.
As the financial advisor works with plan sponsors, they will gain access to participants, and that will afford them more opportunities to sell them investment products outside the plan, Stewart said.
Additionally, financial advisors are always looking for ways to provide an extra bit of value, and by being a fiduciary, they position themselves to be viewed by plan sponsors as providing more services and value, Stewart said.
However, there are downsides to taking on an expanded fiduciary role, as well. There can be increased exposure to liabilities if an advisor gives the wrong advice or doesn't follow the rules set by ERISA, Stewart explained. Acting as a fiduciary, financial advisors are held to higher standards and scrutinized more, he added.
Additionally, companies take on more risk. Broker/dealers need to grant permission to their advisors to provide advice, as they assume some responsibility when their advisors act as fiduciaries, Stewart said.
Currently, the industry is not seeing many requests for added investment advice on top of what plan sponsors are already getting, Stewart noted.
Plan sponsors offered plan participants investment advice services before the Pension Protection Act, but not a lot of participants signed up, he said. It could be a result of the higher fees that would have to be paid, he said.
However, this may change as workers indicate that they would like to take advantage of professional investment advice offered by companies that manage investments that are used to fund employer-sponsored retirement plans, so there is clearly the potential for demand of the services of a qualified financial professional, the report states
Still, there is some misunderstanding as to what a fiduciary role entails. Clients might be confused as to what a fiduciary role actually is, but once they understand it and see the value add, they are receptive, said Karl Hicks, a financial planner with the Leonard Financial Group of Riverside, Calif., who acts as a fiduciary to his clients.
On the other hand, because the Pension Protection Act allows for automatic enrollment and such default options as lifecycle funds, some plan sponsors may see this as a type of customized solution for participants without paying for the extra investment advice, Stewart said.
However, many 401(k) experts believe the options shouldn't preempt advice. While some plan sponsors might think that putting participants in a default plan is the end-all solution, as accounts grow, participants in default plans will need help on how to best allocate their portfolio.
Regardless of automatic enrollment or default options, participants still need to have their plans professionally examined in order to get recommendations on how to best manage their plans and meet their objectives, Hicks said.
Once advisors decide to become a fiduciary, "The main thing is that financial advisors look at the requirements under the Pension Protection Act and understand them," Stewart said.
Specifically, financial advisors should focus on understanding new provisions concerning the investment advisory function, fee structure and investment advice computer models, the report states.
The new requirements include submitting to a thorough evaluation as part of the selection process, entering into an Eligible Investment Advice Arrangement with the plan sponsor, abiding by the mandated disclosure requirements and undergoing an annual compliance audit completed by an independent source, Principal notes.
There are additional requirements to disclose to plan sponsors. An advisor might have to disclose items such as past advice history and rate of return on advice, Stewart noted.
Most investment advisors are taking a wait-and-see attitude toward taking on an expanded role with clients, Stewart said. There is not a race to start this type of practice, he said.
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