By Larry Karle, Longfellow Benefits
While the market crash of 2008 is in the rearview mirror for many participants and plan sponsors alike, the bitter taste that was left due to many people suffering significant hits to the values of their retirement savings and their 401(k) balances remains to this day.
In some instances, participants saw the values of their accounts precipitously drop by tens of thousands, even hundreds of thousands of dollars, and they have yet to fully recover.
Undoubtedly, the market crash has had many lasting effects. In some instances, the precipitous drop in the value of their retirement savings has caused people who may have been “on-track” for retirement re-thinking their strategy, and hoping that they are able to work long enough to catch up to their goals. Where they may have been planning to retire at 65 or even 62, they are now hoping to make it to 70.
And while individual investors are picking up the pieces and rebuilding their nest eggs, another lasting effect of the market crash is the heightened scrutiny of the retirement industry as a whole and criticism of 401(k) plans.
What for many years has been a main staple, if not the staple of retirement savings vehicles, the 401(k) plan has come under fire with many calling it “irresponsible” and a “vehicle for the rich.” But why? And can something be done to make this a vehicle that can work for all?
Most Participants Lack Advice
The main criticism leveled at 401(k) plans in the wake of the crash was that the majority of plan participants are not savvy enough to create and maintain a prudent savings and investment strategy.
While the wealthy may have access to private financial planners or planning tools to help them, the rank-and file-employee does not. In the bull market run of 2005–2007, this wasn’t an issue, as even investors who had no idea what they were investing in, sometimes garnered significant returns.
Fast forward to 2008, and while more savvy investors may have been able to stem losses, “grab a lifeboat,” and head for safety with advice from financial planners, the majority of investors were left on the deck as the orchestra played and the ship sank.
Could some of this have been avoided? Many would argue that while there would still have been losses, the magnitude of the losses could have been mitigated had participants had access to advice and education to set up and periodically review their strategies.
The solution then seems to be elementary: Hire a professional to provide employees with some direction toward achieving their retirement goals.
But not so fast, because remember, as a plan sponsor, you have a fiduciary responsibility to monitor and understand anyone that is compensated for services on behalf of the plan.
Additionally, while the laws and regulations around participant advice are continuously being refined, there are some clear-cut themes that are common throughout the proposals that should be considered to help ensure that there is not a breach of fiduciary responsibility.
Participant advice can be divided into two main areas—adviser-based models and computer-based advice models. While both are clearly distinguishable in their approach, both carry with them some definitive critical success factors when considering what is right for you and for your participants.
Adviser-Based Advice: What You Should Know
In the traditional adviser-based model, the adviser may present to your participants in a large group setting or even perhaps through a webinar. Some advisers even offer one-on-one counseling sessions with employees. Such sessions—particularly one-on-ones —tend to be highly effective in driving participant behavior.
What regulators are looking for here is whether you, as a fiduciary, could be “letting the fox in the henhouse.” Are you giving a broker or investment professional unfettered (and unmonitored) access to a base of potentially naïve investors who have been spooked by recent market volatility?
To make sure that this is not the case and to mitigate fiduciary exposure, you should ask yourself (and the adviser) the following: Is the adviser a true, independent third party, and can his or her compensation be at all influenced by the advice that he or she gives?
For example, if the adviser was affiliated with ABC Fund Company and the ABC Fund Company has funds within the 401(k) plan, is there the potential that he or she could steer participants toward those funds in order to boost his or her compensation?
The preference here is that the adviser is, in fact, an independent third party, not at all affiliated with the plan or the plan investments. But if they are not, as would be the case with the previous example, there may be a fiduciary red flag.
Next, be sure that you know your adviser, and absolutely know how he or she is paid—that is, know his style and approach. Would his style mesh well with your participants or would they be turned off and therefore not be likely to take advantage of the opportunity to gain advice?
Also, know what the adviser plans to present to participants. A good way to know on both counts would be to ask him or her to do a preview presentation for you and/or your team members.
Also, if one-on-one counseling is offered, ask him to conduct one of these sessions for you so that you can see firsthand the approach that he is taking. Make sure that he or she is not trying to “sell” products to your participants, and is strictly advising on how to take advantage of the plan. Remember, as a fiduciary, you are potentially responsible for the adviser’s actions.
Make sure that you know how much the adviser is paid, and from where. Flat-dollar arrangements either paid directly by the plan sponsor or from plan revenues where the adviser is paid an agreed-upon amount tend to be the most transparent and therefore more agreeable to regulators.
Flat-dollar arrangements also do not lend themselves to the adviser trying to sell something to a participant to make his efforts “worth the trip.”
When advisers are paid on a “basis points on assets” basis, the thought is that there is the potential that he may make recommendations that have the potential to drive asset growth but may not necessarily be prudent for the individual participant.
Most advisers in the retirement business should be able to quote you on a flat-dollar basis. If not, you may want to get additional quotes for your valued business.
Computer-Based Advice: What You Should Know
Many plans also engage Web-based modeling and tools as a way to bridge the plan-education gap. In many cases where the firm is too large or spread out over many locations, this is the most efficient solution available. While that may be the case, it does not in any way relieve plan fiduciaries of oversight responsibility for the models they select.
Some good questions to ask of the vendors providing the models are: Has the model been audited by a third party to ensure that it is prudent, and is this review done on a regular basis? Does the model unfairly bias certain investments in the plan? If so, why, and is there a potential that this provides more revenue to someone such as the vendor, record keeper, or potentially the investment adviser? Finally, is the model specific to your plan, and is this model reviewed when changes to the plan are made?
For example, if you add a potentially risky asset class such as an emerging markets equity fund, does this reconfigure the models? If so, is it for participants that use the models in the future only or would current participants using the models be notified as well?
As you can see, even with the Web-based models and advice, plan fiduciaries have a significant level of responsibility.
Many would agree that providing education and advice to plan participants would go a long way in enhancing the overall benefit provided by the 401(k) plan. It would also serve to level much the criticism of 401(k) plans as a vehicle to save for retirement that was prevalent in the wake of the 2008 market crash.
As plan sponsors and fiduciaries, it is then critical to make sure that whatever direction you choose to provide this advice be done in a prudent and thoughtful manner to protect you and your employees.
2 Larry Karle is a senior consultant in the Retirement Plans Group with Longfellow Benefits (www.longfellowbenefits.com), a Boston-based employee benefits consultant and brokerage.
He can be reached at lkarle@longfellowbenefits.com.
Securities offered through NRP Financial, Inc. Member FINRA/SIPC. Advisory services provided by NRP Advisors, Inc.