Impact of the elimination of 12b-1s on retirement plans

The SEC recently published new rules governing 12b-1s and sales charges in general. These are proposed rules and will be in their comment period until November 2010. Final rules are unlikely to be effective sooner than two years from now due to the substantial cost and effort of transition. These are big changes for the brokerage industry, much less so for retirement plans.

Basics of the New Rule:

• 12b-1s Are Dead
These are replaced with 12b-2s and 6c-10s. The 12b-1s are being phased out and replaced with a combination of a 25bp “marketing and service fee” (the “12b-2 fee,” though SEC wants everyone to stop describing it using a Rule number) and an “ongoing sales charge”.

• Lower Lifetime Cap
The maximum ongoing sales charge will be capped at a level lower than what is currently possible under FINRA rules, representing a slight pay cut for brokers under certain circumstances. The change is mainly procedural except in that it eliminates C shares and alters the profile of B shares slightly.

• The “X-Share”
Creates a new “Account Level Sales Charge” option that allows ANY share class to be sold at NAV with no fund level sales charges, and a sales charge is instead assessed at the account level in the same way a fee is assessed. No limits on the amount of such account level charges—just like in the fee-based world.

• 5 Year Grandfathering of 12b-1s
Grandfathers existing share classes for five years after the implementation date, which is realistically about two years out from August 11, 2010.

• Some Forms of Revenue Sharing will Continue
Forms of revenue sharing other than 12b-1s continue to be acceptable, so shareholder servicing fees and sub-transfer agency fees are not affected. The new rules are concerned solely with sales charges. A fund can have a 25bp marketing and service fee, a 25bp shareholder servicing fee, and a 10bp sub-t/a fee, presumably all at once, without being affected by the new rules. But, remember that brokers can’t get paid by shareholder servicing and sub-t/a fees.

Impact on Retirement Plans:

• The Need to Track Share Lots…At Considerable Expense.
A side effect of the new rules is that, in order to keep track of the maximum permissible “ongoing sales charge,” recordkeepers will have to begin tracking share lots, which virtually no one in the industry does today. Building the systems to do this will be expensive and annoying, and will in reality have minimal impact given the relatively small percentage of funds affected. ASPPA Executive Director Brian Graff is considering a push for a retirement plan safe harbor that would allow a flat annual charge (e.g., 50bp) in addition to the 25bp marketing and service fee, and that charge could be perpetual so no share lot accounting would be required. Absent such a change or something with similar effect, recordkeepers will have a job ahead of them, the costs of which will presumably find their way to participants.

• Retirement Share Classes are Dead
R shares (or N shares, or whatever the fund families call them—think American Funds R3) are dead for new plans. They’ll probably be replaced by “X shares” (i.e., any share class that invokes the account level sales charge exemption) or fee-based accounts. The general trend toward fee-based work would seem to have been given a boost by the new rules.

• B and C shares are Dead
They never really belonged in retirement plans anyway.

• Share Class Conversions Will Chew Up Time for the Recordkeeping Industry.
Regardless of whether SEC creates a safe harbor for retirement plans, there will be a rush to do share conversions to share classes that allow brokers to continue getting paid for what they do beyond the grandfathering period. That’s a lot of work, sort of like the work the industry had to do when Rule 22c-2 was created (the SEC Rule concerning redemption fees and trading restrictions to limit market timing and other abuses). Work is cost, and distracts us from our mission, so it will have an impact, but it’s one-time.

• Impact Localized to Small Plans.
Naturally, the impact will be almost exclusively in the small and micro plan markets since those are the only places to find 12b1 fees above 25bp currently. But it’s important to remember that 80% of all plans have fewer than 100 eligible participants; so this change affects most plans.

Impact on Unified Trust Clients and Advisors

Our interpretation is that there will little to no impact to our business model. Our average revenue share from all sources tends to be way below 25bp, and we only trade a handful of funds (e.g., old American Funds R3 shares we’ve not yet converted to R5 for operational reasons) with 12b-1s greater than 25bp. Payments to advisors have nothing to do with the 12b-1s since we follow the Frost model with 100% fee recapture. Bottom line, the new rules are not a big deal for Unified Trust, its clients, and the advisors who serve them.

What to Do If You’re an Advisor

Accelerate your movement to a more fee-style model. Use this opportunity to approach all of your plans that have fund family products and evaluate if any changes make sense. Such as a move to Unified Trust.

Credit to Pete Swisher, Senior Institutional Consultant at Unified Trust Company, N.A. for above content.

Benefit Adequacy is the Focus

The DOL's Assistant Secretary for the EBSA is lighting a fire under the dialogue concerning retirement income for 401(k) participants (or the lack thereof). In a recent article published by Fred Reish, entitled, "Adequate Benefit and Monthly Income", the discussion is expanded to include topics such as benefit adequacy, success measurement, distribution planning, and more. Reish presents a number of questions that providers, plan sponsors, and participants need to be able to answer comfortably. For example:

-Is your 401(k) plan providing an adequate percentage of final pay for your employees in retirement?

-How is benefit adequacy measured for 401(k) plan participants and is each participant aware of where they stand?

-How much does a participant need each year in retirement, and how do they make it last for a lifetime?

-How much can a participant feasibly withdraw each year to make their income last a lifetime?

These are all good questions. It's our belief that Fred Reish absolutely nailed it for those asking questions like, "What is the prevailing concern for most participants and plan sponsors with regard to saving for retirement?" and "What should I look for in a provider to ease participant concerns over accumulating retirement income?"

Please click here to view the article in its entirety.