Recently, Dan Ariely (author of The Upside of Irrationality) published an article in the Harvard Business Review. In this article, linked at the bottom, he describes a public pension system in the country of Chile that looks very familiar to a mandated version of the provisions the Pension Protection Act of 2006. It seems that Chile subscribes to the notion that if they can remove emotional bias from the equation, the net effect would ultimately be an increase in retirement income adequacy for their citizens.
....In Chile, by law, 11% of every employee’s salary is automatically transferred into a retirement account. Employees select their preferred level of risk, with the following restrictions: They may not choose either 100% equities or 100% bonds, and the percentage of equity that they can select diminishes as they age. When employees reach retirement, their savings are converted into annuities.....
That sounds a lot like Automatic Enrollment and QDIA usage. Good ideas, no doubt. Behaviorally, it recognizes that inertia in decision making regarding money is a very real problem. Forcing the savings and forcing the reduction of risk over time probably seems like a diminishing of freedom in the absence of an opt-out clause. However, in the U.S. over the past 25-30 years, the data on retirement readiness never changes. Participants covered by plans are on a path to failure (inadequate income replacement rates) to the tune of 4-1, that's a rough composite stat, but you get my drift. The article points out that people are not good at two aspects of financial planning for retirement:
1.) deciding to save and
2.) eliminating risk in later years
We think that participants in retirement plans have more challenges thant that. After deciding to save, it is difficult for them to determine how much is truly affordable and how much is truly necessary. Additionally, participants are challenged in general when it comes to investing even with a little (or more) education. Common mistakes range from investing 100% in cash (overwhelmed behavior) to overly aggressive investing (gamblers behavior, aka performance chasing). The Chilean system, however does something very smart. It acknowledges that people who enroll in retirement plans are reasonably good at managing their own risk. So, while the investment choices are left to the individual, the choices are limited exclusively to asset allocation portfolios with a fair degree of diversification.
I think I once heard someone say that the safest plan is one that is 100% invested in QDIAs. Now that was in the context of fiduciary safety, so perhaps not directly applicable, however, the elimination of fear based and gambling based decision making by limiting the options only to models is a terrific idea.
This type of design structure is available in the U.S. today inside of 401(k) Plans. At my firm, we call it The Success Pathway. But unlike in the Chilean system, the participants still will have the freedom to opt out of the plan or any of its auto provisions.
We applaud Chile for taking a strong position on embracing a plan design that shows it leads to better outcomes for the folks it serves.
Please click here to see the full text.
Tuesday, September 28, 2010
Friday, September 17, 2010
Senate Passes Roth 401(k) Rollover Provision!
Today, the Senate passed a small-business jobs bill, H.R. 5297, which among other things would allow employers to amend their 401(k) plans immediately to allow participants to roll over pre-tax account balances into Roth 401(k) plan accounts.
The House has not yet acted on the proposal, and it remains to be seen if this will make into law. However, this step by the Senate is a very encouraging sign that this feature will at some point make it into law whether attached to this bill or some other.
According to the bill, it would also allow for some spreading of immediate tax over several years. For example, if a participant were to convert their pre-tax deferrals to a Roth 401(k) this year, taxation could be elected to be paid in 2011 and 2012.
We see this as a big step in increasing tax flexibility to be in line with what is currently available in IRAs. Additionally, another very real benefit is that in 401(k)s, often times the institutional pricing structure of the underlying investments makes this a better deal than for those in IRAs where mutual funds and the like are generally retail priced and thus more expensive. If passed, this could be a strong incentive for investors to finance their retirement from their 401(k) Plans rather than rolling to IRAs and financing that way. Every bit helps especially with the coming wave of retiring baby boomes.
The House has not yet acted on the proposal, and it remains to be seen if this will make into law. However, this step by the Senate is a very encouraging sign that this feature will at some point make it into law whether attached to this bill or some other.
According to the bill, it would also allow for some spreading of immediate tax over several years. For example, if a participant were to convert their pre-tax deferrals to a Roth 401(k) this year, taxation could be elected to be paid in 2011 and 2012.
We see this as a big step in increasing tax flexibility to be in line with what is currently available in IRAs. Additionally, another very real benefit is that in 401(k)s, often times the institutional pricing structure of the underlying investments makes this a better deal than for those in IRAs where mutual funds and the like are generally retail priced and thus more expensive. If passed, this could be a strong incentive for investors to finance their retirement from their 401(k) Plans rather than rolling to IRAs and financing that way. Every bit helps especially with the coming wave of retiring baby boomes.
Friday, August 27, 2010
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.
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.
Tuesday, August 3, 2010
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.
-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.
Tuesday, July 20, 2010
New 408(b)(2) Regulations Released
In February of 2009 we sent out to you a notification (see below) regarding the White House’s decision to put on hold on all proposed regulations while the administrations were in transition. As you are aware, one of those regulations was the proposed 408(b)(2) amendments dealing with Fee Disclosure, Conflicts of Interest and Prohibited Transactions. In case you were not yet aware, this past Friday, July 16, 2010 the DOL released an “interim final regulation” under ERISA Section 408(b)(2) which will be effective on July 16, 2011.
After reviewing this new “Interim Final regulation”, in my view, these are some of the more important points.
1.) Written Disclosure instead of formal written contract or arrangement. This means that for all plans, the contracts in place now will not have to be amended or re-written, but rather a written notice should be sufficient.
2.) Clarified what it covers – Covers All Qualified DC/DB Pension Plans.
a. ERISA 403(b), 401(k), DB and Profit Sharing Plans are included.
b. SIMPLE IRAs, SEPs, IRAs, Non-ERISA 403(b), 457(b) and 457(f) are not included.
3.) There are now ‘Out Clauses’.
a. There is now a De minimis exemption for provider’s whose annual compensation is less than $1,000
b. There is also a “good faith” exception for providers who make a disclosure error as long as it acted in good faith and corrects the issue within 30 days of discovery.
4.) Conflict of Interest disclosures have been substantially reduced. The prior rule required explicit identification of all conflicts of interest. Instead, the DOL is relying on the compensation disclosure rules to address the issue. In other words, it is on the Plan Sponsor to identify the conflict based on following the money trail…..
5.) Fiduciary Status Disclosure – the new rule requires that only one reasonably expecting to be serving as a fiduciary or RIA clearly says so. The old rule required you to state in writing if you were or a fiduciary or were a not a fiduciary. This brings up the old issue of functional fiduciaries whose Broker Dealers do not allow them to serve as fiduciaries, thus the conduct of the rep is in conflict with their contract with the plan. Under these new rules, the registered rep must state if they are a fiduciary, and if their contract with the plan states otherwise, is that contract reasonable? This could be interpreted as a Rule 4975 Prohibited Transaction. See this article on The Broker’s Dilemma from 2008, for the full issue at hand.
For a complete interpretation of the new regulation and the practical impact of it, please link to the article by Pete Swisher entitled, ‘What the DOL’s New 408b-2 Rule Means”.
If you are looking for a more concise view of the main differences between what the previously proposed rules were vs. the important changes, please see this Bulletin published by Fred Reish and Bruce Ashton of Reish & Reicher by clicking here.
After reviewing this new “Interim Final regulation”, in my view, these are some of the more important points.
1.) Written Disclosure instead of formal written contract or arrangement. This means that for all plans, the contracts in place now will not have to be amended or re-written, but rather a written notice should be sufficient.
2.) Clarified what it covers – Covers All Qualified DC/DB Pension Plans.
a. ERISA 403(b), 401(k), DB and Profit Sharing Plans are included.
b. SIMPLE IRAs, SEPs, IRAs, Non-ERISA 403(b), 457(b) and 457(f) are not included.
3.) There are now ‘Out Clauses’.
a. There is now a De minimis exemption for provider’s whose annual compensation is less than $1,000
b. There is also a “good faith” exception for providers who make a disclosure error as long as it acted in good faith and corrects the issue within 30 days of discovery.
4.) Conflict of Interest disclosures have been substantially reduced. The prior rule required explicit identification of all conflicts of interest. Instead, the DOL is relying on the compensation disclosure rules to address the issue. In other words, it is on the Plan Sponsor to identify the conflict based on following the money trail…..
5.) Fiduciary Status Disclosure – the new rule requires that only one reasonably expecting to be serving as a fiduciary or RIA clearly says so. The old rule required you to state in writing if you were or a fiduciary or were a not a fiduciary. This brings up the old issue of functional fiduciaries whose Broker Dealers do not allow them to serve as fiduciaries, thus the conduct of the rep is in conflict with their contract with the plan. Under these new rules, the registered rep must state if they are a fiduciary, and if their contract with the plan states otherwise, is that contract reasonable? This could be interpreted as a Rule 4975 Prohibited Transaction. See this article on The Broker’s Dilemma from 2008, for the full issue at hand.
For a complete interpretation of the new regulation and the practical impact of it, please link to the article by Pete Swisher entitled, ‘What the DOL’s New 408b-2 Rule Means”.
If you are looking for a more concise view of the main differences between what the previously proposed rules were vs. the important changes, please see this Bulletin published by Fred Reish and Bruce Ashton of Reish & Reicher by clicking here.
Tuesday, July 13, 2010
Unified Trust in HR Magazine
Unified Trust's Founder and Chief Executive, Greg Kasten, is a board certified anesthesiologist. In the mid-1980s, he brought the doctor-patient mindset to the realm of investment management with the purpose of providing high level fiduciary services to individuals and plan participants. He and Unified Trust, were recently featured in an article by HR Magazine, entitled, "A Higher Standard of Care". Click here to view the article.
Thursday, July 1, 2010
IRS Is Auditing Retirement Plans Remotely (Sort of)
A quick client service tip, FYI:
On May 17, 2010, IRS sent questionnaires to 1200 plan sponsors. The questions cover the same ground IRS covers in an audit, but not comprehensively. If one of your clients receives one of the questionnaires, be aware of the following:
• This is not an audit, but it can lead to one.
• One risk to the sponsor is that an answer might lead to an audit, and once a plan is under audit it is no longer available for the self-correction or voluntary compliance programs (SCP and VCP, part of EPCRS, the Employee Plans Compliance Resolution System). They could be forced instead into Audit CAP, the penalties for which are much more serious. For this reason, it is best to treat the Questionnaire as an audit even though IRS says it’s not one.
• Clients will want help with these. If a Unified Trust client gets a questionnaire, we will complete it for them except for any information we do not have.
Here’s a link to the IRS overview of the project: http://www.irs.gov/retirement/article/0,,id=223440,00.html
Here also are some of IRS’s FAQ answers:
What is the 401(k) Compliance Check Questionnaire Project?
The 401(k) Compliance Check Questionnaire Project is a compliance check project being administered by the Employee Plans Compliance Unit (EPCU). This project is designed to be a comprehensive look into 401(k) plans to determine potential compliance issues, gain a better understanding of the reasons for noncompliance and determine any potential plan operational issues. This project will also assist us in developing additional education and outreach materials to improve future compliance and help us determine where best to focus our enforcement efforts.
Why was my plan selected?
The 1,200 plans selected to receive this compliance check were selected at random from 401(k) plans that filed a Form 5500 for the 2007 plan year.
Is this an audit?
This is a compliance check, which is neither an audit nor an investigation under IRC section 7605(b) nor an audit under section 530 of the Revenue Act of 1978. This is not a review of an organization’s books and records.
What is a compliance check?
A compliance check is a review by the IRS to determine adherence to certain compliance requirements under the Internal Revenue Code.
Am I required to respond to this compliance check?
Yes, a compliance check is an enforcement action which you must respond to. Failure to respond, or to provide complete information will result in further enforcement actions which may include an examination of your plan.
On May 17, 2010, IRS sent questionnaires to 1200 plan sponsors. The questions cover the same ground IRS covers in an audit, but not comprehensively. If one of your clients receives one of the questionnaires, be aware of the following:
• This is not an audit, but it can lead to one.
• One risk to the sponsor is that an answer might lead to an audit, and once a plan is under audit it is no longer available for the self-correction or voluntary compliance programs (SCP and VCP, part of EPCRS, the Employee Plans Compliance Resolution System). They could be forced instead into Audit CAP, the penalties for which are much more serious. For this reason, it is best to treat the Questionnaire as an audit even though IRS says it’s not one.
• Clients will want help with these. If a Unified Trust client gets a questionnaire, we will complete it for them except for any information we do not have.
Here’s a link to the IRS overview of the project: http://www.irs.gov/retirement/article/0,,id=223440,00.html
Here also are some of IRS’s FAQ answers:
What is the 401(k) Compliance Check Questionnaire Project?
The 401(k) Compliance Check Questionnaire Project is a compliance check project being administered by the Employee Plans Compliance Unit (EPCU). This project is designed to be a comprehensive look into 401(k) plans to determine potential compliance issues, gain a better understanding of the reasons for noncompliance and determine any potential plan operational issues. This project will also assist us in developing additional education and outreach materials to improve future compliance and help us determine where best to focus our enforcement efforts.
Why was my plan selected?
The 1,200 plans selected to receive this compliance check were selected at random from 401(k) plans that filed a Form 5500 for the 2007 plan year.
Is this an audit?
This is a compliance check, which is neither an audit nor an investigation under IRC section 7605(b) nor an audit under section 530 of the Revenue Act of 1978. This is not a review of an organization’s books and records.
What is a compliance check?
A compliance check is a review by the IRS to determine adherence to certain compliance requirements under the Internal Revenue Code.
Am I required to respond to this compliance check?
Yes, a compliance check is an enforcement action which you must respond to. Failure to respond, or to provide complete information will result in further enforcement actions which may include an examination of your plan.
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