From the inaugural issue of 401(k) Specialist magazine: It’s official, 401(k)s experienced net outflows for the first time, which means the rollover frenzy is about to hit. Kitces, Pfau and Finke sound off.
If you’re an independent advisor specializing in 401(k)s, the coming year could present a historic opportunity to capture rollovers—if you move quickly. The current wave of retiring baby boomers, combined with mounting regulatory pressure on broker-dealers who manage 401(k)s, could bring unprecedented rollover activity.
“I really do think it’s a watershed moment,” says Michael Kitces, MSFS, MTAX, CFP®, CLU, ChFC, RHU, REBC, CASL, partner and director of research for Pinnacle Advisory Group, in Columbia, Maryland. With large numbers of baby boomers retiring, Kitces notes that withdrawals from 401(k)s are now outpacing contributions, reversing a decades-old trend. “Aggregate 401(k) assets in total seem to have gone into a net decline that they may not necessarily recover from anytime soon. This is a really big structural issue when the whole pie for everybody in the aggregate might not be growing anymore.”
David Blanchett, head of retirement research for Morningstar Investment Management, says the shift to net outflows makes rollovers more important to 401(k) specialists.
“All of a sudden, what has been a growth business for you will likely only grow in the future, on average, if you’recapturing new business, not the actual plan contributions,” Blanchett says.
UNDERESTIMATING THE WAVE
Advisors have anticipated the boomer retirement wave for years, Kitces says, but they may have underestimated the implications.
For example, Cogent Reports finds that 51 percent of affluent investors with a balance in a former employer’s plan expect to move their money into a rollover IRA within the next 12 months. Additionally, Cerulli Associates finds that rollovers from 401(k)s to individual retirement accounts will likely exceed $450 billion by 2017.
Just when rollovers may be peaking, the Department of Labor has reintroduced its rule to require all financial professionals who give advice on retirement accounts to act in the best interest of their clients. Many brokers and advisors claim the added administrative and compliance costs of acting as fiduciaries would either force them to stop advising on 401(k)s or migrate most commission-based accounts to fee-based accounts and raise their fees prohibitively. Either way, RIAs could gain a significant competitive edge.
In May, a Supreme Court ruling added fuel to the fiduciary issue. In extending the time limit for 401(k) participants to sue their employer, California-based Edison International, the court reinforced standards that could require advisors to monitor plan investments more frequently, weeding them out when nearly identical funds are available at lower cost.
Not everyone, however, believes broker-dealers will concede lucrative 401(k) business easily. Some say broker-dealer objections to the DOL fiduciary rule are just a scare tactic. Others fear a powerful BD lobby could result in a watered-down fiduciary standard. Michael Finke, professor of personal financial planning at Texas Tech University, is among industry observers who think the brokerage community would adapt to the fiduciary environment quickly.
If that happens, the expected window for rollover opportunities could close on RIAs, at least partially.
Wade D. Pfau, Ph.D., CFA, a professor at The American College in Bryn Mawr, Pa., and a principal and director for McLean Asset Management, says if all retirement advisors suddenly become fiduciaries, RIAs might lose one of the key differentiators that already distinguish them from brokers.
EDUCATING ROLLOVER CLIENTS
For advisors who decide now is the time to pursue rollover business more aggressively, Pfau recommends preparing to educate new clients. “I think a lot of consumers don’t understand fees, because there’s an annualized expense ratio, but they don’t see that as a fee listed on their portfolio balance,” Pfau says. Rollover clients may even be unaware they’ve been paying fees. Be careful to explain how fees are collected in 401(k) plans and what the expense ratios of mutual funds are.
Similarly, many Investors may be under the illusion that a target date fund implicitly guarantees a return or that their past contribution rates were correctly set to help them reach their goals, Pfau says.
ANTICIPATING MORE SCRUTINY
Kitces believes many advisors dangerously underestimate potential impact of the DOL proposal on RIAs. Just because advisors meet the SEC’s definition and requirements of fiduciaries doesn’t mean they’ll meet the eventual DOL standards.
“I think it will particularly be challenging for firms that play both the 401(k) side and the rollover side,” Kitces says. “The 401(k) specialists that do 401(k) work and (have) a retirement role over individuals, I think, are going to face a new level of scrutiny that they’ve never had to deal with before, even if they were already an RIA,” Kitces says. “There are still RIAs that are getting uneven compensation from different types of strategies, and they’re going to have to justify that.”
Consider what would happen if you manage someone’s 401(k) plan and encourage that individual to roll the funds over to an IRA with a different fee structure, different investments, and potentially higher costs.
“You have a much higher burden on yourself to justify why it is actually appropriate to roll out of that 401(k) and over to the other side of the business,” Kitces says.
“I think this is where part-time 401(k) advisors can get into trouble because the rules are obviously less stringent in the wealth management space than the 401(k) space,” says Blanchett. But any retirement advisor would be wise to take pains with documentation in a high-scrutiny environment.
For example, says Blanchett, create an investment policy statement for the client and follow it carefully: “If you’re not doing what you say you’re going to be doing, it’s very easy grounds to be sued.”
According to Finke, “The defined contribution environment is one in which the plan sponsor has a fiduciary responsibility to employers, and very often, the investments that are offered within those plans can be very efficient.”
For example, a 2014 survey by New York-based professional services firm Towers Watson & Co. found that many employers are improving investment efficiency by adding index funds.
“There can be a lot of problems when employees roll over their assets into an IRA if they have less efficient investment options,” Finke says. “The question is always, ‘Can you defend that the recommended investment is in the best interest of a client?’ If there isn’t an option for an index fund, then that might be a little bit difficult to defend.”
“One weak spot for a lot of plan sponsors is the target date,” says Blanchett, noting that target date funds make up a huge share of 401(k) assets. “So, what is the plan sponsor doing actually to select that target date?”
Advisors should understand the subtle but important differences between various target date funds, and be able to justify why the one they choose is right for the client, Blanchett says.
Paula Friedman, CFP®, AIF®, managing director of encore401(k), says operational failures—late payroll deposits, not following a plan document correctly, not making sure people know they’re eligible to enroll—may incur penalties and will likely trigger a DOL audit faster than the need to replace an investment option.
MARKETING YOUR STRENGTHS
Elissa Buie, CFP, CEO of Yeske Buie, with offices in San Francisco and Vienna, Virginia, believes many brokerage firms, faced with the prospects of raising fees and meeting fiduciary responsibilities, will opt out of the 401(k) business. She suggests that RIAs hoping to capture more rollovers should scout companies that are primed for massive layoffs or that have older workforces nearing retirement. “Tell them you can handle their rollovers and offer financial planning advice, as well,” she says. “I think you’d get a lot of takers.”
For decades, workers have been prodded to save for retirement, with less attention given to reservation and disbursement, Buie says.
“Having a very structured methodology for how you’re going to help (clients) manage the spending of their money in a sustainable way, in a tax-advantaged way as possible—that would be the way I think to market to people retiring and who have large 401(k)s or some combination of a large 401(k) and large IRA.”
San Francisco-based RIA Personal Capital runs radio spots, offering to analyze listeners’ 401(k)s for hidden fees they may be paying on existing brokerage accounts.
Company spokesperson Kate Cichy says the radio messages don’t specifically target rollovers but are “especially timely given the regulations that are happening,” such as the DOL proposal.
“Clients want to know that who’s helping them is a specialist, (who will) understand their needs,” adds Blanchett. He believes it’s a good time for advisors to continue their education and seek specialized professional designations.
Kitces notes that several new retirement-related credentials have sprung up in recent years, including The American College’s Retirement Income Certified Professional designation, which has quickly become one of the fastest growing in the institution’s history.
KEEPING EXISTING 401(k) BUSINESS
Along with capturing new rollovers, it’s important not to let existing 401(k) clients escape unnecessarily. Friedman says she’s seen a recent increase in the number of retirees closing their 401(k)s and rolling the funds over to IRAs. Because encore401(k) is a division of McLean Asset Management, there is an opportunity—but no guarantee—to keep those funds under the firm’s umbrella. One of her retiring 401(k) clients was ready to roll over his $5 million until she explained that the “new” investments he wanted were actually available in his 401(k), and at a lower aggregate cost.
WHAT’S NEXT?
DOL has scheduled public hearings on its fiduciary proposal in August, after which the rule will be referred back to the Employee Benefits Security Administration for final determination.
According to Pfau, the U.S. Department of the Treasury has been moving in the direction of making it easier for annuities to become part of 401(k) offerings, such as allowing a deferred income annuity to become part of a target date fund. That would pool some of the longevity and market risk of investments the way defined benefit pension plans do. He says he’s been working with the Stanford Center on Longevity about helping employers adopt basic retirement income strategies and spending strategies for investments.
Kitces says the Treasury’s myRA program could have game-changing implications for the 401(k) industry, especially now that some states are developing similar plans for automatic-enrollment retirement accounts.
The myRA, which caps each account balance at $15,000, targets low- and middle-income earners—historically not big 401(k) investors.
“But if there’s one thing we’ve learned from the past 10 years since the Pension Protection Act, it’s that creating automatic enrollment systems can quickly move huge amounts of dollars,” Kitces says. “At a minimum, these could quickly become very large plans and very large players in the overall retirement plan space.”
Perhaps one day, employers will seek to scrap their 401(k) plans and drive employees to the state or federal programs.
“That doesn’t necessarily shrink retirement dollars in the aggregate, but it’s a potentially big shift from using 401(k) plans to using state-based plans instead, and if you’re a 401(k) specialist, that’s a big deal,” Kitces says.
Kitces believes advisors must educate themselves better if they hope to adapt to the changing times.
“I think there’s a huge hunger right now for getting better at retirement income strategies because if you want to win the retirement rollover market, that’s what you have to do,” he says. “All the things we’ve learned as advisors about accumulation isn’t enough. You really need to learn the rollover space.”
Lance Ritchlin is former editor of the Journal of Financial Planning, and now a freelance writer and marketing consultant.
With more than 20 years serving financial markets, John Sullivan is the former editor-in-chief of Investment Advisor magazine and retirement editor of ThinkAdvisor.com. Sullivan is also the former editor of Boomer Market Advisor and Bank Advisor magazines, and has a background in the insurance and investment industries in addition to his journalism roots.
