For investment advisors to 401(k) plans, it’s a tumultuous time. Some 70 million Americans will hit retirement age over the next two decades, whipping the 401(k) advice business into a competitive frenzy over management of those assets. Meanwhile, the U.S. Department of Labor is about to reintroduce stiffer rules that, if adopted, would require advisors to ERISA plans only to provide advice that is in the best interest of plan sponsors and participants, no longer permitting financial advisors to sell products that are merely suitable for clients in favor of an ethical standard requiring ERISA-plan investment advisors to show no self-interest in their advice. At the same time, companies like BrightScope have kicked off a mania for rating and benchmarking 401(k) plans against their peers.
In a sign of the times, a recent documentary on PBS’s Frontline, “The Retirement Gamble,” exposed a dark side of the qualified retirement plan business. All ERISA investment advisors should see the program.
Frontline correspondent Martin Smith recounts how, beginning in the early 1980s, the responsibility for financing the retirement of 70% of Americans was transitioned from corporate-sponsored defined benefit plans that provided lifetime-guaranteed pensions over to defined-contribution plans that made individuals—instead of corporations—responsible for retirement funding. As the transition unfolded over the 1980s and 1990s, medical advances lengthened the lifespan of Americans, raising raised the cost of retirement at a time when medical costs were soaring.
Vanguard Funds’ John Bogle (24 minutes into the video) displays a chart showing the retirement outcome of a plan participant investing in a mutual fund for 50 years at a 7% return with 2% annual fees. Because of the magic of compounding, the effective return of 5% annually nets him only one-third of what he would have accumulated at a 7% annual return.
“Do you really want to invest in a system where you put up 100% of the capital as fund shareholder, you take 100% of the risk, and you get 30% of the return?” says Bogle.
Fund-company record-keepers, accountants, investment advisors, and financial advisors are called out in the documentary for sapping the retirement savings of Americans, and Wall Street executives are asked about the wisdom of selling plans packed with actively managed funds that charge high fees instead of index funds.
“Money managers always want more and that’s natural enough for most businesses,” says Bogle, “but it’s not right for this business.”
With the fiduciary standard likely soon to be applied to ERISA-plan investment advisors, fees under scrutiny, the rules of the 401(k) business are likely to be drastically altered soon. So Tom Kmak should be a great guest speaker at tomorrow’s A4A webinar.
Kmak is the founder of Fiduciary Benchmarks (FB), which helps IAs optimize 401(k) plans. Before founding FB, Kmak started JPMorgan Retirement Plan Services in 1990. When he left in 2007, his business unit employed 1,100 and served 200 large plan sponsors with 1.5 million participants and more than $115 billion in assets. FB makes software allowing advisors to benchmark plans using a patented system and that enables you to simulate “what ifs” at the plan level as well as the participant level.
Kmak says any ERISA-plan benchmarking service based on a Form 5500 is flawed. The data that can be gleaned from the disclosure form, he says, is inadequate to benchmark a plan with any accuracy. For example, Kmak says he was with a large media company earlier this week that had measured its participant rate at 90%, but one of the many benchmarking services using data from the Form 5500 estimated its participation rate at 60%. According to Kmak, services that rely on the Form 5500, which includes BrightScope, Judy Diamond Associates, and AdvisorLab are not used by plan sponsors or consultants to benchmark plan performance and fees.
Kmak knows that he can’t turn the webinar into a commercial for his software, but it has a capability that I’ve asked him to demonstrate. To optimize a plan, you need a dashboard that globally controls seven key variables. For example, if you want to show a plan sponsor how changing the employer-match, auto-enrollment rate, and other key variables is expected to affect the plan, Kmak’s software enables such simulations, and it optimizes for the best projected outcome for participants.
FB’s is also the distributor of software that optimizes for retirement readiness across different 401(K) plans. While plans usually have tools optimizing for retirement readiness, the calculations for retirement readiness from one plan to the next can differ significantly. By applying the same calculation of retirement readiness across all the plans you advise, you’ll be able to make recommendations based on data normalized across the plans. Plus, you won’t have to learn myriad retirement readiness apps used by different record-keepers; you only need to learn one piece of software.
Kmak has strong views on benchmarking services that rate plans versus their peers. He says comparing one plan to another is not very important. The best 401(k) benchmark is retirement readiness—a measure of how effective a plan is at readying participants for retirement.
In a tumltuous time for investment advisors to 401(k)s, Kmak understands the business about well as anyone I know. He should be a good speaker, Friday at 4 ET. To attend A4A webinars and access replays and CE credit 24/7, please join A4A. ($60 annually).
Do you rely on 401(k) benchmarking services basing ratings on Form 5500? Do peer-rating of 401(k)s matter to you? And what do you think of Frontline coverage? Please let me know what you think.