Advisers Can Wave Red Flags, Too

It’s well known that federal auditors look for red flags to target review efforts, but one service provider says retirement plan advisers should use them for better business planning.

It may seem counterintuitive, but red flags can actually be an attractive prospecting feature, Eric Ryles, managing director of Judy Diamond Associates, tells PLANADVISER. His firm recently examined about 550,000 401(k) plans and found striking similarities in the issues keeping advisers’ clients up at night.

For example, nearly a third of the plans show employer contributions that rank in the bottom 10%, based on the value of the employer contribution.

An adviser whose value-add is to drive down administration costs can use this data, Ryles says. “He can offer a cost-effective strategy for boosting the employer match and really increasing the attractiveness of the plan. That’s more effective than targeting happy, healthy plans.

“It goes without saying that you need to be ready to deliver what is promised,” Ryles adds.

The five most common tripwires are if the plan:

  • Falls in the bottom 10% for value of employer contributions (184,442 plans);
  • Shows high average account balances (109,287 plans);
  • Was recently terminated but still has large numbers of participants (68,222 plans);
  • Recently reduced employer contributions (63,694 plans); and
  • Previously issued corrective distributions (63,349 plans).

Plans that trigger these red flags typically make better sales prospects than those with a clean bill of health, Ryles says, adding that the firm’s Retirement Plan Prospector tool is one way for advisers to access Form 5500 data and start picking out these or other red flags. Benefits staff supervising troubled plans are more likely to seek change, he explains. It makes sense for advisers to focus on the segment and bring highly targeted solutions to address specific problems.

Plans with high average account balances can be an opportunity, Ryles says.

“You can come in and say, ‘I know you’re getting beat up on asset-based fees because of the high average account balances—let me talk to the participants about the pros and cons of rolling their assets into an IRA when they retire, and the other options they may have for exiting the plan,” Ryles says. “This is just an example. You want to demonstrate that you’re aware of the plan’s problems, and that you’re bringing the solution.”

The Judy Diamond report identified 17 unique triggers that can represent useful sales tips, Ryles says.

“There are some that are really interesting, but they’re not hugely prevalent,” he explains. “If the plan experienced a loss in the previous year due to fraud and dishonesty, for example, that’s a critical red flag. It’s a relatively small number of plans, but if you want to find a new plan client, find an HR director who lost money last year due to fraud.”

Data prospecting tools come into play here, Ryles says. Probably hundreds—not thousands—of the 550,000 plans suffer losses from fraud and dishonesty, so they will be hard to find. “That’s the value of this kind of tool,” he says.

Ryles says growth-oriented advisory firms should constantly seek ways to winnow potential prospects “to the maybe 10% that are seriously thinking about switching this year. If a plan has a score of 85 out of the 100 rating system we use, they’re not going to be ready to switch. But we can help you find the plans that score 50 or 40. Those should be the target.”

Large amounts of corrective distributions are another obvious red flag, Ryles says. A common reason for corrective distributions is that rank-and-file employees are not contributing enough, which causes problems with nondiscrimination testing.

“If the owner of a 10-person firm wants to max out his 401(k) this year, and if five or six of the employees aren’t participating in the plan, he probably won’t be able to do that and still pass the nondiscrimination requirements,” Ryles explains. In these cases, excess contributions are returned as a corrective distribution, often causing the business owner to become irritated with their plan's design and performance. 

“When this situation occurs, advisers can say to the HR director, ‘I see you’ve got a bunch of highly compensated executives that are angry. Their plan isn’t working like they want it too,’” Ryles says. “Let me show you my solution.”

Low participation is an added problem, he says. “Your pitch becomes, ‘I’m the 401(k) education guru, let me come in and give my seminar and your participation rate will go up, and next year, you’re CFO and the President can contribute the maximum amount no problem.”

Advisers may feel reluctant to adopt clients first identified through red flags, Ryles says, but satisfied clients are rarely going to switch providers. So it’s a matter of finding the right opportunities—where the adviser's skillset can make a difference.

“We look at these red flags more as a benchmark,” Ryles explains. “They tell us where a plan sits in the universe and how the adviser can contribute.”