Branching Out
Advisers who specialize in 401(k) plans have a wealth of opportunities related to the retirement plan space for those hoping to diversify their practices. Three of the hot items seen this year are: retirement income products and services, cash balance defined benefit plans, and 403(b) programs.
The impending retirement of the Baby Boomers is offering potential distribution of trillions of dollars, according to various reports. Advisers can be in the forefront of helping participants with their distribution decision, as well as helping plan sponsors decide whether they want to be involved in aiding the employees in this area.
On the plan design side, the Pension Protection Act (PPA), a landmark U.S. Supreme Court ruling, and new Internal Revenue Service regulations have presented potential additional business opportunities for retirement plan advisers.
The PPA’s declaration that new cash balance plans are legal under the Employee Retirement Income Security Act (ERISA), followed by the U.S. Supreme Court’s refusal to overturn a 2006 7th U.S. Circuit Court of Appeals decision that IBM’s switch to a cash balance pension plan did not discriminate against older workers, has opened the door for plan sponsors to contemplate offering a new cash balance solution, or switching their defined benefit plans to a cash balance design. Further, in 2007, the IRS put in place new 403(b) plan regulations that will require more organization and plan sponsor involvement for these plans.
What should advisers consider when deciding whether to expand their businesses into these markets?
The End in Mind: What are the latest developments in retirement income?
As millions of Baby Boomers enter the retirement phase of their lives, the industry focus has shifted from savings accumulation to distribution strategies. This presents an opportunity for advisers to expand their businesses into the retirement income market. A panel of experts discussed the emerging tools and trends available to advisers and plan sponsors.
Thomas V. Bruns, Divisional Vice President, John Hancock Retirement Plan Services, noted that retirement income solutions are most appealing to participants within 10 years of retirement. However, he said the products, with their guaranteed benefits, also can benefit younger employees who are very risk-averse, and that the guaranteed retirement income solutions are also equally beneficial investments for highly compensated and non-highly compensated employees.
Bruns said John Hancock has developed a product to address three primary risks for retirees—outliving money, market volatility, and inflation—by taking some pieces from variable annuity products and putting them together, creating the opportunity for participants to sign up and lock in an account value at a specific point of their accumulation phase (see “The Inside Story,” September-October 2008). While most of today’s retirement income solutions are in the form of group annuities, Bruns contended that asset allocated funds that evolve into retirement income funds are the best working solution for open architecture platforms.
James A. Lyday, Senior Vice President at Prudential Retirement, said the problem with an asset allocation fund solution, even those that have guarantees built in, is benchmarking. It is difficult to set a guarantee on funds when it is not known exactly how they will perform in the future. However, noting that automatic enrollment and asset allocated funds as default investments have gained a legislative seal of approval in the PPA, he adds that it is “not a far stretch to envision regulation on plans forcing participants into retirement income solutions.”
The retirement income market is split into two schools of thought: product distribution and financial planning process, according to Jack Gardner, Managing Director, National Sales Director, Thornburg Investment Management. He suggested that, for advisers to be successful in the retirement income marketplace, they should talk about process first, then products. Advisers who do that, he predicted, will win a big amount of the $2 trillion in play by consolidating all accounts for a participant under their domain.
Gardner said advisers should become better educated on retirement income trends and products to promote themselves as experts in the market. He recommended that advisers serious about entering the retirement income market read two books: Retirement Income Redesigned—Master Plans for Distribution, edited by Harold Evensky and Deena Katz, and Conserving Client Portfolios in Retirement, by William P. Bengen.
Bruns noted that vendors can train advisers about products, and broker/dealers that package money can train them about processes.
Lyday predicted that it will be a while before the market sees evolution in retirement income solutions. He questioned whether health care and long-term care solutions will be rolled into retirement income products. In the future, Lyday predicted, the market focus will be on simplifying retirement income solutions to match participant understanding. He said there are still not nearly enough products to address the retirement income issue.
For the nonqualified plan market, Kristine Kopsiaftis, Executive Benefits Consultant at The Phoenix Companies, said retirement income solutions will not evolve to the same degree as with qualified plans because sponsors of those plans have different options for providing retirement income, such as adding into the corporate-owned life insurance policies that cover nonqualified plan participants.
Kopsiaftis said Phoenix Companies works with advisers to help them talk to clients about total retirement solutions for senior executives so they can accumulate distribution options as well as plan design options that will meet executive retirement income needs.
Balancing Act: Cash balance plans, having been given a new impetus by the PPA, can offer a design solution providing larger tax deductions and accelerated savings
Cash balance plans, a type of defined benefit plan with some of the characteristics of a defined contribution (DC) plan, have seen significant growth over the past couple of years. Although the plan sponsor is still responsible for making contributions to the plan based on actuarial assumptions, and is required to make up any shortfall from investments relative to the promised benefits, the plans do offer individual account balances for plan participants—and that can help participants appreciate the benefits (see “Best of Both Worlds,” September-October 2008).
Timothy Halls, Principal, Moneta Group, said advisers should educate themselves enough about cash balance plans to be able to discuss the option with clients. Cash balance plans can be lucrative for certain individuals as far as tax advantages, he said—one reason these are principal-focused plans.
Cash balance plans are “particularly potent” with partnerships and small-business owners, but a traditional defined benefit plan is more advantageous if there is only one participant, explained Ken Guidroz, Director New Plan Design at consulting firm Kravitz. The three qualities of firms that are good prospects for cash balance plans, according to Guidroz, include: having high earners making $300,000 or more, maintaining consistent company profits, and currently making significant DC plan contributions. Cash balance plans are seen mostly as less expensive for participants and sponsors than traditional plans, he added. The age-neutral benefit could reduce costs for sponsors depending on participant demographics; the fact that the plan could be funded out of retained earnings is also a selling point. He also added that clients should be told cash balance plans can be amended and can be frozen.
Halls added that contributions can be split between a cash balance plan and the client’s DC plan. He noted that cash balance plans often are integrated with other plans, so advisers should make sure clients are willing to change provisions of their other plans before adopting a cash balance design.
Keith J. Gredys, JD, CEO and COO, Kidder Benefits Consultants, Inc., an NRP member firm, said advisers can address flexibility concerns of plan sponsor clients by showing them how flexibility can be built into the plan design. As an example, he said, sponsors can specify contributions as a percentage of earned income and, if they want to make a smaller contribution, they can claim less earned income.
Halls also suggested that advisers wanting to expand into the cash balance business should partner with experts. The partner should have the technology to handle cash balance plans, but also should be able to handle relationship issues, such as with participants, that may come up.
(b) Prepared: Getting down to business with the new 403(b) regulations
The regulations put forth by the IRS in 2007 requiring more stringent administration of 403(b) plans seem likely to revolutionize these plans, and that is causing many sponsors of such plans to seek help from expert advisers with a whole new urgency. For advisers, there are actually several distinct segments of this market to focus on: public school districts, 501(c)(3) charitable and educational institutions, and church plans; each has unique attributes.
The requirement that all 403(b) plans have a written plan document in place by January 1, 2009, and that participant transactions be monitored to ensure plan limits on things like loans and withdrawals are being adhered to, means that plan sponsors are seeking help on plan design and the mechanics of paring a multitude of vendors down to several or, perhaps, as few as one. David Ray, VP National Practice Leader, Diversified Investment Advisors, said advisers can add value to sponsors by their knowledge of the vendor search and fiduciary processes, providing participant education, benchmarking investments, and helping sponsors know what they already have. Ray contended that all this is more important than an adviser’s knowledge of 403(b)s.
According to Chad Larsen, President, Moreton Retirement Partners, an NRP member firm, advisers can position themselves as selling sponsors the opportunity to do something good for participants and the ability to help them streamline their plans to take away their “overwhelming” feelings about compliance. William Beale, Managing Partner, Henderson Brothers Retirement, added that advisers can sell the single-vendor idea to sponsors by comparing their plans with group medical plans. Since it is cheaper to have a group plan for medical benefits, why wouldn’t the same be true for retirement benefits?
Beale suggested that, because many tax-exempt entities are very political, advisers should start their selling with business managers. For school districts, advisers generally must convince the district superintendent and union representatives that they can add value to their members, because school board approval must be obtained to move forward with any 403(b) program changes.
As with cash balance plans, it is important for advisers getting into the 403(b) business to partner with the right providers or vendors. Larsen suggested advisers look for vendors that focus on the market segment clients fit into. Other than that, partners should have the same qualifications in technology, tools, and relationships as 401(k) partners.
Illustration by Christian Northeast