Horse to Water

Transitioning to a fee-based model can present obstacles for small-plan advisers, notes Jim Sampson, managing principal at Cornerstone Retirement Advisors LLC, who says he discovered issues with recordkeepers and plan sponsors when moving his plan clients to a fee-based model from a traditional commission-based approach. Cornerstone’s book of business is now half fee-based and half commission-based, with all new business operating with fees.

Cornerstone is not alone in its transition to a fee-based model—advisers, as a whole, seem to be making the switch. In 2010, 52% of advisers were fee-based and just 11% were commission-only, according to a March 2011 report by Cerulli Associates.

In the retirement plan industry, however, much of that movement to fee-based service models is happening up-market, not in the micro-plan space.

For Sampson, whose target market is plans with assets between $2 million and $10 million, one issue when making the switch to a fee-based model was platforms, because of their different thresholds. Some platforms were unable to convert plans under $5 million to a fee-based arrangement, while others had a threshold of $1 million. Luckily, he has found a few platforms that offer the needed flexibility.

“The platforms out there are definitely getting better, but there’s still a lot of improvement to go,” Sampson says.

Recordkeepers have many reasons for keeping small plans in a commission-based system, he says. For some, their group annuity contracts require that commission be paid to a broker/dealer and do not recognize registered investment advisers (RIAs). 

It can also be a systems issue. Recordkeepers must be able to segregate the assets from the participants’ accounts, to facilitate the payment. “Not [all recordkeepers’] systems are set up for that in the small market, and they don’t want to invest the required capital to change their systems,” Sampson says. “I also think it’s partly the lack of demand. There aren’t a lot of advisers that operate in the small market that are fee-based advisers. That marketplace is mostly commissioned brokers, so [recordkeepers] cater to the audience.”

Plan Sponsor Indifference 

Companies in the small-plan market often consider retirement plans of low importance and see little value in paying for a service their employees can pay for. “[Retirement is] really at the bottom of the priority list, even though it might be at the top of the liability list,” Sampson says.

He explains to resistant plan sponsors that a fee-based model can provide tax benefits: Sponsors receive a tax deduction on the services they pay for, which has a positive impact on employees, who will be paying less as a result. “Any expense of the retirement plan that is paid by the employer/corporation is a tax-deductible expense, so if the employer uses a fee-based approach, [it has] the ability to pull expenses out of the plan and have the corporation pay them, which makes them deductible,” he says.

Plan sponsors can save money by switching to a ­fee-based arrangement, because they pay only for the cost of managing money, with recordkeeping and advisory service costs layered in. “By buying the items individually, there may be an opportunity to reduce costs,” Sampson says, adding that one of his clients saved 40 basis points after switching to a fee-based model. And moving to a fee-based advisory model frees the company from bearing the cost alone. For example, says Sampson, 20% of his fee-based clients write a check from the corporation and the other 80% have it deducted from the plan assets.

John Moynihan, president of Diversified Financial Advisors, says his company—which has an average plan size of about $1 million—switched to a fee-based model six years ago, with fees charged as a percentage of assets.

“We really wanted to get ahead of the curve and prove that we were providing services and the services we provided were essential,” he says.

For the most part, Moynihan says, plan sponsors have been receptive to this model. Only about 1% of Diversified Financial Advisors’ business is commission-based, which Moynihan says is because a few plan sponsors remain uncomfortable with switching to a fee-based model.

Fee-based advisers can also attract and retain clients, Sampson says. An outlined service model allows clients to feel more comfortable by helping them to better understand the services they are purchasing. When Diversified decided to make the switch, Moynihan explains, the key was educating sponsors and participants about the services and fees, and why these are justified.

Education is crucial to plan sponsors’ understanding that a fee-based model is cleaner from a fee disclosure standpoint, agrees Amanda Arthur, plan consultant at 401k Squared, which works with plan sizes averaging from $2 million to $6 million. “Nine times out of 10, they would rather go with a fee-based, because it’s clearer to them,” she says.

Advisers in the small-plan market should be ready to provide continued value and to inform plan sponsors of the advantages of a fee-based model. Many advisers in the small market are not in the fee-based mindset, Sampson says. Plan sponsors see itemized fees and services on their statements and expect to get their money’s worth, so advisers must justify those fees. One way to add value is through comprehensive employee education meetings and due diligence, notes Sampson.

Another benefit advisers can highlight is the elimination of conflict of interest. In a fee-based system, the adviser does not choose funds in his own interest, to make money, as he might in a commission-based model, Arthur says.

Moynihan says his clients find this refreshing. “Now I’m on your side of the fence because you’re paying me,” he says. “I represent you.”

When the 408(b)(2) and 404(a)(5) regulations go into effect on July 1 and August 30, respectively, Arthur says the conflict of interest in a commission-based model will diminish, because plan sponsors and participants can view the fees they pay. However, she thinks conflict of interest will always exist, to some extent, in a commission-based model, where advisers can earn more just because the plan size grows.

Win-Win

A fee-based model is a win-win because it allows advisers to make money while putting their clients’ best interests first. In a commission-based model, on the other hand, the vendor determines how much the adviser will get paid regardless of the service he provides, Moynihan says. “[Advisers] make more money in the fee-based model, and the plan sponsors do not necessarily pay more, but you’ve got to do more [as an adviser],” he adds.

Sampson agrees that advisers can make more money in a fee-based model, and not necessarily because they are charging more. “When you go fee-based, you can be a lot more flexible about what you offer, and you can get paid [for] what it is you’re actually doing,” he says. “I kind of look at it as earning a fee instead of collecting one.”