One Market, Different Opportunities
“There’s a huge opportunity in the 403(b) market for advisers, especially due to the many market segments,” says Aaron Friedman, national tax-exempt practice leader at Principal Financial Group in Shelton, Connecticut.
“The 403(b) market is by far the market with the most opportunity for advisers,” agrees Carol A. Idone, vice president of Business Development at Strategic Benefit Services in Rensselaer, New York. “It’s not quite like shooting fish in a barrel, as it was when the 2007 rulings came out; advisers may have a bigger barrel, but there are still a lot of fish.” She points to lingering confusion among 403(b) plan sponsors about the Internal Revenue Service (IRS) regulations passed in 2007. Many plan sponsors do not understand fiduciary responsibilities and, once they do, are unsure how to act on them.
According to Idone, the two market segments with the best prospects are education—either K–12 or higher education—and health care. In the education market segment, many plan sponsors have had the same provider since starting their plans; they are behind in investment best practices, as well as technology. Advisers can now make a strong case that these sponsors need to upgrade their plans, she notes.
A challenge is that the education market has historically relied on a single retirement plan service provider; in fact, staying so long with this provider shows how loyal 403(b) plan sponsors can be, Idone says. A plan adviser can tell sponsors about the changes they need to make and help them do so while staying with that trusted provider. Advisers should realize that, if they do a good job and the provider continues to do a good job, the client will remain with them for 30 or 40 years, she says. “Hard work is a small price to pay for that.”
One critical area where advisers can help 403(b) plan sponsors is in paring back their plan investment choices. According to the 2014 Plan Sponsor Council of America (PSCA) 403(b) Plan Survey, 403(b) plan sponsors offered an average of 26 investment options in 2013, down from 31 in 2012 and edging closer to the average of 19 investment options in 401(k) plans. According to the fourth edition of the Higher Education Retirement Plan Survey from Cammack Retirement, while higher education plan sponsors continue to streamline investment lineups for their plans, 56% still offer 26 or more fund options, with 22% offering a staggering 100-plus.
“This is higher than a reasonable amount of choices for plan participants to make good decisions,” Friedman says. “It’s an opportunity for advisers to use their expertise to recommend smaller, more efficient options so participants are not overwhelmed by too much choice.”
Higher education 403(b) plan sponsors have not traditionally worked with advisers, according to Friedman, so they may be unaware of best practices in plan operation and design. He says many have not even done due diligence on their plans and investments; nor have they ever gone to market or carried out a provider search. If their 403(b) plan is governed by the Employee Retirement Income Security Act (ERISA), he says, never benchmarking the plan “is not exactly an ERISA best practice.”
Many—some would say most—403(b) plans are not considered ERISA plans. K–12 and public institutions of higher education have government plans, which will never be subject to ERISA’s reporting, funding and testing requirements. Church plans also are not governed by the act; however, they may elect to be ERISA plans if they choose.
For other market segments, a non-ERISA safe harbor was written into ERISA, stating that if employer involvement remains limited, the plans will not be subject to the requirements of the act. Limited employer involvement means, for example, that the sponsor is prohibited from making employer contributions to the plan, as well as from making discretionary decisions about participant withdrawals or loans. This was much easier in the old regime, where participants were able to set up accounts with vendors on their own; it is much harder to do now that the IRS requires adherence to statutory limits.
As for the health care market segment, Idone says that many
hospitals and their unions have hung onto defined benefit (DB) pension plans;
however, they are starting to freeze those plans and establish ERISA 403(b)s.
What does not make sense to her is that some hospitals have maintained a
voluntary, non-ERISA 403(b) plan alongside their defined benefit plans, and
they continue to offer these multi-vendor non-ERISA 403(b)s as well as the new
ERISA ones. At some point, Idone believes, the Department of Labor (DOL) will
rule to eliminate all non-ERISA 403(b)s
except government plans. Her advice to plan sponsors is to take the step to
move to an ERISA 403(b) while they still have control, instead of under a DOL
timeline. This opens the door for advisers to help health care 403(b) plan
sponsors, she says.
Unions are involved in dealing with health care plan sponsors, and unions will fight for more investment choice. However, if advisers know what they are doing and can explain why it makes sense to change the 403(b) plan and how to go through the process, it will be worth the effort.
Nonprofits in general—and small to midsized plans in particular—offer new possibilities for an adviser because, while they lag so far behind in plan design and administrative best practices, they still have many other priorities. And yet, Idone contends, they are ahead of some other market segments, notably health care and education plans.
Besides following in the footsteps of other 403(b) plans with over-inflated investment lineups, as Friedman previously mentioned, nonprofit 403(b) plan sponsors have been resistant to automatic plan features—creating an opening for advisers to educate them about the benefits of auto-enrollment and -escalation, he says. According to the 2014 PSCA 403(b) Plan Survey, only 16% of 403(b) plan sponsors automatically enroll employees into their plan, and only about one-fifth of those plan sponsors utilize automatic employee deferral increases. “Plan sponsors are concerned about retirement adequacy, and 403(b) plan sponsors have traditionally been more paternalistic than corporate 401(k) plan sponsors have, so I would think they would be more likely to adopt ‘auto’ features,” he says. “That connection between paternalism and automatic plan features can be a point advisers can make to plan sponsors.”
Individual Contracts
A complexity in 403(b)s not found in 401(k) plans creates yet another opening for advisers in the 403(b) market. There are many different contract structures written for 403(b) plans, Friedman notes. Both ERISA and non-ERISA plans may include individual annuity contracts for participants.
“From a plan sponsor perspective, they have no control over the funds in which the contracts are invested; that’s a huge challenge for ERISA fiduciaries,” Idone points out. Plan sponsors cannot force participants to get out of individual annuity contracts. She says she sees most 403(b) plan sponsors wanting to move to a platform that does not include individual annuity contracts. However, they are stymied by liquidity restrictions and the contracts’ individual—rather than group—nature.
Tim Walsh, head of investment services at TIAA-CREF in Boston, says different contracts have different liquidity features. But, for example, if a contract has a 10-year payout, a participant could transfer one-tenth of his fixed account balance per year to other investments offered in his 403(b) plan without incurring a fee for early surrender of assets in the contract, he says.
Idone advises plan sponsors to proceed with the process of trying to move the money so they may eventually have a plan that is free of lingering contracts. Again, she cites provider loyalty as the reason helping 403(b) plan sponsor clients get individual accounts transferred is worthwhile for advisers.
Individual contracts may also hinder 403(b) plan sponsors from adopting more plan design and administration best practices. For example, Friedman says, a plan should have one beneficiary designation per participant, but individual contract providers may reach out to participants separately to get beneficiary designations. A plan needs a process to ensure beneficiaries are appropriately tracked and to prevent conflict at the time of a participant’s death. According to Friedman, this is one area of complexity a plan adviser can point out to a plan sponsor.
Another issue advisers should inform plan sponsors about is the small-balance cash-out provision, Friedman notes. This provision allows plan sponsors to automatically distribute account balances of less than $1,000 or automatically roll over account balances between $1,000 and $5,000. If a participant has several individual annuity contracts totaling more than $5,000, but a provider that holds a balance of less than $1,000 cashes out the participant’s account, it is an ineligible distribution.
Finding Clients
Advisers who are successful with other plan types can be successful in the 403(b) market, Friedman says. They can help with plan governance processes and discussions, because 403(b)s can operate very similarly to 401(k)s. “With a few exceptions, advisers can be comfortable with their general knowledge.” He contends it is all about relationships; developing trust is key.
Many advisers maintain relationships with their alma mater, according to Friedman. “That may be the best place to start,” he says. They might also commence relationships with local universities and colleges, schools, charities and nonprofits. “Just start a conversation about how you can help them,” he suggests.
To find nonprofits in their geographic area of choice, advisers might look into Melissa Data, a provider of contact information, to search for nonprofits by zip code, Idone says. In addition, advisers may look for Form 5500 data on the DOL website. Form 5500 data can help advisers do their homework before they knock on a plan sponsor’s door or make the first call, she says. They can learn how long a plan sponsor has been with its current provider, the plan’s participation rate and the investments in the plan. “The last thing an adviser wants to say is, ‘This will be a lot of work,’” she observes. “As long as the adviser says he can make the plan better and how he can do it, the plan sponsor will say, ‘Yeah, as long as it’s not a lot of work for me.’”
Idone also recommends looking at a nonprofit’s Form 990, filed with the IRS, to understand what the nonprofit does and to find out who sits on its board of directors.
Friedman adds that, unlike with a corporation, which may have a single decisionmaker who can make determinations quickly, decisions at nonprofits are made by boards, which often slows down the process. “This is one reason why relationships are so important,” he says.
Idone says, when she worked for a plan provider and would talk to advisers about 403(b)s, the first thing they thought about was K–12 school systems. “Advisers need to realize there’s a whole 403(b) world that is not K–12,” she says. “There’s a small percentage of advisers who focus on 403(b)s, and an even smaller one focusing on nonprofits. I want to go where no one else is.”