Thinking Small

The economics of working with small 401(k) plans can be tough for plan advisers. “It has been a very challenging market for us,” says Troy Hammond, president and CEO of Pensionmark Retirement Group, headquartered in Santa Barbara, California. “From a plan sponsor perspective, the people managing the plans are wearing multiple hats. Often you end up doing more work on those plans because those plan sponsors are stretched so thin.”

Pensionmark did not want to make working with small plans economically feasible by offering them lesser services than it gives to large plans, Hammond says. The advisory firm faced a choice: Either charge a lot for working with these plans or charge lower fees, operate at a loss and wait for the plans to grow to the point where they become profitable, he says.

 Instead, the company took a new approach. In July, it announced the Retirement Plan Exchange, a new offering for small plans—from startups to those with $7 million in assets—that provides cost-effective fiduciary support and retirement outsourcing. All plans that use the Retirement Plan Exchange will have the same investment lineup, for instance. There will be one master trust, but each individual plan remains a separate entity. These are not multiple-employer plans, Hammond explains.

 Two-thirds (66.6%) of “micro” plans, which have assets of less than $5 million, utilize a financial adviser, according to the 2012 PLANSPONSOR Defined Contribution (DC) Survey. “Right around the $5 million mark, we are definitely seeing more and more retirement specialist advisers,” says Julia Bates, head of individual and business retirement at J.P. Morgan Asset Management in New York. “As companies set up plans and they’re growing, they bring more complexity, and the sponsors need help. Plan sponsors in this space still have significant fiduciary responsibility and risk, and need increased support.”

Adviser Thomas Ming started working with small plans that have less than $10 million in assets in 2004. “To me, the smaller-plan market is so much more rewarding because you get to do so much more—such as more one-on-one employee meetings—than with Fortune 500 plans, where it is auto-everything and [includes] 1-800 numbers for participants,” says Ming, who is president of Tower Rock Advisors Inc. in Bakersfield, California. “It is more work, but in the small-plan market, an adviser can make a bigger difference.”

Three Ways You Can Help

Sources point to three main areas where small-plan sponsors currently need the most help from advisers:

1) Plan nuts and bolts. The 401(k) knowledge level of these plan sponsors may not differ much from that of average participants, Ming says. “There is much more education on what they need to do as a plan sponsor and what their obligations are,” he says. “They don’t understand the complexities of the plan. We let them know, ‘These are the [legal] obligations that you have, and these are the dangers of not meeting those obligations.’”

That need for understanding has only gotten more pressing. “Retirement plans have become simpler for participants and more complicated for plan sponsors,” says Steve Davis, national sales manager at Guardian Retirement Solutions in New York. Sponsors want help with things such as making sure required disclosures get made and keeping up with regulatory developments.

Most sponsors of plans at smaller employers “are looking for the basics of plan support,” says Linda York, director of syndicated research for Cogent Research. When asked what drives their loyalty to an adviser, micro-plan sponsors most often cite plan support, according to “Retirement Planscape,” a report released in April by the firm, which is a unit of Market Strategies International, in Cambridge, Massachusetts.

2) Understanding fees. Fee disclosure has given sponsors both more information about costs and more responsibility for ensuring their reasonableness. In the small-plan market, costs still vary “extremely” widely, Hammond says. “While the prices do vary in the small-plan market, it is not uncommon to see all-in costs of 2.5% to 3%,” he says, adding that this happens most frequently with plans that have less than $1 million in assets.

The small end of the market “has seen a lot of pricing inefficiency” in the past, agrees Phil Chisholm, vice president of product management at Fidelity Investments in Smithfield, Rhode Island. “Today, that range is still pretty wide.”

When Cogent asked “Retirement Planscape” responders about understanding plan fees, only 35% of sponsors at plans with less than $5 million in assets felt they understood their plan’s fees very well, versus 87% of sponsors at plans with $500 million and more in assets. “Mega-plan sponsors historically have a lot more resources available to them, such as a consultant who benchmarks fees,” York says. “The micro-plan sponsors are much less comfortable about their understanding of the fees for the plan administrator and the investment options.”

Once small-plan sponsors delve into the subject, Ming says, they will find that fee disclosure has brought a compression of fees. “Small plans definitely have more options now, and fee disclosure has caused that,” he says. The $1 million point in plan assets “is when you start to see that plans have the opportunity to improve overall plan fees.” These plans have more share classes available to reduce investment expenses, and as plans grow they also get more access to specialist retirement plan advisers who can provide services “at a more reasonable rate,” he says. As an example of fee savings, Ming cites a long-time prospective 401(k) client with $6 million in assets and total fees—including recordkeeping, advisory and average investment expenses—of about 2.3%. “We were able to secure that relationship during fall 2012, after the initial fee disclosure was received by the plan sponsor, and save this client more than 40% in fees by benchmarking the plan and moving the plan assets to another provider,” he says.

3) Plan benchmarking. Small-plan sponsors typically do not initiate this measurement of success, Ming says. “The adviser has to bring it to them—they’re not asking for it,” he adds. “That’s value that the adviser can bring, to say, ‘This is where your plan needs to be, and we are going to track it.’”

These sponsors need help with understanding key elements such as the reasons for a plan’s current participation rate. “It creates an opportunity for sponsors to explore other services that they might have been resistant to,” says Chisholm. Automatic enrollment, automatic contribution escalation and the use of a Roth feature may be a few possibilities.

Smaller employers can usually implement plan changes quickly because they have fewer decisionmakers on their plan committees, says Bates. “At the same time, they tend to not want to be leading-edge,” she says. “They may not even be aware of emerging trends such as re-enrollment. They don’t live and breathe this every day, so they take their time to get up to speed.”

Finding the Right Business Model

In order to work with small plans, advisers need the right business model. These plans can cost advisers the most to serve, says Hammond, because the sponsors often want lots of help. “If you’re not disciplined and efficient and streamlined, it is going to get away from you,” he says. “You are going to look at your book of business and say, ‘We’re losing money on every plan under $1 million in assets.’”

Advisers who serve small plans need processes for areas such as reviewing the investment menu, plan design and providers, says Tom Donnelly, vice president of distribution at Principal Financial Group in Des Moines, Iowa. That could mean the lead adviser referring routine sponsor questions to a staff member rather than personally answering them, for instance, or the adviser might rely on the plan provider’s local staff to do enrollment meetings.

Advisers working with small plans have to stay disciplined, Donnelly agrees. “Do what you say, and when you say you’ll do it,” he says. The service agreement should specify upfront when the adviser will come to the sponsor’s office for a review, for example. “Don’t drive out there every time the employer has a general question,” he says. “It just wrecks the profitability of working with these plans.”

Pensionmark’s Hammond has thought through the efficiency issue. With its Retirement Plan Exchange, Pensionmark serves as the 3(38) fiduciary investment manager, but also has partnered with TAG Resources LLC as the outside 3(16) plan administrator fiduciary and 3(21) investment fiduciary; Sunwest Pensions acts as the third-party administrator (TPA), collecting payroll data and filing Form 5500s; and Transamerica Retirement Solutions serves as recordkeeper.

“It makes a lot more sense for us,” Hammond says. “Not only are we building efficiency and outsourcing on the plan sponsor side, we did it on our side as well. So the cost of us delivering the services drops dramatically, and we can come in at a reasonable cost.”

Employers still get to make some key decisions individually, he says, such as whether they want to offer a match and automatically enroll their employees. But sponsors that opt for the Retirement Plan Exchange “are outsourcing a lot of the functions that they otherwise would have to worry about,” Hammond says. “With that, they lose some control.”

Doing Fee-based Work

While fee-based advisory work has become common in the large-plan market, paying those fees can be a tougher issue at small employers, says Doug Dannemiller, principal at Dannemiller Analytics & Consulting LLC in Duxbury, Massachusetts. “In fee-based plans, it often falls to the sponsor, which is not always the preferred method in small plans,” he says. “With plans that use fund expenses to cover fees, the participants cover many costs—not the plan sponsor.” Asked if that will impact acceptance of fee-based advisers in the small-plan market, he says, “It is certainly a factor that will slow it down.”

The small-plan market has not yet seen as much demand for fee-based advisory work, Davis says. “On a fee basis, the minimum billable fee may be $10,000 a year,” he says. “If you have $1 million of assets in a plan, you’re not going to pay an adviser $10,000 a year.”

Ming has had success with a fee-based approach, however. A fee-based adviser can get paid in one of two ways, he says: invoice a plan sponsor that then writes a check to cover the fees, or invoice the plan provider that then pays the fee and charges participants in turn. He handles it the second way, a method that is more common in the small-plan market, he says. Participants pay a pro rata share of his fee based on their plan assets.