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Fiduciary Education Critical

Advisers must train sponsors, committees

As new fiduciary rules mushroom, retirement plan advisers must keep instilling the basics of fiduciary liability in plan sponsors and committee members.

Many plan sponsors and plan committee members do not realize they are fiduciaries, or they fail to fully appreciate a fiduciary’s personal liability, said Brian Lakkides, managing director for Fiduciary Plan Governance LLC, who serves the Greater Detroit area. Lakkides, along with other plan compliance experts, took a deep dive into fiduciary liability and education at the 2014 NAPA 401(k) Summit, hosted by the National Association of Plan Advisers (NAPA) in New Orleans this spring.

It will be important for advisers to track the impact of new fiduciary rules on contracts with service providers that may gain fiduciary liability under rule changes from the Department of Labor (DOL) and other regulatory groups. Equally critical is providing education for sponsor and plan committee clients about the basics of fiduciary liability and responsibility.

The DOL is considering expanding the definition of “fiduciary” to cover more types of service providers and advice relationships. Alongside other federal regulatory bodies such as the Securities and Exchange Commission (SEC), the DOL has expressed concern that converging business models and the widening use of technology may cause conflicts of interest not currently addressed by the Employee Retirement Income Security Act (ERISA) and other regulations.

While the pending rule changes have created endless speculation and discussion among advisers and broker/dealers (B/Ds), said Lakkides, corporate staff and executives are simply too busy with daily responsibilities to follow the matter closely. And many sponsors do not even fully understand existing service provider agreements that determine how their plans are run and what expenses are paid, let alone the minutiae of how new conflict of interest rules and prohibited transaction provisions might change those agreements.

Using statistics from Koski Research and Charles Schwab, Lakkides said that 30% of senior finance and human resources (HR) executives think their company’s 401(k) plan is free to administer. Nearly 70% of participants believe the same, he said.

“We’ve found that most plans in this still-distorted marketplace are paying 20% to 60% more than necessary, compared with plan services being priced using a fully transparent cost-plus methodology,” Lakkides explained. “It is part of the adviser’s value proposition to help cut down on those percentages.”

Lakkides said the problem stems in part from what he calls the “delegation fallacy.” This emerges from ERISA provisions that require plan fiduciaries who lack the expertise and capabilities necessary to carry out fiduciary duties to “engage experts who have the requisite skill, knowledge and experience needed by the plan.”

Many sponsors and other fiduciaries interpret these provisions to mean that, by outsourcing administrative work related to monitoring plan performance and expenses—as many decide to do—fiduciaries can outsource the related liability. This is simply untrue, Lakkides said, yet many sponsors believe they can turn completely away from daily plan administration once these functions have been outsourced.

“While you can outsource your responsibility for conducting certain functional elements of your fiduciary duty, you can never fully discharge the fundamental responsibility of ‘surveillance and oversight’ and the ‘avoidance of conflicts of interest,’” he said, “so you remain liable to a large extent for the services you outsource.”

This is true under all the most familiar fiduciary outsourcing arrangements, Lakkides said, such as 3(16), 3(21) and 3(38). These may help a sponsor reduce certain liabilities and should save substantial time and energy in compliance efforts, but the fundamental liability of surveillance and oversight remains, he said, adding that it is also critical for fiduciaries to understand co-liability provisions under ERISA, which can hold “innocent” fiduciaries liable for breaches by other named or unnamed fiduciaries.

Lakkides noted another common misunderstanding among plan sponsors: what the ERISA “prudent man” rule implies about the level of expertise required of fiduciaries. Many sponsors take this standard to mean that plan-related decisions must be made by someone as prudent as the average person. In other words, they must carefully consider the decision but are not necessarily expected to grasp all the factors or potential outcomes.

Again, not so, said Lakkides. ERISA’s prudence standard is not that of a prudent layperson but rather of a prudent individual who deals frequently with retirement plan matters. The bottom line: Plan trustees and committee members must be as prudent as the average fiduciary expert—not the average person.

—John Manganaro

Elective Deferred Comp

Many sponsors permit execs to select when to pay taxes

When it comes to executive retirement arrangements, a recent study reveals a continued emphasis by U.S. companies on elective deferred compensation.

Towers Watson finds that such arrangements allow executives to control the timing of the taxation of incentive payouts and are therefore seen as a critical component of the overall executive wealth accumulation opportunity.

“Executive Retirement Benefits: Recent Actions and Design Considerations,” which studied executive retirement practices during 2013, examines the design and prevalence of nonqualified retirement plans in U.S. organizations. Topics covered include the types of plans offered, the level of benefits provided to a typical executive and the prevalence of key benefit provisions.

Although the percentage of U.S. employers that sponsor nonqualified defined benefit retirement plans (NQDBs) continues to decline—reflecting the closing or freezing of many broad-based defined benefit (DB) plans—most of the organizations queried for the study (71%) continue to provide some type of employer-paid arrangement. This includes NQDBs and nonqualified defined contribution (DC) plans. On average, these plans deliver an additional 5% to 7% of earnings in annual retirement income to the typical mid-level executive.

The study finds that, for 2013, the majority of organizations (72%) also provided elective deferral arrangements (EDAs) without any employer matching contributions. While the percentage of organizations offering EDAs has declined slightly in recent years, these plans remain the most prevalent type of nonqualified retirement arrangement.

According to the study, these plans are taking on added importance for many high-level workers, and many organizations are putting more emphasis on communicating to their executives that the EDA is a significant part of their long-term capital accumulation opportunity. However, Towers Watson notes, proposed tax reforms submitted recently to Congress could decrease the tax advantages of nonqualified deferred compensation (NQDC) programs. Other findings include the following:

• About half of the organizations that continue to sponsor employer-paid nonqualified plans (defined benefit or defined contribution) offer “pure restoration” benefits only—i.e., the minimum level of benefits necessary to restore any lost due to the placing of statutory limits on benefit levels or on the amount of pay that can be considered in benefit formulas. True supplemental executive retirement plans, which provide benefits in excess of pure restoration, continue to be more prevalent among organizations that sponsor NQDB plans;
• Nonqualified defined benefit plans are more likely to include annual incentive compensation in determining benefits than are nonqualified defined contribution plans in calculating employer contributions;
• While most nonqualified retirement plans cover broad groups of executives, 20% of the organizations studied provide supplemental individual retirement benefit arrangements for one or more of the named executive officers. These one-off arrangements are generally designed to compensate mid-career hires for any loss in benefit value due to their change in employment;
• In terms of income replacement, the median level of retirement benefits (from qualified and nonqualified plans as well as Social Security) provided for an average mid-level executive is 30% of total cash earnings at age 62 and 37% at age 65; and
• Although there is no requirement to disclose whether and how nonqualified plans are funded, data from the study show that 17% of organizations with NQDB plans and 23% of those with nonqualified defined contribution plans use some type of funding vehicle to secure their nonqualified retirement plan arrangements. The most commonly disclosed funding vehicle is a “rabbi” (or grantor) trust. Although the publicly disclosed data is limited, the study suggests that company interest in funding nonqualified liabilities continues to be high.

 —Kevin McGuinness

Compensation at 7-Year High

The average adviser earns $240,000

The seventh release of the “Adviser Insights” study from Fidelity Investments indicates that financial advisers are enjoying the highest levels of compensation and assets under management (AUM) since 2007.

According to the study, 95% of advisers grew their books of business in the last 12 months. With average AUM at $62 million and average compensation at $240,000, advisers seem to be enjoying strong near-term success. However, the study finds, many advisers overlook several important steps that could help to ensure that growth will continue in the long term, as follows:

• Two-thirds of advisers surveyed for the report have no multi-year growth plan in place, and nearly half have yet to set formal career goals for themselves. Fidelity warns that achieving meaningful, lasting gains in AUM and compensation requires a formal vision of where an adviser wants to be long term, as well as what steps can be taken to lock in any gains;
• Forty-three percent of advisers do not feel it is important to evolve their practice to meet the needs of younger investors, suggesting future challenges as wealth transfers from retiring Baby Boomers to the next generations. Changing market dynamics and emerging technologies call for advisers to consider taking a closer look at how they will build and manage client portfolios in the future, Fidelity says; and
• Two-thirds of advisers believe they stand out from the competition by giving clients personal attention, but Fidelity warns that advisers may want to consider new strategies that set them apart and help position them for long-term success, such as building a well-rounded advisory team or adopting newer technologies.

“Business has been good for advisers, but it’s important they don’t put off what’s needed to ensure [that]the future looks just as attractive,” explains Brian Nelson, vice president of practice management for National Financial, a division of Fidelity Investments, in Boston. “There are steps advisers can take today to help position themselves for tomorrow and ultimately contribute to a high-performing firm, one that is profitable, productive and growing.”

The study finds high-performing advisers—which Fidelity identifies as those who appear positioned for both short- and long-term growth—tend to use three strategies to shape near-term momentum into lasting success.

First, Fidelity finds that the most successful advisers are also the most serious about setting down a growth plan on paper. According to the study, 63% of high-performing advisers have formal career goals, and they are much more likely to have planned out different areas of their business, particularly business continuity and succession planning. Given the link between planning and growth, Fidelity says advisers should consider placing an emphasis on developing formal objectives that articulate a vision for the long-term future and clearly outline initiatives that can bring about lasting success.

Next, Fidelity finds that the most successful advisers take steps to realign their client base to address changing demographics. It is an important step for protecting growth prospects over the long term, Fidelity says, as about 70% of the typical financial adviser’s clients are Baby Boomers or older. Forty-two percent of high-performing advisers actively target Generation X and Y investors, compared with 17% of other advisers. High-performing advisers are also nearly twice as likely to ask less profitable clients to leave the firm and more than twice as apt to target high-net-worth investors.

Finally, high-performing advisers appear to be more proactive about finding ways to differentiate their services from their competition’s. Only 21% of advisers see team building as a differentiator, and while 64% feel technology can increase value to clients, only 35% are willing to spend money on it. Fidelity argues that these features are more significant to client satisfaction than other variables advisers typically point to, such as a lengthy track record or the ability to provide clients with one-on-one attention.

The study finds high-performing advisers embrace strategies such as teaming with others, harnessing technology and customizing their offerings to create a strong value proposition designed to help them stay relevant to tomorrow’s investors. Sixty-seven percent of high-performing advisers work to tailor their approach to each client’s long-term goals, compared with 58% of other advisers. They were also heavier users of technology, with 52% of high-performing advisers actively investing in new technology products.

—John Manganaro

Three Steps to Greater Success

Strategies of high-performing advisers

1. Have a written growth plan.
2. Target various demographic groups, including high-net-worth individuals.
3. Deliver additional value through customization and investments in technology.

Source: Fidelity Investments “Adviser Insight” study

ACA Impacts Retirement Plans

Many employers plan to spend less on DC plans

A new analysis from the LIMRA Secure Retirement Institute (SRI) suggests that more than four in 10 employers believe the Patient Protection and Affordable Care Act (ACA) has directly affected their defined contribution (DC) retirement plan.

Nearly half (45%) believe the ACA will change their retirement plans in the future. Of those that believe the ACA has already changed their retirement benefits strategy, a majority (55%) say they are spending less money and time on retirement benefits and shifting costs to employees to compensate for increased health plan expenses.

The report also shows that the complexity of ACA compliance efforts has caused about 42% of employers that offer workplace retirement savings programs to spend less time evaluating their retirement benefits.

“Employers have limited resources to use to manage their employees’ comprehensive benefits package,” explains Alison Salka, corporate vice president and director of LIMRA SRI research in Windsor, Connecticut. “The added complexity and costs of health care are definitely taking a toll on employers’ ability to manage their retirement savings plans. As a result, employers are looking for more support from the industry to help them provide a comprehensive retirement savings program for their employees.”

LIMRA finds cost-shifting was more prevalent among employers that offer both a defined benefit (DB) and defined contribution plan, underscoring the point that employers have limited staff resources to manage benefits programs. In fact, employers that sponsor both types of plans report a direct impact from the ACA 67% of the time, compared with 48% for those that sponsor just one type.

Of those employers who think the ACA will affect their retirement plan strategies and spending in the future, 63% believe it will mean less money spent on retirement plans.

“For many American workers, their employer-sponsored retirement plan is the primary way they save for retirement,” Salka says. “Our findings about the impact of the ACA underscore the opportunity for plan providers and advisers to help employers better manage the challenges associated with their retirement plans.”

Salka points to previous LIMRA SRI research showing that access to a retirement savings plan at work has a significant positive impact on an employee’s ability to systematically save for retirement. The research finds that among those with defined contribution plan access through their current employer, 95% have at least some household retirement savings versus 73% of those with no access to a defined contribution plan. Previous LIMRA SRI research also indicates workers with access to an employer-sponsored retirement savings plan are more likely to feel confident they will be able to achieve the retirement lifestyle they desire than those without access (43% vs. 34%).

—John Manganaro

Participation in NQDC Rises

Enrollment up 10.5% in 2013

Thirty percent of respondents to a recent survey noted a higher plan participation rate for nonqualified deferred compensation (NQDC) plans.

According to the eighth annual MullinTBG/PLANSPONSOR Executive Benefits Survey, there was a 10.5% increase in enrollment figures. The survey also shows that, for 2013, 19% of respondents noted higher deferral amounts, and, similar to previous survey results, participation rates were highest (56%) for firms that offered a company match.

The survey also reveals that almost all companies (95%) offer NQDC plans to their highly compensated employees, making it the most commonly mentioned executive benefit. In 2012, roughly 90% of responding companies said they offered an NQDC plan.

“With NQDC plan prevalence at such a high, there is no doubt that these executive benefits are crucial to recruiting and retaining high-quality employees,” says George Castineiras, Prudential Retirement’s senior vice president of total retirement solutions, in Hartford, Connecticut.

The survey also found that about 42% of responding companies aspire to making changes to their NQDC plans, hoping to enhance plan education and communication programs. According to the survey authors, education and communications are important: Key stakeholders—such as plan sponsors, plan administrators, financial advisers and benefits consultants—should focus on conveying the more meaningful underlying benefits of the NQDC plan.

The survey report says that participants need to be guided through the process of achieving their financial goals—whether short-term, such as putting their child through college, or long-term, such as retiring to a comfortable house on the golf course—in order to make the process of saving more tangible for them.

“Providing expert resources that can help participants validate their plan choices and create a financial plan that will enable them to achieve a successful, comfortable retirement is one way to take some of the guesswork out of decisionmaking and realize the potential of their executive benefit packages,” says Yong Lee, chief operating officer (COO) at MullinTBG in El Segundo, California.

Just under half (45%) of responding companies reported providing a financial planning advice component for their plan participants. “In-plan offerings designed to support executives’ retirement readiness are a notable trend,” Lee adds. “Offering model or managed portfolios, retirement-income-generating options and financial planning advice demonstrate that plan sponsors are responding to concerns about their employees’ retirement readiness.”

In terms of the number of investment options, the survey finds that companies like to keep them at a “diverse but reasonable level,” with the majority of respondents (82.4%) saying their company offers up to 20 options in their NQDC plan.

Other survey findings include:

• Criteria used for determining NQDC plan eligibility varied among categories, with title (23.5%) and job grade (23%) cited most often;
• Informal funding continues to be a popular strategy, used by 57.2% of companies, and can help to manage the NQDC plan’s asset-to-liabilities ratio. These companies primarily utilize corporate-owned life insurance (46.2%) and mutual funds (44.7%);
• Rabbi trusts—i.e., trusts created to support the nonqualified benefit obligations of employers to their employees—maintain their position as the top choice for a security vehicle, employed by 97% of respondents that have a security vehicle for their NQDC plan;
• More than two-thirds of companies (70%) rely exclusively on a third-party recordkeeper to administer their NQDC plan;
• About 70% of plan sponsors rated their plan as either “effective” or “extremely effective”; and
• More than three-quarters (77.8%) of respondents reported that their NQDC plan is offered to “provide a vehicle for retirement savings.”

—Kevin McGuinness

Inadequate Retirement Income

The majority fear they’ll run out of savings

More than half of employees are unsure their 401(k) retirement plan will provide them with adequate funds for retirement, according to a new report.

A survey from Pentegra Retirement Services finds that among U.S. adults who are employed and enrolled in a 401(k) plan, 65% do not believe or are unsure whether their plan will provide enough money for them to retire when they want or plan to. Nonetheless, the survey shows that 75% of 401(k) participants still think that 401(k) plans are the most important source for a person’s retirement income.

Survey findings also reveal that 45% of 401(k) participants contribute only 6% or less of their yearly earnings to a retirement account. However, 42% of 401(k) participants say they understand that you do not have to pay taxes on contributions made to the plan.

“We cannot emphasize enough the importance of putting this money away and taking advantage of a 401(k) plan, not only for retirement but also to save money on taxes,” says Rich Rausser, senior vice president of client services at Pentegra Retirement Services in White Plains, New York. “Tax deferred contributions through a 401(k) plan lower your reported income, so the more you contribute, the less taxable income you have. It is a win-win. By saving $20 per week on a $400 weekly salary, you are left with $380. After subtracting the 28% federal tax amount, your take-home pay is $274. Put that same $20 into a [taxable] savings account, and your take-home pay drops to $268. That six-dollar difference may not seem like much now, but multiply it over 52 weeks for 25 years and you are looking at pocketing an extra $7,800.”

The fact that nearly two-thirds of 401(k) participants do not believe or are uncertain that their 401(k) plan will provide enough money in retirement is discouraging news, says Rausser. “The fact is that you need to try to save enough to provide income replacement of 80% to 90% of your annual pre-retirement income, for each year in retirement, to enjoy a lifestyle similar to the one you have now.”

In addition, the survey also reveals that three in 10 (31%) of 401(k) participants admit they have no understanding of where or how their plan contributions are being invested. Thirty-seven percent of 401(k) participants say that as long as their plan balance is there for them when they want it, they are not concerned about how it is invested.

Rausser encourages people to have a greater understanding of the process. “People really need to have a basic knowledge of how their money is being invested and how the process works. This is your hard-earned money and your future. Take the time to sit down, even just once a year, with someone in charge of your plan. Ask questions and get answers you understand.”

On an encouraging note, says Rausser, the survey finds that 63% of 401(k) participants have increased their contributions at some point. Only 19% of participants say they have never increased their contributions.

“Increasing your contribution every year is the key to retirement planning success,” adds Rausser. “Each time you get a raise, increase your contribution by at least 1% or 2% annually. A simple way to do this is to have an automatic escalation feature as part of the 401(k) plan, so that contributions are increased automatically on an annual basis. This puts saving on auto-pilot so that participants don’t have to think about it.”

Other highlights:

• On average, the last time 401(k) participants increased their contribution was 2.4 years ago;
• Those who contribute more than 10% of their salary to their 401(k) plan most recently increased their contribution, on average, 3.3 years ago, significantly longer ago than the average of 2.1 years among those who contribute 10% or less of their salary;
• About one-third (32%) of 401(k) participants believe that starting a 401(k) later in life with larger contributions will yield the same results as if they had started at a younger age.

—Kevin McGuinness