The Rules of the Retirement Game Have Changed

Author: Tim Nihill

Retirement plan provider firms have been ending up in the papers recently-and not for good reasons. The Department of Labor (DOL), IRS, SEC, and other agencies are taking a closer look at the qualified retirement plan market. The reason for this scrutiny: revenue sharing arrangements and improper marketing agreements between mutual fund companies, TPAs, custodians, and retirement plan providers.

The Pension Protection Act provides independent advisors with potentially the largest market opportunity they'll see over the next 10 to 20 years. The act allows the independent advisor to engage a retirement plan as a "fiduciary advisor" and to provide customized investment advice to plan participants. But with that opportunity come responsibilities.

  

FULFILLING ERISA RESPONSIBILITIES

Whether or not you act in a registered representative capacity or take on the fiduciary advisor role defined in the Pension Protection Act, there are responsibilities set forth by ERISA that you must be aware of when engaging in a qualified plan relationship:

ERISA § 406(a) prohibits certain transactions between a plan and parties of interest. A party of interest is a person or entity who is closely related to the plan, as defined in ERISA § 3(14), including a) any fiduciary (including, but not limited to, any administrator, officer, trustee, or custodian), counsel, or employee of such employee benefit plan; or b) a person providing services to such plan. This section also prohibits fiduciaries from engaging in acts of self-dealing.1

ERISA § 404(a)(1)(A) and (B) maintain that a fiduciary shall discharge his duties with respect to a plan solely in the interest of the participants and beneficiaries, and with the care, skill, prudence, and diligence under the circumstances then prevailing that a prudent man acting in a like capacity and familiar with such matters would use in the conduct of an enterprise of a like character and with like aims.2

DOL Advisory Opinion 97-16A supports ERISA § 404(a)(1) by concluding that responsible plan fiduciaries must act prudently and solely in the interest of the plan participants and beneficiaries in determining which investment options to use or make available to said participants and beneficiaries. In this regard, the responsible plan fiduciaries must ensure that the compensation paid directly or indirectly by the plan is reasonable, taking into account the services provided to the plan, as well as any other fees or compensation received by vendors in connection with the investment of plan assets.3

In other words, you need to understand and disclose all fees, whether direct or indirect, to the plan and its participants.

  

SO WHAT DOES ALL THIS MEAN ON A PRACTICAL LEVEL?

It means you need to do some extra legwork to identify and explain various fees to any plan sponsors you do business with. The following list isn't inclusive of all expenses to be considered, but, in my experience, these are the expenses that are responsible for many conflicts of interest.

12(b)-1 fees. This distribution money paid from mutual fund companies has historically been part of our compensation. But it's an inherent conflict of interest for fiduciary advisors, to say the least. ERISA states "mutual fund expenses must be used for the benefit of the plan and its participants." In short, fiduciaries cannot receive this money as compensation and therefore must move to a flat-fee compensation model, like that offered through our Preferred Portfolio Services® (PPS) Retirement Solutions platform.

Sub-TA fees. A transfer agent is typically a bank or trust company that executes, clears, and settles a security buy or sell order and maintains shareholder records. When certain functions of the transfer agent are sub-contracted to a third party, that third party becomes a sub-transfer agent.

Such sub-transfer agent could be one of the following:

A third-party administrator

A bank or trust company performing recordkeeping services

Some other entity tracking the number of shares held for the benefit of a specific participant within an individual account plan4

Fees paid to these entities for their services, referred to as sub-TA fees, are generally paid as either a flat dollar amount or a flat percentage of assets, ranging from 5 bps to 30 bps. These fees, typically hidden from plan sponsors and participants, are then split between TPAs, custodians, record keepers, and product sponsors.

Variable annuity wrap fee. This inclusive fee, generally based on the percentage of assets in a retirement program, typically pays for asset allocation, execution of transactions, and other administrative services. Generally, if there is no wrap fee, or there is a wrap on one set of funds in the program but not another, it's because there is a sub-TA agreement in place between the funds without the wrap and the fund provider.

Mortality risk and administration expense (M&E). Insurance companies charge this fee to cover the cost of the insurance features of an annuity contract, including the guarantee of a lifetime income payment, interest and expense guarantees, and any death benefit provided during the accumulation period.

Surrender charges. This refers to charges for withdrawals made from a variable annuity within a certain period of time (typically five to seven years). The fee is used to reimburse the insurance company for the upfront commission payments it made to a broker or an insurance agent. When a plan moves from one annuity company to another while still subject to a surrender charge, the receiving annuity will often "pick up" the surrender charge. In doing so, the receiving provider will either raise its wrap fee or increase its surrender charge to cover the cost. It's the equivalent of the plan loaning its assets to obtain some future benefit.

Now, in explaining all of this, I'm not trying to imply that we should do away with fees in our retirement plans-nor is that what the DOL and other regulatory bodies are telling us. The takeaway is that it is in our best interest, not to mention that of our clients, to understand all fees, direct and indirect, involved in retirement plans.

LEGAL UPDATE

The U.S. Government Accountability Office (GAO) recently released a report concluding that information on fees that plan sponsors are required to disclose is limited and does not provide for an easy comparison among investment options. The GAO further concluded that the DOL has the authority, under ERISA, to oversee plan fees and certain types of business arrangements that could affect fees but lacks the information it needs to provide effective oversight.5

The GAO's recommendation is that Congress amend ERISA to require sponsors to disclose fee information to participants on each 401(k) investment option in the plan and to require that 401(k) service providers disclose to plan sponsors the compensation providers receive from other service providers. In addition, it recommends that the DOL require plan sponsors to report a summary of all fees paid out of plan assets or by plan participants.

In other words, all fees paid and received by all parties, whether direct or indirect, must be disclosed on the annual 5500 filing to the DOL. The DOL generally agreed with the findings and conclusions of the report, so we may very well be seeing new regulations soon.

For more on retirement plan fee disclosure, contact the Retirement Marketing team at x9415, option 5.

Sources:

1) Fiduciary360, Legal Memorandums, prepared by Reish, Luftman, Reicher & Cohen.

2) Ibid.

3) Ibid.

4) Hutcheson, Matthew D., "Uncovering and Understanding Hidden Fees in Qualified Retirement Plans," accessed January 2007, .

5) United States Government Accountability Office, Private Pensions: Changes Needed to Provide 401(k) Plan Participants and the Department of Labor Better Information on Fees, November 2006, .