Coupling Financial Advice to Your Retirement Plan

Offering employees personalized investing advice for their 401(k) plan accounts is now more doable, but choose a provider as carefully as you’d choose a plan.

By Carolyn Hirschman Mar 1, 2007
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HR Magazine, March 2007

Baby boomers who rocked to the Beatles hit “I Want to Hold Your Hand” might wish now, as they approach retirement, that they could hold the hand of a financial planner.

Many older workers—and 401(k) participants of all ages—are lost when it comes to saving for retirement. They need and want professional help.

Provisions of a 2006 federal law taking effect this year make it easier for employers to provide employees with specific, personalized investing advice for their defined contribution retirement accounts.

Most employers have been wary of supplying much more than general financial education to their employees, fearing that they might be held liable for poor outcomes if they provided individualized advice.

But now the risk essentially has been removed. The new Pension Protection Act (PPA) enables employers to have employees receive, through the workplace, specific recommendations for their 401(k) accounts, with the goal of helping them save more money for retirement. The new law not only could help employees nearing retirement but also could encourage younger workers to get an early start on financial planning.

(See chart, "401(k) Facts, 2005.")

In turn, the PPA could mean enlarged tasks for HR professionals. Fiduciaries who routinely choose and keep tabs on their retirement-plan administrators could also be responsible for selecting the best possible providers of investing advice and the delivery methods for their workforces.

Then and Now

Before the PPA, individual investing advice could be offered only through independent third-party providers—to guard against plan providers steering employees to more costly but inappropriate investment options. Online tools sold by companies such as Financial Engines Inc. and Morningstar Associates Inc. flourished in the 1990s as employers sought ways to help employees while staying within the U.S. Department of Labor’s regulatory restrictions on advice.

Under the PPA, plan administrators, investment managers and other service providers for the first time can offer advice to participants, including recommendations of their own mutual funds and other investments, as long as they follow PPA requirements for an “eligible investment advice arrangement.” (See “How Advice Is Given,” at right.)

The PPA absolves plan sponsors of fiduciary liability for individual investing advice, a responsibility that now clearly belongs to advice providers, or “fiduciary advisers.”

Easing access to individual investing advice should help 401(k) plan participants build the largest possible nest eggs for their retirement years. Many participants “really want advice, and they need it,” says Terese M. Connerton, a benefits attorney at Baltimore-based law firm Ober, Kaler, Grimes & Shriver. “Most people, including me, just don’t know what the proper investments should be. People make a lot of mistakes.”

To help employees avoid mistakes and make the most appropriate investments, employers increasingly have been offering plan participants access to personal financial advisers and online financial tools. In fact, according to the 2006 Benefits Survey Report of the Society for Human Resource Management, 48 percent of employers said last year that they offered some form of advice, compared with 33 percent in 2005 and 29 percent in 2004.

Whether the PPA will prompt many employers to increase such efforts and start providing personalized investing advice is uncertain, however. Some consultants say those deciding to do so will be a trickle, not a flood, at least for now. “You’re going to see the door cracked open a bit,” says Gary Kushner, SPHR, president of Kushner & Co., a Portage, Mich., benefits consulting firm. “I’m not getting a lot of employers clamoring for it.”

Some employers are waiting for the Department of Labor to issue regulations for the PPA’s investment-advice provisions later this year. “Clarifications from the Department of Labor are going to determine how useful the legislation is in effecting change,” says David Wray, president of the Chicago-based Profit Sharing/401(k) Council of America, a plan sponsors group.

Who Should It Be?

For small and mid-size plans that are accustomed to bundled retirement-plan services and decide to start offering individual investing advice, it might seem logical to select an existing service provider or its chosen third party. But would that be the best choice? Or would it be better to go with a totally independent adviser?

Of course, an existing service provider has an ongoing relationship and compatible technology with the employer, affording easier access to participants’ personal and 401(k) information than an independent provider would have, experts say. “There’s a relationship and a level of comfort there,” Kushner notes.

But the potential for conflicted advice makes some experts uneasy, and questions could arise if too many participants invest in the adviser’s funds.

Some experts recommend the use of an independent adviser with no products to sell.

“It looks better and smells better if you’ve got an independent financial adviser. … You want to avoid any hint of self-interest on the part of your recordkeeper,” says Doug Judd, investments manager at Hallmark Cards Inc. The greeting card company, based in Kansas City, Mo., has offered advice to participants in its $2 billion-plus profit-sharing/401(k) plan through Financial Engines since 1999. It also trains employees during working hours to use the tool.

The PPA requires advisers to disclose any conflicts of interest, but “401(k) participants do not read legal notices,” so it’s up to plan sponsors to make sure an advisory service is in participants’ best interest, Wray says.

Whatever their final choice, employers have a duty to shop around for advice providers, benefits experts agree. The Employee Retirement Income Security Act requires plan sponsors to act prudently in selecting and monitoring service providers, a mandate unchanged by the PPA.

“It’s pretty hard to demonstrate due diligence if you haven’t looked at other service providers,” says Lisa Van Fleet, a benefits lawyer at Bryan Cave LLP in St. Louis. “The plan sponsor does have a fiduciary obligation to make sure that anyone they contract with satisfies the [legal] requirements.” It’s also important to check potential vendors’ professional credentials, experience, technology, fees and references. (See “Who Pays?,” at right.)

Moreover, once chosen, an advice provider must be monitored, Van Fleet adds, by looking at the results of the investing advice arrangement’s annual audit, participants’ asset and fund allocations, use of and satisfaction with advisory services, and the reasonableness of fees.

Deciding on the Methods

Choosing a provider also involves determining the type of advice employees want and how they want to receive it. Workplace-based advice focuses on 401(k) investments, but employees often want broader help with their finances. The goal is to tailor advice to workers’ needs.

Employees also may prefer different delivery methods, which can range from online tools for do-it-yourself investors to face-to-face meetings for the majority who need more hand-holding. Factors that can affect those preferences include participants’ ages, education levels and computer access, consultants say. “Younger employees, Generation X and Generation Y, will be very comfortable with computer modeling. They’ve used computers all their lives,” Kushner says. “Older employees may be more inclined to sitting down face to face with an adviser.”

Another method consists of online advice with help available from call centers. For example, Principal Financial Group, a plan administrator, offers its clients an online tool from Ibbotson Associates along with backup from trained counselors who can give general information but not specific advice over the phone, says spokeswoman Terri Hale.

The Employer Factor

Another consideration in choosing the method of delivering advice is company size. Small, single-site employers can offer employees one-on-one meetings with financial advisers more easily than can large corporations with many locations, which generally prefer online tools. (See “Prevalence of Advice by Plan Size.”)

McNaughton & Gunn Inc., a book manufacturer in Saline, Mich., has both a defined benefit and a 401(k) plan for its 212 employees, and it offers them free one-hour sessions at least twice a year with advisers from its plan administrator, Comerica Bank. Those who have used the sessions “like the direction from someone else who knows what they’re doing,” says CEO Julie A. McFarland.

At NASCAR, the stock-car racing circuit based in Daytona Beach, Fla., advice methods for its 900 employees vary. The company offers free, 30-minute, one-on-one sessions annually at each of its seven sites by The PFE Group. Last year NASCAR added an online tool from 401(k) administrator Charles Schwab to supplement group and one-on-one meetings. ›

The sessions are “always booked up,” says Starr George, managing director of human resources, and the online advice suits employees with heavy travel schedules. “We want our employees to be prepared for retirement,” she says. “The average person doesn’t think about it until they’re ready to retire.”

Retirement experts and financial advisers generally say that one-on-one counseling is the most effective way to get plan participants to invest properly. “Most individuals will not execute on advice unless they can talk to a human being,” Wray says.

Andrew C. Orr, an independent financial adviser in Orlando, Fla., agrees: “There’s a lot of information out there, but there’s not enough wisdom. People want direction. They get that more so face to face than from an e-mail or online.”

Individual counseling costs more than online or telephonic help, of course, and it can be harder to find. Some fee-only advisers, including Orr, don’t view it as sufficiently profitable, so they don’t offer it. Orr conducts group meetings at employer sites but not one-on-ones.

Another option for helping employees get the most out of a 401(k) is a “managed account,” in which a participant provides initial direction but lets a professional investment manager do it all, from selecting funds initially to rebalancing the portfolio periodically. This part of the market is growing fast because participants increasingly want someone else to handle their 401(k) accounts and because plan sponsors using automatic enrollment can choose them as default investments.

However, Wray says, managed accounts are not advice because participants are far removed from decision- making. The PPA doesn’t cover managed accounts.

“It’s really designed for the reluctant investor who’s willing to delegate these responsibilities,” says Christopher Jones, chief investment officer at Financial Engines, whose managed-account business has grown to more than $7 billion in assets in two years.

Long-Range Impact: Unknown

While the subject of individual investing advice is only one of the issues addressed by the PPA, it’s an important one for employers and their 401(k) plan participants. And for HR and benefits managers long frustrated by participants’ neglect to save enough—or save at all—for retirement and to manage their accounts most effectively, it could be an important tool. The new law encourages them to offer a service that, if properly customized, may put more employees on the road to a secure retirement.

Carolyn Hirschman is a business writer in Rockville, Md., who specializes in HR and benefits issues.

How Advice is Given

The Pension Protection Act’s Section 601 lays out a framework for offering investing advice to individual participants in defined contribution retirement plans such as 401(k)s. The section, which took effect Jan. 1, doesn’t require employers to offer advice. But if they do, they and their advice providers, called “fiduciary advisers,” must follow several requirements.

Most significant for plan sponsors is that they are not legally liable for advice given to participants. That liability is now borne by the fiduciary adviser, which must be a bank or similar financial institution, an insurance company, a registered investment adviser, a registered broker-dealer, or an employee or affiliate of any of these.

As with any service provider, plan sponsors must prudently select and monitor fiduciary advisers to make sure that they meet PPA requirements and that their fees are reasonable.

“Employers will have no defense if advice arrangements are made without a thorough background check on the fiduciary advisers,” writes Dalbar Inc., a Boston-based financial services research firm, in an analysis of the new law.

The PPA specifies that advice must be given under an “eligible investment advice arrangement.” There are two types:

  • Computer-generated advice. Such a system must recommend specific asset allocations based on generally accepted investment theories, participant information such as risk tolerance and expected retirement age, and objective criteria. No other advice may be offered unless a participant asks for it.
  • Advice developed by an adviser. The adviser’s fees cannot vary according to the individual’s investment choices. This provision is designed to prevent conflicted advice.
Under either arrangement, before any advice is given, advice providers must tell participants in writing certain information, including their compensation, any interest they or their affiliates may have in the investment options, and the role of any affiliated parties in developing the advice program.

These notices must be written in a “clear and conspicuous manner, calculated to be understood by the average plan participant,” according to Congress’ Joint Committee on Taxation. But there’s no guarantee that participants will read them, experts say, which makes plan sponsors’ vetting of advice providers all the more important.

In addition, an advice arrangement must undergo an annual compliance audit, to be conducted by an independent auditor who reports to the plan sponsor. The Department of Labor is expected to issue rules later this year for the audits as well as for independent certification of computer-advice models.

Fiduciary advisers who violate the PPA are subject to civil lawsuits by participants, Labor Department penalties and Internal Revenue Service excise taxes.

—Carolyn Hirschman

Who Pays?

How much does individual investing advice cost? Who pays for it? Good questions. Here are some answers.

Not surprisingly, in-person advice costs more than online advice. Independent, fee-only financial planners typically charge an hourly or daily rate for worksite visits, usually paid for by employers. The PFE Group of Southborough, Mass., charges plan sponsors about $3,000 per day for a one-hour group meeting followed by 15- to 30-minute individual sessions, for example.

Online tools such as those offered by Financial Engines and Morningstar cost much less, tens of dollars annually per participant. The plan sponsor foots the bill, spreading the cost over the entire plan population.

In between is an arrangement like Smart401k’s. The Overland Park, Kan., firm advises individuals by e-mail and telephone, then manages their accounts with quarterly updates. It charges $59 per quarter or $199.95 per year, with discounts for employer-sponsored retirement plans.

The exact cost of advice can be hard to determine when it’s bundled with other retirement-plan services, a common arrangement. But advisory fees of any sort are usually asset-based or per-head charges paid out of plan assets. “It comes out of the participant one way or another, either all participants or the participants who use the advice,” says Scott Revare, CEO of Smart401k.

The Pension Protection Act allows plan assets to pay for “reasonable” expenses of individual investing advice, with different fees for different advice arrangements.

With the computer model, advice providers can make more money from some investments than from others, as long as recommendations are based strictly on what the computer turns out. In contrast, using a person rather than a computer for advice ensures level fees that won’t vary with the types of investments chosen.

Service providers that prefer the traditional pricing structure of higher fees for certain investments will opt for the computer model because it may be more profitable for them, Revare says.

Managed accounts, in which professional money managers handle everything, cost participants about 25 to 75 basis points of assets annually depending on the size of the account and the services provided. One basis point equals 0.01 percent, so a $100,000 account could cost about $250 to $750.

Advice fees aside, insurance companies, banks and other companies that service 401(k)s also see opportunities to sell non-401(k) products to plan participants—another revenue stream. It gets complicated to sort out all the fees and arrangements.

“At the end of the day, you have to feel like whoever you’re dealing with is trustworthy,” says independent financial adviser Andrew Orr, president of Orrgroup LLC in Orlando, Fla.

—Carolyn Hirschman

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