401(k) industry howls as DOL lets state governments become DC providers with advantageous exemptions
Multiple employer plans' under states will have economies of scale, fewer rules, while ERISA bars private firms from banding together
Brooke’s Note: The sources in this story are of two minds about state governments being allowed to compete with private providers in the 401(k) business. So am I. The good news is that states will bring more competition to a defined contribution industry that badly needs it. But if that competition exists on a less-than-level playing field, it starts to feel like a government subsidy, with the attendant unintended consequences, that tend to always be bad and the intended consequences that are far from guaranteed. The lack of outcry about a proposed system, or network of systems, bearing more than a passing resemblance to the struggling Obamacare system speaks loudly to how baffling all this is to observers. Maybe it’s because it will happen under state control, not federal? Maybe because the legacy players will end up as the profit-realizing custodians anyway? Of course, there could be another explanation for the muted response: Nobody outside the know seems to know it’s even in the works — a situation this article seeks to counter.
The retirement industry is in a swivet at the prospect of states running their own individual retirement accounts with the blessing of — and perhaps even with a leg-up from — the Department of Labor.
Washington state has already created a marketplace in which employees of small businesses may purchase IRAs; Illinois, California and Oregon are well on their way to creating IRAs for small-business employees who don’t have a retirement plan in place; and more than 18 other states are considering similar measures. See: Why Wall Street’s DOL killer threat — that 'millions’ of IRA investors will go unadvised under new rules — is hogwash.
Advisors and their watchdogs are not yet of one mind about the Obamacare-evoking government 401(k) providers: They see a way to bring unadvised assets out from under the mattresses but are also leery that a monster is being created.
“For retirement advisors, the positive side of such state-run programs will be the large increase in available retirement dollars in IRAs that will need professional guidance,” says Rick Meigs, founder of the 401khelpcenter.com, pointing out that when these IRA balances grow, individuals may seek help from an advisor down the road.
But, he continues: “On the negative side, if you are an advisor or firm that has a large presence in the small-plan market, your state government has just become your chief competitor.”
Last month, the Department of Labor issued guidance about state-run retirement plans, encouraging states to consider either creating IRA or 401(k) plans to help the nearly 70 million workers nationwide without access to an employer-sponsored retirement plan.
Under that guidance, a company could set up automatic enrollment for an state-created IRA without it triggering ERISA rules — but only if several conditions are met.
By contrast, an employer in the private sector setting up automatic enrollment for an IRA would trigger an ERISA restrictions. See: Why exactly DOL’s latest action is so shocking to so many brokers — and even ERISA lawyers — despite years of warnings.
“Today if a company sets up automatic enrollment for an IRA, the plan would fall under ERISA rules and regulations,” says Michael Kreps, an attorney with Groom Law Group based in Washington, D.C.
“However, the DOL is allowing states to set up automatic enrollment for IRAs without triggering ERISA rules. This is setting up an unfair advantage in that the states won’t have to follow the same rules and regulations as advisors.” See: IRA assets could be ripped from the grasp of brokers if DOL has its way.
No safety in multiples
But it’s not just the removal of ERISA red tape from state-run plans that’s problematic, according to Jason Roberts, lawyer and CEO of Pension Resource Institute LLC
One potentially huge advantage that state-run plans have over private IRA providers is that numerous states will be allowed to work together, in essence creating a giant cooperation with thousands of employees. By contrast, per ERISA regulations, private employers aren’t allowed to form “multiple employer plans” unless they are part of the same company or shared ownership. See: The White House puts its best Obamacare minds behind cleaning up the 401(k) business — starting by issuing a withering memo.
“These economies of scale would be unfairly competing with the private sectors and these things could be huge if you can consolidate across states,” Roberts says.
But Scott Dauenhauer, principal and owner of Meridian Wealth Management and Meridian Fiduciary Consulting in Murrieta, Calif., isn’t daunted by the prospect of state-sponsored competition.
“I am supportive of the state-run 401(k)s, if done right. California is currently working on launching one and I’m interested to see what it looks like. I know many advisors have issues with them, but I don’t. I think there is a lot of money to be made overcharging small 401(k) plans and to have a multi-employer option that is possibly run with low costs and modern features that could be offered to small employers would be a good thing. I’m afraid I don’t see the downside,” he says. See: Two advisors debate the financial viability of serving as a fiduciary to small accounts amid DOL’s new rules.
Multiple employer plans, or MEPs, offer small businesses the opportunity to band together to purchase one retirement plan. The DOL has nixed MEPS in the private sector unless employees have “commonality,” Roberts explains.
For instance, a MEP may exist for members of the American Bar Association or for those involved at business or residential co-ops. But the DOL allows MEPs without any commonality other than the fact that they are under the state’s plan — or perhaps even under a group of states.
“They’re looking to allow states to run and operate as multiple employers plans and they were even considering allowing regional MEPS where several states could combine their otherwise unaffiliated companies into these giant multiple employer plans. The private sector can’t run these open MEPs. Given the direction of where we’re at now, how do we get them to level the playing field?” Roberts asks.
The latitude ERISA gives states to form MEPS is indeed a formidable advantage, says Kreps.
“In the DOL bulletin, they said they believe a state set up a multiple employer plan because it creates the nexus between employers because of its representation. However, if Prudential steps in, it couldn’t put the same employers and employees in one plan because they are unrelated. But if the state steps in, they can create a multiple employer plan.” See: Report: 'Brother-in-law’ dabblers are giving 401(k) ground slowly to specialists in $1.3 trillion market.
The Labor Department has not responded to a request for comment.
The Department of Labor announced the guidelines for states on Nov. 16.
“Both automatic IRAs and state-based ERISA plans have been created, or are being considered, by various states,” the statement reads. “A lack of clarity of this area of the law has made other states reluctant to move forward with plans to create additional retirement savings opportunities for workers. The department’s guidance is meant to give states clear information as they move forward in creating programs.”
In December 2014, Illinois approved the Secure Choice Retirement Savings Program, which state officials say would help 1.2 million small business employees to save more for retirement with an automatic IRA payroll deduction program. The program is slated to start in 2017 with 3% automatic enrollment. Illinois officials were waiting for the guidance from the federal government.
All this talk of state- and pan-state-administered IRAs and 401(k)s is leading to industry fear that some smaller employers will simply dump their own 401(k) plans in favor of ones run by the government. Many RIAs oversee smaller 401(k) plans.
“For smaller-plan sponsors, these state-run plans could be seen as a way to abandon existing 401(k) plans,” Meigs says.
Advisor Jim O’Shaughnessy at Sheridan Road Advisors, who works mostly with retirement plans, is adopting an wait-and-see attitude.
“Illinois is one of the states, so we have been paying attention,” he writes in an email. “I have held off on forming too strong of an opinion because I feel this issue is still in early stages and will potentially change a ton over next couple years. We at Sheridan are all for progressive policy and regulatory changes that ultimately help create a stronger public/private retirement system.”
Illinois-based Sheridan Road Advisors is part of LPL Financial.
But other private entities have no problem going public with their dissent.
For instance, New York-based BlackRock Inc. posted a paper Nov. 25 pointing out that if government-sponsored retirement plans don’t need ERISA rules, perhaps the rules are too cumbersome for the private sector as well.
“States’ reluctance to proceed with programs that might be subject to ERISA requirements highlights the burdens imposed by these rules. Given that ERISA was designed to protect the interests of plan participants and their beneficiaries, we recommend a comprehensive review of legal/compliance burdens imposed by ERISA and similar state laws to determine what rules are truly necessary to protect participants.” See: The great 401(k)-or-not debate: RIABiz webinar lays out the perils and rewards for RIAs thinking of wading into the fast-moving 401(k) stream.
New York-based BlackRock is a big player in the private sector 401(k) arena.
SIFMA, always leery of any instrument that offers low fees, published a similar paper on its website arguing against the new DOL scheme. See: New York conference: SIFMA wants members to be like RIAs — minus the same rules of accountability.
The state-run plans, SIMFA states, are based on the “misguided notion that private sector retirement plans are inaccessible to most Americans …. The reality is that over 75% of full-time American workers have access to retirement plans through their workplace,” writes Marin E. Gibson, managing director of state government relations for SIFMA.
Gibson says that 25 states have considered such legislation.
“Before jumping into a state-run program, states should not only explore all the costs and benefits of running a plan, but also look to other states for workable alternatives,” Gibson writes.
Fidelity Investments, the nation’s largest retirement provider with more than $1.2 trillion in assets, commented but without revealing any point of view.
“Many retirement savings vehicles exist today, and we remain focused on helping thousands of employers and their advisors set up competitive workplace retirement plans so workers can save toward their financial goals,” says Steve Austin, spokesman for the Boston-based company. See: How the future of the 401(k) industry may hinge on the outcome of a lawsuit brought by Fidelity employees against their own company.
Another big player in the retirement plan field, Malvern, Pa.-based Vanguard Inc., has not yet replied to emails seeking comment.
What do these changes portend for RIAs, who count on many of these smaller 401(k) plans? In the long run, a net gain, speculates Fred Reish, attorney with Drinker Biddle and Reath LLC.
“Over the longer haul, it will depend on the type of state plan and how well they are run. I think the MEP alternative has some potential to become popular among employers … at the small end of the market. But, to do that, they will need to embrace advisors. That’s because plan sponsors will still need help in operating their plans and will want the help of advisers” Reish writes in an email. See: DOL tells employers when they must fire advisors to 401(k) plans.
The bottom line is that millions of employees still don’t have access to retirement plans, says Brooks Herman, a researcher at financial data provider BrightScope Inc. in La Jolla, Calif.
That’s why he’s in favor of state-run IRAs.
“The real reason we favor this is there are a lot of Americans who work in companies who don’t have 401(k) plans and can’t put $18,000 away and have it grow tax free over time. This is an attempt to have them experience tax deferred savings.”
Herman says these plans may resemble those of a mammoth company like Wal-Mart Stores Inc., which has a giant 401(k) plan that’s cumbersome for advisors because so many employees are coming and going.
“My understanding is the target for these 401(k) plans will be lower-income earners making less contributions. They might look kind of like Wal-Mart. Wal-Mart has more than a million active participants. Wal-Mart spent a lot of time and energy on its plan. They have lower-wage employees and lots of employees coming in and out of it.” See: What a wave of 401(k) lawsuits tell us about what RIAs really need to worry about.
He also suspects that small employers will still continue to host 401(k) plans. There are many questions about portability too, he adds.
“The question is where was all of this money going before these state run plans? Was it going to savings or checking accounts or under the mattress? Advisors can’t really call it their money if it’s in a checking or savings account. Chances are these plans will be targeting people with small accounts and I’m not sure the first iteration will be rich enough environment for advisors to swim.”
The idea of fed-run (MyRA) or state-run private sector plans are problematic and should send a chill to every retirement plan practitioner save for the very largest Wall Street firms and insurance carriers. State-run plans – whether individual plans, single MEPs or regional MEPs run by the states – smacks at the very heart of the intentions of ERISA which was to keep the states from running private retirement plans.
Personally, I am not willing to take a “wait and see” position as the handwriting on the wall is clear as to the extent of damage this will do to all the small businesses in the retirement plans space, i.e. advisors, TPAs, recordkeepers, auditors, attorneys, etc. The purpose of any government is to expand small business opportunities not constrict them by unfairly competing against them.
This is one issue where we need to lay our differences aside and fight this intrusion tooth and nail. We can only hope Congress will step up and do their job and “stop the madness” before the horses have all left the barn. Let them hear from all of us.
Seems to me the writing is on the wall and advisors had better re-think their services and how they get paid for them. Sure there is downside for existing business models here, but this also opens a myriad of opportunities to industry participants.