Part 3: The Changing 401(k)
By Thomas Rowley
Director, Retirement Business Strategy
This is the last of a three-part series examining how retirement-related regulatory proposals could potentially affect plan consultants, field associates and financial advisors by altering their business models. The series includes discussion of automatic IRAs, revision of the definition of "fiduciary" and the changing 401(k).
"Disruptive innovation" is the term used to describe innovations that change a product or service in ways the market doesn't anticipate. Several proposals among the multitude before Congress, the Department of Labor (DOL) and other regulatory bodies could create disruptive innovation in the retirement marketplace. Changes to the traditional 401(k) plan could also change your business model.
Shortcomings of the 401(k)
The 401(k) provision — created in 1978 as part of the Tax Revenue Act — was originally intended to be a supplement to defined benefit pension plans, which most workers had then. But for a variety of economic and regulatory reasons, 401(k) plans have, over time, replaced the plans they were originally supposed to complement.
Now the 401(k) is the primary retirement plan for the majority of Americans who work in the private sector, and millions of them are facing a shortfall of savings in retirement. As a result, there is greater scrutiny on what may be considered the shortcomings of the 401k. The attempts to remedy those shortcomings could potentially alter the retirement marketplace.
The DOL's new plan sponsor and participant fee disclosure regulations went into effect in 2012, requiring 401(k) service providers to disclose costs associated with plan management that were previously included in expenses charged for each investment fund option in a plan. Companies must also disclose each fund's expense ratio in dollar terms so participants can determine how much of their investment returns they spend on operating expenses. The DOL is expected to ramp up its capabilities to enforce fee disclosure regulations in 2013.
The new regs are intended to provide participants with the information they need to make informed decisions about managing and investing money they contribute to 401(k) plans — including being empowered to make apples-to-apples decisions about investment options offered by their plans. The idea is that retirement savings may get a boost if participants pay lower fees.
Proposals around greater fee disclosure, such as displaying absolute dollar amounts to participants, could induce a shift toward flat, per-participant recordkeeping fees and away from revenue-sharing models with asset managers, making recordkeeper economics more stable but capping their upside. This may serve as the catalyst to retain assets in the 401(k), as opposed to watching them roll out to an IRA.
Guaranteed lifetime retirement income products
Legislation aimed at finding ways to provide guaranteed retirement income has had bipartisan congressional support in the past. However, many complex issues need to be addressed if there is to be a mandate to provide guaranteed retirement income products to all workers. For example, policymakers must:
- Settle on an acceptable level of tax benefits for investing in the products.
- Decide on permissible contribution levels.
- Set guidelines for the expenses and fees charged by providers.
- Determine who delivers on the guaranteed lifetime payout aspect of the product if a provider defaults.
Retirement income products could provide an entry point for manufacturers with annuity capabilities and dramatically shift a plan's typical allocation. This would also greatly reduce the IRA opportunity, changing the economics for integrated investment managers and recordkeepers significantly.
The adoption of any of these regulatory measures could significantly impact who wins and who loses longevity/annuity contracts. We may see proposed Internal Revenue Service regulations concerning business contracts finalized in 2013.
Disruption by any measure
In this series, I've examined how automatic IRAs, the revised definition of "fiduciary" and changes in the 401(k) could potentially impact the retirement marketplace — and your business model. And these potential outcomes are the ones we can foresee. Disruptive innovation denotes changes we don't anticipate. So be prepared to respond to the disruption that may ensue from any measure that changes the retirement market status quo.