Are Financial Planners About To Get Blindsided On Their Qualified Plan Clients?

Posted by Michael Kitces on Monday, April 23rd, 11:35 am, 2012 in Planning Profession

Over the past few years, the Department of Labor has been working to bring transparency of fees and pricing to qualified plans, culminating in new regulations going into effect this year that will require new disclosures of direct and indirect compensation of service providers to the plan and the plan participants. While generally targeted at the segment of qualified plan consultants and advisors who regularly work with qualified plans, the reality is that any financial planner who has even just one qualified plan may be subject to the new rules - a fact that many are unaware of. Yet with the new 408(b)(2) rules set to go into effect in just 2.5 months, financial planners who provide any consulting, investment advisory, or other services have very little time to get up to speed on drafting and preparing the appropriate disclosures, or deciding whether to just walk away from their qualified plan clients. The decision may vary from firm to firm, but inaction is no excuse - especially since if the disclosures aren't provided in a proper and timely manner, the plan fiduciary will actually be required by the Department of Labor to fire the advisor!

The inspiration for today's blog post are conversations I've been having with several financial planners recently regarding the new disclosure requirements for service providers to qualified plans, who must by July 1st provide a disclosure of all direct and indirect compensation to the plan fiduciaries under the new Department of Labor Section 408(b)(2) regulations.

The new rules have been part of the Department of Labor's overhaul of the qualified plan industry, with a heavy focus on improving disclosures of compensation so that plan fiduciaries can make more informed decisions about the costs of various options. The rules also include a disclosure requirement later this year from the plan to the participants of the dollar amount of both plan-level and investment-level costs incurred, which is expected to shake up the retirement plan industry as most may realize for the first time just how much they are paying.

Financial Planners Caught In The Web

While most have been focused on how the new disclosure rules will impact the major providers of qualified plans, the reality is that any financial planner who expects at least $1,000 of compensation to be received for services to a qualified plan may be subject to the rules. For the large number of financial planners who have only one or a few qualified plans they work with - perhaps even just as a convenience to a small business owner client - the reality is that the planner has just a few months to get up to speed on the new rules, or face the consequences.

In order to be subject to the rule, the plan must be a "covered plan" - essentially, a defined benefit plan or defined contribution plan under ERISA - and the financial planner must be a "covered service provider" - which includes amongst other categories, anyone who is an investment adviser, and any service provider receiving "indirect compensation" in connection with services including consulting, insurance, investment advisory, or securities brokerage services. If the plan is a covered plan and the planner is a covered service provider due to receiving at least $1,000 of direct or indirect compensation - which might include anything from investment advisory fees to consulting fees to commissions or 12(b)-1 fees for plan assets - the appropriate disclosures must be provided.

Disclosure Requirements

Although there is no specific format, the disclosures generally must provide a description of the services rendered, and all compensation expected to be received, both direct and indirect. If indirect compensation is expected, the service provider must further describe the arrangement between the third-party payer and the provider that will result in indirect compensation, the sources of the indirect compensation, and explain to which services the indirect compensation relates. If multiple parties are part of a single fee (e.g., an asset-based fee that is split amongst multiple providers), the allocations of compensation amongst all the parties must be disclosed. Notably, if compensation is being paid from plan assets (e.g., an AUM fee, or a service fee charged against participant accounts), it will also be disclosed to the plan participants when those regulations go into effect later in the year.

The disclosures must be provided in writing to the plan fiduciary (generally the trustee or qualified plan investment committee); if proper documentation is not provided within 90 days of the deadline, the plan is required to notify the Department of Labor, and terminate the service provider.

Notably, additional disclosure requirements apply for so-called "designated investment alternatives" - separate investment options that a plan sponsor makes available to participants. There is some concern that advisors who offer asset allocation models may find them treated as designated investment alternatives, which would then require disclosure of performance data, benchmark comparisons, expense ratios, and more. It is expected that further clarification may be forthcoming on this issue from the Department of Labor in the coming weeks.

Implications For Planners

Financial planners who are regularly providing services to the 401(k)/qualified plan market are likely already up to speed on the new 408(b)(2) disclosures, but the large number of planners who provide such services only occasionally may be totally unprepared for the obligations that await them in just a few months. Fortunately for some planners, because the rules apply only to ERISA qualified plans, they are generally not applicable to individual 401(k) plans for the self-employed, nor are the disclosure rules applicable to small business SEP and SIMPLE IRAs.

Nonetheless, for planners who do provide services to qualified plans, the decision needs to be made soon about whether the firm will step up to draft and provide the appropriate disclosures, or terminate their advisory relationship with the plan and step away. Firms that choose to go the disclosure route will likely wish to engage the services of a compliance firm that is up to speed on the new rules; notably, Fred Reish of Drinker Biddle has been a leader in this space. And of course, some firms may find that their costs are no longer competitive, and may feel pressure from their qualified plan clients to lower their fees to stay competitive in a more fee-transparent environment (which is the exact intention and goal from the Department of Labor).

But the bottom line is that there's only 2.5 months remaining to prepare for the new qualified plan disclosure rules, and there appears to be a general lack of preparedness for all the financial planners out there who have "a few" qualified plans intermixed amongst their overall client base. If that describes you, then I hope today's blog post will be a helpful reminder to start working on those disclosures.

(Editor's Note: Special thanks to Josh Itzoe, Partner and Managing Director of the Institutional Client Group at Greenspring Wealth and author of "Fixing the 401(k): What Fiduciaries Must Know (And Do) To Help Employees Retire Successfully", for his assistance on some of the technical details regarding the new 408(b)(2) regulations.)

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  • http://www.jataj.com Janet Tyler Johnson

    Michael: How do these rules effect self-directed accounts for 401k plans. I have an account that I manage for a participant of a 401k plan in his self-directed account but I do not advise the plan.

    Thanks!
    Janet

    • Michael Kitces

      Janet,
      It appears that individual 401(k) plans will fall entirely outside the scope of the new 408(b)(2) disclosure requirements. Since the plan has no employees, it is not subject to ERISA, and without being subject to ERISA, it is not a "covered plan" for the purposes of the new rules.
      - Michael

      • C

        Reread the question...

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