Recruitment

The Rise of the Robo-Advisers

By Patty Kujawa

Oct. 22, 2015

In the defined contribution world, being a bigger record-keeping provider is the only way to survive today. Why? Plan sponsors are demanding more from these suppliers than ever before and want it at very little cost.
 
As a result, larger providers are gaining ground, and smaller ones are disappearing.
 
“It’s really hard to stay in the record-keeping business without lots of scale,” said Robyn Credico, defined contribution practice leader at consulting firm Towers Watson & Co. “I can count on one hand how many providers service” the large plan market today.
 
What once used to be a field of many has whittled down to 40 national providers this year, according to the National Association of Plan Advisors. Fewer than half of those have enough assets and participants to stay competitive, the report said.
Read Up on Retirement Plans
By Richard Y. Hu
As a human resources professional, you are often tasked with creating a financial retirement plan for employees of the company, both to attract and retain talent and to ensure that employees are cared for when they retire after a lifetime of work. Financial security in retirement can be accomplished in several manners, and here are some key points you should consider for your employer and employees when dealing with 401(k) plans.
401(k) retirement plans: The foremost tool in your repertoire for retirement planning is the traditional 401(k) plan, which is a salary-deferral plan. Under this plan, employees can request employers to withhold pretax dollars from their pay check (up to $18,000 annually for 2015) for depositing in an account, and the employer can also contribute to the account by matching a portion of the employee’s contribution. The employee is usually responsible for how money in the 401(k) account is invested. Employees, however, can only withdraw their own contributions before the age of 59½ subject to a penalty and withdraw the employer’s contributions after working at the company for a certain period of time.
Taxes, taxes, taxes: Taxationwise, an employee can decrease his or her taxable income by diverting part of the salary into this account and the money in the account can accrue interest, dividends or capital gains from investments that won’t be taxed until the money is withdrawn from the account. On the other hand, an employee can’t claim capital losses if the investments have lost value. The employer’s contributions are also deductible on the employer’s federal income tax return subject to certain limitations.
Roth 401(k) plans: Employers are now increasingly offering Roth 401(k) plans. The difference between a traditional 401(k) plan and a Roth 401(k) plan is that while the traditional 401(k) plan allows for contributions from pretax income, thereby reducing the taxable income that is reported to the IRS, the Roth 401(k) plan allows for contributions that are from post-tax income and, therefore, won’t reduce the taxable income that has to be reported. However, that means that when an employee withdraws money, the withdrawal is tax-free provided that the Roth 401(k) has been open at least five years and the employee has reached the age of 59½. Employers can only offer a Roth 401(k) plan if they already have a traditional 401(k) plan. Employers, however, can give employees the option of splitting their annual contributions between the two types of 401(k) plans, though the overall limit is $18,000 as of 2015.
The employer’s liability: An employer can administer the 401(k) plan itself or use a third party. If the employer administers the plan, the employer is responsible for establishing the factors for eligibility, what percentage of salaries can be contributed to the plan, whether to match employee contributions and to what degree, and what investment options are available within the plan. When determining the eligibility criteria, an employer can impose two restrictions: An employee must work for a full year (usually at least 1,000 hours over 12 months) and be at least 21 years of age before enrollment. All employees must have an equal opportunity to save for retirement.

Read Up on Retirement Plans

By Richard Y. Hu
 
As a human resources professional, you are often tasked with creating a financial retirement plan for employees of the company, both to attract and retain talent and to ensure that employees are cared for when they retire after a lifetime of work. Financial security in retirement can be accomplished in several manners, and here are some key points you should consider for your employer and employees when dealing with 401(k) plans.
 
401(k) retirement plans: The foremost tool in your repertoire for retirement planning is the traditional 401(k) plan, which is a salary-deferral plan. Under this plan, employees can request employers to withhold pretax dollars from their pay check (up to $18,000 annually for 2015) for depositing in an account, and the employer can also contribute to the account by matching a portion of the employee’s contribution. The employee is usually responsible for how money in the 401(k) account is invested. Employees, however, can only withdraw their own contributions before the age of 59½ subject to a penalty and withdraw the employer’s contributions after working at the company for a certain period of time.
 
Taxes, taxes, taxes: Taxationwise, an employee can decrease his or her taxable income by diverting part of the salary into this account and the money in the account can accrue interest, dividends or capital gains from investments that won’t be taxed until the money is withdrawn from the account. On the other hand, an employee can’t claim capital losses if the investments have lost value. The employer’s contributions are also deductible on the employer’s federal income tax return subject to certain limitations.
 
Roth 401(k) plans: Employers are now increasingly offering Roth 401(k) plans. The difference between a traditional 401(k) plan and a Roth 401(k) plan is that while the traditional 401(k) plan allows for contributions from pretax income, thereby reducing the taxable income that is reported to the IRS, the Roth 401(k) plan allows for contributions that are from post-tax income and, therefore, won’t reduce the taxable income that has to be reported. However, that means that when an employee withdraws money, the withdrawal is tax-free provided that the Roth 401(k) has been open at least five years and the employee has reached the age of 59½. Employers can only offer a Roth 401(k) plan if they already have a traditional 401(k) plan. Employers, however, can give employees the option of splitting their annual contributions between the two types of 401(k) plans, though the overall limit is $18,000 as of 2015.
 
The employer’s liability: An employer can administer the 401(k) plan itself or use a third party. If the employer administers the plan, the employer is responsible for establishing the factors for eligibility, what percentage of salaries can be contributed to the plan, whether to match employee contributions and to what degree, and what investment options are available within the plan. When determining the eligibility criteria, an employer can impose two restrictions: An employee must work for a full year (usually at least 1,000 hours over 12 months) and be at least 21 years of age before enrollment. All employees must have an equal opportunity to save for retirement.

 
But as the number of existing providers shrinks, a new financial technology giant has hit the market. Betterment, an online investing service company, became the first robo-adviser to jump into the record-keeping business in September. Betterment claimed its technology offerings will outperform existing ones.
 
While this new entrant remains to be tested, the defined contribution service business is maturing. Just like many industries in that position, the number of retirement plan record-keeping providers is shrinking. There has been speculation that fewer providers will mean limited services and lower quality — think the airline industry — but, so far, record-keepers are working with employers.
 
“This happens with every industry that matures,” said Rick Meigs, president of the 401khelpcenter.com. “It’s usually not a negative.”
 
Meigs is right. Companies are feeling the heat from two areas and are in turn squeezing providers for better solutions. First, companies are realizing that retirement plans need to be strong and effective so people can retire on time and move out of the workforce. Second, federal regulations and lawsuits are forcing companies to have strong reasons for choosing plan service providers. 
 
And with the $6.8 trillion held by Americans in defined contribution plans, providers are willing to work a little differently. 
 
“Ten to 15 years ago, [companies] didn’t think they had the leverage to ask for changes,” said Mike Alfred, co-founder and CEO of BrightScope Inc., a financial information technology company that tracks defined contribution plans. “When a large client says they want to have certain things, providers need to listen.”
 
A May 2015 Cogent Wealth Reports from Market Strategies International found that 4 in 10 midsize and large plan sponsors said they would ask for fee reductions from current providers, and 34 percent of large plans said they were likely to issue a formal request for proposal for record-keeping services, up from 21 percent last year.
 
“They want to make sure they are getting the best value,” said Linda York, a vice president at Cogent Reports. “Even if they are staying put [with a provider], they want to make sure they are benchmarking and can justify their decisions.”  
 
Plan sponsors are also calling shots on investment lineups on record-keeping platforms. Employers can and often use the recordkeeper’s available funds like target-date, mutual or other funds. According to 2012 data from BrightScope and the Investment Company Institute published late last year, a little over 62 percent of 401(k) plans used proprietary funds in investment lineups. Larger plans, ones with $1 billion in assets, tend to be trailblazers in terms of changes, and just under 58 percent offered proprietary funds.
 
Plan sponsors are acutely aware of their responsibility to offer the solid investment choices at reasonable prices. U.S. Labor Department rules that require plan sponsors to tell participants how much they are paying for their plans served as a wake-up call for companies to really look at costs. In addition, several recent lawsuits, including this year’s U.S. Supreme Court case Tibble v. Edison, make it clear that plan sponsors are responsible for monitoring investment options and removing the lackluster ones.
 
“These lawsuits certainly get a plan sponsor’s attention,” Alfred said. “They don’t want to have a mediocre lineup.”
 
Meanwhile, record-keepers continue to feel pressure from plan sponsors to keep costs low. The median record-keeping fee for all defined contribution plans dropped 12.5 percent in 2014 to $70 per participant, according to investment consulting firm NEPC. That’s a serious drop from the $118 per participant cost in 2006 when NEPC started tracking this data.
 
Record-keepers are the nuts and bolts of defined contribution plans, like 401(k) or nonprofit 403(b) plans. They are the ones managing the daily operation of a plan, like processing enrollments, tracking and handling investment elections, contributions and payouts as well as providing employees information through plan statements. 
 
The BrightScope/ICI data showed asset managers like Fidelity Investments and The Vanguard Group, (which also provide record-keeping services) hold nearly 52 percent of all 401(k) assets and serve about 31 percent of plans. Insurance companies, like Prudential Retirement and MassMutual Financial Group have their niche with smaller plans and come in second holding 13 percent of assets but serving 41 percent of the market. The remaining assets and plans are served by brokerage firms, banks and pure record-keepers. 
 
But the asset managers are moving up. Fidelity Investments has long claimed the top spot, with $1.25 trillion in assets, covering 13.5 million participants.
 
Empower Retirement, which was the result of the largest acquisition in 2014 by Great-West Financial, is aggressively moving through the market, laying claim as one of the next largest providers with $440 billion in assets for 7.5 million participants.
 
“I have 4,000 people who get up every day and just think about defined contribution,” said Edmund F. Murphy III, president of the Greenwood Village, Colorado-based retirement organization. “Scale clearly matters in this business.”
 
Every Participant Gets a Little Help
 
Record-keeping services used to be routine, like enrolling workers into plans and managing contributions and withdrawals. Today, plan sponsors want record-keepers to make sense of all that busywork so they can design more efficient plans. Companies want to see how its plan stacks up against peers as well as whether participants are making good decisions to help them stay on track. Companies also want better Web-based tools to help workers get interested and take ownership of their retirement savings progress, experts agreed.
 
The Rise of the Robo-Advisers_HotList
 
“It’s not enough to just to do the record-keeping,” Cogent’s York said. Companies “are looking for more data, and on a timely basis. They want to really get into the details.”
 
With volume — in terms of accumulating retirement data — large providers are able to deliver.
 
Doug Fisher, senior vice president of thought leadership and policy development for Fidelity said because the company holds about a quarter of the market, it is able to answer employers’ primary concerns: whether plan design achieves certain goals, hits set performance levels and has the ability to target and resolve weaknesses or gaps.
 
Meanwhile, employees get a simple way to enroll in plans and are able to see whether they are saving and investing appropriately. They can compare their progress to peers not just at their company, but geographically as well.
 
“We are investing in technology to find insights that help employers design plans that meet the particular needs of the participant in a more personal way,” Fisher said. “It’s a real advantage to Fidelity to deliver this when we hold 25 percent of the market.”
 
Even with scale, being a full service provider isn’t easy, 401khelpcenter.com’s Meigs said. An August survey by Charles Schwab Corp. showed that 67 percent of participants want personalized investment advice, and 73 percent said they would be “very” or “extremely” confident in making investment decisions with help from an adviser. 
 
“We’ve observed that when advice is built into the plan so that participants start off with it and are fee to opt out if they wish, nearly 86 percent stick with it,” said Catherine Golladay, Schwab’s vice president of participant services and administration, in a written statement. “That can make a big difference.” 
 
But one-on-one advice can be time-consuming and expensive — and not to mention too costly for participants with low account balances. That’s why more providers are turning to robo-adviser partnerships and acquisitions. As the name suggests, robo-advisers use technology to help participants pick investments in their 401(k) lineup that complement their goals and other factors.
 
“For low account balances, it doesn’t make sense to do customized financial planning,” said Fred Barstein, founder and executive director of the Retirement Advisor University. “That’s where robo-advisers come in.”
 
While providers like Charles Schwab, Vanguard and Fidelity have in-house robo-adviser operations, Wells Fargo & Co. announced a partnership with independent adviser Financial Engines in August to offer online advice on its record-keeping platform. The deal could reach all 3.8 million 401(k) participants on the Wells Fargo platform. 
 
Robo-advisory programs require participants to do a little more legwork in terms of entering information but are becoming a requisite feature for plan sponsors. Aon Hewitt’s “Hot Topics in Retirement” report showed 69 percent of the 250 employers surveyed offer online investment guidance in 2015 compared with 56 percent in 2014.  
 
“It is a scalable solution,” York said. “It doesn’t require [an adviser] going through all the necessary questions.”
 
So Why Stay?
 
It’s not the low fees or fewer proprietary funds on platforms that keep the record-keepers large enough to stay in the industry. It’s the access, experts agree.
 
“You do record-keeping as a method to get to participants for other services,” said BrightScope’s Alfred.
 
The Rise of the Robo-Advisers_DataBank
Source: Investment Company Institute: Federal Reserve Bank and Department of Labor
 
A recent study by Cogent Reports found about half of affluent investors in an employer-sponsored retirement plan will move their money into a rolled-over individual retirement account by early next year. Cogent said the investors include workers who will switch jobs as well as retire and have $382 billion available.
Cogent named Vanguard, Charles Schwab and Fidelity as the top three preferred rollover IRA firms because of low fees and strong name recognition.
 
“To be in the rollover business, you have to be a consumer brand, and that’s not true of all record-keepers,” Barstein said. 
 
What Will the Future Look Like?
 
Experts agree the record-keeping business may look very different in a few years than it does today. Consolidation will continue, but just like Betterment’s debut, other new players may enter, offering sophisticated technology at lower prices.
 
Some speculated that a company like Zenefits, an online human resources platform, may develop, or an existing robo-adviser may jump in, or existing technology titans like Google Inc. could enter the industry. Already, Silicon Valley has technology-based companies like Captain401 and Guideline Technologies Inc. forming online 401(k) record-keeping platforms.
 
“The race is coming down to data, and a provider’s ability to prescribe a solution and apply it,” Barstein said.
Patty Kujawa is a freelance writer based in Milwaukee.

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