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DOL Rule Impacts Far More Than Advisors’ Pay

Posted on October 8, 2016 by -

Although some financial services companies are still stuck in one of the first four stages of grief (denial, anger, bargaining and depression) over the Department of Labor’s fiduciary rule, a few companies are already well into the fifth stage—acceptance—and have tweaked their businesses to fit the new normal.  

Attorneys from three firms in the latter category—Vanguard, USAA and OneAmerica—shared war stories about how their companies have adapted to the DOL rule in a presentation to a standing-room-only crowd at LIMRA’s annual conference in Chicago this week. The rule takes preliminary effect next April; full compliance is expected by the start of 2018.

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The DOL rule, the attorneys quickly made clear, poses much broader questions for firms than, “Will we be sued?” It has implications for—and will potentially require changes in—almost every part of any firm that builds and/or sells investment or insurance products or advisory services to IRA clients or qualified plan participants.

In requiring firms to comply, and to document their compliance, with a fiduciary standard when advising IRA or 401(k) clients, the rule has ramifications for operations (call center training programs,  the configuration of IT systems), for product development and design, for wholesaling, and for distribution relationships. The rule demands new analyses of the relative costs, risks, and benefits of low-balance accounts, commissioned accounts and fee-based accounts.

“It’s a Herculean task,” said James Whetzel, general counsel at USAA. The scale and scope of the internal review that’s occurring among companies that collectively manage trillions of dollars in retirement savings may be unprecedented. “It’s a common statement we hear from clients—that they’re examining the whole enterprise,” said Jon W. Breyfogle, the Groom Law Group attorney who moderated the presentation. (Below right: a slide from the session.)

DOL rule triggers a re-think of the whole business

Foreseeing the implications of the DOL rule more than a year ago, OneAmerica hired consultant Oliver Wyman to evaluate its entire business. Based in Indianapolis, OneAmerica owns a life insurance company that sells products through a career force and through third-party insurance marketing organizations (IMOs). It also owns a broker-dealer, thus enabling its career force to sell investments as well as insurance products. 

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“Oliver Wyman charted how our products fed into our distribution and examined how our IT would be impacted,” said Tom Zurek, OneAmerica’s general counsel and secretary. “We identified 50 different ‘work streams.’ It was a daunting process.” Systems that once ran separately or parallel must now be integrated. To establish a client’s “best interest,” more data must be gathered and assessed. The rule forced OneAmerica to reexamine its overall direction and goals as a business. “We decided that it was no longer acceptable for us to be all things to all people,” Zurek said. 

We Believe What We Like to Believe

Posted on October 6, 2016 by -

RIJ reviews five retirement-related research papers this week:    

  • “Mindful Economics: The Production, Consumption, and Value of Beliefs,” by Roland Benabou and Jean Tirole.  
  • “Economic Conditions and Mortality: Evidence from 200 Years of Data,” by David Cutler, Wei Huang and Andriana Lleras-Muney. 
  • “The Impact of Intergenerational Transfers on Household Wealth Inequality in Japan and the United States,” by Yoko Niimi and Charles Hokoida. 
  • “Older Women’s Labor Attachment, Retirement Planning and Household Debt,” by Annamaria Lusardi and Olivia Mitchell. 
  • “You Get What You Pay For: Guaranteed Returns in Retirement Savings Accounts,” by William Gale, David John and Bryan Kim.

The things we know aren’t always so 

Economists once assumed, for the sake of convenience, that investors were “rational”—they knew what they were doing, minimized their risks and maximized their upside. This belief gave way to behavioral finance, which established that irrational quirks like the “endowment effect,” “loss aversion” and “hyperbolic discounting” are hard-wired into us.   

Now comes another psychological spin on financial behavior: the concept of “motivated beliefs and reasoning.” In a new research paper, a Princeton economist argues that we subconsciously deceive ourselves in ways that we think will further our goals, in both our financial and political lives and often regardless of our intelligence level.    

“Beliefs often fulfill important psychological and functional needs of the individual, write Roland Benabou of Princeton and his co-author, Jean Tirole, chairman of the Toulouse School of Economics. “Economically relevant examples include confidence in ones’ abilities, moral self-esteem, hope and anxiety reduction, social identity, political ideology and religious faith.”

That very idea invites denial, if not umbrage, and the authors acknowledge that it’s scary. “When motivated thinking becomes a social phenomenon… [c]ollectively shared belief distortions may amplify each other… so that entire firms, institutions, and polities end up locked in denial of unpleasant realities and blind to major risks,” they write in “Mindful Economics: The Production, Consumption and Value of Beliefs” (Journal of Economic Perspectives, Summer 2016). 

How does the motivated-beliefs phenomenon manifest itself? Mainly through the kind of everyday self-serving self-deceptions that we’re all familiar with: Overconfidence, denial of bad news, wishful thinking, and so-called group-think.    

Denial, as the character Stuart Smalley said to Michael Jordan on Saturday Night Live, is not just a river in Egypt. It’s both widespread and pernicious.

“The more people fail to attend to bad news and continue doing ‘business as usual,’ the worse the bad state becomes, making it even harder to face the impending disaster,” the authors write. Overconfidence and denial can be contagious in an organization. “In a hierarchy,” they note, “top management’s (mis)perceptions of market prospects, legal liabilities, or odds of victory will tend to trickle down to middle echelons, and from there on to workers or troops.”   

Beliefs can be especially susceptible to the influence of incentives. “Each individual tends to align their beliefs with the fixed stakes they have in different states of the world.” (Or, as Upton Sinclair wrote, “It is difficult to get a man to understand something when his salary depends on his not understanding it.”)

Market timing: Be a teen in boom times

The go-go 1960s were a paradise for teenagers. Food was plentiful if industrial (Wonder bread, Hawaiian Punch, Jello, Mrs. Paul’s fish sticks and American cheese). Everyone seemed to drive a Mustang or a VW. The Beatles and Motown ruled AM radio. Steel mills and chemical plants belched smoke and fumes, but no cared.

Here’s more good news for anyone whose adolescence happens to coincide with an economic boom. They are relatively more likely to lead longer, more satisfying than people who come of age during bad times, according to economists David M. Cutler and Wei Huang of Harvard and Adriana Lleras-Muney of UCLA.    

“In the long run good economic conditions in adolescence have a particularly long lasting effect on lifetime incomes and appear to improve health substantially by providing individuals with more satisfying lives, better social conditions and improved mental health and cognitive capabilities,” they write in a new paper, “Economic Conditions and Mortality: Evidence from 200 Years of Data.” The findings were based on the economists’ analysis of mortality and GDP experience in 32 countries, much it from the Human Mortality Database (www.mortality.org).

Boom-times do bring more pollution—just ask the Chinese—which harms health. And boom-era adolescents are statistically more likely to afford and use alcohol and cigarettes, which also raises mortality. But those adverse effects appear to be outweighed by the health and social benefits of being ages 16 to 25 during prosperous times.

Other factors, such as whether people lived in urban or agricultural areas, or whether their country spent a lot on social services, were considered. The agricultural areas experienced fewer pollution-related affects, and there was less of a boom-bust effect on mortality in countries where the socials spending was high during economic busts.

The family way: Estate tax policy and inequality    

Estate taxes are relatively mild in the U.S.; they apply only to the few estates (one in 500) worth over $5.25 million. At the same time, the rise in wealth inequality in the U.S., where government figures show that three percent of households own 54% of the wealth and the top 10% owns 75%, makes sociologists fret about the future of the bottom 90%. New evidence shows that if we want low estate taxes, we should expect more inequality.  

That’s because “intergenerational transfers”—bequests and gifts within wealthy families—tend to foster inequality. Two researchers at Japan’s Asian Growth Research Institute, Yoko Niimi and Charles Horioka, have studied the matter, and found that wealthy people are more likely to leave bequests, that children who receive inheritances are likelier to leave money to their children, and that these habits promote wealth concentration over time. The effect is weaker in Japan than in the U.S., because of more stringent estate taxes.

One surprising finding: Poorer people who received gifts from parents were more likely to give money to their children than were wealthier people in the same circumstances. As an explanation, the researchers speculated that the pass-it-along ethic may be more evident among poorer individuals simply because they can’t afford to leave legacies to their children unless they themselves have received bequests from their parents.    

Not so surprisingly, Niimi and Horioka found that “those who receive intergenerational transfers from their parents tend to come from better-off families and that wealthier individuals are more likely to leave bequests to their children than less wealthy ones.” People are also more likely to receive intergenerational transfers if they have relatively highly educated parents or fewer siblings.

Sharp differences were evident between Japan and the U.S. with respect to estate taxes, bequest activity and wealth inequality. Americans are twice as likely to plan to leave bequests as Japanese, by 54% to 24%, and Japanese are more likely not to make special efforts to leave bequests but leave whatever they don’t use to their children, by 49% to 31%.

Tax policy helps explain those differences. The minimum taxable bequest in the US as of 2016 is $5.45 million US dollars, more than 10 times the Japanese figure. The tax rate of the bequest tax is also much higher in Japan (a maximum rate of 55% in Japan vs. 40% in the US). As a result, one in every 25 Japanese (4%) are liable for bequest taxes at death while only one in 500 Americans (0.2%) are. 

Mortgage slavery: Housing debt keeps some women working 9-to-5

During the housing boom that preceded the Great Financial Crisis, many people were able to buy big homes with low down payments and large mortgages. There’s evidence that the burden of those big mortgages is forcing a significant number of older women to delay retirement, relative to women of 25 years ago.  

In a new research paper, “Older Women’s Labor Market Attachment, Retirement Planning, and Household Debt” (NBER Working Paper 22606), Annamaria Lusardi of George Washington University and Olivia Mitchell of the University of Pennsylvania examine the upward trend of workforce participation by older women and its causes.      

 “Recent cohorts of women drawing near to retirement have more debt than before, and this is positively associated with older women being more likely to work currently, as well as to plan to continue to work in the future,” they write. Compared to women 25 years ago, more women ages 51 to 56 and 57 to 61 are working.

Lusardi is an internationally known expert on financial literacy. Mitchell is director of the Pension Research Council at the University of Pennsylvania’s Wharton School of Business.

Debt was the primary cause, they found. “Significant factors included education, marital disruption, health, and fewer children than prior cohorts. Yet household finances also appeared to be playing a key role, in that older women today have more debt than previously, and they are more financially fragile than in the past,” the paper said.

Of the debt load, much of it was linked to mortgages. “A standard deviation increase in the ratio of mortgage debt to home value was associated with a 3.4–5.5% rise in women’s anticipated probability of working at age 65. In large part this can be attributed to having taken on larger residential mortgages due to the run-up in housing prices over time and decline in required down payments.”

The price of a guaranteed investment return

The 2008 market crash traumatized a lot of people by halving the market value of their retirement savings almost overnight. “This experience, coupled with continuing concerns about retirement security, has generated new interest in the idea of having the government provide minimum rate-of-return guarantees for retirement savings accounts,” write William Gale, David John and Bryan Kim in a new Brookings Institution Economics Study.

The three authors try to calculate the cost of providing such a guarantee. It depends on the richness of the guarantee, the level of equities in the underlying portfolio, the time horizon of the guarantee, and whether it’s nominal or inflation-adjusted. It also depends on whether the guarantee is financed by insurance premiums, the government, a reserve “smoothing” fund, or a “collar” that puts both a cap and a floor on potential returns.

Of the few existing examples of guaranteed-return funds, the paper points to stable value funds and to TIAA’s “traditional annuity,” which offers a guaranteed minimum rate of return that’s reset annually and is accompanied by, in every year since 1948, by an annual bonus.

Among defined contribution plans with exposure to both stocks and bonds, Belgium offers a savings program that returns at least 3.75% for employee contributions and 3.25% for employer contributions, while the National Provident Fund in New Zealand offers a guaranteed 4% nominal return.

There’s a reason why you don’t see more of the pooled-risk defined contribution plans in the US: Our pension law, i.e, ERISA, discourages them. (TIAA’s annuity is not subject to ERISA.) Written before the advent of DC plans, ERISA “requires all investment returns be used solely for the benefit of pension participants, with reasonable allowance to defray administrative costs,” the authors write. Ergo, no ERISA plan can operating a reserve fund that would stockpile excess returns in good years and use them to protect the guarantee in bad years.

Gale and Kim (both of Brookings) and John (of AARP, and a co-creator with Mark Iwry of the “auto-IRA”) reach a conclusion that many life insurance company actuaries might reach instantly: Even modest capital market guarantees don’t come cheap, regardless of whether the guarantor, the owner or some governmental body absorbs the cost. “A private insurer would likely charge the economic cost to offer a guarantee,” they write. “The government may not, for political reasons, but that does not make the economic costs disappear.”

© 2016 RIJ Publishing LLC. All rights reserved.

Two Definitions of ‘Best Interest’

Posted on October 6, 2016 by -

More and more frequently, I catch myself stewing about retirement income—my own. For starters, I plan to work until age 70 if I can and postpone claiming Social Security until then. That’s mainly for my family’s sake.

My spouse is six years younger than I am, and I want her to qualify for the largest possible widow’s benefit. A back-loaded Social Security payment should help ease the pressure she might feel to spend our kids’ inheritance.

With three daughters, we have a strong “bequest motive.” My wife inherited some money from her parents, and we’d like to pass it through to our children more or less intact. On a per-child basis, the legacy will be modest. My frugal in-laws split their bequest evenly among their three children. So each of our daughters stands to receive one-ninth of the family fortune.

We’ll rely on our own savings, most of it in tax-deferred plans, to generate income. Neither of us has a defined benefit pension. So I’m considering the purchase of guaranteed income products. Out of all the products that I write about, immediate variable annuities have always appealed to me. Vanguard used to offer an immediate annuity that was part fixed and part variable. It seemed like the perfect compromise. 

On the other hand, the product that would probably best relieve my anxieties about the future is the period certain annuity. I worry most about the years from 75 to 85, when I’m statistically likely to be alive but too old to work. The idea of an extra blanket of guaranteed income during those years, via one or two period certain annuities, just feels safer. (Maybe that’s what it feels like to have a pension—as my engineer brother does. But even he frets.) 

At present—things could change—I would define that solution as the one in my “best interest.” But if the DOL used the same definition, advisors are in trouble. How would an advisor ever know that such a solution would bring me the most peace of mind, unless I told him or her? If, like most clients, I had no background in annuities, I probably wouldn’t be able to communicate my needs.

The DOL fiduciary rule didn’t necessarily set the “best interest” bar that high. As I understand the Best Interest Contract exemption, it equated “best interest” with what a “prudent” financial specialist would recommend, without regard to his or her own reward. If the rule stops there, the financial industry—i.e., the world of product distribution—may be able to live with it merely by flattening advisor and broker-dealer compensation. Life as you’ve known it would go on (albeit with more automation).    

But if clients interpret “best interest” to mean a customized solution that’s a) tailored to their unique sets of needs, risks and wants; b) encompasses their entire household balance sheets; c) requires their costs to be as low as possible; and d) forces advisors to have virtually every known option or tool at their disposal, then the era of advice-as-product-recommendations may be over.

If that higher definition of best interest dominates, then it’s easy to imagine a world where advisors sell only low-cost generic products in computer-generated portfolios. If not replaced entirely by algorithms and call centers, advisors will likely be salaried or charge by the hour, be independent or self-employed, have a 360-degree knowledge of investments, insurance and taxes, and have a balanced understanding of accumulation and distribution strategies. They’ll also need a set of interpersonal and consultative skills that many today’s sales-driven reps and employee-advisors don’t necessarily have.    

You could argue that the gap between the narrowest and the broadest definitions of best interest is impossibly wide, and that not even the DOL will expect employees of broker-dealers (or even the robots who replace them) to bridge it.

But that fuzzy gap—between what advisors can deliver and what clients feel that the DOL rule promises them—is exactly where the plaintiff’s attorneys may focus their litigation efforts. Despite the disruption it will comes with it, advisors and broker-dealers should probably start defining “best interest” in the larger sense.

© 2016 RIJ Publishing LLC. All rights reserved.

Student Debt Weighs on All of Us

Posted on October 6, 2016 by -

The 2016 presidential election has made student debt a national issue. Two just-released books, one by Sandy Baum and one by Beth Akers and Matt Chingos, have done a great job of identifying the real problems with student debt, while debunking much of the rhetoric that tends to identify wrong problems and come up with wrong solutions. I highly recommend the books, though I am hardly unbiased since Matt and Sandy are colleagues of mine.

By focusing on the real risks associated with the current system, the authors emphasize thatwe must pay attention to who acquires the debt and who benefits from it. For instance, future doctors and lawyers with high returns to postgraduate education acquire some of the highest levels of student debt. Akers and Chingos emphasize that over 40 percent of student debt is held by those in the top 20 percent of the income stratum. Thus, simply eliminating student debt would help the highest income borrowers most.

Sandy Baum focuses on designing proposals that would prevent so many at-risk students from borrowing for programs unlikely to serve them well. She especially discredits proposals that provide the most assistance to those who are actually in the best position to repay their loans. One example of how all this plays out was shown earlier by some other colleagues: blacks as a group, who are less likely to come out of college with a degree, end up with higher average student debt than whites.

Here I wish to address a more macro question: whether this shift toward higher student debt represents just one more way that government has disinvested in the economy. As students accumulated $1.3 trillion in debt, did government make an equivalent increase in investment in what economists often call “human capital”? Or did government simply shift additional burdens onto these students with few or no significant gains in educational achievement nationwide? Or something in between?

When we look at budgets as a whole, both federal and state, it’s quite clear how resources are being shifted. Average tax rates are about where they have been, maybe a touch higher. Taxpayers may have gotten a break for a while as rates went down a bit and then back up a bit, but that’s not the main story. Both federal and state budgets have adopted huge spending increases for retirement and health care. States have also put a lot more into prisons, while the feds have put much more toward interest costs, though offered a reprieve—if one can call it that—by a weak worldwide economy that has led to low interest rates.

Clearly, a smaller share of revenues and incomes goes for education—not just higher education, but primary and secondary education as well. Almost anything that might qualify as investment, such as infrastructure, has also seen a downturn.

Taking the budget as a whole, therefore, it’s hard to avoid the conclusion that the net effect of federal and state policies, of which student loans become merely one example, has been a disinvestment in the economy as a whole.

This raises an additional issue for those assessing programs by comparing benefits to costs. In the case of student loans, if more borrowing on average increases human capital by more than the value of the loans, we would say it was worthwhile for individuals to take out those loans. Correspondingly, if we were replacing a system with less education and no loans with one that on net created more assets than debt, we would likely conclude that the shift was worthwhile societally, not just individually. However, starting from a society that had financed education more directly, the student loan policy may be a failure.

Put another way, the starting point matters. In this arena and others we usually want government to increase net investment, as well as improving the allocation of funds so as to garner the highest returns on the investment, and we need to figure out the effect across the entire balance sheet of assets and liabilities.

The individual perspective compares the personal increase in assets with the personal increase in borrowing and asks whether enough people come out ahead that society is better off. But if the additional loans don’t finance an increase in education societally, whether because some students don’t attain degrees or others don’t acquire any more education than they would have undertaken anyway, then we must ask what we got for our money.

If this debt policy additionally discourages risk taking and marriage after education, then all this debt may even reduce investment over time in education, businesses, and homes combined. Unfortunately, I think this has been the most likely outcome of recent policy. Even the creative reforms that Baum, Akers, and Chingos recommend won’t restore those past losses, though they may help minimize them in the future.

Whatever your take on this issue, this presidential campaign makes clear that higher education reform very likely will be on the national agenda in the next year or two. The Baum and Akers-Chingos studies should be required reading for anyone undertaking that reform.

© 2016 The Urban Institute.

Envestnet’s new tools to aid compliance with DOL rule

Posted on October 6, 2016 by -

Envestnet, Inc., the investment platform provider, said it has introduced “comprehensive Fiduciary Rule compliance solutions and consulting services: to help advisors and enterprises comply with the Department of Labor’s (DOL) Fiduciary Rule, which goes into effect next April. 

The solutions include:

Best Interest assessment. To give advisors a ‘comprehensive understanding of a client’s financial situation and objectives’ and accelerate the on-boarding process, Envestnet will provide “integrated client-permissioned account aggregation.’ The solutions integrate with the leading financial planning providers.

Product shelf development. To help advisors develop compliant investment portfolios and programs, Investment consultants from Envestnet | PMC will provide chief investment officer (CIO) support and investment consulting services.

Account documents and disclosures.  Envestnet’s new-account and proposal technology will help firms to meet new requirements for account documentation and disclosures by providing: 

  • Best Interest Contract provisions and disclosures
  • Investment product and program expense analysis
  • Fee rationalization illustrations
  • New account documentation and retention

Enterprise Business Intelligence Solutions. Envestnet’s Vantage enterprise-level data aggregation solutions, along with the Envestnet Intelligence platform, will make all of the firm’s investment products easily visible. “This visibility is critical to help bring legacy assets into compliance with the fiduciary rule as well as provide ongoing monitoring and surveillance,” the release said.

© 2016 RIJ Publishing LLC. All rights reserved.

 

Ghilarducci book calls for new breed of DC plans

Posted on October 6, 2016 by -

New School economist Teresa Ghilarducci, once dubbed the “most dangerous woman in America” by conservative pundit Rush Limbaugh for her criticisms of the 401(k) industry, has published “Rescuing Retirement: A Plan to Guarantee Retirement Security for All Americans” with co-author Hamilton “Tony” James, president of private equity giant Blackstone.

The book, published by Disruption Books, outlines “a deficit-neutral proposal to ensure that all workers can save enough to retire through mandated, individually-owned, and effectively-invested Guaranteed Retirement Accounts,” according to a press release. “Left unaddressed, the authors emphasize, the strain of a newly poor population of senior citizens would devastate federal, state, and local budgets for decades to come.”

Ghilarducci and others have identified weaknesses in the existing 401(k) system. Plans typically work best for long-tenured employees at large companies that offer low-cost plans and generous matching contributions. But many small companies don’t offer them at all, and at any given time around half of the full-time work force has no access to a plan.

Those weaknesses, which include inconsistent fees and investment options, vulnerability to “leakage” during job changes, and the absence of a mechanism for converting savings to retirement income, have inspired calls for statewide or nationwide defined contribution plans that don’t rely on each employer’s willingness or unwillingness to offer a plan.

The U.S. government has proposed its own universal auto-enrolled IRA program for small business, call MyRA, and states like Washington and California have taken steps toward requiring all their employers to offer an auto-enrolled IRA or qualified plan.  

Components of the Ghilarducci-James plan include:

Universal coverage. Every American worker would have a Guaranteed Retirement Account, individually owned as in a defined contribution plan but pooled and invested in professionally managed funds, as in a defined benefit pension.

Costless for families at or below median income. The plan would redistribute the current tax expenditure for retirement savings, which favors those in higher tax brackets, more evenly across the income distribution.

Deficit-neutral. The program would save money by using existing Federal payment infrastructure.

Guaranteed lifetime income. At retiring, savings would be converted to an annuity.

Bipartisan appeal. This model keeps accounts under personal control, distributing savings based on the amount invested, not based on income, and without impacting the budget or raising taxes.

The publication of the book follows the authors’ March 2016 white paper, “A Comprehensive Plan to Confront the Retirement Savings Crisis,” and their January 2016 New York Times op-ed, “A Smarter Plan to Make Retirement Savings Last.” It also coincides with the launch of a website dedicated to the plan and its promotion, rescuingretirement.org, and a social campaign driven by the hashtag #fixretirement on Twitter and Facebook.

© 2016 RIJ Publishing LLC. All rights reserved.

Mercer offers new turnkey fiduciary services to plan sponsors

Posted on October 6, 2016 by -

Mercer, the global benefits consultant, has launched Mercer Wise 401(k), a service that will allow employers to turn the administration, operations, investment decisions and fiduciary responsibilities of their plans over to Mercer.

At a time when plan sponsors face the potential for class-action lawsuits over activities once regarded as business-as-usual, such as revenue-sharing agreements with plan providers, Mercer evidently sees an opportunity to serve as the ERISA “plan administrator” and “named fiduciary” for employers and help ensure that they’re compliant with pension law.

“We believe that segments of the 401(k) marketplace suffer from high fees and lack of transparency, among other challenges. Against this background, plan sponsors face an increasingly difficult regulatory environment, increased litigation risk and heightened demand on their limited resources to support their 401(k),” said Tom Murphy, Senior Partner, Mercer, in a release.

“By assuming the responsibilities of named fiduciary, Mercer can reduce risks for plan sponsors, who may be challenged in meeting an ever increasing burden. We will leverage our global research and investment expertise and use our economies of scale to provide transparency, cost reductions and improved services.”

Participants in Mercer Wise 401(k) will have access to Mercer Financial Wellness, an open architecture financial wellness platform that includes access to online budgeting tools, credit-score monitoring, a robo-advice solution, student loan refinancing and other services provided through third-party providers.

Mercer Wise 401(k) offers its clients features including but not limited to:

  • Taking ownership of many of the fiduciary responsibilities of plan sponsors.
  • Offering participants access to high quality institutional investment solutions developed by Mercer’s global research team by engaging independent investment managers.
  • Assuming responsibility for plan administration and meeting certain regulatory requirements, such as Form 5500 filings and non-discrimination testing.

Mercer Wise 401(k) services are provided by Mercer Investment Management, Inc., which is a unit of Marsh & McLennan Companies, a global professional services firm with annual revenue of $13 billion and 60,000 employees. Other units include Marsh, an insurance broking and risk management firm; Guy Carpenter, a provider of risk and reinsurance intermediary services; and Oliver Wyman, a management consulting firm.

© 2016 RIJ Publishing LLC. All rights reserved. 

Women need advice on claiming Social Security: Nationwide

Posted on October 6, 2016 by -

A survey sponsored by Nationwide Retirement Institute and conducted by Harris Poll shows that older women need help maximizing their Social Security Benefits. Nationwide’s “Social Security 360” service enables advisors to provide that help, according to a release from the Columbus, Ohio-based insurer.

Nationwide’s survey, conducted last February, covered 909 U.S. adults aged 50 or older who were retired or planned to retire within 10 years. The sample included 465 women, of whom 301 were currently retired. The results showed that:

  • Retired women spend 70% of their Social Security benefit on health care, on average.
  • Retired women depend on Social Security for 56% of their expenses in retirement, on average.
  • 80% of retired women currently collecting Social Security benefits took their benefits early.
  • Only 5% of women currently collecting Social Security claimed at age 70 or later.
  • 24% of retired women said that health care expenses keep them from enjoying  “the retirement they desired.”
  • 17% of women currently drawing Social Security wish they could change their claiming decision and file later.
  • Of those who would not change their filing decision, 39% say an unforeseen life event compelled them to take it early, including unplanned health problems (17%).
  • 30% of women currently drawing Social Security say their payment is smaller than they expected.
  • Although women who don’t yet collect Social Security expect to receive an average of $1,527 in monthly benefits, current recipients collecting only $1,153 on average and those claim Social Security early receive $1,084 on average.
  • Only 13% of women say they received advice on Social Security from a financial advisor.
  • 86% of women who worked with an advisor said their Social Security payment was as large or larger than they expected.
  • 61% of women surveyed said that they would switch financial advisor if theirs couldn’t show them how to maximize their Social Security benefit.  

Besides helping advisors find their clients’ optimal Social Security filing options, the Social Security 360 program’s software can compare election strategies available to married couples, single people, divorced people, widows, and government employees, the Nationwide release said.  

© 2016 RIJ Publishing LLC. All rights reserved.

One Step Ahead of a Rolling Boulder

Posted on September 29, 2016 by -

Pressured by the approaching activation of the Department of Labor’s fiduciary rule in April 2017, the retirement industry—product manufacturers, distributors, and hundreds of thousands of financial advisors—finds itself in a state of uncertainty, convulsion and frantic activity.

At the Insured Retirement Institute meeting this week in Colorado Springs, preparation for compliance with the rule was a common concern, according to one person who attended:

“The tone of the meeting was one of collaboration—like, ‘How will we all get through this together? But it’s weird. The insurance carriers are waiting to hear back from the broker-dealers about what they should do about the rule. But the broker-dealers and the IMOs still don’t know what they’re going to do,” he told RIJ.

“Tactically, people seem comfortable that they will be able to issue the required disclosures and ‘Best Interest Contracts’ by next April. But they haven’t solved the problem that people can start getting sued after that for violating their fiduciary duties. The big question is: How can we limit liability? They’re hearing that class-action lawyers are already creating billboard ads” to attract potential plaintiffs.

“The overall answer to that seemed to be: if you, as an advisor, intend to sell annuities, or even mutual funds, you’ll need a full financial plan. The product-pushing days are over. You’ll have to look at the client’s whole situation. If you sell annuities, you may not be able to push them alone. If you’re an RIA, you might have to start considering annuities.”

The DOL rule was intended to, and will, dampen retirement industry profits. The rule is expected to reduce and standardize, though not eliminate, the non-transparent fees, such as commissions and so-called 12b-1 marketing fees, that mutual fund and annuity manufacturers pay to distributors (broker-dealers and their advisors) for marketing and selling their products.

“Intentional or not, the DOL fiduciary rule will change the landscape of the retirement market for decades,” said a LIMRA researcher this week.

It’s as if, with respect to tax-deferred accounts, the government had told powerful people, with equally powerful secret lovers—in this case, broker-dealers and makers of mutual funds and annuities—to go back to their legal spouses.

For monogamous people, as it were, not much will change. For Vanguard, or fee-only planners, or elite wealth managers at Morgan Stanley, business will go on largely as usual. But thousands of lives, and livelihoods, will be rearranged as the lovers either break up, agree to remain friends, or try to carry on their mutually enriching relationships despite the rule.

Darkness at noon

Broker-dealers, especially the smaller ones without economies of scale, are experiencing the most disruption. The conflicts of interest that the DOL rule targeted are endemic to them and their registered reps. Broker-dealers who’ve relied on manufacturer-paid commissions to compensate advisors may have to switch them to salaries or fees as a percent of client assets. Many broker-dealers expect some of their advisors to retire. (See related story in today’s issue of RIJ.)

“Smaller broker-dealers who can’t keep up with the new technology that BIC demands will be threatened,” David Macchia of Wealth2k, who is trying to position his proprietary web-based advisor marketing and income planning software as the right tool for advisors in the fiduciary era.

An August 2016 report from consultant A.T. Kearney now estimates that by 2020 independent broker-dealers will have $350 billion (11%) fewer assets under management and $4 billion (11%) lower revenue. Such firms should think about merging with larger firms, the report said.

Wholesalers of annuities, especially indexed annuities, will also be hurt, Macchia said. “Career-type field forces that have relied on proprietary product sales will face a big disruption. Standardization will become a much bigger problem. The idea of the ‘rep as portfolio manager’ doesn’t have legs. Most or many advisors will end up as salaried employees delivering packaged solutions. Everybody will be impacted,” he told RIJ.

Several factors make the annuity business vulnerable. The DOL rule won’t hurt fixed deferred or immediate income annuities, but those aren’t the top sellers. Instead, it puts a new regulatory hurdle, the so-called BICE, in the path of indexed and variable annuities, which sell in much higher volumes. LIMRA predicts lower sales for both product types in 2017.

Annuity manufacturers are responding to the DOL rule’s scrutiny of commission-driven sales by rolling out no-commission products. Jackson National recently introduced a fee-based variable annuity with a lifetime income option, and Great American introduced the first fixed indexed annuity. Yesterday, Nationwide announced its purchase of Jefferson National, a provider of low-cost investment-only variable annuities for clients of registered investment advisors who are seeking a tax-deferred trading vehicle.

But annuity sales have long relied on commissions to drive sales, and after the Great Financial Crisis advisors showed little interest in the no-commission or low-commission products that came on the market. If advisors choose to sell annuities, it’s not clear if they would charge the same or much less than their usual asset management wrap fee on unmanaged annuity assets, or if removal of commissions would translate into higher product value for customers.

The DOL rule is also expected to stifle efforts to solicit rollovers by separated employees from defined contribution plans to retail IRAs, and that could reduce the broker-dealer assets. But their loss would presumably help 401(k) plan providers.

“There will probably be fewer rollovers than there are today, but it’s hard to know how much the volume will change or how long it will take to see a difference,” said Srinivas Reddy, senior vice president, Full Service Investments, Prudential Retirement.

“On the other hand, while we strive to provide the best institutional solutions, we recognize that one size doesn’t fit everybody for their entire lifetimes. On the positive side, we’re seeing more interest among plan sponsors in lifetime income solutions than we’ve seen in several years. More sponsors are saying that their retirees are looking for those solutions.”

The four wirehouses, Morgan Stanley, UBS, Wells Fargo and Bank of America—are expected to weather the storm more easily, in part because the final DOL rule allows their advisors to go on recommending “proprietary” products—investments underwritten by other parts of the company. Even so, the wirehouses will lose $300 billion in assets (5%) and $4 billion in revenue because of the DOL rule by 2020, according to A.T. Kearney.

Sunshine at midnight

“It’s not all doom,” said Wealth2k’s Macchia. “If there’s a saving grace, it’s about retirement income planning. Getting expertise in that area is the obvious way for an advisor to move up the value chain and avoid commoditization.”

Macchia is describing the narrow shaft through which the retirement income industry—the sect of the retirement industry whose members believe that annuities and investment products, in the context of the “household balance sheet,” work best for retirees—might escape its dilemma.

In a webinar on Wednesday, Macchia gave his version of an argument that the income industry keeps repeating in hopes that it will come true: That no advisor can claim to act truly in the best interest of an older client without a) assessing the client’s longevity risk, b) considering an annuity product to mitigate that risk, c) incorporating guaranteed income into the financial plan, and d) using software to document the process.

“If there’s a saving grace to the DOL rule, it’s about retirement income planning. Getting expertise in that area is the obvious way for an advisor to move up the value chain and avoid commoditization,” Macchia said.

The major technology providers, like Fidelity’s eMoney, also see opportunity in providing planning tools and documentation tools for advisors and broker-dealers who want to protect themselves from lawsuits. Its website says: “See how eMoney is bridging the gap between planning tools and compliance software to help fiduciary-focused advisors in a post-DoL world.”

Other software providers are getting legal opinions that their product will help advisors do that. One is Manish Malhotra, founder of Income Discovery, who obtained a letter from Wagner Law Group, an ERISA specialist, asserting that “in our view the use of Income Discovery’s retirement planning software, coupled with a Rep’s comprehensive data collection process, and the software’s ability to compare investment or annuity products, would assist an RIA in satisfying its duty to act with the care, skill, prudence and diligence of a prudent person under ERISA’s Prudent Man Standard of Care.”

The letter continues, “For this reason, even if an RIA is not subject to the BICE or the BICE’s Best Interest Standard of Care, the RIA may still wish to consider utilizing the Income Discovery retirement planning software when advising any retirement clients that are subject to Title I of ERISA.”

Malhotra hopes that all advisors will feel compelled to consider annuities for retirement clients in the future. “As a fiduciary you are responsible for developing multiple options. But if you’re an RIA who gets paid a percent of AUM [assets under management], you have a built-in resistance to recommending an immediate or deferred income annuity, even though those products might be good for your client. So you need at least some process in place to explain why you’re excluding that product. RIAs will be in a bind. I don’t know if they realize it,” he said.

“We are making the point that this software can be used to justify the advisors’ decisions and improve the clients’ outcomes,” Malhotra told RIJ. “The letter says that if you used Income Discovery that, in the attorney’s opinion, you would have demonstrated a high standard of care. The bigger advisory firms may have their own legal departments, but the smaller firms can go by this opinion.”

Independent, self-employed advisors, for whom being fiduciaries is nothing new, assume however that their own integrity matters more than any software they use or an attorney’s opinion of it.

“A tool is just a tool,” said Mike Lonier, an Osprey, Florida, advisor who uses his own proprietary planning tool, the R-MAP. “Any financial tool, and any legal opinion of it notwithstanding, can be used by a non-fiduciary agent acting in an irresponsible way contrary to a client’s best interest. The fiduciary responsible lies with the advisor, regardless of the tools the advisor uses.

“Nothing about a tool assures that the advisor is acting according to the fiduciary standard. Further, the responsibility to act as fiduciary remains rooted in the advisor’s behavior, and cannot be transferred or waived away by the use of a tool. No magic bullet makes you a fiduciary. That’s my view.”

President ‘Id’ or President ‘Super-Ego’?

Posted on September 29, 2016 by -

Ideally, I’d like to hear the voice of a healthy adult ego from a presidential candidate—a succinct, pragmatic, circumspect voice of reason, confident but self-effacing. During Monday night’s debate we heard the voice of an unfettered id on the one hand and the voice of an ultra-disciplined superego on the other.   

Neither struck the desired tone, but of those extremes—id or superego—only one is suited to assume the transcendent POTUS position. I predict that a majority of voters would rather see a parental figure in the White House than a temperamental child. Or maybe not. We’ll know by November 9.

Freudian analogies aside, the candidates’ comments about money absorbed all of my attention. Trump, the Houdini of debt, had much more to say about debt, income, trade deficits and taxes than Clinton. My favorite of his zingers: A twofer suggestion that the stock market will crash if the Fed raises rates and the Fed chair isn’t raising rates for political reasons. Here’s the quote:

Trump: Look, we have the worst revival of an economy since the Great Depression. And believe me: We’re in a bubble right now. And the only thing that looks good is the stock market, but if you raise interest rates even a little bit, that’s going to come crashing down. We are in a big, fat, ugly bubble. And we better be awfully careful. And we have a Fed that’s doing political things. This Janet Yellen of the Fed. The Fed is doing political — by keeping the interest rates at this level.  

He’s accusing Yellen of conspiracy to suppress interest rates so that the economy looks good for Democrats during the pre-election period. That’s old hat. More interesting to me was the prediction that the stock market will crash if rates go up “even a little bit.” Trump scores a point for voicing what many fear (but are afraid to say in public). He loses a point for not saying what as president he might do about it—other than seize the opportunity to buy blue chip stocks at steep discounts. If Trump is right, and Boomers really are within a quarter-point of losing a big chunk of their retirement savings, maybe we should start taking profits off the table? Maybe we should lock those profits into annuities.

The next eyebrow raiser: Trump’s income and his taxes. According to him, he earned $694 million last year. That’s more than four times what Taylor Swift earned, according to Forbes, and almost nine times what LeBron James earned. Impressive. As for him being “smart” for paying no federal taxes when he applied for a state casino license, I wonder if he means to lead by example.

Trump: The income is filed at $694 million for this past year; $694 million. If you would have told me I was going to make that 15 or 20 years ago, I would have been very surprised.

Clinton: He had to turn [his tax returns] over to state authorities when he was trying to get a casino license, and they showed he didn’t pay any federal income tax.

Trump: That makes me smart.

The U.S. became a net debtor nation for the first time about 35 years ago, and I applaud Trump for calling attention to our trade deficit. Here’s what he said:

Trump: We have a trade deficit with all of the countries that we do business with, of almost $800 billion a year.

But the chronic trade deficit is a complex topic, not material for a snappy one-liner. Trump sees the trade deficit as a sign that other countries are beating us. It’s more complicated than that.  

The U.S. dollar is the world’s reserve currency. Decades ago we struck a bargain with the rest of the free world: We’ll buy your products if you’ll take our dollars. In purchasing power, this gives us a so-called “exorbitant privilege.” It also promotes capitalism, democracy and, in combination with our military power, stability abroad. So Trump should take a history lesson or two before making provocative statements like the following.

Trump: the 28 countries of NATO, many of them aren’t paying their fair share. Number two—and that bothers me, because we should be asking—we’re defending them, and they should at least be paying us what they’re supposed to be paying by treaty and contract.

Trump: we pay approximately 73% of the cost of NATO. It’s a lot of money to protect other people. 

On the equally complex subject of the national debt, a president needs to understand that U.S. sovereign debt isn’t like personal debt. Trump said outside the debate that he’d consider resolving the debt by buying back U.S. Treasuries from our creditors (of whom I am one). But this shows that he doesn’t understand sovereign debt. Last Monday night he said:

Trump: When we have $20 trillion in debt, and our country’s a mess, you know, it’s one thing to have $20 trillion in debt and our roads are good and our bridges are good and everything’s in great shape, our airports. Our airports are like from a third world country.

Trump: We owe $20 trillion, and we’re a mess. We haven’t even started. And we’ve spent $6 trillion in the Middle East, according to a report that I just saw. Whether it’s $6 or $5, but it looks like it’s $6, $6 trillion in the Middle East, we could have rebuilt our country twice.

Trump: We’re a debtor nation. We’re a serious debtor nation. And we have a country that needs new roads, new tunnels, new bridges, new airports, new schools, new hospitals. 

Trump: Our country is losing so much in terms of energy, in terms of paying off our debt. You can’t do what you’re looking to do with $20 trillion in debt.

Trump: Look, we owe $20 trillion. We cannot do it any longer, Lester.

But our $20 trillion in debt doesn’t mean that the U.S. is broke. (The U.S. “can’t run out of money,” it’s been said, “any more than a scoreboard can run out of points.”) Owners of U.S. Treasuries regard them, obviously, as assets—as “cash equivalents.” They are fully liquid, selling at par or even above par, if you factor inflation in. Banks and sovereign countries hold them as reserves, in lieu of gold. A “deal” to buy back the debt would be appropriate only if it were illiquid and the price were depressed. Neither is true today, and shows no sign of being true tomorrow.

Trump’s willingness to raise sensitive topics like the national debt, the trade deficit, Fed policy, interest rates, profit repatriation and the cost of NATO is refreshing and welcome. In doing so, he addresses legitimate middle-class anxieties. These topics are too often missing from policy debates. That audacity helps explain his popularity. But audacity isn’t enough. It’s irresponsible for a prospective president to stoke anxieties, to inflate them like toy balloons and leave them hanging in the air, without demonstrating a grasp of the underlying problems, or offering specific solutions to them.     

© 2016 RIJ Publishing LLC. All rights reserved.      

Don’t Let Commoditization Sneak Up on You

Posted on September 29, 2016 by -

In May 2010 I traveled to Vietnam with a group of fellow MBA candidates in order to learn about a variety of NGOs [non-government organizations] and commercial companies. Our trip began in Hanoi. We traveled south by bus and airplane, making numerous visits along the way. The Vietnamese people I encountered were warm, friendly and entrepreneurial.

A daylong visit to a sneaker factory outside Ho Chi Minh City was truly memorable. The single-story factory, owned by a Korean conglomerate, HWASEUNG, encompassed 1.6 million square feet, or the equivalent of about 33 football fields, and housed 16,000 workers. The building was spotless. Every worker was neatly dressed in the same-style of short-sleeve shirt, in one of several colors. The shirts reminded me of doctors’ scrubs at a hospital.

In a far corner, a group of workers, four thousand strong, all wore blue. Another group wore yellow. Still another wore red. Each of these teams performed a different function in the sneaker manufacturing process, together turning out 1.4 million pairs of sneakers per month.

At noon a horn blew. With great precision, half of the workers filed out of the building to be handed a tray holding a nutritionally balanced lunch. Thirty minutes later, this group returned to the factory and the other 8,000 people went outside to eat their lunches. The entire process was carried out with clockwork precision.  vietnamese sneaker workers

That was the day I learned the meaning of globalization. And commoditization.  

The Vietnamese workers struck me as some of the happiest people I had ever met. Later, in 2012, I wasn’t at all surprised to learn from the Happy Planet Index (HPI) that among 151 countries surveyed, the people in Vietnam are the second happiest, after Costa Ricans.

Those Vietnamese factor workers I met were paid just $5 per day. Yet they were happy. Why?  Because two years earlier, they had been earning only $2 per day. Happiness, I realized, varies according to one’s relative economic circumstances, especially when those circumstances have recently changed.

The United States, a much wealthier country than Vietnam, ranks 104th on the Happy Planet list. We rank behind Zambia, Saudi Arabia, Malawi, Serbia, Paraguay, Nepal and Turkey. The relative unhappiness of American workers, I believe, is due to commoditization.

In America, people and jobs are continuously being commoditized. It’s not an inspiring experience. The American sneaker factory worker became commoditized long ago. As a result, American sneaker manufacturing jobs, which paid little in the U.S., migrated to other places, like Vietnam, where they paid relatively much more and raised the standard of living of thousands of workers.

Economists sometimes advise American workers to sidestep commoditization by moving up the “value chain.” Workers who offer greater value to customers, it is said, are more likely to experience bright economic futures. This is easier said than done. Most workers can’t independently shift to higher value jobs. Instead, they often end up in lower-paying jobs that result in lower living standards.

The impact on advisors

As I think about the likely impact of the Department of Labor’s fiduciary rule on financial advisors, I think about commoditization. Each day, financial advice is becoming more commoditized. The robo-advisor that provides accumulation-focused investment advice at a cost 80% below the amount charged by a human advisor is like the Vietnamese factory that slashes the cost of manufacturing sneakers by 90%.    

The DOL rule aims to reduce costs. It also makes almost all advisors fiduciaries. To be sure, I believe that all clients deserve unconflicted advice. But when assisting clients with retirement income distribution, a fiduciary must do more than simply lower his or her fees. Low investment fees alone won’t stop a client from going broke in retirement. When working with retirees, advisors also need to choose an appropriate income-generation method, or integrate “flooring” and other insurance elements into clients’ portfolios, or segment assets over time through a “bucket” method.

To avoid commoditization and achieve long-term success, advisors should move up the value chain by acquiring a broader range of income planning skills. Even better, to maintain job security, they should consider specializing in micro-niches such as “outcome-focused” income planning, or income planning for “constrained” investors, to make even more valuable contributions to investors’ lives. Such advisors aren’t likely to see robots take their jobs, or see their jobs outsourced to Asia.    

© 2016 RIJ Publishing. All rights reserved.

Nationwide to acquire Jefferson National, provider of IO-VAs to RIAs

Posted on September 29, 2016 by -

Nationwide, the privately-held Columbus, Ohio-based insurance giant, has agreed to acquire Jefferson National, the Louisville, Kentucky-based insurer that pioneered the marketing of no-frills variable annuities to registered investment advisors and their clients who wanted a vehicle for tax-deferred investing without expensive insurance features.

Jefferson National serves nearly 4,000 RIAs and fee-based advisors with its product Monument Advisor, an investment-only variable annuity with a flat monthly fee rather than an expense ratio. As of June 30, 2016, Jefferson National reported $4.7 billion in GAAP assets.

Jefferson National is a portfolio company of Napier Park Financial Partners, Napier Park Global Capital’s private equity group.

Nationwide Life Insurance Company will purchase all of the stock of Jefferson National, which will become a wholly-owned subsidiary of Nationwide. Terms of the purchase agreement between Nationwide Life Insurance Company and Jefferson National are not being disclosed. Both parties, which are privately held, expect the transaction to close early in 2017, pending approvals by state and federal regulators.

Deloitte Corporate Finance LLC and Sutherland Asbill & Brennan LLP served as the financial and legal advisors for Nationwide in connection with the transaction. Raymond James & Associates and Sidley Austin LLP served as the financial and legal advisors for Jefferson National.

© 2016 RIJ Publishing LLC. All rights reserved.

Broker-dealers expect DOL rule to prompt exodus of advisors: LIMRA

Posted on September 29, 2016 by -

If advisors retire, who will advise retirees?

Broker-dealers expect at least some of their advisors to retire instead of change their business practices in response to the Department of Labor’s fiduciary rule, according to a survey of broker-dealers by the LIMRA Secure Retirement Institute.   

More than half (54%) of the broker-dealers surveyed by LIMRA believe some of their advisors will retire. The DOL rule, among other things, prohibits advisors from selling commissioned products to IRA clients unless the advisors pledges to act in the clients’ best interest and disregard their own or their firms’ financial interest.     

“This is a transformational event in the financial services market,” said Kathy Krozel, research director, LIMRA Distribution Research, in a press release.

Broker-dealers also expect advisors—the broker-dealers surveyed didn’t specify whether they were referring only to registered reps of broker-dealers or to other types of intermediaries—to serve fewer middle-class retirement clients in the future, because the account balances are likely to be too small to generate enough revenue on a percentage-of-assets basis. Critics of the DOL rule have long predicted this outcome.

“Because the rule increases advisors’ liability, B-Ds also expect their advisors to stop providing advice to clients with lower IRA account balances,” the release said. “At a time when more Americans need access to advice, it appears that the new DOL rule may actually reduce access for middle income consumers.”

Supporters of the DOL rule have countered that middle-income consumers were never well-served by the broker-dealer industry, or that they often received conflicted sales recommendations in lieu of unconflicted advice, and that online “robo” advice providers like Vanguard, Financial Engines or Betterment will serve them just as well and at lower cost.

The Institute found that eight in 10 broker-dealers plan to employ both the PT 84-24 or the Best Interest Contract exemptions allowed under the new rule. PT 84-24 allows advisors to continuing selling fixed deferred and fixed income annuities as usual, without having to satisfy the BIC exemption. Under the BIC exemption, which allows properly licensed advisors to sell variable or indexed annuities, advisors must pledge to act only in the client’s interest.

Nearly three quarters of broker-dealers told LIMRA they will use so-called fee leveling/fee offset to avoid the variable compensation methods prohibited by the rule.  Overall, firms said they will employ multiple strategies in order to ensure compliance.

Two thirds of broker-dealers expect consumers to bear the increased cost of compliance and nine in 10 believe that the rule will spur consolidation of the brokerage industry. 

“Smaller firms may be unable to afford the high cost of implementing the changes needed to comply with the rule and some may opt to merge with their larger counterparts” that can leverage their economies of scale, Krozel said. 

Most broker-dealers expect their risk of litigation to be exacerbated by the DOL rule and expect the rule to force changes in advisor compensation practices and structures. The cost of compliance will require changes in business practices and reporting, they agreed. 

“The feedback we received from the B-Ds is aligned with responses from carriers and advisors,” Krozel observed. “Intentional or not, the DOL fiduciary rule will change the landscape of the retirement market for decades.”

© 2016 RIJ Publishing LLC. All rights reserved.

Unexpected taxes can hurt seniors who work longer: Kotlikoff

Posted on September 29, 2016 by -

People who have earned income and take Social Security benefits can face unexpectedly high tax rates on their earnings, according to Boston University economist, software maker and presidential candidate Larry Kotlikoff.

“Senior workers earning an average income can easily lose more than half of their earnings to higher taxes and reduced government benefits,” said Kotlikoff, in a press release. “In some cases, workers can lose 95 cents out of each dollar they earn.”

Kotlikoff, a senior fellow at the Goodman Institute, studied the tax impact of working in one’s 60s with University of California at Berkeley economist Alan Auerbach and two co-authors. The Sloan Foundation funded the study.

The economist analyzed penalties for working that can arise from some 30 major federal and state tax and transfer programs. The economists also consider how the additional earnings could affect future taxes and transfers. They summarize the financial impact in what they call the worker’s “lifetime marginal net tax rate.” 

“We are all made worse off when [elderly citizens] are pushed out of the labor market by policies that encourage them to retire,” Kotlikoff said.

The study shows how the Social Security System penalizes working:

  • Beyond a certain income level, early retirees from age 62 to the year they turn 66 lose 50 cents of Social Security benefits for each dollar they earn—a 50% tax rate.
  • From Jan. 1st in the year in which they turn 66 until their 66th birthday, they lose 33 cents of benefits for each dollar of wages—a 33% tax rate. These taxes are in addition to income, payroll and other taxes.  

Though government begins adding the benefit reduction back once the worker reaches the normal retirement age, many seniors don’t realize that or don’t understand it, so the reductions may discourage them from working.

“If we abolished these ‘earning penalties’ the government would probably be a net winner. Seniors would work more and earn more and the other taxes they pay would more than make up for any short term revenue loss,” said Kotlikoff.

Another impediment to work is the Social Security benefits tax, he said:

Beyond a certain threshold, seniors must pay income taxes on 50 cents of Social Security benefits for each dollar they earn – increasing their marginal tax rate by 50%. After a certain point, they must pay income taxes on 85 cents of Social Security benefits for each dollar they earn – increasing their marginal tax rate by 85%.

When the Social Security benefits tax is added to the earnings penalty, the tax rate on moderate-income seniors can reach 95%, Kotlikoff said in a release. For someone in the 15% bracket for ordinary income, the Social Security benefits tax can increase the tax rate on pension income and IRA withdrawals to 27.75%, and raise the tax on capital gains and dividend income from zero to 12.75%. Even tax-exempt income can be taxed at a rate of 12.75%.

“These high marginal tax rates only hit in the middle of the income ladder. They don’t affect the work incentives of the rich or the poor,” said Kotlikoff. “However, the loss of the Earned Income Tax Credit and the potential loss of Medicaid and other entitlement benefits create high marginal tax rates for low income workers in other ways.”

© 2016 RIJ Publishing LLC. All rights reserved.

 

Asset location tool could boost savings by 15% over 30 years: Betterment

Posted on September 29, 2016 by -

Betterment, the largest independent online “robo-advisor,” now offers “Tax Coordinated Portfolio,” a feature that aims to boost investors’ cumulative after-tax returns by increasing the tax efficiency of their portfolios. In a release this week, Betterment said no other robo-advisor offers this service.

“Americans wind up saving for retirement in three account types: taxable, tax-deferred, and tax-exempt. Each type of account has different tax treatment, and certain investments fit one account type better than another. Choosing wisely can significantly improve the after-tax value of their savings, when more than one account is in the mix,” the release said.

According to one Betterment hypothetical example, saving in all three types of accounts showed an estimated annualized after-tax benefit of 0.48%, which can raise accumulations by 15% over 30 years.

The release did not say if the service might move existing tax-deferred IRA assets, for instance, to taxable accounts, or if such a move might trigger a taxable event for the investor. The release didn’t say if the service only considered new contributions to Betterment accounts.

“Asset location is the closest thing there is to a free lunch in wealth creation,” Boris Khentov, vice president of operations and a tax attorney at Betterment. “Customers saving for retirement in more than one type of account should be using it to increase their after-tax returns. However, doing it properly is a complex, mathematically rigorous, and continuous process. Betterment’s Tax-Coordinated Portfolio automates this sophisticated strategy every step of the way, helping our customers make the most of their investments.”

Tax-Coordinated Portfolio is one of Betterment’s suite of tax-efficient features, which include Tax Loss Harvesting+ and Tax Impact Preview. Betterment, launched in 2010, now manages some $5.6 billion in assets for more than 185,000 customers in globally diversified portfolios of exchange-traded funds (ETFs) “with personalized advice in a goal-based investing framework.” Customers can open and customize regular investment accounts, traditional/SEP/Roth IRAs, trust accounts, and accounts for retirement income.

© 2016 RIJ Publishing LLC. All rights reserved.

Russell and Envestnet roll out managed account option for DC plans

Posted on September 29, 2016 by -

Russell Investments said this week that it will make its customized managed account option available as a qualified default investment alternative (QDIA) to retirement plan participants through Envestnet | Retirement Solutions’ Qualified Individualized Life Target Solutions (ERS QuILTS) technology.

The Russell QDIA is called Adaptive Retirement Accounts, and ERS QuILTS delivers participant investment advice. It gives each participant a customized glide path or lifetime asset allocation evolution for each participant. Plan sponsors and advisors will be able to begin offering it in the first half of 2017, a Russell release said.

According to the release:

  • The solution automatically captures a participant’s personal information from a DC plan sponsor’s record keeper and human resources system without requiring a participant’s direct involvement or feedback. ERS’ QuILTS technology facilitates a seamless connection with the record keeper.
  • Personal information—age, gender, salary, current account holdings and contribution rate—is combined with Russell Investments’ asset allocation model to construct a portfolio of the DC plan’s existing investment options which is customized to each individual participant.
  • Through a participant user interface developed by ERS, participants have the ability to add in outside assets and incorporate personal preferences regarding savings rate, retirement age, income needs and risk tolerance.
  • Each participant’s customized asset allocation is assessed quarterly and adjusted as needed based on progress toward his or her targeted retirement income goal.
  • The open-architecture framework empowers advisors to select and monitor a plan’s investments from a broad range of investment products, including passive and active options.
  • The solution is designed to provide plan sponsors co-fiduciary support through Russell Investments’ asset allocation model advice and an advisor’s guidance regarding plan investments.

© 2016 RIJ Publishing LLC. All rights reserved.

Helicopter Money Is in the Air

Posted on September 22, 2016 by -

Fiscal policy is edging back into fashion, after years, if not decades, in purdah. The reason is simple: the incomplete recovery from the global crash of 2008.

Europe is the worst off in this regard: its GDP has hardly grown in the last four years, and GDP per capita is still less than it was in 2007. Moreover, growth forecasts are gloomy. In July, the European Central Bank published a report suggesting that the negative output gap in the eurozone was 6%, four percentage points higher than previously thought. “A possible implication of this finding,” the ECB concluded, “is that policies aimed at stimulating aggregate demand (including fiscal and monetary policies) should play an even more important role in the economic policy mix.” Strong words from a central bank.

Fiscal policy has been effectively disabled since 2010, as the slump saddled governments with unprecedented postwar deficits and steeply rising debt-to-GDP ratios. Austerity became the only game in town.

This left monetary policy the only available stimulus tool. The Bank of England and the US Federal Reserve injected huge amounts of cash into their economies through “quantitative easing” (QE) – massive purchases of long-term government and corporate securities. In 2015, the ECB also started an asset-buying program, which ECB President Mario Draghi promised to continue “until we see a sustained adjustment in the path of inflation.”

QE has not been a magic bullet. While it helped stop the slide into another Great Depression, successive injections of money have yielded diminishing returns. The ECB’s announcement of its policy narrowed the gap in bond yields between Europe’s core and periphery. But a study by Thomas Fazi of the Institute for New Economic Thinking emphasizes QE’s lack of influence on bank lending, the increase in non-performing loans, and the dire output and inflation figures themselves. Moreover, QE has undesirable distributional consequences, because it gives money to those who have already have it, and whose current spending is little influenced by having more.

Policymakers should have been alert to the likelihood of this mediocre outcome. When central banks try to reduce inflation by pumping liquidity out of the system, their policy is subverted by commercial banks’ ability to pump it back in by making loans. In today’s deflationary environment, the reverse has happened. Central banks’ attempt to pump in liquidity to stimulate activity is subverted by commercial banks’ ability to pump liquidity out by augmenting reserves and refusing to lend.

That leaves fiscal policy. The logic of current economic conditions implies that governments should be taking advantage of ultra-low interest rates to invest in infrastructure projects, which would both stimulate demand and improve the structure of the economy. The problem is the climate of expectations. As the Oxford economist John Muellbauer says, treasuries and central banks have been “hammering into the consciousness of the private sector the importance of reducing gross government debt relative to GDP.”

This orthodoxy arises from the idea that borrowing is simply “deferred taxation.” If the private sector believes that taxes will have to rise to pay for government borrowing, according to this view, people will increase their savings to pay the higher taxes, thus destroying any stimulative effect. The orthodoxy mistakenly assumes that government spending cannot generate any extra income; but so long as it prevails, debt-financed fiscal policy is ruled out as a means to revive economic growth.

As a result, analysts and policymakers have started mooting ideas for unconventional fiscal policy to supplement unconventional monetary policy. In particular, they are debating variations of so-called helicopter money, following a famous thought experiment by Milton Friedman in 1969, in which “one day a helicopter… drops an additional $1,000 in bills from the sky.” Former Federal Reserve Chairman Ben Bernanke, among others, has offered influential support for “helicopter drops” to revive flagging economies.

Helicopter money comes in two forms, which could (and should) be dropped together. The first is to put purchasing power directly into the hands of consumers – for example, by issuing each voter or citizen with smart cards worth $1,000 each. The Swiss economist Silvio Gesell, who originally proposed a scheme of “stamped money” at the start of the last century, added a stipulation that balances unspent after a month should be taxed, to discourage hoarding.

Alternatively, helicopter money could be used to finance infrastructure spending. The advantage of such “monetary financing” is that such spending, while adding to the deficit and leading to a permanent increase in the money supply, would not increase the national debt, because the government would “owe” the money only to its own banker. This would eliminate the offsetting negative expectation of higher taxes.

Surely, issuing debt that never has to be repaid is too good to be true, right? There is indeed the obvious danger that governments might easily become addicted to monetary finance to pay for private and public spending, which is why it is unlikely to be tried openly unless economic conditions worsen significantly. But the political risk of doing nothing if we stumble into another recession (as seems quite likely) is worse. Like it or not, unconventional fiscal policy could well be the next game in town.

© 2016 Project-Syndicate.

Anecdotal Evidence

Posted on September 22, 2016 by -

Expect the DOL rule to apply to taxable accounts

At the Financial Planning Association’s annual conference in Baltimore last week, RIJ asked ERISA attorney Marcia Wagner, who is a kind of defensive coordinator for firms wishing to ward off potential class action lawsuits under the DOL fiduciary rule, if she thought the ethical standard established by the rule would eventually apply to taxable accounts as well as IRAs and 401(k) plans.

Yes, she said, she believes it will, regardless of what the SEC does or doesn’t do. Others have noted that it will be difficult or impractical for advisors to apply a suitability standard to the taxable part of a client’s portfolio and the fiduciary standard to the tax-deferred part. That may be true. But multiple standards will continue to exist. The protections that apply to hedge fund customers, for instance will presumably continue to be different from the protections for less wealthy investors.

If the DOL rule applies to all advisors and all types of accounts, we can expect to see an even faster and more extreme shift among advisors to AUM compensation models and to the use of robo-advice for younger investors and smaller accounts.  

Put guardrails around your four percent withdrawal: Vanguard    

For planners and advisors who like to tell their clients to spend about four percent of their assets in retirement—as opposed to those who prefer “bucketing” or partial annuitization as their income-generation tools—Vanguard has created a new formula for calculating a safe rate of withdrawal from savings. 

In a white paper published this month, “From assets to income: A goals-based approach to retirement spending,” a Vanguard team recommends a compromise between two versions of the 4% rule: one (“A”) that calls for spending an inflation-adjusted 4% of the original balance and another (“B”) that calls for spending 4% of the current real balance.

Each of those alternatives has a drawback. The first is too rigid, the second too flexible, in the face of market volatility to provide sufficiently predictable and sustainable income. Splitting the difference, Vanguard’s decumulation experts call for using the second alternative but putting upper and lower limits on annual spending.

Supposed, to use the classic example, that a new retiree has $1 million in savings and, conveniently, a need to spend $40,000 in the first year of retirement. He takes Vanguard’s advice and, in the following years, promises not to give himself a raise of more 5% or to tighten his belt by more than 2.5%.

Here’s how the hypothetical numbers play out. At the start of the second year, after earning a 10% return and spending $40,000, the retiree has $1.06 million. Under version B of the 4% rule he could spend $42,400 (.04 x $10.6 million). But since his upper limit is $42,000, that’s all he spends. Conversely, if the market gone down that year, he would have spent no less than $39,000 ($40,000 – ($40,000 x .025)).

Since retirees often disregard their recommended spending limits, this might seem like a labor-intensive exercise in false precision. It gets even more complicated when you factor in variables like asset allocation and portfolio choices, and even more so when you try to obey the rules of tax-efficient decumulation.

Still, Vanguard’s method adds nuance to the 4% rule. Advisors can also point to research like this to show that they did their homework before recommending a withdrawal rate.     

Bad day at Wells Fargo, good day at BlackRock

One of America’s great financial services brands was sullied this week when Wells Fargo’s over-zealous sales practices, which reportedly included the creation of false accounts by more than 5,000 employees who hoped to reach or were compelled to reach big, hairy aggressive sales goals, became front page news.

“A brand is a promise kept over and over and over,” a consultant once told me. That’s a variation on the truism that it takes a long time to achieve trust but a short time to lose it. Wells Fargo may yet emerge whole from this episode. Consumers have short memories. And, just as many voters hate Congress but admire their own district’s representative, the ubiquitous bank’s retail relationships will probably survive.

But the incident indicates the pressure at publicly held companies to stoke earnings and please shareholders—even if it means throwing customers under the bus. That may sound harsh, but this fundamental conflict of interest tinges every public company’s product design, compensation, sales practices and even the wording of its advertising and communications. In the extreme, it results in incidents like those at Wells Fargo.   

By contrast, BlackRock and its CEO, Laurence D. Fink, received almost unalloyed praise from the New York Times last weekend. BlackRock, formerly Blackstone, has grown dramatically through acquisition (absorbing Merrill Lynch’s funds in 2006 and Barclays Global Investors in 2009) and its share price has soared.

In the retirement income market, its primary product entry seems to be CoRI target-date bond funds. These are long-term bond funds that track the proprietary CoRI Index, which reflects the fluctuating price of $1 of lifetime income on your retirement date, as determined by prevailing immediate annuity prices, which also follow long-term bond returns. 

The concept relies on asset-liability matching. The CoRI Index and the value of CoRI funds, like immediate annuity prices, move in the opposite direction of long-term interest rates. As rates rise, your fund will lose value, but immediate annuity prices will fall too, so that your CoRI fund will always buy the same income (in proportion, of course, to your investment in the fund).

But if you never intend to buy an annuity, the long maturities of the CoRI funds entail a lot of interest rate risk. And the funds aren’t cheap. According to page 3 of the CoRI 2017 prospectus, there’s a front-end Investor A share load of 4% for purchases under $1 million, and an annual fund expense ratio of 83 basis points (58 basis points for institutional shares requiring an investment of $1 million or more).

The cost could potentially be much higher. The prospectus explains that the annual operating cost is 2.06%, of which BlackRock has waived 1.23%. A footnote adds, “the Fund may have to repay some of these waivers and/or reimbursements to BlackRock in the following two years.” Such ambiguity makes the value of the CoRI funds proposition hard to assess. 

© 2016 RIJ Publishing LLC. All rights reserved.

Jackson offers no-load VA for fiduciary era

Posted on September 22, 2016 by -

As rumored at the FPA annual conference last week, Jackson National Life has launched a fee-based variable annuity. Called Perspective Advisory, it offers the same investments and optional benefits, for an additional charge, as Perspective II, Jackson’s flagship commission-based variable annuity, the company said in a release today.

The launch is directly linked to the Department of Labor’s so-called fiduciary rule, which will makes the sale of a variable annuity to an IRA owner a “prohibited transaction” unless the seller signs a contract promising to act in the client’s best interest.

“The company’s entrance into the fee-based space is designed to meet increased market demand for products compatible with fee-based accounts and platforms as a result of the U.S. Department of Labor (DOL) fiduciary rules, released in April 2016,” according to a release from Greg Cicotte, Jackson’s executive vice president and chief distribution officer.

“In today’s heightened regulatory environment, many of our distribution partners are choosing this type of product to serve their clients who are seeking strategies for retirement planning,” the release said. “The legal and compliance costs, as well as additional disclosure requirements related to managing a commission-based platform under the DOL mandates, have set the stage for utilizing fee-based variable annuities.”

Perspective Advisory also gives Jackson a product for advisory distribution channels where insurance products historically have not been widely utilized, such as the Registered Investment Advisor market.   

Perspective Advisory’s key features include:

  • Compensation structure: Advisor compensation is fee-based, rather than commission-based.
  • Minimum initial premium: $25,000.
  • Product cost: 0.30% annually for mortality, expense and administration costs.
  • Surrender period: Three-year withdrawal charge schedule of 2%, 2%, 1% and zero. 
  • Investment options: More than 90, ranging from 56 to 219 basis points in annual fees.   
  • Additional options: AutoGuard and LifeGuard Freedom living benefits, ranging from 80 to 160 basis points in annual fees, and death benefits ranging from 30 to 100 basis points in annual fees.    

© 2016 RIJ Publishing LLC. All rights reserved.

With eye on DOL, IRI hires Milliman to survey annuity comp

Posted on September 22, 2016 by -

To help financial services firms and financial professionals comply with the reasonable compensation standard under the Department of Labor’s fiduciary rule, the Insured Retirement Institute will survey current compensation practices regarding sales of annuities and other investment products, IRI announced.  

Milliman, Inc., the global consulting firm, will conduct the survey for IRI. Financial firms have until the end of 2017 to fully comply with the rule, which was issued last April.

The survey aims to help firms demonstrate their existing reasonable practices, rather than to reveal non-compliant practices, according to IRI CEO Cathy Weatherford.

“While we believe our members’ have always strived to design their compensation practices in an appropriate and reasonable manner,” she said in a press release, “demonstrating compliance with this new legal requirement is another matter.”   

The new rule’s Best Interest Contract (BIC) Exemption or amended Prohibited Transaction Exemption (PTE) 84-24 allows firms to recommend variable or fixed indexed annuities and accept commissions or variable third-party compensation on the sale only if the compensation is reasonable.

According to the IRI release, the survey is necessary to establish industry compensation benchmarks because the DOL didn’t define “reasonable,” or offer examples or so-called safe harbor suggestions, except to say that compensation should follow “a market based standard.” 

© 2016 RIJ Publishing LLC. All rights reserved.