Recently published in the Denver Business Journal, Volume 59, Number 9, August 24, 2007-August 30, 2007, (Denver Business Journal), by Rich Todd. A reprint of the article may be found at the Innovest Website (Reprint).
Employers should be careful when recommending advisors and brokers to their retirement-plan participants.
A recent settlement between the National Association of Security Dealers (NASD), a self-regulatory body in the brokerage business, and Citigroup illustrates the issue.
The NASD alleged that CitiGroup's advisors used misleading tactics to convince Bell South employees to cash out retirement plans and trust the proceeds with its brokers. CitiGroup will pay more than $15 million in fines and restitution, and individual broker licenses were suspended.
The NASD has issued an investor alert at www.nasd.com titled, "Look Before You Leave: Don't be Misled by Early Retirement Investment Pitches That Promise Too Much."
The problem also can stem from vendors that provide retirement-plan education through commission-based salespeople.
For example, a local employer's defined contribution plan was handled for many years by an insurance company that relied on its salespeople to provide education. When a longtime advisor/salesman left the insurance company, the human resources department became alarmed after learning that he sold numerous insurance and investment products outside the retirement plan to plan participants.
The employer also was surprised that the advisor/salesman earned commissions on these sales. In this field, retirement-plan providers, with the approval of their clients, will offer individuals education on assets that are outside the plan -- thus no commissions are involved.
Occasionally, broker advisors use annuity products to induce participants to cash out of plans upon retirement (sometimes early retirement), or use an in-service withdrawal benefit.
Another local defined contribution plan that was exempt from ERISA (federal law) had a unique option. Participants could cash out of the plan before retirement. A broker peddled immediate annuities to these participants, locking in a fixed income for life for them.
The rub was that the annuity products were high-commission retail products, earning the brokers 5 percent to 10 percent of the participants' account balances in the first year -- often hundreds of thousands of dollars.
For employers who want to provide annuity options to employees, there are low-cost institutional alternatives that will cut brokerage commission costs by 75 percent to 90 percent.
Most investment professionals are honest and ethical, but often can be myopic about what they're selling. They know only what they know.
Employee education has become a much bigger issue to the regulators. The federal Department of Labor considers target-date retirement funds as a safe harbor for employers. The DOL may designate funds as a Qualified Default Investment Alternative, which means they're an option for those who haven't made an option election into their retirement plan.
For younger participants with a long time frame, the options have a large bias toward equities and are gradually made more conservative (more in fixed-income strategies) as a participant approaches their retirement date.
Target-date portfolios can be designed based on the underlying options in the retirement plan or can be separate off-the-shelf products. But know that differences between target-date portfolio products can vary immensely. Plan sponsor fiduciaries must carefully examine fee differences, use of passive or active strategies, philosophy about risk control and the allocation to a firm's proprietary products.
The Pension Protection Act (PPA) has put employee education at the forefront for plan sponsors, and they need to be prudent about making appropriate approaches for participants and employees alike.