Overnight it seems as if states are mandating that small businesses offer retirement plans to employees, starting with Oregon, California and Illinois to the point that, according to Angela Antonelli, executive director at the Georgetown University Center for Retirement Initiatives, “All but four states have some kind of legislation at varying stages.”
Defined contribution plans, like 401(k)s and 403(b)s, are great social experiments, shifting the responsibility and liability from employers to workers to save for retirement, a task that most are ill-prepared for. The state mandates, which will most affect smaller organizations starting with zero assets, will stress the private DC system that has evolved, as most businesses prefer to engage private entities to run their plan, according to the Pew Charitable Trusts research—most state plans are simply IRAs with no ability for an employer match.
Tax incentives in SECURE 2.0, which has a 50% chance of passing this year, and the growing availability of group plans like PEPs, MEPS and GOPS will further facilitate the explosion.
State IRA mandates cannot be converted en masse into a 401(k) plan, but they can spur new plan growth. Form 5500 research from Ascensus, which mirrors Pew’s study, shows a dramatic increase in new plan formation in states after the mandates go into effect with a 72% increase in Oregon, 61% in California and 42% in Illinois, according to Scott Parry, senior vice president of the company’s state-facilitated retirement programs (SFRP) business.
Yet only Ascensus and Vestwell, the two major state mandate providers, have been bidding on state mandates moving from a 100% asset-based fee to hybrid where the employer and/or the participants also pay a flat fee. Though CalSavers has 358,000 funded accounts, there are just $270 million covering 108,000 registered employers; Illinois has just $84 million with 7,500 employers. Most states overestimated the growth and neither Vestwell nor Ascensus is willing to go forward with a pure asset-based fee. Costs can be high to start the programs: Ascensus employs 110 people in its call center to verify accounts as mandated by the SEC, while Aaron Schumm, CEO at Vestwell, claims, “We can set up an account in four minutes.”
According to Jeff Rosenberger, COO at Guideline, which has over 30,000 401(k) plans, mostly startups, selling a whopping 11,000 in 2021, decided not to bid on state mandates. So far Paychex has not bid, which speaks volumes about the opportunity.
That is the crux of the problem—current providers and advisors alike charge asset-based fees but not as DC plans started in the 1980s where defined benefit providers charged hard dollar fees and were eclipsed by mutual fund providers like Fidelity in the 1990s as assets grew. Rosenberger noted, “Anyone who monetizes on assets will struggle.”
So with the potential explosion of DC plans, who will sell and service these startups?
Currently, plan formation is plagued by manual processes and complicated by delicate compliance and fiduciary issues with growing cybersecurity and data privacy concerns. Firms like Envestnet and BidMoni are trying to make the complex simple but, like Amazon experienced initially, major sellers with great brands and proprietary distribution are resisting, according to BidMoni CEO Stephen Daigle.
“There are third tier providers willing adapt to a streamlined process to get sales but larger ones are resisting,” Daigle said.
Envestnet is leveraging the power of broker/dealers to push providers to engage using the recently acquired 401kPlans.com. Sean Murray, head of retirement at Envestnet, said, “We have straight through processing, which includes pricing as well as data on 200,000 plans where many have ‘out of whack’ investments and costs. Record-keepers are responsive and broker/dealers are interested if they can use their own ‘paperwork’ and processes.”
RPAs, unless forced to because they are part of benefit and P&C firms, eschew small and startup plans. Wealth advisors dislike DC plans with lots of work and liability and little revenue. Though Daigle explained that wealth advisors overlook the opportunity to be the company’s advisor when they are sold, he added, “Most RPAs don’t do wealth management and most wealth managers don’t do plans.”
Sales by banks, even the larger ones like JPMorgan Chase and Bank of America, are limited.
Most likely, firms like Guideline, which partners with payrolls like Gusto, and accountants will sell directly with RPAs interested when assets grow and wealth advisors to serve current clients. “Payrolls are hiring internally,” said Vestwell’s Schumm, which could certainly be a factor to likely outsource record-keeping to a fintech like Guideline.
The potential explosion of small-business retirement plans will force providers to adapt to new systems, deploying straight-through processing with a hybrid fee model leveraging participant data. The question is whether RPAs can and will adapt and whether broker/dealers can get their wealth advisors interested in DC plans no matter how simple they make it.
Small plan creating will fuel the already growing convergence of wealth, retirement and benefits at work. It is the classic case explained brilliantly by Harvard professor Clayton Christensen in The Innovator’s Dilemma:
“… how large incumbent companies lose market share by listening to their customers and providing what appears to be the highest-value products, but new companies that serve low-value customers with poorly developed technology can improve that technology incrementally until it is good enough to quickly take market share from established business.”
Fred Barstein is founder and CEO of TRAU, TPSU and 401kTV.