Sorting Out Legacy Retirement Plans By: Gabriel PotterMBA, AIFA®
The Freedom of a Blank Slate

There is an underappreciated cost to establishing most systems:  disassembly.  There are always logistical problems when phasing out and replacing systems in pieces or running two overlapping systems concurrently. If you erect a building, the owners will have to keep updating its purpose to ensure it remains useful.  Otherwise, someone will bear the cost of tearing the building down, or else the community will bear the cost of a dilapidated eyesore.  If a nation sets up an infrastructure for gasoline-driven cars, there is an additional cost to repurpose it for other competing technologies such as liquid natural gas, hydrogen cell, or battery-driven electrical.  Here in Rochester, part of America’s Rust Belt, being mindful of the cost of an overextended and obsolete system is an influential part of our mentality. 

On a positive note, the least developed countries, companies, and communities have an advantage.  They can start fresh and take advantage of modern innovations at inception.  They can leapfrog several levels of development without the burden of renovation costs to an existing, obsolete infrastructure.  This principle applies to quickly growing economies, like those of sub-Saharan Africa, which can take quantum leaps into cellular communication and independent power generation, bypassing traditional 20th-century standards like landline and energy-transmission lines.  This principle equally applies to individual businesses, like JetBlue, which took advantage over larger, more established peers with newer fleets and less restrictive union arrangements.

Until now, we’ve mostly been considering the costs of change to tangible, literal systems.  The same principles of restructuring cost apply equally to intangible systems.  You might suspect that the costs to changing a tangible system should be greater because there are real-world physical structures that must be created, transported, and installed to replace a system.  That’s true.  It’s easier to scrap a few ideas on a piece of paper than make a physical object.  It’s easier to change a system early in a planning stage, when everything is abstract and unrealized.  However, an intangible system may mature and innovate more quickly, since it operates free of physical limitations.  Thus, an intangible, abstract system can advance more quickly, free of real-world burdens.  So being behind the curve can be equally damaging to an intangible system since the potential for modernity advances more quickly. 

Let’s be more specific and consider the changing environment of an intangible system – namely, an employer-sponsored retirement plan.  For the past decade, the financial recordkeeping services industry has created enormous savings for plan sponsors for both public and private retirement plans.  Moreover, the service-level agreements for plan participants have never been better, with lots of customized education options, inexpensive loan arrangements, daily balances, and other options available to employees. 

403(b) & 457 Plans Are Further Behind the Curve

Startups and new companies starting fresh should be able to get great deals, in the context of history, with a little bit of comparison shopping and modest benchmarking efforts.  The competitive nature of the marketplace has pushed many cost and service benefits widely across the 401(k) universe.  However, in our work as a fiduciary consultant, we have noted a number of retirement plans that have been harmed by adherence to a legacy of uncompetitive service agreements and old-fashioned thinking.  Specifically, we’ve noted a particular slowness in public plans and non-profit plans, i.e.: the 403(b) and 457 universes.  We expect the free market and their corresponding retirement system, the 401(k), to move more quickly than government plans, but the difference between the levels of services and fees between very comparable plans is surprising. 

Some of this deficiency is due to inaction at the client level, and some is due to a lack of pressure upon service providers.  Why might public and non-profit plans be slow to take advantage of modern retirement plan benefits?

Group-Level Contracts vs. Individual Contracts

Some retirement plan providers in the government or public education arenas had prudently began a relationship with a retirement plan vendor but had implemented their contracts on an individual, plan participant level.  For example, John Doe is an employee working at a Municipality.  This Municipality’s retirement plan is being provided by ABC Custodial and Asset Management.  The Municipality wants to fire ABC and transfer retirement plan management duties to a less expensive competitor.  However, ABC may point out that their contracts are between ABC and individual participants, like John Doe.  New and future employees at the Municipality may start a new retirement plan administered with XYZ management, and that plan itself may be portable to future competitors if necessary.  However, John Doe and other employees will have to personally opt-out of their relationship with ABC to make the transition to XYZ.  This is a step not everyone is willing to take.  Many plan participants are famously difficult to convince to make short-term efforts to ensure a better deal, no matter how objectively attractive the long-term benefits are.  As a result, the Municipality will end up overseeing multiple plans concurrently, new employees with XYZ and a legacy of older employees with ABC. The plan committee and investment consultants will have to manage multiple vendors concurrently.

The Long Unwind

Contractual obligations that attach substandard service levels to participants are bad enough.  Worse, depending on the vintage of the plan, there may be inherent lock-up periods even if you can separate plan participants en masse to a more competitive service provider.  So, for example, the Municipality is now allowed to move all of their participants from ABC’s system to XYZ Asset Management, but it may not happen in a timely way.  First, there are some investments like Stable Value products that have lock-up periods where the plan must allow 12 to 24 months to fully redeem the book value of the original investment.  So any of the Municipality’s employees with assets in the ABC Stable Value program may have to wait a few years to move all their money to the new plan.  Similarly, there are some lock-up provisions that have extended this principal to create five-to-ten-year lockups from changing service providers.  So employees know that their money will eventually change hands, but it will still take years to happen.  Given the inevitability of a long-term period of a plan sponsor monitoring multiple plans during this lock-up period, it understandably discourages sponsors and their planning committees from making a move. 

Personal Relationships

Speaking anecdotally, there is a greater cultural tendency in the non-profit world to act and to portray one’s actions as being separate from self-interest.  It isn’t just business; it’s personal.  It isn’t just dollars-and-cents; it’s emotional.  The relationships are more insular; service providers move beyond trusted professional partnerships into potentially one-sided friendships.  This type of business arrangement can end up being lucrative for service providers who do not have to react as quickly to industry best practices or competitive-pricing pressure.  To promote change, it becomes necessary to translate how the ultimate goals of the non-profit are being undermined by the current, uncompetitive service agreements. 

Making the Change

Given these discouraging elements, plans sponsors and their committees may be lulled into inertia and hopelessness.  If the process is going to take years, why not simply defer the decision to future committee members?  There is a proverb, “The best time to plant a tree is 20 years ago; the second best time is now.”  The fiduciary duty to act in participants’ best interest should bolster the case for action, if its benefit is deferred.  Therefore, we advocate forward looking action from today’s committee members to ensure a better future for tomorrow’s employees and plan fiduciaries.
Gabriel Potter

Gabriel is a Senior Investment Research Associate at Westminster Consulting, where he is responsible for designing strategic asset allocations and conducts proprietary market research.

An avid writer, Gabriel manages the firm’s blog and has been published in the Journal of Compensation and Benefits,...

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