Our View on the Final Participant Advice Rules

Seth J. Masters

In a reversal, the US Department of Labor’s final regulation requires computer-generated investment advice to include target-date funds when comparing the investment offerings provided by a defined contribution plan. But the hurdles to being compliant are high.As a result, many advisers may choose to provide advice in other, easier ways, as our ERISA attorney, Daniel Notto, explains below.

 

The Department of Labor’s (DOL’s) final regulation on providing investment advice to participants is welcome news. It closes the loop on this issue in the Pension Protection Act (PPA), which was passed five years ago. It’s also good for participants, especially those in midsize and smaller plans who probably don’t have much, if any, access to investment advice.

The final rule establishes new mechanisms that advisers can use to help participants choose among the specific investment options in a company’s defined contribution (DC) plan, while avoiding potential conflicts of interest if the adviser may have a vested interest in promoting one option.

We’ve written a synopsis of the final regulations. Here, I’d like to focus on two interesting changes made from the 2010 proposed rule to October’s final rules. The changes relate to advice generated by a computer model certified to be unbiased by an independent investment expert.

The initial proposal allowed these models to exclude asset-allocation funds, such as target-date funds, probably because computer programs would have difficulty comparing them with stand-alone funds. But that would have eliminated target-date funds from the modeling “contest” before it even began. And that might unfairly skew a participant’s eventual investment selection against target-date funds.

AllianceBernstein helped write comments that were sent to the DOL about the benefit of target-date funds. We believe that the comments contributed to the change in the final rule, which states that computer models must consider target-date funds if they’re on an investment menu.

The initial proposal also said that the computer-advice model couldn’t take into account the historical performance of investment options but must account for any fees or expenses. This would favor lower-cost index funds over actively managed funds, several comments noted.

While the debate over the merits of active versus passive investing may never end, the DOL clarified that it didn’t intend to ban consideration of historical performance: the computer models can take this into account when generating advice.

One big question remains: The final rule creates a lot of hurdles that advice providers would have to clear to be compliant. Among them is an annual audit of the advice model performed by an independent auditor. Since there are already other ways to provide advice, it’s unclear how much use this feature of the PPA will get.

The phrase “target date” in a fund’s name refers to the approximate year when a participant expects to retire and begin withdrawing from his or her account. Target-date funds gradually adjust their asset allocation, lowering risk as participants near retirement. Investments in target-date funds are not guaranteed against loss of principal at any time, and account values can be more or less than the original amount invested—including at the time of the fund’s target date. Also, investing in target-date funds does not guarantee sufficient income in retirement.

Seth J. Masters is Chief Investment Officer for Defined Contribution Investments and Asset Allocation at AllianceBernstein and Chief Investment Officer of Bernstein Global Wealth Management, a unit of AllianceBernstein. Daniel Notto is Senior Retirement Plan Counsel at AllianceBernstein.

2 comments

  1. Akhileash

    Start with these questions: Have I ever been convicted of a crime? Has any regulatory body or investment-industry group ever put you under investigation, even if you weren’t found guilty or responsible? Then ask for references of current clients whose goals and finances match yours.

    Financial Planner Washington DC

    • I would pay the mortgage down early, wouhitt relying on the renters covering the payment. That will protect you in the event that you can”t get renters for a while (economic downturn or some other issue you can”t control) or interest rates going sky high. You will get a far better return if you reduce your interest costs than you would if you invested the money. Here”s why.Say you borrow $ 100 000 at 6%, with repayments of $ 150 a week. Over 30 years, it will cost about $ 116 000 in interest. That”s on top of the payments, so adding the principle to that means you”ve spent $ 216 000 to pay off $ 100 000. I”ll just guess (you haven”t told us how much extra you”d be adding to the mortgage) that you pay double repayments, which would take repayments to $ 300 a week. That would clear the mortgage in a little over 9 years, and only cost about $ 130 800 to do so. That”s only $ 30 800 in interest. If you instead invested that extra $ 150 a week ($ 600 a month) at 4% interest for 30 years, you”d have over $ 416 000 on paper, but about a quarter of that at least would go in tax. That investment would reap income, but it would be taxable income. So you”d probably come out with an effective return of about 3%, which would be just ahead of inflation. So you”d be left with about $ 350 000, minus the $ 116 000 you”ve paid on interest, leaves you with a return, after 30 years, of $ 234 000. Taking into account inflation, the value of this after 30 years would be much less. It would probably only be worth about half of that, or $ 117 000. However, paying the homeloan out in 9 years frees you to put the entire amount (rental income and personal contribution) into an investment. That makes it $ 1200 a month over 20 years at $ 393 962 before inflation, or just under $ 200 000 in today”s dollars. That”s not including capital gains on the investment property.I”d pay the mortgage out early, to reduce your debt burden, and then consider buying another investment property. You”d be better off in the long run.Best wishes

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