Unintended Consequences: IRA Rollovers and the DOL Fiduciary Rule

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There has been a great deal of media coverage and talk in the industry of late about the Department of Labor’s Fiduciary Rule, due largely to the fact that the rule went into effect on June 9th, despite the Trump administration’s mandate that the rule be reviewed for possible alteration or roll back. Last week also saw legislation introduced by Rep. Ann Wagner R-MO, which would completely repeal the rule, and replace it with a “Best Interest Standard” instead. The future of the rule remains unclear, but most financial institutions have been moving forward with plans to address and implement changes necessitated by the new regulations despite the questions that remain.

At its core, the DOL Fiduciary Rule is designed to streamline the standard of care for financial professionals who work with retirement plans or give retirement planning advice, and elevates them to the level of ‘Fiduciary’. As a fiduciary, an advisor is required to act only in the best interest of the client when making recommendations or giving advice. Before the rule, there were different standards of care for different financial professionals, allowing some to offer advice or recommend products simply on the basis that they were considered ‘suitable’ for the investor.

You would be hard-pressed to find anyone to argue that any advisor or broker should not act in the best interest of the client when making investment recommendations, and so many in the industry, including any Registered Investment Advisor, was already bound by a fiduciary standard of care, so why all the hand-wringing? The truth is that this legislation (as most sweeping legislation tends to), contains some provisions that will most likely result in unintended consequences, which may not actually serve to help retirement savers as expected. Many people have argued about what those consequences may be, but an area that hasn’t been talked about as much, is that of IRA rollovers from qualified plans. These types of rollovers seem to have been a major target of the rule, but the new regulations may result in outcomes that do not necessarily benefit investors.

That rollovers from workplace retirement plans (such as 401(k)s, 403(b)s etc.) to Individual Retirement Accounts (IRAs), have come under scrutiny is no surprise. Because an IRA can effectively be used as a wrapper for almost any kind of investment, unscrupulous brokers have been able to persuade investors to cash in their retirement plans for all manner of high priced or ill-suited investment products for years, while pocketing hefty commissions for themselves. So the fact that these transactions are a focus of the new rule makes complete sense. The problem, as is the case with many broad legislative acts of this nature, is that we may just be throwing the baby out with the bathwater.

The first issue is that the rule is principally focused on fees. This is perfectly understandable, particularly in light of the potential for abuse discussed earlier. The problem is that it doesn’t just address rollovers into high commission products, but specifically addresses those going into ongoing asset-based pricing, which is the primary fee structure for investment advisors who were already operating under a fiduciary standard. The DOL believes that there is a substantial conflict of interest when an adviser recommends that a participant roll money out of a plan into a fee-based account that will generate ongoing fees for the adviser that he or she would not otherwise receive. In order to comply with the new rules in this area, advisors are tasked by their compliance departments to create an avalanche of new paperwork, and gather so much personal financial information, that it makes even financial planners blanche. Additionally, it requires a comparison of the fee structure of the current retirement account, to that of the new arrangement with the advisor. This sounds like a simple thing, but in my experience, it is anything but simple.

Qualified retirement plans are required to disclose fees and expenses annually to participants. Most investors are probably familiar with this as the 404a-5 notice 401(k) plans send out each year. Sometimes the notice is simple to read and understand. Often, though, particularly when the provider is an insurance company, these notices can be extremely complicated, and include different numbers based on different features that may or may not be included in each plan, or participant’s account. It can be extremely challenging to determine the true costs associated with a workplace retirement plan, and that’s for a veteran of the industry who sees these notices all the time.

My fear is that due to these new rules and regulations, good advisors may simply choose to avoid retirement plan rollover business altogether, and refuse to give advice on them at all because of the liability. The fact is that there are still an enormous amount of high-priced workplace retirement plans in use out there, particularly in the small business market, where the companies do not have the size and scale to demand lower pricing. So, if advisors don’t help participants roll out of these kinds of plans once they’re eligible, they may be destined to continue paying high fees, long after they have stopped working, and could benefit from lower cost structures and advice.

Further, this uber-focus on fees, I believe, misses the point that so many financial advisors and their clients understand: fees alone are not the only determinant of successful investing outcomes. All else being equal, lower fees are better, no question about it. But all else is not equal. Many would argue that investor behavior is a much more important factor in investing outcomes than fees. Who will keep clients from bailing out of their investments during bear markets, or chasing overvalued sectors during bull markets? Who will design effective draw-down strategies to replace their income in retirement, and help them manage the tax implications if advisors cannot rollover and oversee these accounts? The retirement plan providers, for the most part, do not have the knowledge, expertise or relationship with the clients to effectively do these things.

The idea that financial professionals should be held to a fiduciary standard of care is unquestionably important, and there is no doubt that the rules and protections for retirement plan participants afforded by ERISA needed to be updated to reflect the realities of today’s investing world. For that, the DOL’s Fiduciary Rule should be supported. My concern is that one unintended consequence of the new rule will be many workers left in high-priced plans, managed by unqualified or overwhelmed administrators, without access to quality investment advice.