Original Post date: 4/6/16
Six years in the making, rules to force financial advisers to do what’s best for their clients — rather than themselves — are finally a reality, and they could potentially save investors $40 billion over 10 years, according to the Labor Department.
The department on Wednesday unveiled its new rules designed to protect owners of retirement accounts — including for the first time IRAs — from stockbrokers, insurance agents and other types of financial advisers who “put their own profits ahead of their clients’ best interest.”
The rules — which are set to go into effect starting next April — require retirement advisers to meet a higher “fiduciary” standard when selling investments (mutual funds) and products (variable annuities) to retirement account owners. In the past, many advisers had to abide only by a suitability standard.
“The DOL has indeed taken a major step toward a more secure and dignified retirement for millions of Americans,” says Harold Evensky, chairman of Evensky & Katz/ Foldes Financial. “It seems that the Department of Labor’s years of effort will be a major win for investors.”
Under the Labor Department’s definition, any person — be they a broker, registered investment adviser or insurance agent — paid to give advice to a plan sponsor (an employer with a retirement plan, for instance), plan participant or IRA owner is a now considered fiduciary. The new rule would also apply to advisers who help workers decide whether to roll over their money from an employer-sponsored retirement plan, such as a 401(k) or 403(b), to an IRA.
Proponents have praised the new rule but suggest it might take some time for investors (and advisers, too) to understand the consequences. “The key issue is that the Labor Department rule puts investors in charge, but investors may not yet know it,” says Knut Rostad, president of the Institute for the Fiduciary Standard.
Meanwhile, opponents of the new rule, including Rep. Scott Garrett, R-N.J., weren’t pleased. Critics say the cost of advice will rise and that there will be fewer advisers serving an ever-growing number of people who need help with their investments and retirement plans. “Washington doesn’t need to put another roadblock between people and their financial goals,” Garrett said in a statement. “By ignoring the advice of the SEC and Congress, the DOL’s rule will increase the cost of retirement advice for lower- and middle-income Americans while creating a preferred class of rich investors.”
Proponents, however, say the new rule will change the advice industry/profession for the better. Robo-advisers will likely start to serve the needs of investors who want low-cost advice that complies with the new fiduciary rules and who aren’t necessarily being served by advisers today. Brokerage firms will likely launch more fee-based accounts and start selling no-load variable annuities. Plus, it’s likely advisers who largely earn a living by not acting in their client’s best interest will exit the business.
Exemptions exist. According to the Labor Department, being a fiduciary simply means that the adviser must provide impartial advice in their client’s best interest and cannot accept any payments creating conflicts of interest unless they qualify for an exemption intended to assure that the customer is adequately protected.
In essence, advisers when selling commission products and investments must document to clients that they are acting in their best interest.
Carve-outs. The new rule carves out education from the definition of retirement investment advice. That means advisers and plan sponsors can continue to provide general education on retirement saving across employment-based plans and IRAs without triggering fiduciary duties.
Recourse available. If advisers and firms don’t adhere to the standards, the Labor Department says, retirement investors will be able to hold them accountable — either through a breach of contract claim or under the provisions of ERISA.
Resistance likely. The new conflict-of-interest/fiduciary rule will face resistance in the form of lawsuits and legislation designed to block it from becoming a reality. Critics say the cost of advice will rise and that there will be fewer advisers serving an ever-growing number of people who need help with their investments and retirement plans.
Change for the better. That may be true, but proponents also say it’s possible the new rule will change the advice industry/profession for the better. Robo-advisers will likely start to serve the needs of investors who want low-cost advice that complies with the new fiduciary rules and who aren’t necessarily being served by advisers today. Brokerage firms will likely launch more fee-based accounts and start selling no-load variable annuities. Plus, it’s likely advisers who largely earn a living by not acting in their client’s best interest will exit the business.
10 things to consider about the new rule
- The new rule applies only to retirement accounts, not taxable accounts. If you have taxable accounts with your adviser, he or she may not have to act as a fiduciary with respect to those accounts. If you have a traditional stockbroker with just a Series 7 license the “advice” they give need only be suitable. Plus, they can still get a commission on the sale of investments and insurance products in taxable accounts.
- Advisers who are registered investment advisers (RIAs) regulated by the Securities and Exchange Commission already have to act as fiduciaries, in the best interest of clients, with respect to investment accounts, including IRAs. And RIAs who give advice to 401(k) plan participants are already regulated by Labor Department under a law commonly referred to as ERISA. The new rule extends ERISA to include retirement accounts other than employer-sponsored retirement plans, such as IRAs and Roth IRAs.
- Advisers can still receive commissions on the sale of investment and insurance inside an IRA if they can demonstrate that the investment or insurance product is in the client’s best interest. Be prepared to sign a lot of paperwork.
- Investors should expect or require four things from their adviser in this brave new world, says Rostad. Any adviser must 1) affirm fiduciary status in their advisory agreement in writing, 2) estimate in writing all fees and expenses for the upcoming year and an accounting of the prior year’s fees and expenses the client paid and the broker / adviser or firm received, 3) provide a list of conflicts and a written description of how conflicts are managed, and 4) affirm there will be no proprietary products or principal trading.
- Expect to see more no-load investments and products.
- In some, but not all cases, advisers will charge more for their advice. Ask your adviser how much they are charging and for what service and/or product.
- An adviser might, in some cases, “fire” their small retirement account clients. If this happens to you, don’t despair. They may be doing you a favor, says Rostad. “Either a discount broker or a robo or an hourly fee-only adviser is likely to provide greater guidance and education or advice at a far, far lower cost,” he says.
- Don’t fret if there are fewer advisers serving investors after the rule is fully implemented. “Immediately, perhaps, there may be fewer salespersons who recommend products,” says Rostad. “But going forward, there will be a greater number of true advisers relying on better technology providing higher-quality advice.”
- What’s the worst-case scenario for investors? Short-term inconvenience.
- What’s the best-case scenario for investors? “Far, far higher-quality advice,” says Rostad.