A higher standard for retirement accounts

Unless you offer financial advice for a living, you probably didn’t notice an announcement from the Department of Labor in early April.

But if you pay a professional of any kind to manage your retirement accounts or give you advice on how to manage them, you can be sure your advisor will take notice. The long-anticipated new rule will change the way the financial industry offers retirement advice, in both major and minor ways.

Here are the basics of the new fiduciary rule that consumers need to understand.

Brokers and other financial professionals are sometimes allowed to earn commissions and other forms of compensation that create potential or actual conflicts of interest. Their advice simply has to pass the “fitness” test, that is, they must suggest investments that are not too out of line with the client’s needs or situation. As long as the eligibility requirement is met, brokers operating under these rules can and often do favor products that result in higher commissions or bonuses.

The new rule requires anyone offering financial advice on a client’s retirement account to meet the strictest fiduciary standard, meaning they must put the clients’ interests before their own. Under the fiduciary rule, brokers will be required to disclose the commissions they charge to help protect investors from conflicts of interest that could arise if brokers are compensated more for recommending their firm’s proprietary investment products over those of the competition. to retirement account investors. Not only will they have to disclose those commissions; brokers will also need to be able to demonstrate that their advice is in the best interest of the client.

“Better” is a rather nebulous concept. After all, it would be unreasonable to expect advisors to have an omniscient understanding of all potential products around the world and to assess the best course of action for a particular client. In practice, the fiduciary rule means that an advisor must offer the advice that a similar prudent professional would give in his or her place with the same level of knowledge and attention to the client’s interests.

This is, of course, a simplified explanation. The final rule is nearly 60 pages long, with many additional supporting materials.

The new rule only applies to retirement accounts. Taxable investment accounts are, at least for now, subject to the old eligibility rule unless the adviser is subject to fiduciary standards for other reasons (such as Securities and Exchange Commission rules for investment advisers). registered). This means that some companies will have to separate clients with retirement accounts from those without or extend their fiduciary standard beyond what is technically required to cover all clients.

For institutions whose employees offer advice on retirement accounts, the Department of Labor rule requires a best-interest contract with clients. The contract will recognize the advisor’s status as a fiduciary and will establish a commitment to provide advice in the best interest of the client, collect no more than “reasonable” compensation, and not make misleading statements about any conflict of interest. For new clients, the best interest agreement can, and almost certainly will, be included with the general paperwork involved in establishing a working relationship with the firm; for existing clients, a contract must be in place before any new advice that would be covered by the rule is offered.

Additionally, financial firms will need to take steps to fairly disclose any conflicts of interest, along with fees and compensation. They will have to refrain from providing any inducement for advisers to act against the best interests of their clients, such as fees or bonuses for particular products. And companies will need to implement policies designed to prevent violations of the new standards, including a person responsible for preventing material conflicts of interest.

The Department of Labor can only enforce the rule for plans covered by the Employee Retirement Income Security Act, generally abbreviated as ERISA. For IRAs and other retirement savings accounts that aren’t covered, enforcement technically falls to the Internal Revenue Service. For any type of plan, however, the new rules prohibit financial institutions from requiring consumers to completely waive the right to bring a class action lawsuit. Labor clearly plans to use the potential for a lawsuit from clients themselves as a major deterrent.

The new rules will take effect on April 10, 2017, but some of the more detailed requirements will not apply until January 1, 2018. During this generous transition period, we will no doubt see some debate about how the rules should be implemented. . Larger brokerage firms or other affected companies may back off in the hope that the rule will be scrapped entirely, but the Labor Department has already onboarded requests from many firms, such as an extended implementation period and grandfathered rights. existing investments in certain cases. As Jeff Masom, co-director of sales for Legg Mason Inc., told The Wall Street Journal, the Labor Department “certainly made a lot of concessions” in developing the final rule. (one)

In the future, the SEC and the Financial Industry Regulatory Authority are likely to expand the rules to taxable accounts, which would extend the fiduciary standard to all financial advice. As Michael Kitces observed in his explanation of the new rules, “It is clearly untenable in the long run for retirement account advice to be held to a fiduciary standard, while everything else remains the domain of eligibility and caveat.” . (two)

However, the decision to start with retirement accounts was smart from a consumer perspective. After all, if you only have one investment account, it’s probably a retirement account like a 401(k) or IRA. It seems likely that regulators will eventually push for a consistent standard across the board, but in the meantime the new rules will still cover many savers, in whole or in part.

The rules offer a “simplified” approach for advisers who qualify as level-fee fiduciaries, recognizing that advisers whose compensation has no connection to the products they recommend effectively prevent many potential conflicts of interest. This means that many RIAs who do not receive compensation from third parties will feel less affected by the new rules. The compensation structure of companies that eschew commissions and other sales-based payments and rely on a percentage of assets under management is one that regulators have not considered designed to push clients toward a particular investment.

However, flat fee fiduciaries must still provide justification for recommending that an investor move their 401(k) account to an IRA, or from one IRA to another, due to the additional fees the investor may incur as a result. . For companies that are already committed to a fiduciary standard, the main change will be some additional documentation to clarify the customer-centric logic behind such recommendations. The new rule should create minimal additional administrative burden for such companies, in contrast to broker-dealers who may have to make significant changes to the way they conduct business.

Overall, the new rules are a step in the right direction. Many companies that were not previously committed to a fiduciary responsibility to their customers will need to take steps to ensure that they offer all retirement savers the same high standards.


1) The Wall Street Journal, “America Introduces Retirement Savings Renewal, But With Some Industry Concessions”

2) Nerd’s Eye View on Kitces, “Advisor’s Guide to the DoL Trustee and the New Best Interests Contract (BIC) Requirement”

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