Five things to know about the new rules for retirement advisors
You might think the people you hired to help arrange your retirement finances have to put your best interests first. That’s not always the case.
So the Obama administration has taken a controversial step to try to protect more Americans from being ripped off.
The new rules unveiled Wednesday by the Labor Department are designed to prevent consumers from being steered toward IRAs and other retirement investments with higher fees or lower returns that benefit the advisors recommending or selling them.
The White House estimated that those conflicts of interest cost Americans $17 billion a year.
Initially proposed in 2010, the rules would save a 45-year-old worker with $100,000 in retirement savings about $37,000 over the two decades before turning 65, the White House estimated.
Consumer advocates, Democrats and retiree groups such as the AARP cheered the administration’s move.
“When you’re planning for retirement, your advisor should be focused first on what makes sense for your finances, not theirs,” said Pamela Banks, senior policy counsel for Consumers Union.
But the financial industry, top business groups and Republicans complained that complying with the complex new rules would drive up the cost of investments and make it more difficult for average Americans to get retirement advice.
“This is Obamacare for your IRA and 401(k),” said Rep. Jeb Hensarling (R-Texas).
Here’s five things you need to know about the new rules, which will be phased in over eight months beginning in April 2017:
Your nest egg takes precedent
For decades, many investment advisors have been required under federal law to put the best interest of their clients first. That makes the advisors, who usually are paid a flat fee, into what are known as fiduciaries.
But other retirement advisors, such as brokers and insurance agents, have had a lower standard.
They are only required to make sure investments are suitable for their clients. That allows those advisors, who often receive commissions for the sale of specific investments, to recommend investments that benefit their bottom line as well — sometimes even more than the client’s.
The commissions are paid by the companies that offer the mutual funds or other investments that can have higher fees or lower returns, benefiting the company and harming the client.
This has become a bigger issue as Americans have shifted from pension plans administered by their employer to 401(k) and other retirement plans that they manage themselves.
The new rules makes all retirement investment advisors into fiduciaries, meaning they must put the client’s best interests above their own.
The biggest impact will be on IRAs
A 401(k) plan is administered by a fiduciary who selects and monitors the investment options available to participants in the plan.
That’s not the case with IRAs, which can be sold by a host of financial advisors.
The risks of conflict of interest are greater with IRAs. The costs related to those products tend to be higher because they are purchased individually, while 401(k) plans are run by companies that pool the investments of their employees.
“When you’re with all the other employees, you have more buying power,” said Robert Kaplan, an associate at the Ballard Spahr law firm in Philadelphia, who specializes in employee benefits and executive compensation.
“It’s much cheaper to service a million-dollar client than service a $50,000 client,” he said.
The new rules require the advisors who sell IRAs or help you roll over your 401(k) balance into an IRA when you leave a job to act as fiduciaries.
Financial advisors can still accept commissions – with a caveat
The Labor Department said that being a fiduciary means an advisor must provide impartial advice in his or her client’s best interest and can’t accept any payments, such as commissions, that would create conflicts of interest.
Still, there’s a way for advisors to continue receiving commissions from retirement products.
Advisors can sign a contract that, among other things, promises to charge only reasonable compensation, discloses conflicts of interest and commits to adopting policies to ensure they are acting in their client’s best interests.
But the so-called best-interest contract comes with a catch: It allows for class-action lawsuits if violated, rather than the binding arbitration that many financial firms require of clients.
Arbitration can be required for individual claims, but class-action suits must be allowed if a group of people are harmed, the Labor Department said.
More financial advisors could switch from commission to upfront fees
The new regulatory burdens on financial advisors who want to accept commissions means that it could be more attractive to work for a flat fee, Kaplan said.
“I think we’re going to have a shift from the world of commission advisors to hourly rate advisors,” he said.
Fee-only advisors advertise themselves as such and charge a flat, upfront fee for their work. That removes a key incentive – lucrative commissions – for conflicts of interest.
Those advisors also would not have to sign the best-interest contract and provide all the additional disclosures.
Although the Labor Department made some changes to the final rule, the legal liability probably will be “severe enough” that publicly traded broker-dealers with financial advisory businesses “will switch to a fee-for-service model from a commission model,” said Jaret Seiberg, a policy analyst for Guggenheim Partners in Washington.
Among such publicly traded companies are E-Trade, Charles Schwab and TD Ameritrade.
The rules could make it more difficult for some people to get financial advice
Upfront fees can be more than $100 an hour, which could be difficult for average Americans to afford, Kaplan said.
“Fee-only (advice) tends to be for only high net-worth people because it’s expensive,” he said.
While there is the potential for conflicts of interest, commission-based advisors don’t require the customer to pay upfront for the service.
That’s part of the reason opponents of the rules have argued retirement saving will become more difficult.
“Policymakers should do everything they can to help Americans be more prepared for retirement and not create red tape that makes saving for retirement more difficult,” said Tim Pawlenty, former Minnesota governor who is chief executive of the Financial Services Roundtable, which represents the largest banking and financial services companies.
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