April 6, 2016 / 9:43 PM / 4 years ago

Best-interest standard is a game-changer for IRA rollovers

CHICAGO (Reuters) - A friend called recently looking for advice about her 401(k). Kate had decided to leave her job to pursue new career options, and money was tight during the transition. Should she roll over her $250,000 nest egg and withdraw some of the funds to help her through the career transition?

A screen shows the final tally for the Dow Jones Industrial Average on the floor of the New York Stock Exchange, August 21, 2015. REUTERS/Brendan McDermid

An adviser at a brokerage firm was proposing that she close out her 401(k) account and open an IRA that would cost three times as much in annual fees. I explained to Kate (not her real name) that this “adviser” was not acting in her best interest.

The 401(k) cost her 45 basis points annually, while the broker-managed IRA would cost 150 basis points. His proposal would cost her at least $74,000 in fees over the next 20 years, compared with $23,000 in the 401(k) - based on a simple back-of-the-envelope calculation assuming no asset growth. In all likelihood, the total fees would be far higher.

What would she be getting in return for that huge bite from her nest egg? Not much, just a mediocre mix of mutual funds and quarterly rebalancing, with no broader plan for retirement. We left the 401(k) where it is - and adjusted the investment mix to get the costs down further (around 17 basis points). That will cut her 20-year expenses even further, to around $7,400.

This type of predatory marketing underscores why the conflict-of-interest rule unveiled on Wednesday by the U.S. Department of Labor is so badly needed. The rule will impose fiduciary requirements on stockbrokers, requiring that they act in the best interest of clients whenever a tax-advantaged retirement account is involved (taxable retail accounts are not affected directly by the new rule).

The new rule, which will not be fully implemented until the end of next year, will sharply curtail the industry’s pitching to persuade retirement savers to roll over their 401(k) accounts when they switch jobs or retire.


“Any advice to do a rollover must now be in the best interest of the investor,” said Kate McBride, who chairs the Committee for the Fiduciary Standard, an organization of financial professionals. “It means that many people will stay in their 401(k)s instead.”

IRA rollovers are the key battleground. Nine out of 10 new IRA accounts are rollovers, according to the Investment Company Institute (ICI). The President’s Council of Economic Advisers estimates that $300 billion is rolled over annually, and the cash surge is accelerating as more baby boomers retire.

Rollovers make sense if you are in a bad 401(k) plan with mediocre investment options or high costs. The best plans tend to be the large ones offered by major corporations. In 2013, plans with more than $1 billion had total participant-weighted costs of 0.29 percent of assets, compared with 1.17 percent for plans smaller than $10 million, according a study by Brightscope and the ICI.

Fees will not be the only consideration in the new fiduciary era. For example, Kate’s would-be adviser could still recommend a solution with a higher cost if it is justified by the services provided. “Maybe the adviser will be providing planning services beyond what the client can get in the 401(k) - that’s defensible,” said Jason Roberts, chief executive officer of the Pension Resource Institute, a consulting firm that works with advisory and brokerage firms.

That would require the type of holistic retirement plan typically provided by fee-only Registered Investment Advisors - not only investment recommendations, but projections that integrate savings with other sources of retirement income, such as Social Security or pensions - and how they balance against living costs and health care expenses.


The final rule also contains some important concessions to the financial services industry that could allow some business-as-usual practices to continue. The rule grandfathers in existing accounts that may be conflicted, requiring only a brief notification to clients of the new rule. It also allows continued sales of investment products that are inappropriate for most IRAs - such as nontraded REITs and variable annuities - as long as advisers guarantee they are putting their clients’ interests ahead of their own.

Investors will need to be especially wary of something called a “Best Interest Contract Exemption.” These are documents clients may be asked to sign which would waive the fiduciary requirement in some cases.

Yet most retirement savers do not understand the different business and regulatory models used in the advisory profession. A recent survey by Financial Engines, a fiduciary provider of workplace investment help, found that 46 percent of Americans think all financial advisers are already required to meet a best-interest-of-the-client standard. Among people who already work with an adviser, 41 percent could not say if their adviser was a fiduciary.

Unless you are a lawyer with expertise in fiduciary matters, I would simply refuse to sign these exemption agreements. Ask for a better, fiduciary-compliant solution or take your business elsewhere.

How to be sure? Ask any potential adviser to sign the Fiduciary Oath, a simple, legally enforceable contract created by the Committee for the Fiduciary Standard. The adviser simply promises to put the client’s interest first, exercise skill, care and diligence, not mislead you and to avoid conflicts of interest. You can download the oath here. (bit.ly/1PtGy4w)

Editing by Matthew Lewis

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