Understanding the New Fiduciary Rules for Retirement Accounts

You might have noticed a lot of reports in the media in early April regarding the application of the “fiduciary standard” to IRAs and similar accounts. You likely will see additional reports, because some in Congress want to override these new regulations by the Department of Labor, and some private entities might sue to overturn the rules. If they’re not successful, the rules will be phased in over the next 18 months or so.

Let’s take a quick look at what the fuss is about. I don’t have all the answers, because the regulations issued by the Department of Labor are 1,023 pages long. But here’s a summary.

Employer-sponsored retirement plans and everyone who advises on the plans have been subject to the fiduciary standard all along. The new rules apply that standard to IRAs and other qualified retirement accounts. Under the fiduciary standard, a financial adviser must act both prudently and solely in the interests of the client. In addition, there are specific prohibited transactions, such as offering a client an investment that provides the adviser a higher fee than another, even if the potential conflict is disclosed and the client agrees to it.

When advising on accounts other than employer retirement plans, registered investment advisors have been subject to a fiduciary rule that requires them to act in the best interests of the client. But potential conflicts are allowed when there is informed consent from the client. Brokers, on the other hand, have had a standard that only requires them to recommend investments that are “suitable” for the client.

In new regulations, the Labor Department applies the employer plan fiduciary standard to anyone who gives individualized advice to, or advice specifically directed at, a plan sponsor or participant, or an IRA. The department is mostly concerned about people who roll over 401(k) accounts to IRAs. Its view is that many people are making bad decisions and paying too much in fees when they engage in rollovers. The department’s position is that the suitability standard that applies to brokers is a major reason for those decisions.

There likely will be several effects from the new rules.

Some advisers who have operated as commission-based brokers might switch to charging annual fees of 1% or so of the assets managed for a client. Those brokers who continue to be paid in commissions must have clients sign a “best interest contract” requiring the advisor to act in the best interests of the client and that includes information about potential conflicts of interest. After a client’s request, they must make detailed disclosure of costs and fees. When a client is rolling over a 401(k) to an IRA, the best interest contract must be signed when the account is opened but it also covers any advice provided before the account is opened.

Some firms report they will have to decline some smaller accounts they now accept, while others predict smaller clients are likely to be given “robo-advice” instead of personalized investment advice. Supporters of the rules say forecasts of such changes are false arguments made to defeat the rules.

It is not clear how the rules will affect the investments offered to IRA owners. The original proposed rules provided a list of acceptable IRA investments that excluded or would have made it difficult for advisors to recommend private equity, hedge funds, REITs that aren’t publicly-traded, listed options, some annuities and other investments. The proposed regulations also included language that many interpreted as saying an advisor had to recommend the lowest-cost option.

Those provisions were dropped from the final regulations. But many analysts say that under the final language, it still will be risky for an advisor to recommend many of the investments not on the earlier approved list. While variable annuities were expected to be treated badly in the final regulations (and were), index annuity firms expected to receive a favorable status similar to those that provided for immediate annuities. They didn’t. The index annuity issuers might have to revamp their offerings if they want to sell them to IRAs.

Critics, however, say the final version was watered down too much and allows most current practices to continue with modest changes. Brokerage firms, for example, still can offer proprietary products with proper disclosure.

For existing IRAs, firms must send investors an acknowledgement of their new fiduciary status by April 2017. Other provisions and disclosures must be complied with by January 1, 2018.

While the intent of the regulations is to prevent individuals from moving their assets from low-cost 401(k) plans to high-fee investments that the regulators don’t like, it will be interesting to see how it affects the rest of the IRA rollover industry. For example, will a mutual fund firm have to show investors how the costs of the retail funds in its IRAs compare to the institutional funds that might be in their 401(k) plans? Will advisors and investment firms have to show how the costs of their recommended investments compare to lower-cost providers, such as Vanguard or ETFs? Some analysts believe the regulations will reduce the number of advisors who recommend actively managed mutual funds for IRA rollovers, believing that only index funds can be justified under the new rules.

It’s likely that the attorneys are gearing up to test these and other questions.