While uncertainty lingers with the new administration assuming office this Friday, January 20, 2017, the Department of Labor’s (DOL) new Fiduciary Rule is currently set to become effective on April 10, 2017 with full implementation required by January 1, 2018. The ultimate impact of the rule will be widespread and complex and one marketplace that will certainly feel the impact of the rule is the IRA rollover space. According to the 56th Investment Company Institute Fact Book, 86% of new traditional IRAs in 2013 were funded solely with rollovers from employer sponsored retirement plans. The study also noted that 63% of traditional IRA-owning households with rollovers first consulted advisors and nearly half indicated they primarily relied on advisors to make their rollover decisions.
To set the stage, it is critical to differentiate an advisor or broker from a registered investment advisor (RIA) and how those differences will change under the new Fiduciary Rule. Currently, an advisor/broker is held to the “Suitability Standard” which means the advisor or broker must know their clients’ financial circumstances and recommend investments that are suitable given those circumstances. Under this standard, recommendations may entail higher costs or the advisor/broker firm’s own investment products (proprietary investments) yet they can still remain suitable. RIAs generally adhere to a stricter fiduciary standard in which they must act in their clients’ best interest and seek to avoid any potential conflicts of interest.
Under the new rule, all financial advisors will be held to the same fiduciary standard. Advisors that rely on rollover dollars from employer sponsored retirement plans to increase revenue may be harder pressed to justify that it remains prudent and in a participant’s best interest to rollover assets from his or her plan. Advisors will have to first evaluate current plan fees, the available investment options and other plan-related services and features in order to validate that they have a better offering for the client by rolling assets over to an IRA.
Investment options and fees are critical components of the evaluation process, but advisors should not overlook the different benefits 401(k) plans and IRAs offer and how they address participants’ needs. For example, most retirement plans offer access to loans which can serve as a participant benefit, one not available within an IRA. Traditional IRAs can be converted to Roth IRAs, while the majority of plans don’t offer an in-plan conversion. Moreover, 401(k) participants may take a penalty-free distribution at the age of 55 upon separation of service, four and a half years earlier than an IRA (“Rule of 55”). These and other factors must be considered when determining a participant’s best interest as each situation will be unique.
Lower fees within the defined contribution landscape have been well documented the past few years due in part to both fee disclosure legislation and growing fiduciary litigation in the retirement industry. Plans are increasingly moving to lower cost institutional share classes of mutual funds as well as collective investment trusts (CITs) and separate accounts. In addition, recordkeeping fees have long been on the decline. Advisors will need to uncover what type of share classes their clients have access to within their plan, how recordkeeping fees are assessed structurally (asset-based vs. per participant), who pays for recordkeeping fees and the role revenue sharing plays within the plan.
With advisors subjected to a much higher standard going forward, they should also evaluate other key considerations within the plan’s investment menu aside from fees: adequate diversification, active vs. passive investment options, etc. These concerns represent only a small slice of questions that must be answered by the advisor before recommending a plan rollover. While advisors will likely have access to a much wider range of investment options relative to a traditional 401(k) investment menu, they must determine if they have the ability to add value when using the larger opportunity set.
Please contact any of the professionals at DiMeo Schneider & Associates, L.L.C. for further discussion regarding the Fiduciary Rule and your evolving fiduciary responsibilities.
