Any day now, the U.S. Department of Labor is expected to finalize new rules that would change the way financial advisors are allowed to give advice to their clients.
The controversial changes are meant to reduce the conflict of interest amongbroker-dealers and financial advisors who advise consumers on how to invest their savings. And the rules would apply to both major firms like Fidelity and Vanguard as well as smaller independent ones. As it stands, broker-dealers receive commissions based on the products they sell their clients, which critics say creates an inherent conflict of interest. Under the new rules, broker-dealers would be required to act in their clients’ best interest rather than encouraging money moves that directly benefit the broker’s bottom line. The fancy word for this is “fiduciary duty.”
One of the biggest profit centers for broker-dealers is the IRA rollover. Since only a small portion of 401(k) plans allow retirees to set up their accounts for monthly withdrawals in retirement, it’s common for broker dealers to encourage savers to roll their 401(k) into more flexible IRAs. But the risk here is that brokers will direct savers to invest in products that may be too risky and expose them to additional fees. A White House report found that up to $1.7 trillion of assets held in IRAs are invested in products that financially benefit advisors, creating the potential for a conflict of interest. This conflicted advice costs savers an estimated $17 billion each year in unnecessary fees.
Federal workers have been a hot target for companies looking to convince them to roll their low-cost Thrift Savings Plan funds (the federal equivalent of the 401(k)) into high-fee IRA plans after they retire. Of course, not all broker-dealers are out to take advantage of their clients, but the DOL’s new rules would at least ensure brokers will put their clients’ interest first before fiddling with their nest egg.
The financial advisory industry has been trying to block the new rules before the DOL has a chance to implement them. In its letter to the DOL, Fidelity asked the agency to reconsider its plan to hold IRA rollover advice under the new fiduciary standard, which would mean broker dealers could only advise clients to roll over their funds into an IRA if it’s in their best interest. Instead, Fidelity argues that only advice on where to invest after the rollover is initiated should be held to the fiduciary standard.
Barbara Roper, director of investor protection for the Consumer Federation of America shot back at Fidelity’s letter, saying “there is little mystery” why the firm supports that approach. “Their ability to siphon money out of 401(k) plans and into IRAs could continues unabated,” Roper said in a letter to the DOL last fall. “This has been a major source of profits for financial firms in recent years, though far less beneficial for retirement savers who are too often moved into higher cost or otherwise inferior investments.”
Another argument posed by opponents is that the new rules will make it less profitable for small and midsize firms to work with people who have smaller portfolios, making it harder for low- and middle-income folks to get the financial guidance they need. There just isn’t enough profit in it for a fee-based advisor earning a flat percentage of a client’s assets when that client only has a few thousand bucks saved up.
Brian Graff, CEO of the American Retirement Association, a nonprofit that represents 20,000 retirement industry professionals, says those fears may be overstated.
“My honest opinion is there will be some displacement, but I do think there will be other types of services that fill the void,” he says. “I have a hard time imagining that no one is going to try to seize an untapped market.”
Startups like Betterment and Wealthfront have built their businesses on that untapped market, offering low-cost investment advice to workers whose portfolios may not be big enough for traditional firms. The 11 largest so-called roboadvisors held a combined $21 billion in assets as of July 2015, up 83% year over year, according to Corporate Insight.
Overall, 401(k) savers likely won’t notice too much of a difference under the new rules, as a large number 401(k) plans already have a fiduciary duty to their workers. The rules are largely aimed at protecting 401(k) savers when they prepare to leave their employer and roll over their nest egg into an IRA.
Once the rules are implemented, firms will have several months to transition.
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