A higher standard for retirement accounts

Unless you’re offering financial advice for a living, you likely haven’t noticed an announcement from the Department of Labor in early April.

But whether you pay a professional of any kind to manage your retirement accounts or advise you on how to manage them, you can be sure your advisor will notice. The long-awaited new rule will change the way the financial industry offers retirement advice, in both important and secondary ways.

These are the basics of the new fiduciary rule that consumers need to understand.

Brokers and other financial professionals are sometimes allowed to earn commissions and other forms of compensation that create actual or potential conflicts of interest. Your advice simply has to pass the “suitability” test, that is, it should suggest investments that do not deviate too much from the client’s needs or situation. As long as the eligibility requirement is met, brokers operating under these rules may, and often do, favor products that result in higher commissions or bonuses.

The new rule requires anyone offering financial advice on a client’s retirement account to meet the strict fiduciary standard, which means that they must put clients’ interests first over their own. Under the fiduciary rule, brokers will be required to disclose the fees they charge to help protect investors from conflicts of interest that could arise if brokers receive more compensation for recommending your company’s proprietary investment products over competitors to investors. in retirement accounts. Not only will they have to disclose such fees; Brokers must also be able to demonstrate that their advice is in the best interest of the client.

“Better” is a pretty nebulous concept. After all, it wouldn’t be reasonable to expect advisers to have omniscient knowledge of all potential products around the world and to evaluate the best course of action for a particular client. In practice, the fiduciary rule means that an advisor must offer advice that a similar prudent professional would instead with the same level of knowledge and care for the client’s interests.

This is, of course, a simplified explanation. The final rule is almost 60 pages long, with many additional supporting materials.

The new rule only applies to retirement accounts. Taxable investment accounts are, for now at least, subject to the old eligibility rule unless the advisor is subject to the fiduciary standards for other reasons (such as the Securities and Exchange Commission’s rules for advisers in registered investments). This means that some companies will have to separate clients with retirement accounts from those without or extend their fiduciary standard beyond what is technically required to cover all clients.

For institutions whose employees offer retirement account counseling, the Department of Labor rule requires a best interest contract with clients. The contract will recognize the advisor’s status as fiduciary and establish a commitment to provide advice in the best interest of the client, not charge more than “reasonable” compensation, and not make misleading statements about any conflict of interest. For new clients, the Best Interest Agreement can be, and almost certainly will be, with the general paperwork involved in establishing a working relationship with the company; for existing clients, a contract must exist before offering any new advice that would be covered by the rule.

Additionally, financial firms will need to take steps to fairly disclose any conflicts of interest, along with fees and compensation. They will have to refrain from offering incentives for advisers to act against the best interests of their clients, such as fees or bonuses for certain products. And companies will need to implement policies designed to prevent violations of the new standards, including a person responsible for preventing material conflicts of interest.

The Department of Labor itself can only enforce the rule in regards to plans covered by the Employee Retirement Income Security Act, generally abbreviated to ERISA. For IRAs and other uncovered retirement savings accounts, the application technically falls to the Internal Revenue Service. However, for any type of plan, the new rules prohibit financial institutions from requiring consumers to completely waive the right to file a class action lawsuit. Labor clearly plans to use the potential of a lawsuit from the customers themselves as a major impediment.

The new rules will go into effect on April 10, 2017, but some of the more detailed requirements will not apply until January 1, 2018. During this generous transition period, we will no doubt see some debate about how the rules should be implemented. Larger brokerage firms or other affected companies may back down in hopes that the rule will be removed entirely, but the Department of Labor has already incorporated requests from many firms, such as an extended implementation period and protection. of existing investments in certain cases. As Jeff Masom, Legg Mason Inc. co-director of sales, told The Wall Street Journal, the Department of Labor “certainly made a lot of concessions” in developing the final rule. (1)

In the future, the SEC and the Financial Industry Regulatory Authority are likely to extend the rules to taxable accounts as well, extending the fiduciary standard to all financial advice. As Michael Kitces observed in his explanation of the new rules, “it is clearly untenable in the long run for advice on retirement accounts to be held to a fiduciary standard, while everything else remains in the domain of adequacy and caveat.” . (2)

However, the decision to start retirement accounts was a smart one from a consumer perspective. After all, if you only have one investment account, it is likely a retirement account, such as a 401 (k) or an IRA. It seems likely that regulators will eventually push for a consistent standard across the board, but in the meantime, the new rules will continue to cover many savers, in part or in full.

The rules offer a “streamlined” approach for advisers who qualify as level fee fiduciaries, recognizing that advisors whose compensation is unrelated to the products they recommend effectively prevent many potential conflicts of interest. This means that many ARIs who do not receive third-party compensation will feel less impact from the new rules. The compensation structure of companies that avoid commissions and other payments based on sales and are based on a percentage of assets under management is one that regulators have not considered designed to push clients towards a particular investment. .

However, level-rate trustees still need to provide a justification for recommending that an investor roll over their 401 (k) account to an IRA, or from one IRA to another, due to the additional fees the investor may incur as a result. For companies that are already committed to a fiduciary standard, the main change will be some additional documentation to clarify the customer-centric logic behind such recommendations. The new rule should create minimal additional administrative burden for such companies, in contrast to stockbrokers who may have to make significant changes to the way they do business.

Overall, the new rules are a step in the right direction. Many companies that were not previously committed to fiduciary responsibility to their clients will need to take steps to ensure that they offer all retirement savers the same high standards.


1) The Wall Street Journal, “US Presents Retirement Savings Renewal, But With Some Concessions To Industry”

2) Nerd’s Eye View in Kitces, “Advisor’s Guide to the DoL Trustee and the New Best Interest Contract (BIC) Requirement”

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