Last week the Senate voted 56 to 41 to repeal the Department of Labor’s (DOL) new fiduciary rule. However, while serving out the rest of his term in office, President Obama vowed to veto any legislation dismantling the new regulation.
The fiduciary rule redefines who is now a fiduciary and further clarifies the distinction between “education” and “advice.” It’s important now for retirement plan participants and Individual Retirement Accounts (IRAs) holders to understand the relationship changes with their advisors, as the regulation impacts advice about a 401(k) and IRA rollover or distribution.
The Role of Advisors Under the New Rule
According to the new rule all advisors are expected to act as fiduciaries, where previously only Registered Investment Advisors (RIAs) were. As we’ve known it, there were two distinct types of advisors—brokers and RIAs—but the DOL’s new rule aims to bridge the gap between them, and create uniformity.
The expanded definition of advice leaves very little room for brokers to operate under a “suitability” standard as they once did. Previously, brokers would be able to skirt the requirement of being a fiduciary by offering “only education” and not broach the “advice” threshold. Now the new rule expansion of the definition has all but eliminated that loophole. It now requires all advisors to act as fiduciaries when making recommendations and/or giving advice on 401(k) plans or IRAs—including recommendations for a rollover or a distribution. The “suitability” standard that brokers were once held to is now gone for retirement accounts (but not individual retail accounts)—eliminating the conflicted compensation model that was an environment ripe for abuse.
IRA Rollover and Distribution Under the New Rule
Since the updated definition of advice also includes recommendations about distributions to or from IRAs or a 401(k) plan, a fiduciary status is triggered if and when an advisor suggests a rollover or a distribution for those plans.
Now that the fiduciary standard applies to all advisors when providing recommendations about 401(k) and IRA accounts, current methods of conflicted compensation for brokers are now “prohibited” as they are not conducive to a “best interest” environment. However, there is an exemption to conflicting payment structures or “prohibited transactions” that allows the advisor to continue working with the client even if compensation increases. This exemption is known as the Best Interest Contract Exemption (BICE).
BICE
Formerly, brokers might have steered clients to products like load mutual funds or annuities that rendered higher commissions after the sale, and since brokers were previously held to a “suitability” standard of care—not a fiduciary standard—they were not required to offer the “best product,” only a suitable one. However, some brokers hope to continue their same conflicting commission practices under the DOL’s new rule via an exemption, BICE.
BICE allows the now prohibited methods of conflicted compensation to continue, if the broker enters into a contract with the participant or IRA account holder stating the broker will:
- Attempt to act in their best interest.
- Disclose all potential conflicts of interest.
- Provide a detailed breakdown of their collected commission.
For small investors, BICE may offer the most cost effective compensation structure, because fee-only RIAs may be too costly for small accounts. Another viable option for small account holders is the robo-advisor route, where computer based calculations produce investment allocation advice. For larger accounts, an RIA acting in a fiduciary capacity provides less of a challenge but still needs to enter into a “streamlined” version of BICE called the “level fee” exemption, where an advisor receives flat-rate fees as compensation.
IRA Rollovers and Distributions Under BICE
Regulators such as FINRA and the SEC, who has issued a soft date for the release of its own uniform fiduciary rule, will remain wary of the level fee exemption. Most of the concern stems from the recommendations regarding 401(k) accounts that can be rolled over to outside IRA accounts from previous employers or from career changes. Currently, brokers recommend only a “suitable” investment—too often this recommendation results in high commissions, high-fee annuity products or front-load mutual funds. While suitable, it will be difficult to rationalize how such a product is in the client’s “best interest” moving forward.
Under this new regulation, careful processes must be implemented to assure all options involving rollovers have been discussed with the client. These options include:
- Remaining with the current/previous 401(k) plan. Items to consider:
- Costs of previous plan
- Investment lineup quality
- Who’s paying the administration costs
- Rollover to a current or next employer. Items to consider:
- Costs of new plan
- Investment lineup quality
- Who’s paying the admin costs
- Hardship withdraws
- Rollover to an outside IRA. Items to consider:
- Fees or costs
- More investment options?
- If annuity, why?
- Including other services, financial planning, etc.
What Now?
In lieu of a congressional attempt to overrule the new regulation, the rule becomes law April 2017 and then fully phases in through January 2018. Moving forward, should you choose to rollover your retirement plan, it’s vital to know which rollover option (if any) is best for you. Additionally, should you need to enter into a BICE agreement, knowing how it will affect you is important.
This change is a victory for investors. Now all retirement assets will be protected by the new, higher standards. However, this change will not prevent bad advice, of course, but all advice will now be offered in good faith, and such precautions will inevitably lead to better overall outcomes.
Brian Menickella is a co-founder and managing partner of The Beacon Group of Companies, a broad-based financial services firm based in King of Prussia, Pa.
Securities offered through TFS Securities, Inc., Member FINRA / SIPC, a full service broker dealer. Investment Advisory Services offered through TFS Advisory Services, a division of TFS Securities.
