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 An adviser at a brokerage firm was proposing that she close out her
401(k) account and open an IRA that would cost three times as much
in annual fees. I explained to Kate (not her real name) that this
“adviser” was not acting in her best interest.
The 401(k) cost her 45 basis points annually, while the
broker-managed IRA would cost 150 basis points. His proposal would
cost her at least $74,000 in fees over the next 20 years, compared
with $23,000 in the 401(k) - based on a simple back-of-the-envelope
calculation assuming no asset growth. In all likelihood, the total
fees would be far higher.
What would she be getting in return for that huge bite from her nest
egg? Not much, just a mediocre mix of mutual funds and quarterly
rebalancing, with no broader plan for retirement. We left the 401(k)
where it is - and adjusted the investment mix to get the costs down
further (around 17 basis points). That will cut her 20-year expenses
even further, to around $7,400.
This type of predatory marketing underscores why the
conflict-of-interest rule unveiled on Wednesday by the U.S.
Department of Labor is so badly needed. The rule will impose
fiduciary requirements on stockbrokers, requiring that they act in
the best interest of clients whenever a tax-advantaged retirement
account is involved (taxable retail accounts are not affected
directly by the new rule).
The new rule, which will not be fully implemented until the end of
next year, will sharply curtail the industry’s pitching to persuade
retirement savers to roll over their 401(k) accounts when they
switch jobs or retire.
KEY BATTLEGROUND
"Any advice to do a rollover must now be in the best interest of the
investor,” said Kate McBride, who chairs the Committee for the
Fiduciary Standard, an organization of financial professionals. “It
means that many people will stay in their 401(k)s instead.”
IRA rollovers are the key battleground. Nine out of 10 new IRA
accounts are rollovers, according to the Investment Company
Institute (ICI). The President's Council of Economic Advisers
estimates that $300 billion is rolled over annually, and the cash
surge is accelerating as more baby boomers retire.
Rollovers make sense if you are in a bad 401(k) plan with mediocre
investment options or high costs. The best plans tend to be the
large ones offered by major corporations. In 2013, plans with more
than $1 billion had total participant-weighted costs of 0.29 percent
of assets, compared with 1.17 percent for plans smaller than $10
million, according a study by Brightscope and the ICI.
Fees will not be the only consideration in the new fiduciary era.
For example, Kate’s would-be adviser could still recommend a
solution with a higher cost if it is justified by the services
provided. “Maybe the adviser will be providing planning services
beyond what the client can get in the 401(k) - that’s defensible,”
said Jason Roberts, chief executive officer of the Pension Resource
Institute, a consulting firm that works with advisory and brokerage
firms.
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That would require the type of holistic retirement plan typically
provided by fee-only Registered Investment Advisors - not only
investment recommendations, but projections that integrate savings
with other sources of retirement income, such as Social Security or
pensions - and how they balance against living costs and health care
expenses.
CONCESSIONS
The final rule also contains some important concessions to the
financial services industry that could allow some business-as-usual
practices to continue. The rule grandfathers in existing accounts
that may be conflicted, requiring only a brief notification to
clients of the new rule. It also allows continued sales of
investment products that are inappropriate for most IRAs - such as
nontraded REITs and variable annuities - as long as advisers
guarantee they are putting their clients' interests ahead of their
own.
Investors will need to be especially wary of something called a
“Best Interest Contract Exemption.” These are documents clients may
be asked to sign which would waive the fiduciary requirement in some
cases.
Yet most retirement savers do not understand the different business
and regulatory models used in the advisory profession. A recent
survey by Financial Engines, a fiduciary provider of workplace
investment help, found that 46 percent of Americans think all
financial advisers are already required to meet a
best-interest-of-the-client standard. Among people who already work
with an adviser, 41 percent could not say if their adviser was a
fiduciary.
Unless you are a lawyer with expertise in fiduciary matters, I would
simply refuse to sign these exemption agreements. Ask for a better,
fiduciary-compliant solution or take your business elsewhere.
How to be sure? Ask any potential adviser to sign the Fiduciary
Oath, a simple, legally enforceable contract created by the
Committee for the Fiduciary Standard. The adviser simply promises to
put the client’s interest first, exercise skill, care and diligence,
not mislead you and to avoid conflicts of interest. You can download
the oath here. (http://bit.ly/1PtGy4w)
(Editing by Matthew Lewis)
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