Beginning September 23, 2024, financial advisors and their firms must comply with a new, stricter federal rule for managing clients’ retirement assets.
The Retirement Security Rule from the Department of Labor imposes a fiduciary standard on certain circumstances for retirement advice where there was none before.
Under the rule, a recommendation for a one-time rollover of 401(k) assets into an IRA or an annuity will be subject to the ERISA fiduciary standard. The same will apply to one-time recommendations for investment options in a company’s 401(k) plan.
The new DOL rule extends fiduciary requirements to all advisors, brokers and independent insurance agents who make recommendations for retirement accounts, whether they are workplace retirement plans or IRAs.
“If you are working with a retirement saver, it doesn't matter whether you are working through your advisory affiliate, broker-dealer affiliate or insurance affiliate. If you meet the requirements of the rule, you are an ERISA fiduciary and you will have to comply with the requirements of the new rule,” says Micah Hauptman, director of investor protection at the Consumer Federation of America (CFA) and former counsel to Securities and Exchange Commission (SEC) Commissioner Caroline A. Crenshaw.
The new Retirement Security Rule defines more broadly who is an investment advice fiduciary when working with retirement accounts and requires them to follow strict conduct standards and mitigate conflicts of interest. It replaces an outdated 1975 rule that defined a fiduciary as someone who provided advice “on a regular basis” and operated under "a mutual agreement, arrangement, or understanding" where their advice would serve as "a primary basis for investment decisions.”
“The investment landscape has changed, the retirement landscape has changed and it is critical that our regulations are responsive to those changes,” said Lisa Gomez, Assistant Secretary of DOL, in announcing the new rule so that workers can reach the secure retirement that they work for decades to finally achieve.”
A new definition of an investment advice fiduciary
Under the new rule, a financial services provider is considered an investment advice fiduciary if the provider recommends investments to a retirement investor, receives a fee or commission for that recommendation and represents themselves as a trusted advisor by stating they’re a fiduciary or making a recommendation that a “reasonable investor” would believe is based on the investor’s best interest.
It will have a limited effect on registered investment advisor firms and fee-only certified financial planners; they are already fiduciaries acting in the best interest of their clients. However, they will need to explain in writing those one-time recommendations that are within the scope of the new rule.
Compliance requirements
“What advisors need to do is document, document, document,” says Jeremiah Barlow, Head of Wealth Solutions at Mercer Advisors. “The documents of the advice provided will have an intense amount of compliance oversight. It could be quite expansive.”
“At a minimum, even RIA firms will face increased compliance requirements,” writes Sheryl Rowling, a CPA and columnist at Morningstar. “All firms need to adjust internal processes and implement new training programs.”
Donald LaGrange, a fee-only wealth manager at Murphy & Sylvest Wealth Management in Dallas, Texas, says his firm has already formalized a compliance checklist to clearly document the reasons for any recommendations made for a 401(k) rollover into an IRA.
The checklist documents the reasons for a 401(k) rollover such as a change in employment, retirement, termination of a retirement plan, or a desire to consolidate multiple workplace retirement plans into a single IRA. It also requires the advisor to compare the fees and investment options in a client’s workplace retirement plan to the fees and investment options the advisor’s firm would charge for managing the IRA.
“Even if our fee is higher, if the client wants professional management and more investment options than they currently have, the ultimate recommendation can still be to roll over the account. The client knows they may be paying a little more and are OK with it. It’s very transparent.”
The advisor must also attest to having made no misleading statements and the client must give their consent to a rollover, says LaGrange. If both parties agree to the analysis and recommendation, they sign the document.
Additional Compliance for Hybrid Advisors
Within the advisory industry, the new DOL Retirement Security Rule rule will have its greatest impact on those hybrid advisors who collect commissions on recommended investments for clients’ retirement accounts. They are already required to act in the best interest of their clients (duty of care) and disclose any conflict of interest (duty of loyalty) for securities recommendations in brokerage accounts under the SEC’s Regulation Best Interest (Reg BI). They must do the same for clients’ retirement accounts, with additional documentation required by the DOL.
“What the DOL is saying is that these same standards should apply to all retirement advice and not just advice about securities,” says Leo Rydzewski, general counsel of the CFP Board.
Indeed, the new DOL rule covers non-security assets in retirement accounts, such as fixed-indexed annuities, real estate, certain certificates of deposit and other bank products. “The rule will fill an important regulatory gap,” says Rydzewski.
Many investors didn’t even know such a gap existed. According to a recent CFP survey, 92% of Americans believe that one-time financial recommendations for retirement accounts require advisors to act in their clients’ best interests. Moreover, 97% favored such a requirement.
The DOL initiative allows fee-based advisors to charge commissions for investments in retirement accounts if they file for exemptive relief under the Prohibitive Transaction Exemption 2020-02 or PTE 2020-2. Advisors will have an additional year to comply with this provision. (Independent insurance agents recommending annuities have to file an exemption under PTE 84-24.)
These filings need to document that the advisor or agent has followed impartial conduct standards, meaning they provide a professional standard of care, put their client’s interest above their own, charge a reasonable fee, avoid misleading statements and mitigate conflicts of interest.
The Impact on Annuities
One of the biggest effects of the new rule will be its impact on annuities, especially annuities with the highest commissions, such as fixed index annuities. “It will be tough to justify a really different type of commission for a fixed index annuity versus a cheaper multi-year guarantee annuity when the risk and return profile of the products are relatively similar,” says Spencer Look, associate director of retirement studies at the Morningstar Center for Retirement and Policy Studies. Reg BI does not currently cover annuities.
Marcia Wagner, founder and managing partner of The Wagner Law Group, which specializes in ERISA and employee benefits law, says financial advisors need to be concerned about recommending annuity options for defined contribution plans. She explains that the SECURE Act and SECURE 2.0 have encouraged the use of lifetime income options in defined contribution plans but these annuity options are “a lot more complex” than the more common mutual funds and ETFs plan options and may “make it difficult for advisors to determine if annuity options are in the best interest of plan participants.”
Morningstar believes that as a result of the new DOL rule, the annuity industry will innovate, creating more fee-only commission-free annuities that advisors could comfortably use and be in compliance. It projects that retirement investors rolling into fixed index annuities will save over $32.5 billion in the first 10 years of the rule’s enactment because of the greater demand for lower-priced annuities. The fund research firm also expects small retirement plans will save over $55 billion during the same period and $130 billion over the next 10 because of lower-priced annuities.
The Impact for Investors
The biggest beneficiaries of the new rule are investors. “This rule protects retirement investors from improper investment recommendations and harmful conflicts of interest,” said Acting Labor Secretary Julie Su when the rule was announced. “Retirement investors can now trust that their investment advice provider is working in their best interests and helping to make unbiased decisions.”
That’s quite a big deal given that as of the end of last year. Americans held $7.4 billion trillion in 401(k) assets and $13 trillion in IRA assets, according to the Investment Company Institute. In 2022 alone, nearly $845 billion in plan assets moved from defined contribution plans into IRAs and nearly two-thirds of those rollovers were done with the assistance of a financial advisor, according to Cerulli Associates.
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