A New Set of 401k Best Practices for IRA Rollovers

Since the turn of the century, the financial industry has adapted to demographic and social changes, technological advances, economic and political power shifts, and other factors with a profound influence on the way our industry has operated for best practices. Not only have we adapted, we’ve thrived.

The U.S. Department of Labor (DOL)’s Conflict of Interest Rule is the newest challenge before us. Depending on the outcome of pending legal cases, it has the potential to significantly affect the ways in which firms and advisors conduct business in the IRA and qualified retirement plans arenas.

The new rule extends fiduciary responsibility beyond 401(k) plans to Individual Retirement Accounts (IRAs). Anyone who receives direct or indirect compensation for providing investment advice to retirement plans, plan fiduciaries, plan participants, beneficiaries, IRAs or IRA owners and represents or acknowledges that it is acting as a fiduciary, renders such investment advice based on the particular investment needs of the recipient or directs the advice to a specific advice recipient or recipients regarding the advisability of a particular investment or management decision, will be deemed to be acting in a fiduciary capacity.[1]

Between now and April 2017, broker-dealer firms, product sponsors, and financial advisors will establish best practices for the marketplace. While options are debated, processes are adopted, and training is administered, all advisors need to proceed with caution, especially when recommending IRA rollovers.

Fiduciary responsibility and rollover decisions

Current interpretations of the DOL rule suggest that two decisions made during the rollover process will be subject to fiduciary scrutiny:

1. The recommendation to rollover from a 401(k) plan account to an IRA must be in the client’s best interest. Recently, CFP and financial planning blogger, Michael Kitces, shared his thoughts with representatives from the American College of Financial Services.

“Historically…The mere act of changing from a 401(k) to an IRA was not itself a fiduciary event, so the regulators didn’t care if you did a rollover, but if you did a rollover into a bad investment, then regulators cared that you bought a bad investment. What has changed here is that the act of giving a recommendation to rollover is itself subject to fiduciary scrutiny.”[2]

This aspect of the rule affects both fee-only RIAs and commission-based advisors.  The DOL is concerned that advisors could recommend an IRA to a retirement plan participant in order to increase their own compensation. Starting in April of 2017, fee-only fiduciaries must adhere to the Impartial Conduct Standards and document the options considered for each client, as well as the reasons the final recommendation was in the best interest of each client.[3]

The requirements for commission-based brokers and brokerage firms are more onerous. Many are currently in the process of developing administrative processes, implementing technology, and delivering training designed to help their advisors meet the standards set by the Conflict of Interest Rule.[4]

2. The investments recommended for inclusion in the rollover IRA must be in the client’s best interest. Many advisors, whether they are subject to fiduciary or suitability standards, already act in their clients’ best interests. They provide carefully considered recommendations that fit the client’s financial objectives and circumstances.

Going forward, fiduciary scrutiny will focus on compensation and compensation arrangements, and their influence on investment recommendations. In general, fee-only RIAs—those who charge ‘level’ fee no matter which investments are chosen—should have little trouble meeting the fiduciary standard.

However, commission-based advisors—those whose income is determined by the actual investment products selected—may find themselves subject to significant scrutiny.

For example, recommending a rollover from a 401(k) plan account to an IRA that pays the advisor commissions is prohibited, unless there is a Best Interest Contract Exemption (BICE). The BICE exemption is a written contract (whether stand alone or incorporated into other account opening documents used with new clients) that:

• Acknowledges the fiduciary status of the advisor
• Discloses fees and conflicts of interest to clients
• Promises the advisor will act in the client’s best interests
• Guarantees the advisor will earn only reasonable compensation
• Gives investors the right to sue their advisers in court if the investors believe their advisors have not acted in their best interests

Some have speculated that these changes will provide an incentive for advisors to shift from commission-based to fee-only practices. Others argue that commission-based advisors will lose interest in the IRA market and broker-dealers have been strategizing new ways to price investment products, including applying the same commission schedule to all products with similar characteristics in order to reduce the risk of conflict of interest. For example, all variable annuities with a seven-year surrender charge must pay the same commission.[5]

Over the next 8 or 9 months, final interpretations of the DOL fiduciary rule will be hammered out. As the rough spots are smoothed, investment advice fiduciaries, including broker-dealers, RIAs, and their clients will be identifying and adapting a new set of best practices for IRA rollovers. It will be a challenge, but the investment advice business will thrive.

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[1] Domino, Anthony. “The ABC’s of the DOL fiduciary rule.” Investment News. July 12, 2016. [http://www.investmentnews.com/article/20160712/BLOG09/160719997/the-abcs-of-the-dol-fiduciary-rule] [2] American College of Financial Services. “The DOL Fiduciary Rule and Rollover Advice.” ThinkAdvisor.com video. 2:28. June 28, 2016. http://www.thinkadvisor.com/2016/06/28/the-dol-fiduciary-rule-and-rollover-advice?&slreturn=1468509570.

[3] Damato, Karen. “Fiduciary Q&A: Will the New Rule ‘Bleed Over’ to Nonretirement Accounts?” The Wall Street Journal. April 27, 2016. [http://www.wsj.com/articles/fiduciary-q-a-will-the-new-rule-bleed-over-to-nonretirement-accounts-1461749403] [4] Skinner, Liz. “The DOL fiduciary rule will forever change financial advice, and the industry has to adapt.” Investment News. May 9, 2016. [http://www.investmentnews.com/article/20160509/FEATURE/160509939/the-dol-fiduciary-rule-will-forever-change-financial-advice-and-the] [5] Iacurci, Greg. “Broker-dealers eye level commissions to reduce risk under DOL fiduciary rule.” Investment News. July 11, 2016. [http://www.investmentnews.com/article/20160711/FREE/160719996/broker-dealers-eye-level-commissions-to-reduce-risk-under-dol]