The U.S. Department of Labor's recent proposal would impose significant new rules on retirement accounts, which includes IRAs and qualified employer-sponsored plans. This rule would enforce fiduciary standards on advisers who offer advice on retirement investment options. On one hand, with these new rules there is potential to limit the amount of retirement investment options for high income earners, because some advisors may stop offering certain products altogether. On the other hand though, the rules could have substantial benefits for investors in that they could drive down retirement advisory and product costs.
The potential issues are the way advisers sell retirement-centric products, because they are designed to protect clients from conflicts of interest in retirement advice. Brokers would be held to new fiduciary standards to 401(k) programs, Individual Retirement Accounts and other retirement plans. In short, advisers will be required to act in the best interests of their clients, and therefore must disclose all information behind the promotion of certain retirement investment plans over others.
"The U.S. Department of Labor's proposal could affect retirement accounts."
How it impacts the relationship between clients and financial planners
Advisers and sponsors of workplace retirement plans would still be able to offer education such as stock selections based on age and income levels of individuals without incurring fiduciary obligations. Brokers would also be able to process orders from clients if there were specific buy or sell instructions involved in the prospective client's request. However, the nature of the relationship will change because advisers can no longer make recommendations as a sales pitch to prospective clients. These advisers will need to be contracted with clients in order to provide recommendations of specific selections. In turn, advisers will also be required to disclose why they recommend certain retirement plans to clients – for example, if brokers promote annuities because of the potential for higher commissions, they need to disclose that to clients.
What does it mean for retirement accounts for high income earners?
While the rules will not directly limit the advice to individuals that can afford these services, the rules may shrink the amount of retirement investment options, according to the Economic Consequences of the U.S. Department of Labor's Proposed New Fiduciary Standard report. The costs may also result in less investment capital into their retirement accounts, thereby reducing savings.
There are also significant issues that may arise which impact retirement accounts for wealthy clientele under the new rules. For starters, an adviser's fiduciary obligation kicks in for any investment recommendations, regardless of context. The result could be that advisers will be less inclined to offer their services without signed agreements, which may drive up costs for these advisory services.
Another issue is that many brokers may simply eliminate smaller, less profitable IRA account options. These types of accounts may become too expensive under the new compliance and disclosure requirements. Like the previous issue, this may not cut off these services to high income earners, but the costs may cause these clients to switch advisers based on competitive prices.
There is also the issue of changing cost structures offered by advisers under the new rules. For instance, if a client is allowed to maintain their IRA account, they could end up with higher costs for advisory services as they are transferred to fee-based accounts. That is a particular drawback for active high income earners because the fees would cut into their net returns.
While the rules will not directly limit the advice to individuals that can afford these services, the rules may shrink the amount of retirement investment options.
Looking ahead, there is another potential issue with the Dodd-Frank Act, which encourages a different set of fiduciary rules than the Department of Labor for advisers and the treatment of qualified and nonqualified deferred compensation plans. The Department of Labor proposal offers more strict ERISA rules, but the SEC could potentially change securities laws as well, which may adversely affect retirement accounts. On a positive note, this could lead to the proliferation of nonqualified deferred compensation plans, like supplemental executive retirement plans. These rules would not apply to individual retirement plans held outside of an employers' custodianship or fiduciary duty. However, the SEC has not decided its course of action yet, although it should be noted that any decision that results in different rules for qualified and nonqualified plans could complicate the retirement investing options offered by financial planners.
The Department of Labor's proposal could ultimately drive down costs for retirees, but it will initially create havoc for advisers. In fact, according to a Morningstar report, the new rules will impact roughly $3 trillion of retirement assets under management by costing the advisory industry $2.4 billion. But the long-term consequences for high income earners are that some options may not be available for qualified plans because financial advisers may not offer them. So these clients may be left with lower growth potential and less liquidity over their retirement savings.
With all these new changes, you must consider your financial circumstances thoroughly. That is where our team of financial advisers can help. We can sit down with you on a one-to-one basis to demystify the potential impact of these Department of Labor rules on your retirement plans.
Additional information regarding this proposal, courtesy of the U.S Department of Labor, can be viewed here.