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On April 6, the Department of Labor finalized its long-awaited fiduciary rule for retirement plan investment advice. Under this rule, all financial advisors to retirement plans are required to act according to a “fiduciary” standard – in other words, they must give impartial investment advice that’s in their clients' best interest. Prior to this rule, only some advisors were subject to a fiduciary standard. Brokers and insurance agents were subject to a lesser “suitability” standard.
The problem with the suitability standard is that there is practically no investment that is “unsuitable.” Hidden fees, outrageous redemption charges, lousy performance and house funds with high commission payouts – everything is suitable and anything goes. The old standard allows for certain advisors to provide financial “products” that give the appearance of unbiased advice, but in reality represent blatant conflicts of interest.
Freed from the consequences of self-dealing, certain plan advisors recommend investments that pay them well, but often have excessive fees and lower investment returns. When this happens, retirement security is less likely for plan participants and personal liability is more likely for plan sponsors. The DOL’s fiduciary rule roots it out, which makes it great news for 401(k) participants, sponsors and specialized financial advisors.
Conflicted advice is bad for both 401(k) participants and sponsors
I think it’s pretty obvious why conflicted advice is bad for 401(k) participants – when financial advisors recommend investments based on their compensation, and not their value, participant returns can suffer. According to a White House study, conflicted advice lowers participant investment returns 1% per year on average. This reduction can add up over time. According to the DOL, a 1% difference in fees per year can reduce a 401k account balance by 28% over 35 years assuming a 7% rate of return. That’s a lot!
What’s less obvious is how 401(k) plan sponsors can be harmed by conflicted advice. 401(k) sponsors have a fiduciary responsibility to pay only reasonable plan fees and expenses. When sponsors follow conflicted investment advice, and participants pay too much for investments or investment-related services, personal liability for the sponsor can result.
The irony is that non-fiduciary advisors are rarely held accountable for giving conflicted advice that results in excessive 401(k) fees. Why? Because they have no legal obligation to make impartial recommendations. That’s a pretty raw deal for plan sponsors who thought they had paid for 401(k) investment advice and got sued because they followed what turned out to be only a conflicted “recommendation.”
Financial advisor “value” will be more important now than ever
The DOL’s new fiduciary rule is a game-changer. It puts 401(k) plan sponsors and financial advisors in the same boat – they’re both fiduciaries that must put the interests of 401(k) participants first.
Why is that a big deal? When a 401(k) plan sponsor and a financial advisor are both fiduciaries, the value of 401(k) investments and investment-related services becomes a critical consideration for both parties. When 401(k) participants pay more, they should get more. With respect to 401(k) investments, that means more costly investments should deliver greater returns than their less costly alternatives and ancillary services should improve participant retirement outcomes.
So what’s the benchmark 401(k) fiduciaries should use to evaluate the value of investments and investment-related services? In my view, it’s Target Date Index Funds (TDIFs). TDIFs offer 401(k) participants access to professionally managed portfolios that deliver diversified market returns at a low price. They also offer 401(k) plan sponsors protection from fiduciary liability when they’re used as a plan’s default investment alternative.
A 401(k) plan can pay higher fees for a professional financial advisor, but participants should receive commensurate value in return. Otherwise, personal liability for both the plan sponsor and the financial advisor can result.
The DOL’s fiduciary rule is good news for 401(k) participants, sponsors and specialized financial advisors
While the DOL’s new fiduciary rule is primarily meant to protect retirement plan participants from conflicted investment advice, it will also help plan sponsors meet their fiduciary responsibilities by rooting out conflicts of interest that could otherwise go unnoticed and result in personal liability.
I also believe the rule is a good thing for financial advisors that specialize in retirement plans. Many 401k plans can benefit from the use of a professional financial advisor, but too many financial advisors treat 401(k) plans like a cash cow today. And why not? Prior to the DOL’s fiduciary rule, there were no consequences for fleecing a 401(k) plan with unnecessary fees. These bad apples will likely leave the 401(k) market before the fiduciary rule is effective – April 10, 2017. Their departure will mean new opportunities for specialized retirement plan advisors that can demonstrate value. Don’t know where to find such an advisor? We have a financial advisor directory full of them.
