Economy / Labor Force

How NOT to Help Retirees Get Good Advice

"401(K) 2012" via 401kcalculator.org on flickr

“401(K) 2012” via 401kcalculator.org on flickr

In February of 2015, President Obama called on the Department of Labor (DOL) to update the rules and requirements for retirement advice. The administration stated that its goal would be to end loopholes that allow some advisors to put their own profits ahead of their clients’ best interests. In response to this request, the DOL proposed a rule that aims to prevent backdoor payments and hidden fees in order to protect middle class families. The rule would require retirement advisers to follow industry standards by expanding the definition of “fiduciary” under the Employee Retirement Income Security Act to include them. Fiduciary standards are legal requirements that bind an adviser to act in their client’s best interest.

While the Obama administration has stressed its intent to help and protect retirement investors, the proposed rule has encountered much backlash for potentially doing the exact opposite. The fiduciary rule is expected to impose costs on both retirement savers as well as businesses that provide investment advice.

Experts in the brokerage-industry believe that the rule will result in greater numbers of fee-based accounts as opposed to commissions. The Securities and Exchange Commission (SEC) studied the potential impact this shift could have. The agency concluded that a one percent increase in annual fees would likely result in a drop in returns by around 18 percent over the next 20 years. Another study indicated this shift would raise average costs somewhere between 73 and 196 percent for a large number of retail investors. Besides imposing hefty costs on investors, the rule is also expected to result in fewer Individual Retirement Accounts (IRAs) qualifying for advisory accounts and fewer IRAs being opened. Specifically, it is estimated that 7 million IRAs with low balances would fail to qualify for investment advice and support. Approximately 360,000 fewer IRAs would be opened each year. It seems that these adverse effects would ironically be most detrimental to the kinds of people the rule supposedly intends to help.

As for businesses in the broker-dealer industry, compliance costs associated with this rule are projected to be very high. Last summer, Deloitte conducted a cost survey to investigate how the fiduciary rule might impact operational expenses. For large and medium sized firms, the survey estimated that start-up costs would amount to $4.7 billion with additional on-going costs of around $1.1 billion. This substantial impact would likely cause firms to change their business models in response.

Currently, the rule is with the Office of Management and Budget for a final review. As it nears finalization, lawmakers on both sides of the aisle continue to express concerns regarding consumer choice and access to retirement advice. While it is important to ensure that advisors consistently act in the best interest of their clients, it seems that this objective could be achieved by implementing a more cost effective rule than the one currently under consideration. Proponents of the current proposal worry that overhauling the entire process would derail the progress that has been made. In reality, this would be highly preferable to the massive disruption that is expected to result from the finalization of this rule. At least now calculations and research have been undertaken to understand these costs and impacts, so devising less costly alternatives should be easier to do with an initial proposal to compare to. If the DOL truly wants to protect middle class families and retirement savers like it says, then going back to the drawing board appears to be the best course of action.

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