By Anne Tergesen
A rush of savings from company 401(k) plans to IRAs may slow just as baby boomers are retiring, as a result of the Labor Department’s anticipated move to toughen standards for advice on retirement accounts.
The proposed regulation, which may be finalized by early April, extends a revamped version of the “fiduciary” standard that governs corporate retirement plans to individual retirement accounts.
Under the rule as last proposed, advisers will generally have to avoid conflicts of interest and put their clients’ best interests first—both when recommending investments for IRAs and when suggesting moving money from a company plan to an IRA in the first place, which is known as a rollover.
The new rule will make it harder for advisers to recommend such a move, as they will have to clearly document why it is in a client’s best interest. Additionally, once the money is in an IRA, advisers would generally have to avoid payments, including commissions, that create incentives for them to select one product over another.
Advisers to individuals typically have an incentive to recommend rollovers, since they stand to earn fees or commissions on the dollars shifted to IRAs.
At stake is a large pot of money that is expected to grow as the baby boomers continue to leave the workforce. IRAs hold an estimated $7.3 trillion of the nation’s $24 trillion in retirement assets, more than the $6.7 trillion in 401(k)-type plans.
Fueled by the rise of the 401(k) and an increasingly mobile workforce, rollovers are expected to amount to $439 billion this year, up from $271 billion in 2010, according to Cerulli Associates, a research firm that specializes in the asset-management industry.
Because rollovers now account for more than 90% of the money flowing into IRAs each year and carry relatively high median balances—$100,000 for traditional IRAs with rollover money, versus $40,000 for those funded solely by annual contributions, according to the Investment Company Institute trade group—they are “all the more important to financial-services companies and advisers seeking to grow their businesses,” says Michael Wong, an analyst who covers brokerage firms at Morningstar Inc.
The expected Labor Department rule for retirement savings would be a change from current regulation, which allows brokers to provide “suitable” rather than fiduciary advice, a lower standard.
Critics argue current requirements permit advisers to encourage investors to abandon 401(k) plans for IRAs that often hold higher-fee investments, even though those added fees can reduce returns. “In many cases, that’s clearly not in the best interests of investors,” says Christopher Jones, chief investment officer at Financial Engines Inc., a Sunnyvale, Calif., company that mainly manages 401(k) accounts for participants who want investment help. The firm also offers an IRA service.
The White House Council of Economic Advisers estimates that individual investors sacrifice about 1 percentage point of annual returns due to advice from conflicted advisers that leads them into higher-cost investments—or about $17 billion a year.
Participants in 401(k) plans who invest in stock mutual funds pay annual expense ratios of 0.54%, on average, versus 0.71% for IRA owners, according to the mutual-fund industry’s Investment Company Institute.
Experts say more advisers may think twice under the coming rule before recommending transfers that result in higher fees. As a result, more money may stay in employer-sponsored plans, especially large plans that leverage their size to negotiate low institutional rates.
“We’ll definitely see fewer rollovers,” says Jason Roberts, a pension-law attorney and chief executive of Pension Resource Institute, a compliance consulting firm. Because advisers will have to research clients’ needs better and document why recommendations are in their interests, “you may see recommendations that are being made today not being made in the future,” he says.
That would be welcome news to Robin Diamonte, chief investment officer at United Technologies Corp., who oversees $44 billion in retirement money for the conglomerate’s employees.
“We have various record keepers and advisers aggressively calling our retirees and trying to persuade them to roll over to their platforms, in many cases with conflicted and misleading marketing material,” says Ms. Diamonte. “This rule is going to have a chilling effect on these high-fee, aggressive rollover chasers.”
A slowdown in rollovers could benefit participants in the United Technologies 401(k) plan, which is among a growing number urging former employees to remain in the 401(k) after changing jobs or retiring. One goal is to stem the withdrawals that undermine a plan’s leverage to negotiate lower fees.
By contrast, at smaller companies, workplace retirement plans often have high expenses, which can make IRA rollovers a cost-saving maneuver for participants. Beyond cost considerations, retirement savers can find rollovers attractive to consolidate assets in a single account or to get more personalized advice or additional investment options.
Under the fiduciary-duty rule as last proposed, advisers typically wouldn’t be able to suggest a rollover without first asking the investor to sign a contract that includes detailed information about the investment fees and the adviser’s compensation and obligations to act in the investor’s best interests, says Fred Reish, a lawyer who specializes in employee benefits and compensation. That is a requirement that many in the financial-services industry have called unworkable and burdensome.
An upfront request to sign such a contract won’t likely discourage investors from rolling 401(k) money to IRAs with advisers they already work with, said Bing Waldert, managing director at Cerulli, but it could affect transactions that involve new advisers.
It is likely that some firms and individual advisers will respond to the Labor Department rule by emphasizing low-cost investment options for IRAs. Rob Foregger, co-founder of digital-advice software company NextCapital, says “there will be increased scrutiny on the cost differential between rollover IRAs and 401(k)s, which will put increasing downward pricing pressure on IRA fees.”
Some advisers may stop soliciting rollovers from certain 401(k) participants altogether. Many brokerages opposed to the Labor Department rule say it will no longer be profitable for them to accept rollovers of relatively small accounts, such as those of $50,000 or less. That said, some brokerages have recently announced plans to offer fee-based accounts for minimums as low as $5,000 or $10,000.