Among the most critical social issues facing Americans today is the prudent management of retirement wealth. Most people would agree that more needs to be done to encourage workers to save more and become better versed in investing for retirement. They also need access to sound investment options and professionals who follow the highest standards defined by law.
Against this backdrop, a 40-page document of new regulations from the Department of Labor was released in February. It set out to ease the challenges of offering investment advice to retirement plan participants and to lessen any conflicts of interest. We think these rules could have a negative impact on advisors and may raise more questions than they answer.
The easiest way to grasp the new regs is to understand what they mean to you. Here are some scenarios.
If you are contemplating serving as a fiduciary advisor to plan participants, you'll feel a significant impact. We suggest you do a cost/benefit analysis. Unless you are giving advice on a large scale, or to those with hefty account balances, the costs associated with providing advice will outweigh any monetary gain. There are auditing and special record-keeping requirements. And you will be expected to perform a comprehensive investment process that takes into account each participant's age, life expectancy, risk tolerance and retirement goals and objectives. In turn, we think the average participant will be willing to pay only about $100 a year for this advice.
If you are offering advice through a certified computer model, ditto. Unless you're one of the few firms already giving computer-based investment advice, it probably is not worth the effort and expense. A significant change from the original 2006 Pension Protection Act (PPA), is that the fiduciary advisor/investment advisor using the computerized model is still considered a fiduciary and is limited to a level fee compensation arrangement. Under the original act, a broker or salesperson could use the computer model and not be held to a fiduciary standard.
If you are advising clients with IRAs, you'll also notice a significant impact. You may think that the new regs deal only with 401(k) plans. Not so. The logic is pretty straightforward: A retirement asset is a retirement asset. Whether the asset is invested through a 401(k) plan or an IRA, it still warrants equal fiduciary care. The new rule will affect brokers not dually registered the most. If an investment advisory agreement's scope includes the client's IRA assets, the broker will likely need to be a registered RIA. (RIAs are already subject to a fixed fiduciary standard.) The 2006 PPA included a provision that charged the Secretary of Labor to consider how advice regulations affect IRA assets management.
If you believe in the merits of both passive and active investment management styles, you may notice a real change. Since 1974, ERISA has been the hallmark of prudent, principles-based fiduciary standards. Unfortunately, the new regs are a step backward.
For example, if you decide to use a computer model, it has to be designed to avoid making investment recommendations that inappropriately distinguish an investment option on the basis of factors that "cannot confidently be expected to persist in the future." The DOL cited that differences in fees and expenses are likely to persist and, therefore, constitute appropriate criteria.
However, in contrast, the historical performance of an investment option is less likely to continue and, therefore, is less likely to constitute appropriate criteria for asset allocation. Some early commentators have said that index funds will be the only acceptable investment option.
If you are serving as an investment advisor to a 401(k) plan, there will be little impact. Stay the course. Traditional sound, procedural prudence is still probably the best way to insulate plan sponsors from investment-related liability. All existing regulations remain in effect. The new regulations should have a minimal impact on current investment practices at the plan level, but you'll see more changes at the participant level.
There are other provisions to the new regulations, but the five outlined here represent the most significant items. This is a good example of less is more. If the DOL had simply said that any person who gives advice on retirement assets will be held to a fiduciary standard, it could have accomplished more than it actually did.
What led to the latest regulations
In the late 1980s to early 1990s, most 401(k) plans began offering participant-directed plans, making individuals responsible for managing their own retirement assets.
The industry quickly discovered, however, that the vast majority of 401(k) participants lacked the time, inclination or knowledge to manage their own investment decisions. Since ERISA requires that a plan be managed in a way that helps its participants, it became obvious that they needed better guidance in handling their investments.
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