Someday you might not have to wonder whether a retirement adviser is thinking about your best interests or a bigger commission.
That is, if a new proposal President Obama just outlined in a speech to AARP (appropriately during America Saves Week) comes to pass.
The U.S. Department of Labor proposal would require advisers to adhere to what’s known as a “fiduciary standard,” putting their customers’ interests ahead of any other considerations, such as their own compensation.
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Two Standards for Advisers
It might come as a surprise that financial advisers aren’t already held to such a standard.
But many are actually governed by the looser standard of “suitability.” That means, if they believe a certain type of investment is suitable for the client, they’re free to recommend the particular financial product that will be most rewarding to them, even if it performs worse and costs the client more than an alternative. The administration says this means the advisers can pocket “hidden fees.”
By law, registered investment advisers must meet a fiduciary standard and certified financial planners are held to a fiduciary standard by their organization if they offer planning services. But brokers and many others who provide retirement advice are not, although they may do so of their own accord.
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What 'Conflicted Fees' Can Cost You
What difference does it make? A big one.
According to figures cited by the president, “conflicted investment advice” costs retirement savers an average of 1 percentage point a year (trimming, say, a 6 percent return to a 5 percent one) and reduces their savings by more than 25 percent over a 35-year period. Put another way, a $10,000 retirement account that would have otherwise grown to more than $38,000 would instead be worth just over $27,500.
The numbers are truly eye-popping, however, when you look at 401(k) rollovers.
According to the administration’s report, a retiree who receives conflicted advice when rolling over a 401(k) balance to an IRA at retirement will lose an estimated 12 percent of the value of his savings if they're drawn down over 30 years. As a result, his money could run out more than five years earlier.
A 45-year-old woman rolling a $100,000 401(k) into an IRA who gets conflicted advice from her broker could lose an estimated $37,000 by the time she turns 65, the White House says. (Obama estimates the aggregate annual cost of conflicted advice is about $17 billion a year.)
Even more than the money, Obama said, the conflict of interest “offends our basic values of honesty and fair play.”
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What the Obama Proposal Would Do
According to a fact sheet released by the White House, the proposed new rules would:
- Require retirement advisers to put their clients’ interests first In particular, they would update how “retirement advice” is defined by the Employee Retirement Income Security Act (ERISA) to include more types of advisers. ERISA dates back to 1975, before IRAs and 401(k)s became Americans’ main retirement-saving vehicles, and was primarily meant to govern traditional employer pensions and their advisers.
- Continue to let financial firms set their own compensation practices
- Allow advisers to provide “general education on retirement” without triggering fiduciary duties
What Happens Next
As the president conceded in his remarks, the proposal has a long way to go before it can take effect (assuming it ever does). He said he expects its opponents to “fight with everything they’ve got.”
Indeed, Obama was barely off the stage of AARP — a longtime proponent of this proposal — when the Financial Services Roundtable, an industry group representing banks, insurance companies and other interested parties, weighed in, charging that the rule would “reduce access to investment advice for moderate income Americans.”
A Reuters article said the financial industry thinks a rule change would trim compensation for brokers and limit the types of investment products they could offer.
The proposal now needs to go through the regulatory system, for review, public comments and a public hearing, all of which should happen — the White House says — “in the coming months.”
When the Department of Labor came out with a similar proposal in 2010, Congressional Republicans blocked it, Wall Street fought it and the administration backed down. The Department of Labor told Bloomberg that this one will be “very different” from earlier versions, though.
Greg Daugherty is a personal finance writer specializing in retirement who has written frequently for Next Avenue. He was formerly editor-in-chief at Reader’s Digest New Choices and senior editor at Money.
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