New Fiduciary Duty for Retirement Advisors

The Obama Administration recently finalized a rule to impose a fiduciary duty on financial advisors that offer retirement advice. This duty requires due care, loyalty, and utmost good faith when advising a client. This new rule puts investors’ retirement interests first and not the profit interest of the advisor selling a financial product. The rule is long overdue.

This new rule begins to make financial advisory fees more transparent and easy to understand. To protect yourself, always ask how your advisor is compensated. If you don’t understand the advisor’s fee, look elsewhere. Plenty of financial advisors already have a fiduciary duty and provide full fee transparency. Use the CFP Board’s look-up tool to find Certified Financial Planner professionals in your area.

The biggest caveat of this new rule is that it applies only to retirement accounts, and not to taxable investment accounts purchased with after-tax dollars. This omission may force the SEC to add a fiduciary rule for taxable investment products. Of course, you can still protect yourself by hiring a financial advisor who already has a fiduciary duty such as a CFP® professional.

Contours of the New Fiduciary Duty Rule

Financial advisors, such as stock brokers and annuity salespersons, are able to provide advice about and sell financial products that may only be “suitable” for consumers. Current compensation practices provide incentives to advisors to place their own interests ahead of the investor’s interests. Advisors are permitted to recommend products that are more expensive to consumers, pay more to the advisors, and provide lower returns to the investor.

The recent rule changes this regulatory scheme for retirement investors only.

A fiduciary duty requires that the advisor put the client’s interest before their own interest (usually meant to be profits). In legal terms this new duty requires the duty of due care, the duty of loyalty, and the duty of utmost good faith. An advisor with a fiduciary duty acts as the “purchaser’s representative” on behalf of the client. The duty requires the person to have loyalty to the client because of the potential for abuse. The advisor does not represent the financial product provider.

A common example of how this proposed rule will work is when a consumer rolls over his or her 401(k) plan assets into an Individual Retirement Account. Whether to roll over and how to invest the rolled over proceeds is one of the most important financial decisions for retirees. Clients deserve a financial advisor who is on their side 100 percent.

Advisors that are Certified Financial Planner™ professionals already have a fiduciary duty to their clients. This proposal is not a change for them. You can verify a CFP®’s credentials here. Registered investment advisers (“RIAs”) also have a fiduciary duty. You can check their credentials here.

Securities brokers, sellers of annuity products, insurance agents do not have this duty if they aren’t CFPs® or RIAs. The rule will affect them the most.

The rule will be fully phased in by January 1, 2018 to allow industry to conform their compensation practices. My expectation is that over the next year firms will figure out when/whether they are providing fiduciary investment advice to Retirement Investors (i.e., when the fiduciary rule applies), and to make adjustments to their compensation practices to ensure they are meeting the fiduciary requirements.

One Big Exemption

The rule has a big exemption that allows the continued use of sales-based compensation for retirement investment advice. Oddly it is called the Best Interest Contract Exemption (although it’s really not in the investor’s best interest). In short the exemption allows a financial advisor to use sales-based compensation if they provide a lot of consumer disclosures and pledge to do the right thing by their investors.

Examples of when you would likely receive BICE disclosures under the new regime include:

  • Shifting from a 401(k) or IRA account with a lower fee into a new IRA with a higher fee (e.g., where the advisor already manages a low-cost 401(k) plan and recommends a rollover to an IRA with higher costs);
  • Rolling over to an IRA that would allow the advisor to earn a fee that he/she wasn’t previously earning (because the advisor had no relationship to the prior 401(k) but will now get paid for advising on the IRA); and
  • Switching a client from a commission-based account to a fee-based wrap account (for which the advisor will now earn ongoing fee revenue that wasn’t previously being earned).

My advice is simple:  hunt for a new advisor who isn’t offering these types of hidden charges if you receive a BICE disclosure!

Upshot from the Rule

I believe more advisors will begin to charge a flat fee (e.g., $XX/year) to manage portfolios. I prefer this fee method because it is easy to understand and doesn’t have the inherent conflict as a fee based on assets under management – say 1% of your investment balance. Fees based on assets under management just encourage the advisor to consolidate all your holdings, which may not be in your best interest.

In sum, make sure your advisor, even for your taxable accounts, has a fiduciary duty and that you understand how they are compensated.


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