The New Fiduciary Rule: Unintended Consequences

This year represents a watershed moment in terms of retirement planning, as the first of 79 million Baby Boomers inaugurate a nearly 20-year long Retirement Boom throughout America. The number of retired Americans over age 65 is projected to swell to 72 million by 2030, nearly an 80 percent increase from today. As the primary governmental safety net gets smaller — many groups now concede Social Security benefits must be trimmed in the future — most Americans face a personal savings crisis that threatens their financial future.

According to research from the Employee Benefits Research Institute, half of all American workers do not have confidence that they will have enough savings to live comfortably in retirement. Equally alarming, 45 percent of Americans age 36-62 are at risk for having inadequate retirement savings.

The future of IRAs

Because of this, many experts are concerned about the U.S. Department of Labor’s efforts to modify a 35-year-old rule governing Individual Retirement Accounts, which may produce unintended consequences that would make it harder, not easier, for individuals to set aside money for their Golden Years.

The proposed new rule extends strict ERISA fiduciary requirements to persons and entities that only occasionally offer advice incidental to IRA investments, and who are acknowledged not to be the account’s decision-maker. (Under the present rule, only persons who are primary advisors are fiduciaries.)

I believe that the DOL is well-intentioned and they are seeking to fulfill their mission to protect working Americans. However, if enacted, this subtle change threatens to make IRAs unaffordable for most Americans and is likely to deter major financial services firms from opening or maintaining IRAs.

A brief history

It is clear that IRAs work. Since their introduction in 1974, they have grown to represent $4.7 trillion in savings with almost 50 million households participating. As the number of employer-sponsored pension and 401(k) plans has shrunk, the percentage of retirement assets in IRAs has grown. In fact, it has increased 265 percent since 1995.

Research from the Insured Retirement Institute shows that more than six out of 10 Boomers plan to rely on IRAs as a source of income in retirement. It’s not hard to see why. Not only are IRAs affordable (most can be maintained for an annual custodial fee of roughly $20), they are also flexible. An IRA can hold almost any asset from mutual funds to real estate, it is not tied to an employer and virtually every financial institution — bank, insurance company, broker-dealer and investment advisor — can help a family start one.

The realities of regulation

Ostensibly, the DOL wants to expand the ranks of fiduciaries to ensure that financial institutions avoid any potential conflicts of interest that might influence investment recommendations. Admittedly, this sounds appealing. A fiduciary standard is the highest and best the law allows, similar to what is imposed on trustees and guardians. The trouble is that fiduciary status triggers a little-known IRS regulation, making it nearly impossible for broker-dealers to handle IRAs held by average investors. These firms cannot satisfy the labyrinth of rules unleashed by fiduciary status except by (1) curtailing investment advice or (2) forcing IRAs into “advisory accounts” overseen by a registered investment advisor.

Either path is a potential problem. The “no advice” approach puts individuals at risk for poor financial decisions, or more likely, for not having an IRA at all. Advisor accounts are beyond the reach of most middle-income households due to high minimum asset thresholds. A recent study conducted by Oliver Wyman, concluded that the cost of owning an IRA will increase between 75-195 percent annually if investors are forced into advisor accounts. And considering that more than one-third of IRAs are owned by families making less than $75,000, such a surge in costs would make IRAs virtually inaccessible to working class Americans.

All this leads to less retirement savings at a time when more is needed. The Wyman study demonstrates that, over the next 20 years, the DOL rule is likely to diminish retirement savings by a staggering $240 billion, and roughly 18 million current IRAs will be left out in the cold, without any help managing their savings.