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Practice Management > Compensation and Fees

3 reasons to avoid an IRA rollover

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The Department of Labor recently announced it will extend the comment period on its fiduciary rule proposal by 15 days, and it’s not clear when a final rule will be issued. In the meantime, advisors should consider the value they bring their clients.

“We’ve been watching [the DOL’s fiduciary rule proposal] very closely and it’s our view that advisors ought to start at least thinking about this proposed regulation now, even though it has yet to play out,” Matt Sommer, vice president and director of retirement strategy for Janus Capital, told ThinkAdvisor on Tuesday.

Sommer said that the industry has been “hyperfocused on the issue of advice in IRAs and variable compensation and the need to get a best interest contract exemption” but that “soliciting a rollover from a plan into an IRA” hasn’t been given enough attention. “That in and of itself according to the proposed regulation is a fiduciary act,” he said. “Regardless of how this all plays out, even for fee-only advisors and fee-only product providers, the act of telling someone they ought to consider moving their money out of an employer plan into an IRA is part of this potential rule change.”

Sommer noted that now is a good time for advisors to “not only retool and refine their value proposition, but also brush up a little bit on some of the more technical aspects of rollovers [and] when it may be in a participant’s best interest to simply stay put.”

Here are three such cases:

1. Participants who are 55 or older when they leave their jobs can waive the 10 percent penalty on early distributions. “Clearly a plan participant who qualifies for the 10 percent penalty exception and who needs liquidity really ought to leave at least a portion of their money behind in the qualified plan,” Sommer said.

2. Participants who own company stock in their 401(k) may also consider leaving money in the plan if the cost basis is low to take advantage of net unrealized appreciation. “The stock is distributed from the plan. The participant recognizes ordinary income based on the cost basis, and when they sell the stock, all the appreciation above the cost basis is a long-term capital gain,” Sommer explained.

He added, “The fact that they can turn all that appreciation into a more favorable capital gain, versus rolling the stock into an IRA and taking the distribution and paying ordinary income tax, may be another reason to forgo the IRA.”

3. Participants in a large or mega retirement plan may also be getting a much better deal on fees than they could get in an IRA. “The plan has economies of scale, and I’m sure their employer has done a good job negotiating with their 401(k) service provider,” Sommer said. “If that person rolls out of that plan to an IRA, it’s going to be very difficult for that IRA to be able to match those fees.”

That’s not necessarily a bad thing, he said. However, “if the IRA is a little more expensive, […] what is it exactly that the participant is receiving for those higher fees they’re going to incur?”

That’s why it’s important for advisors to think about what they provide their clients beyond investment and asset management, Sommer said. “It’s not about the rollover per se, but it’s about the entire holistic retirement picture.”

Sommer said that regardless of how the proposal plays out, “it’s likely that many of the broker-dealers could respond [differently], so advisors need to check in with their home office and their local compliance professional to make sure they follow their firm’s specific rules.”

As the proposal is written now, the best interest contract exemption would allow advisors to continue to receive variable compensation while providing advice to IRA clients by signing a contract with the client and the broker-dealer.

There are significant disclosures in the contract about fees and compensation, Sommer said, but “what this contract essentially says is that the advisor will act in the best interest of the client. […] There’s also going to be a requirement that any conflicts of interest are disclosed, and from the broker-dealer perspective, what they need to do is be able to institute a process that mitigates conflicts and provides necessary information and training to their advisors.”

Fee-only advisors and RIAs already have “levelized compensation,” Sommer said, “so they would not need to use a best interest contract for their IRA and IRA rollover clients.”

He added, though, that “even a fee-only RIA who is soliciting a rollover from a qualified plan to an IRA, we’re of the opinion that he or she would still need to use a best interest contract for the solicitation of the rollover because that’s one fiduciary act. Then of course once the money’s rolled over and the advice is dispensed, there’s a separate fiduciary act. There’s perhaps no need for a contract because the fee-only levelized, but we’re of the opinion that he or she would still need to use it when soliciting rollovers out of company-sponsored plans.”



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