Since the U.S.Department of Labor released its long-awaited fiduciary rule last April, advisors have been clamoring for information, trying to figure out if and how the rule will impact their business.
While questions have been coming fast and furious, some have popped up more often than others. With that in mind, here are some of the more frequently asked questions we’ve seen, along with their answers:
Question: Other than IRAs, what accounts are going to be covered under the new fiduciary rule?
Answer: Advisors to most Employee Retirement Income Security Act-covered plans have long been subject to fiduciary requirements, but even they will have some adjustments in light of the new fiduciary rule. The biggest changes, however, will be for advisors working with:
Health savings accounts.
Medical savings accounts.
Coverdell education savings accounts.
All of these accounts will now subject to fiduciary requirements.
Question: If the Republicans take over the White House in 2017, could the entire fiduciary rule could be scrapped?”
Answer: Of course. But there’s no guarantee the Republicans will win the White House. And you can be sure that if the Democrats control the White House, they will do everything in their power to ensure the fiduciary rule (plus Obamacare and other key Obama-era policies) remain in force.
Also, even if the Republicans do win the White House, there’s a reasonable chance the fiduciary rule would remain in place for political reasons. Presumptive Nominee Donald Trump has remained mostly mum on his stance for or against the fiduciary rule.
That said, can you imagine the headlines if the rule is repealed shortly after a shift in power? “Republicans take over the White House; immediately repeal rules protecting retirement investors” isn’t the press you want to begin your term of office with — especially if you’re trying to bridge the chasm that will almost certainly divide our country after this election.
Finally, even if the Republicans gain control of the White House and the rule is repealed, there’s a good chance that “the entire” rule won’t be “scrapped.” Rather, certain key parts, especially those that give the appearance of protection (to save political face) will remain.
At the end of the day, does it really matter? The fiduciary rule is here … now! So as a retirement advisor, you have only two choices: prepare for the rule or don’t. If you choose the former and the rule is scrapped, you’ve only lost your time and, perhaps, wasted some valuable business resources. But if you choose the latter and the rule remains in place, then you may not have any business left by the time you catch up to those advisors who proactively prepped for the rule from the get-go.
Question: I heard that under the final fiduciary rule the best interest contract exemption (BICE) is between a client and a company, rather than between a client and an advisor, as stipulated under the 2015 proposed rule. Ultimately, the advisor has to be the fiduciary, so why does it matter?
Answer: This may not seem like a big deal, but the change in the exemption language was among the more significant ones since the DOL proposed the rule. For some, this change provides huge benefits; for others, it puts their business model in jeopardy.
Clear winners of this change are large companies that use call centers or teams of individuals to assist clients. Under the 2015 proposed rule, a separate contract appeared to be necessary for each person with whom a client engaged.
Thus, every time a client called an institution to speak to someone about an account, a new BICE may have been necessary. Now, because the institution will be the counterparty, a single contract with a client will cover all persons associated with the institution.
That may sound good but it is potentially crippling some. To understand why, it’s first necessary to clarify one point; The BICE is a contract between a client and a “financial institution,” not just any company. In general, financial institutions include banks, broker/dealers, insurers and registered investment advisors.
Where does that leave independent insurance-only advisors who use equity-indexed products as part of their planning? They’re generally not affiliated with any of the above companies and thus, appear to be unable to take advantage of the BICE its present form.
Even the field marketing organizations, with whom many such advisors affiliate, do not appear to be able to qualify as financial institutions. Thus, many insurance-only advisors may find themselves forced to either affiliate with a financial institution, use only fixed (not fixed-indexed) annuities with retirement investors or work only with nonretirement investors.
Question: If a client is interested in rolling over an old 401(k) to an IRA, how does an advisor justify an investment in a managed account with higher fees?
Answer: This question, or some version thereof, is one of the most common ones we’re hearing from advisors. Ironically, it’s the one question advisors themselves should be in the best position to answer.
Think about it: From a client’s perspective, isn’t this question really asking, “What’s the point of rolling my 401(k) over to you if I have to pay higher fees?” Or, what’s the value proposition of such a transaction?
If you don’t have a good answer to that question, you shouldn’t be making the recommendation! Many advisors asking this question have been recommending rollovers for years. If that’s the case, how were you justifying those actions in the past?
Truthfully, the fiduciary rule should change almost nothing in the rollover evaluation for the educated advisor and for the advisor who was — and has been all along — doing appropriate due diligence prior to recommending a rollover. That said, there will certainly be more scrutiny in situations where clients are moved from a lower-fee account to a higher-fee account than there would be if client fees in the new account were the same, or lower. But, that has (or should have) always been the case.
Unfortunately, there’s no magic bullet or single answer for advisors looking to beef up their “Why did you recommend that rollover” defense. Rather, a move to a higher-fee account — whether managed money or not — could be justified by any one or combination of the following:
A desire to consolidate funds.
Simplified required minimum distributions.
More appropriate investments.
More favorable distribution options (many plans don’t offer systematic distributions).
More favorable withholding options.
Ability to utilize IRA-only 10% penalty exceptions.
The above list is not all-inclusive, but it does highlight common reasons why a 401(k)-to-IRA rollover could be justified, even in light of higher fees. Of course, higher fees may not be the only downside of a rollover; other disadvantages would have to be factored in.
Again, this should not be anything new for advisors. But in a post-fiduciary rule world, it will be even more important for advisors to follow a process and to document their justifications and disclosures to clients.
Question: Are 403(b) plans covered by the new fiduciary rule?
Answer: Maybe. Certain 403(b) plans are covered under Employee Retirement Income Security Act and advisors working with such plans will be impacted by the new rule. Other 403(b) plans, such as those sponsored by state and local governments, are not covered under ERISA. Therefore, advisors working with such plans will not be impacted by the new Fiduciary Rule.
Question: I’ve seen a lot written about something called 84-24. Can you explain what that is?
Answer: 84-24 is an old prohibited transaction exemption the Labor Department granted more than three decades ago. The prohibited transaction exemption helped to facilitate sales annuities to retirement savers.
You’re not seeing so much written about it now because, as part of the introduction of the final fiduciary rule, prohibited transaction exemption 84-24 was amended. The amendment removed variable annuities (a forgone conclusion) and equity-indexed annuities (a hotly debated issue) from the prohibited transaction exemption.
Result: To use those investments with a retirement investor (as defined under the new rules) advisors will have to use the new best interest contract exemption. In contrast, advisors using fixed annuity contracts can continue to use prohibited transaction exemption 84-24 and will not have to enter into a best interest contract.
Question: I know the fiduciary rule is primarily concerned with advisors recommending rollovers from plans to IRAs, but what if I recommend a rollover from an IRA to a plan? Will this be subject to the new rule?
Answer: Yes. While there’s little doubt the Labor Department rule was created to address the flow of retirement funds from Employee Retirement Income Security Act -covered plans (subject to fiduciary oversight) to IRAs (which were not subject to the same oversight) the final rule is agnostic as to which direction retirement savings flows.
If you’re moving money from one account subject to fiduciary oversight to another account subject to fiduciary oversight, the scrutiny to which you’ll be subject will be roughly the same. Thus, most 401(k)-to-401(k), 401(k)-to-IRA, IRA-to-IRA, and IRA to 401(k) rollovers will be subject to the same rules.
Question: Are specific investments endorsed or prohibited by the fiduciary rule?
Answer: Unlike the proposed rule, the final rule eliminates assets covered by the best interest contract exemption. The final rule also doesn’t restrict access to a single or class of investments. Thus, the final rule neither endorses nor prohibits specific investments. But it places a heavy emphasis on evaluating an investment’s fees and other costs.
Thus, while investments with higher fees and/or costs are not prohibited by the fiduciary rule, advisors recommending such strategies/investments are likely to find themselves subject to greater scrutiny than advisors offering lower cost options.
Question: Will the Labor Department be able to enforce its new rule?
Answer: Yes. While the Labor Department will have to develop many enforcement procedures, there are several obvious paths. For example, if a financial institution is not appropriately ensuring that employees/representatives are adhering to applicable standards, the Labor Department could revoke the institution’s ability to use the best interest contract exemption, all but crippling the institution’s ability to work with retirement Investors.
Question: I am a fee-only registered investment advisor and offer single premium immediate annuities to certain clients. Am I eligible for the level-fee fiduciary streamlined exception?
Answer: Good question. Experts are divided on this issue. Our opinion is that you would NOT be eligible for the exception. The level-fee fiduciary streamlined process is for fiduciaries that “receive only a level fee…” (emphasis added). Clearly, a commission received for using a single premium immediate annuity with a client would constitute variable compensation, negating one’s ability to the exception. A full best interest contract would be needed.
Question: Is it best to move clients from commissionable accounts to fee-based accounts?
Answer: You have to look at this on a case-by-case basis. In some instances, moving a client into a fee-based account will be a good fit and will benefit both your client and your practice.
If, however, the benefit is skewed towards your practice, and the client would be better off remaining in a commissionable account, then transitioning to a managed account would likely be considered a nonexempt prohibited transaction.
As a result, if you’re going to suggest a client make such a move, you should be 100 percent confident that such a change will be in your client’s best interest. You should also document the basis for that belief to protect yourself.
Question: Will the fiduciary rule be applied retroactively and impact commissions I’m receiving for investments I’ve already sold?
Answer: Under the final fiduciary rule, ongoing compensation received for existing investments as of the rule’s effective date will be grandfathered into the old rules. However, if advice is made to clients regarding these investments after the effective date, including recommendations to buy, sell or hold, such advice would be subject to fiduciary requirements.
You will also need to provide a negative consent letter to such clients, letting them know that unless they opt out, they will be transitioned, so to speak, to the best interest contract exemption.
Question: I’ve heard that the fiduciary rule mandates that advisors receive reasonable compensation. Can you please define reasonable?
Answer: For starters, the fiduciary rule doesn’t mandate that advisors receive reasonable compensation. It requires that they receive no more than reasonable compensation. There’s a big difference!
Now the tougher part of your question: What is reasonable? Unfortunately, “reasonable” is one of the most important terms in the fiduciary rule and the best interest contract exemption. And yet it is also one of the more nebulous terms.
There is no precise definition of reasonable; ultimately, this may lead to trouble for advisors and investment providers. That said, in many cases, “reasonable compensation” will be “reasonably” ascertainable. You might liken it to U.S. Supreme Court Justice Potter Stewart’s famous quote in Jabobellis v. Ohio: “I know it when I see it.”
If you walk into an arbitration proceeding and you’re charging a client two times what the average advisor charges and you’re providing half the level of service… well, you know where that’s going to go.
So if you’re concerned about ensuring you’re fees/costs are reasonable, make certain you’re continuously benchmarking your costs and services against those of your peers. If you’re charging more for more service or less for less service, you’ll probably be okay If you’re charging less for more service, you should have very little to worry about. If, however, you’re charging more for less service, then you better revisit your business model — and fast!
Question: The BIC exemption and the fiduciary rule talk about recommendations made to a “retirement investor.” Who, or what, is a retirement investor?
Answer: This seems like an easy question, but it’s not. A retirement investor is not just an individual; it can also be an entity. Individual retirement investors are pretty easy to determine. They include any Employee Retirement Income Security Act plan participant or beneficiary and any IRA owner or beneficiary.
A retirement investor also includes “retail” fiduciaries of ERISA plans or IRAs, including small plan sponsors. Retail fiduciaries are generally persons who hold or manage less than $50 million in assets, and are not banks, insurance carriers, registered investment advisers or broker dealers.
Question: We hear a lot in the new Labor Department fiduciary rule about doing what is in the best interest of a client or a retirement investor. What is the Labor Department’s definition of “best interest?”
Answer: What is best interest? Is there really only one possible solution to each client’s problem? Is there only one possible investment choice that is right for each client? Is it possible that two true fiduciary advisors can disagree as to what is best for a client?
The Labor Department’s definition of “best interest” really means acting in a prudent manner. Prudent advice is “advice that is based on the investment objectives, risk tolerance, financial circumstances, and needs of the retirement investor, without regard to the financial or other interests of the adviser, financial institution or their affiliates, related entities, or other parties.”
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