Advisors take note: ERISA concepts are coming to IRAs under the Department of Labor’s new fiduciary rule, and you need to change your practices accordingly before the April compliance date kicks in.
It is a prohibited transaction under the Employee Retirement Income Security Act for a tax-qualified, ERISA-governed retirement plan to pay more than reasonable compensation to the plan’s service providers. That includes investment advisors and financial advisors, regardless of whether they are fiduciaries or simply service providers.
In addition, under the Internal Revenue Code, it is a prohibited transaction for a service provider, including advisors, to receive more than reasonable compensation. However, while the rule is well known in the retirement plan area, there has been little, if any, focus on the reasonableness of compensation for IRAs.
The DOL’s new fiduciary rule and the Best Interest Contract Exemption will soon change that (see ThinkAdvisor’s DOL Fiduciary Compliance resource page).
Beginning on April 10, the expanded definition of fiduciary advice will cause almost every advisor to retirement plans and IRAs to be a fiduciary.
When the advisor is a “pure” level fee fiduciary to an IRA, the advisor will be regulated by only the prohibition against unreasonable compensation in the Internal Revenue Code, which is enforceable only by the IRS. (Having said that, an emerging trend that I’ve noticed is the Securities and Exchange Commission recently raising issues about advisors’ prohibited transactions in plans and IRAs.)
My reference to “pure” level fee advisor is to a situation where the advisor, his supervisory entity (e.g., a broker-dealer or RIA), and all affiliates and related parties receive no more than a stated level fee. For example, an advisor might charge 1% per year for advising an IRA, which would be a level fee.
However, there cannot be any other compensation for the aggregated related entities. That means there can’t be any proprietary products, 12b-1 fees, commissions, revenue sharing, other payments, or gifts or awards. (“Compensation” includes money and items of monetary value.)
Where the advisor is not a pure level fee fiduciary, the advisor and his supervisory financial institution (e.g., broker-dealer or RIA) will need the relief provided by a prohibited transaction exemption, for example, BICE. In that case, the financial institution will need to contractually agree with the IRA owner (called the “Retirement Investor”) to receive no more than reasonable compensation relative to the services rendered.
In my experience, many RIA firms and broker-dealers have not benchmarked the compensation paid from IRAs to determine whether it is reasonable relative to the services provided. I expect that will change on or before April 10.