Planning for retirement can be a daunting task—regardless of your occupation or where you are in your career. In order to ensure a secure financial future, it is common to seek professional advice to advise you on retirement plans and investments. Considering the impact that a retirement plan has on your life, one would hope that the professional giving advice is putting your best interests first. However, until a recent change in law from the Department of Labor, this has not always been the case.
A fiduciary duty is a legal duty to put the interests of a person or party above all else; violating this duty leads to legal repercussions. Somebody who has a fiduciary duty is called a fiduciary. In 1974, the Employee Retirement Income Security Act (ERISA) was passed to help create standards and practices for retirement and health plans. The original act applied a broad rule, assigning fiduciary duty to those rendering investment advice regarding a retirement plan for compensation. However, one year after ERISA was passed, the act was amended so that the application of fiduciary duty to retirement advisors was substantially limited.
The new rule applied a five-part test before a retirement advisor owed a fiduciary duty to the person they are advising. Under the 1975 rule, employers still owed a fiduciary duty to employees taking advantage of retirement plans offered by that employer. However, many private retirement advisors didn’t carry such a duty. Instead, advisors were only required to make recommendations that they themselves reasonably believe were suitable for clients.
How Good is “Suitable” Advice?
So just how much damage can entrusting your retirement to an advisor who is held to less than a fiduciary standard do? While there are certainly advisors who will provide non-conflicting advice regardless of the standard they are held to, the damage caused by conflicted advisors is substantial. The Obama administration recently issued a study estimating that conflicts of interest cost retirement plans about $17 billion a year. The Department of Labor estimates that conflicted investment advice “could cost IRA investors between $95 billion and $189 billion over the next 10 years and between $202 billion and $404 billion over the next 20 years.”
These conflicts generally occur where financial advisors, not subject to a fiduciary standard and not required to act exclusively in your best interest, suggest investment opportunities that provide them better commissions instead of providing you better returns. It is very common for companies to offer percentage commissions or rewards to advisors on certain investments or types of investments. For example, the company Table Bay offered “a Maserati to advisers who sell at least $7.5 million in annuities in 2014 and a BMW, Range Rover, or Porsche to those with at least $6 million in sales.” These sort of deals can lead a retirement advisor to recommend investments with the best commissions as opposed to investments that are best for your retirement portfolio—leading to the costs described above.
The Department of Labor Has Changed Who Owes You a Fiduciary Duty
With the landscape of retirement planning changing, and the potential for so much damage to investors before them, the Department of Labor has taken action to change the 1975 test. They first introduced a proposal to update the rule for who owes a fiduciary duty in 2010. Since then, they have introduced an updated proposal in 2015 and released a final rule which will take effect in June 7, 2016 and will be applicable to financial advisors beginning on April 10, 2017.
The new rule substantially expands who has a fiduciary duty in regards to your retirement account. In addition to explicitly including advice regarding private plans like IRAs, the Department of Labor has done away with the 1975 five-part test entirely—replacing it with a broader standard.
The new rule assigns fiduciary duty to advisors providing recommendations regarding the investment of retirement plan or IRA assets, including recommendations regarding the investment of assets that are being rolled over or otherwise distributed from plans to IRAs. It also requires that advisors making recommendations regarding investment management of plan or IRA assets hold a fiduciary duty to their client.
These new changes substantially expand the situations where a retirement advisor will be treated as a fiduciary. However, not every advisor will be a fiduciary. The new rule has a specific definition for what constitutes a “recommendation” and what constitutes “financial advice.”
While critics argue that holding advisors to a higher standard may push some advisors out of the market—or lead them to stop offering services to moderate income individuals—it seems unlikely that the changes will lead financial advisors to abandon such a huge market. The increased protection to retirement investors far outweighs the loss of advisors who don’t feel they can sustain a business while maintaining a fiduciary relationship. If advisors feel they need to offer recommendations that are not in your best interest, is that really advice or is it a sales pitch?
Authored by Jonathan Lurie, LegalMatch Legal Writer and Attorney at Law