It’s hard to imagine how the state of retirement finance could get any worse, but the Department of Labor seems ready prove that it’s possible.
This federal department, which regulates employee benefit plans, is preparing to introduce rules that would create a “fiduciary standard” for retirement accounts like an individual retirement account, or IRA.
What’s not to like about this idea that the brokers will be required to act exclusively in our interest? That’s what fiduciary means, so proponents hope new rules will help protect what money folks have managed to put aside from being ripped off by brokers.
What’s not to like is that small savers, and by that I mean those with less than maybe $100,000, are likely to just get booted by their brokerage firms. They will be left to save and invest totally on their own — and good luck to them.
Any change in the IRA market is a big deal, as the total saved in IRAs is approaching a third of U.S. retirement assets and has been growing, as people “roll over” funds that have been collecting in 401(k) type retirement savings plans.
At the risk of oversimplifying a complex concept, bringing IRAs under a Labor Department fiduciary standard basically means that the person delivering the financial advice has to sell investments that are clearly in the best interest of the client, sort of like how a trustee has to act when overseeing money held for kids. Investments with a conflict of interest, such as shared fees with a broker, would be out.
A fiduciary standard is not a new idea, and lots of the financial services industry operates under one right now. The Securities and Exchange Commission also has long had the authority to issue a fiduciary standard rule, but only now seems stirred into action.
There is no shortage of regulations to apply to the brokerage industry already, of course, but the standard for a common brokerage account such as an IRA is “suitability.” That means the adviser can only sell investments that are suitable given a client’s age, income and other characteristics.
The idea behind this policy is that the suitability test is easily met by offering two bond mutual funds to a worker nearing retirement, even though one fund has twice the fees and commissions. And would the broker recommend that more expensive fund to his mom?
Charging too much for mediocre (or worse) investment advice is not an easily defended practice. There’s a pretty thick file here of news accounts describing big fees and disastrous investments.
Bloomberg published a particularly devastating article last year under the headline “Retirees Suffer as 401(k) Rollover Boom Enriches Brokers,” describing in one example how a 51-year-old took his retirement savings to a broker and got sold Puerto Rican municipal bonds.
That’s a genuinely terrible IRA investment idea, given that Puerto Rico proved to be one of the shakiest bond borrowers in recent memory. And, of course, Bloomberg pointed out that having interest exempt from income taxes doesn’t seem to be of much help in a client’s tax-deferred IRA account.
No investment company executive could easily defend selling those bonds into an IRA account, but it’s far from clear that the Labor Department’s idea of a fiduciary standard would have made any difference.
Executives of local financial firms were not eager to talk about the issue, as the rules haven’t yet been published. They are not generally opposed to a fiduciary standard, just the one the DOL seems to favor.
If adopted, then what they say will happen seems almost certain to happen. And that’s that the $50,000 traditional IRA brokerage account will become a thing of the past. It’s already hard to take a 401(k) rollover check that size and then try to open an IRA account at RBC Wealth Management or Merrill Lynch. It may seem like a lot of money, but these firms don’t really want it, as the fees won’t be enough to pay the firm for the risks of oversight.
A fiduciary standard rule just raises that risk.
For the IRA business already at these firms, the clients with the biggest accounts will likely see their IRAs converted to “managed” accounts and get charged an advisory fee, and that’s on top of other fees.
For a smaller IRA account, particularly if it’s the clients’ only account at the firm, they are likely to be “demarketed,” a curious term that came up in conversation with a Minneapolis financial services executive who was actually talking about telling IRA clients to hit the road.
They won’t be getting overcharged, true, but they won’t be talking to the good brokers, either. Where are they to go?
Perhaps the dedicated do-it-yourselfers will do just fine picking their own funds, and at low cost. Others trying the same approach unfortunately will buy the next Puerto Rican bond fund.
Perhaps others will just throw up their hands and buy bank certificates of deposit, with yields so low that outliving their savings becomes their biggest risk.
That’s the problem that dwarfs the issue of getting charged too much by brokers. The policymakers of 2015 have no interest in making retirement savings anything other than an on-your-own adventure. And they believe that if we just regulate financial firms enough, all American workers can generate enough investment income to have a decent retirement.
It would be far better to admit that that’s an unrealistic expectation and go to work on creating a retirement finance system that would reduce some of the risk of outliving one’s money.
An ideal system would create a reasonable amount of retirement income that a person could actually count on, without becoming an expert on the financial markets. It would require the money to be set aside and invested in assets managed by the best in the business, and all of it at low cost.
There was such a retirement finance system in this country, of course. It was called a pension system, and enough of it’s still around in 2015 to know that it mostly worked just fine.