Can you trust your financial adviser? Many Americans aren’t so sure. Thanks to a recent announcement from the U.S. Department of Labor, however, the answer may soon be “yes.”
Today, the Department of Labor announced its final rule on conflicts of interest in retirement investment advice, also known as the fiduciary rule. Fiduciary is a five-syllable legal concept, but in practice, the intended effect of the rule is quite simple: All financial professionals selling retirement products will be legally required to act in the best interests of their clients rather than their own.
The only reason why financial professionals are not required to do this currently is because of a 40-year-old loophole in the Employee Retirement Income Security Act, or ERISA, that the Department of Labor is now closing. This effort has the potential to return at least $17 billion a year to savers and retirees through lower fees, according to the White House Council of Economic Advisers. The crafting of the rule has not been without controversy, however. Speaker of the U.S. House of Representatives Paul Ryan (R-WI) plans to challenge the rule, calling it “Obamacare for financial planning.” But any vote on the this rulemaking would make it clear which side members of Congress are on: the side of savers and retirees or the side of an expensive and sometimes predatory status quo.
If we set the clock back 40 years to when the rules in ERISA were written, three-quarters of workers with retirement plans had savings through traditional pensions. They did not have to worry about how much they were saving or how to invest, since investing one’s own money for retirement was an afterthought. But today, most families are on their own when planning for retirement, with their savings in 401(k) plans and Individual Retirement Accounts, or IRAs. Additionally, many Americans have had trouble saving for retirement as they face stagnant wages and rising costs.
Not surprisingly, many families turn to financial professionals for advice. And in one recent survey of retirement investors, 87 percent considered it “very important” or “somewhat important” that advisers be legally required to act in investors’ best interests. Yet under the current loophole, advisers are only required to recommend products that are considered suitable—in other words, that generally meet their investment objectives—instead of being required to recommend the best options available. This opens the door to potential conflicts. As University of Mississippi School of Law professor Mercer Bullard noted in his testimony before Congress, the types of investments that advisers recommend can determine how much those advisers get paid—sometimes allowing them to earn double in commissions or even more for investments that may not be appropriate for a saver’s level of risk or future financial needs. And selling certain insurance products may lead to free Caribbean vacations or other in-kind kickbacks for advisers, as Sen. Elizabeth Warren’s (D-MA) office discovered in an investigation last fall. As a reward for sales, advisers may receive such forms of noncash compensation either directly from firms selling these products or from third-party marketing companies that support them.
Some may argue that fees don’t matter if investments are performing well, but they most certainly do. Even a 75 basis-point, or 0.75-percent, difference in fees over a lifetime of work could require an employee to work three years longer just to achieve the same level of retirement income as someone with lower-cost investments. And many of the abuses that the Department of Labor rulemaking anticipates involve more than just fees. For example, Elaine and Merlin Toffel of Illinois relied on a broker at their local bank branch to help them manage their retirement funds, but the broker recommended converting low-cost investments into high-cost variable annuities with negative tax consequences along the way. The Toffels’ story is one of many, including that of Ruby H. of Philadelphia. Her retirement funds did well until her adviser switched firms and started making inappropriate investment choices as a result of conflicting incentives, ultimately losing all of her meager savings.
Some opponents of the rule have argued that it is a question of jurisdiction and that the U.S. Securities and Exchange Commission, or SEC, should be acting on this instead. But the two agencies both have the authority to regulate different types of investments, and the SEC has struggled to move forward due in part to conflicting opinions among its members. Meanwhile, the Department of Labor has moved forward in its role—in conjunction with the Internal Revenue Service—to ensure that the more than $170 billion in tax breaks for retirement savings actually fulfill their purpose of helping families achieve secure retirements instead of enriching financial professionals’ interests. Savers and retirees should not have to wait for the SEC to step up.
The you’re-on-your-own approach to retirement planning of the past few decades has left many families short on retirement savings. The share of working-age families at risk of retirement insecurity is now 52 percent—up from 31 percent in 1983. When Americans meet with financial professionals, they should be able to hold these advisers accountable for maintaining the trust that they claim to impart—instead of falling victim to uncertainty and fine print.
Joe Valenti is the Director of Consumer Finance at the Center for American Progress.