Rollovers are the lifeblood of growing assets for any financial advisor—and regulators have taken notice. With 401(k) rollovers to individual retirement accounts serving as the main source of new assets, advisors now face greater scrutiny to show they are acting in the best interest of their clients.
IRAs are getting increasing attention by regulators given the rapid growth in IRA assets over the years. About $12.2 trillion of U.S. retirement assets were in IRAs at year-end 2020, representing 35% of the $34.9 trillion in U.S. retirement assets, according to the Investment Company Institute. 401(k)s ranked second, with about $6.7 trillion in assets, or 19% of the pie. Both of these account types have grown over time, in absolute terms and as a percentage of the overall market. Fifteen years ago, IRAs comprised 23% of U.S. retirement assets, while 401(k)s made up about 17%.
Meanwhile, over the years, the use of defined benefit plans—or company-run pensions—has declined. Pension plans left the onus of investment decisions to professionals, but with this shift toward IRAs and 401(k)s, it’s up to the individual to manage on their own or proactively seek help.
This worries regulators. Regulations now require advisors to show they are meeting best-interest standard of care for recommendations of rollovers from 401(k)s and other retirement plans to an IRA. The most recent catalyst for this higher standard was a Department of Labor’s rule that took effect in February. The guidance, “Prohibited Transaction Exemption 2020-02—Improving Investment Advice for Workers & Retirees,” addresses fiduciary requirements under the Employee Retirement Income Security Act (ERISA) for professionals who recommend investments to participants in 401(k) or other employer sponsored plans and IRA holders.
The regulation is controversial in that it allows fiduciary advisors to take compensation from mutual fund companies. But the DOL rule also requires policies and procedures are “prudently designed to ensure compliance with the impartial conduct standards” and “mitigate conflicts of interest.” Advisors must also include written disclosure to retirement investors of the reasons that a rollover recommendation was in their best interest.
The DOL guidance comes after the Securities and Exchange Commission’s 2019 rule, “Regulation Best Interest: The Broker-Dealer Standard of Conduct,” or Reg BI, which took effect on June 30, 2020. (This in turn was a follow-up to the Department of Labor’s original Fiduciary Rule, which was vacated by a federal court in 2018.)
The regulations aim to solve a long-standing problem for policymakers as DB plans phase out: ensuring Main Street investors have access to unbiased and effective advice for their retirement savings. Their intent is to ensure advisors are acting in the best interest of the retail customers when a recommendation is made, without placing the financial or other interests of the broker-dealer ahead of the interest of that customer.
With respect to rollovers, financial professionals must evaluate how they advise customers and demonstrate that a particular transfer of assets is in the best interest of the client. They must show how the benefit of a rollover may in part be due to the value of advice or asset-allocation recommendations that match a client’s goals. For the DOL rule, proof of this value must explicitly lie in the documentation, and while Regulation Best Interest is not explicit about documentation requirements, most firms will want documentation processes in place to demonstrate compliance.