Investors contribute more than $600 billion to IRAs each year. Anticipated Labor Department regulations may strengthen their safeguards.
According to attorneys who specialize in retirement law, the U.S. Department of Labor is set to adopt a regulation in the coming weeks that would strengthen safeguards for investors who roll money from a 401(k) plan into an individual retirement account.
The stakes are really high: Every year, millions of Americans transfer their savings from employer retirement plans to IRAs. It’s a frequent move when employees change employment or retire.
However, present restrictions may expose people to bad investment advice from brokers, insurance agents, and others in the financial ecosystem, with negative consequences like as increased fees that erode their funds, according to attorneys.
“It may not cause fewer rollovers, but it will almost certainly cause more thoughtful rollovers,” Fred Reish, a retirement specialist and partner at law firm Faegre Drinker Biddle & Reath, said of the upcoming rule.
There is a ‘tsunami’ of IRA rollovers.
According to the Investment Company Institute, IRAs will have around $11.5 trillion in 2022, nearly twice the $6.6 trillion owned by 401(k) plans. According to the association, around 55 million American families own IRAs.
The majority of the IRA assets are rollovers.
According to IRS data, almost 5.7 million Americans rolled $618 billion into IRAs in 2020 alone. This is more than double the $300 billion that was rolled over a decade ago.
This ratio is also seven times more than the proportion of funds given directly to IRAs. According to ICI, 74% of new pre-tax IRAs (also known as “traditional” accounts) will be created with rollovers in 2020.
Phyllis Borzi, who oversaw the Labor Department’s Employee Benefits Security Administration under the Obama administration, said during a webcast last month that there is a “tsunami of assets” migrating from workplace plans to IRAs.
While there are advantages and disadvantages to rolling money into an IRA, one disadvantage is that the accounts often have higher costs than 401(k) plans. According to Pew Research Center, a neutral research organization, investors who transferred money to an IRA in 2018 would lose around $45.5 billion in fees over a 25-year period.
Most suggestions to roll over money to an IRA made by brokers, insurance agents, and others aren’t subject to a so-called “fiduciary” standard of care, which means investors may not be getting advice that’s in their best interests, according to Reish.
According to attorneys, this is what the Labor Department will most likely change.
‘Game changer’: Rollover counsel might be considered ‘fiduciary’
Borzi, the former EBSA director, led a broad Labor Department push to reform “fiduciary” laws under the Obama administration. These regulations seek to limit conflicts of interest among brokers and others who provide financial recommendations to retirees.
However, the rule was struck down in court.
The Labor Department is now attempting again, though analysts predict that new regulation will be less far-reaching.
In September, it filed a draft regulation titled “Conflict of Interest in Investment Advice” to the Office of Management and Budget. Borzi stated that the OMB has 90 days to study the rule before the Labor Department issues its proposal publicly.
Attorneys anticipate that, based on previous legal hints, the Labor Department will seek to increase the threshold on any rollover guidance supplied by the financial ecosystem.
“That’s a game changer,” said Andrew Oringer, a partner at The Wagner Law Group and a retirement law specialist.
However, critics believe that a new regulation would be detrimental.
Sen. Bill Cassidy, R-La., and Rep. Virginia Foxx, R-N.C., wrote to the Labor Department in August, claiming the agency’s actions were “misguided” and risked causing market uncertainty, unjustified compliance costs, and instability for retirement plans, retirees, and savers.
Due to the average duration of the regulatory process, a final regulation may take two years or more to take effect, according to Borzi.
For rollovers, there are legal loopholes.
Here’s why a new regulation would be significant.
There are presently a slew of restrictions controlling how consultants, brokers, insurance agents, and others can provide financial advice to retirees. Different actors are bound by different rules, some more lenient than others.
According to experts, the fiduciary protections for 401(k) investors are typically the strongest available under the law. The Employee Retirement Income Security Act of 1974 governs them.
This typically indicates that investing advice must be delivered entirely in the best interests of the investors. Advisors must put their personal interests aside and cannot, for example, advocate purchasing a fund, annuity, or other investment that gives them a bigger fee at the expense of an investor.
It may not result in fewer rollovers, but it will almost certainly result in more deliberate rollovers.
According to Oringer, the exclusive focus on investors’ best interests “is an extremely significant difference” from other investor safeguards.
However, due to loopholes, rollover guidance often falls beyond the scope of such safeguards, according to attorneys.
However, the Labor Department may narrow such loopholes and subject all rollovers to the protections of ERISA.
“All of a sudden, I’d have to care about your best interests when I try to get you to do that rollover,” Oringer said of financial institutions and their representatives. “That completely changes the way in which I have to behave.”
ERISA safeguards, for example, would allow investors the opportunity to sue someone in court for poor rollover advice, according to Reish.
Currently, that private right of action does not extend to investment advisors, brokerage firms, insurers, banks, or trust corporations; only their respective regulators (rather than individual investors) may enforce their regulations, according to Reish.