New federal requirements could mean a different relationship between you and your financial adviser.
“Do unto others …” is not only a good idea to maintain healthy relations with friends, neighbors and acquaintances, it’s also at the heart of most of the world’s major religions. When it comes to professional relationships, such as those between fee-based financial advisers and their clients, the golden rule becomes the fiduciary rule. Now the Department of Labor (DOL) has expanded the reach of the fiduciary rule to include any adviser, regardless of credentials or licenses, who recommends moving money into, out of or between retirement plan resources. This includes IRA, IRA rollovers, Roth plans and even Health Savings Accounts. Also, the new rule applies even if your adviser recommends not moving money.
Rationale Behind the New Rule
Perhaps you’re already working with a financial adviser who puts your interests above their own and whose compensation is reasonable. That’s the basic standard for a fiduciary, as put forward in the DOL’s new mandate, which goes into effect in spring 2017. (See sidebar, “What’s a Fiduciary?”) But if you are working with more than one adviser or broker, or are not sure about their legal obligations or how they are paid for their services, here is what this big change might mean for you.
What’s a Fiduciary?
A fiduciary is someone who holds a legal or ethical relationship of trust with another person (or group), typically responsible for money or other financial assets. In addition to putting your interests ahead of their own, a fiduciary acts with “prudence” and uses the skill, knowledge, care, diligence and good judgment of a professional. A fiduciary doesn’t mislead clients, but in fact goes out of her way to provide conspicuous, full and fair disclosure of all important facts. A fiduciary avoids conflicts of interest, if possible, and discloses and fairly manages in the client’s favor any unavoidable conflicts.
Before the new rule, commission-based stockbrokers and insurance agents have been subject to a suitability standard with the products they recommend and sell. That means they’re supposed to match your circumstances (income, assets, tax bracket, financial lifestyle, time horizon and risk tolerance, among other criteria) to a range of compatible investment and insurance options, including annuities. The suitability standard means that the broker must have a reasonable basis for the recommendation that is offered to you. But suitability doesn’t mean lowest cost, and a suitability standard doesn’t prevent a potential conflict of interest between the recommendation and the broker/agent who makes the recommendation. Brokers and agents have not typically been required to give your best interest their first consideration, although many do as a matter of their professional commitment to their clients.
At the other extreme are fee-only Registered Investment Advisors (RIAs). Individual advisers working for such firms are referred to as Investment Advisor Representatives (IARs), and they and their firms for many years have been governed by the fiduciary standard—where they are required by laws and rules to put your interest first.
If you had a choice between advisers working as commissioned agents, and not previously held to a best-interest standard, versus advisers working solely by fee, why wouldn’t you want to work exclusively with a fee-only, best-interest adviser?
Fee-only advisers typically don’t “sell” or manage annuities or life insurance, and only a few insurance companies make their products available directly to consumers. That’s for good reason: annuities and life insurance are complicated financial assets that need professional assessment of your situation and explanation to your satisfaction that they’re right for you. An insurance agent is an intermediary, an individual licensed by a state insurance department and authorized by the insurance company to sell its life insurance and annuities.
Fees and commissions—and the disclosure of these costs—are only one part of the overall structure of any investment or insurance, whether it’s a mutual fund or an annuity or a life insurance policy. Often the expenses are “baked in” and may not be easy to define or describe. With insurance products, commissions are paid by the insurance company and are not subtracted from your account unless you surrender the policy within the surrender charge period, which can range from 5 to 15 years. The major issue should be that if you need an annuity, what are the benefits, and does it help make you financially more secure, less anxious and/or comfortable that you’ve made a good decision?
How Will This New Rule Affect Me?
Insurance companies and stock brokerage firms are already working to conform to the rules that are now less than half a year away. Bank of America’s Merrill Lynch, for example, recently became the first major firm to announce it would no longer pay commissions for investment recommendations made for IRA accounts; rather, its brokers will be compensated by ongoing fees through its advisory platform. Other options may include self-directed (i.e., do-it-yourself) accounts and even artificial intelligence-powered “robo" advisers. If that latter option sounds like science fiction, it isn’t. Computer-driven robo advice is one of the hot innovations in financial services, propelled even more quickly because of the changes needed to accommodate the new fiduciary rules. While some seniors may prefer to self-direct or automate their own way through a volatile stock market, many more clients will likely be comfortable with human, professional-to-client advice, compensated through a small percentage of assets assessed annually to the portfolio. This would presumably allow the focus to be on advice rather than just selling investment and insurance products. However, if you don’t have at least $50,000-$100,000 of retirement assets to invest, you may not readily find a qualified adviser willing to work with you, and “robo” may be your only option.
What’s Best Interest? What’s Reasonable Compensation?
In 1,023 published pages, the new DOL regulation does not explain “client’s best interest,” and it’s likely something that means different things to different people at different times. The concern is that along with the requirement that advisers receive only reasonable compensation, it may take years of litigation through state and federal courts to better define these new standards.
So consider: if you believe you have been well-served in relationships with financial service professionals, what was it that made you feel that way? Ideally it was a sense that the adviser listened and understood your circumstances and issues. The adviser likely addressed things that you wanted to fix, accomplish or avoid and brought to your attention planning ideas and investment or insurance products that would help you reach your objectives. In other words, such an adviser provided enough relevant information and guidance that you could make a decision you believed was in your best interest. As for compensation, ask yourself: if you are well served through a relationship of financial intimacy with a qualified financial professional, how important is it to you what the adviser is paid?
What Can You Expect From a Financial Adviser?
If you’ve been working with a commissioned insurance agent or stockbroker, some products fitting under the broader umbrella defined by the DOL will require a written contract between you and the financial institution. If nothing else, this gives you a more explicit understanding of what to expect from the agent and her institution. It’s also likely that more stock brokerage firms will follow the Merrill Lynch initiative and only offer managed funds as opposed to mutual funds or individual stocks for IRA and similar retirement plans. Either way, here are some questions you may want to explore with your existing or new adviser:
- When these new rules kick in, what will be different in the way you work with me? And how will that affect my portfolio from the standpoint of costs and products?
- What are my options for receiving information and services and acquiring any products you recommend, and how will you get paid?
- How should I evaluate this new process? What are reasonable benchmarks to measure if I’m achieving my goals? How will I be able to evaluate if this is working for me?
- (For the adviser choosing to meet narrow exceptions in order to continue to receive commissions while still held to a fiduciary standard), “What will be different?”
- (For the financial planner charging fees and selling no products), “How will you evaluate my need for insurance and/or annuity solutions and how will you provide me with access to those solutions?”
Although the new fiduciary rule is being challenged in court, the inherent customer focus of fiduciary standards will likely ultimately survive. To this end, it’s important for seniors to talk to their current advisers and, regardless of current or future rules, assure themselves of services and products that meet their needs.
- Richard M. Weber, MBA, CLU, AEP
Richard M. Weber, MBA, CLU, AEP, is a 50-year veteran of the life insurance industry. He has been a successful agent and insurance company executive, and for the last 20 years has worked as a fee-only insurance fiduciary.™ He is the author of more than 300 articles encompassing insurance products, sales practices and the due diligence necessary to buy and sell insurance and annuities. Richard served as the 2012-2013 national president of the Society of Financial Service Professionals.