Personal Finance

New investment rule could save investors billions

3 steps to avoid running out of money in retirement
The new rule that could mean billions in savings
The new rule that could mean billions in savings

The Obama administration announced on Wednesday a new rule on investment advice that may change how millions of Americans choose their retirement investments — potentially saving them billions of dollars in the process.

By requiring all financial advisors to act in their clients' best interests, a criterion known as the fiduciary standard, the rule aims to protect investors from conflicted investment advice when they are exiting a workplace savings plan like a 401(k) and transferring their money into an IRA.

"American families are losing billions of dollars because of an out-of-balance system," said Labor Secretary Thomas Perez in a news briefing. "With the finalization of this rule, we are putting in place a fundamental principle of consumer protection in the retirement landscape."

The rule will take effect in stages beginning in April 2017, Perez said. But that time is unlikely to pass quietly, not least because various financial industry groups have vowed to fight the rule.

For many, retirement savings decisions are some of the most important financial choices they ever make.

According to an estimate by the Council of Economic Advisers, a worker who rolls over 401(k) savings to an IRA at age 45 and followed conflicted advice could have 17 percent less savings by the time he or she reaches age 65. In all, it estimated that conflicted investment advice currently costs savers roughly $17 billion a year.

Opponents of the rule say that estimate may be woefully high, yet David Certner, legislative policy director for government affairs at AARP, thinks the cost could be even greater because the council did not examine conflicts in the insurance market.

No matter the exact figure, the costs are hitting savers at a time when millions are facing retirement with little in the way of financial resources. Only 25 percent of workers report feeling on track with retirement savings, according to the Employee Benefit Research Institute, and 60 percent say they are behind to some degree.

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Some 75 million families have a workplace retirement account, an IRA, or both, the council found, and savers often transfer hundreds of billions of dollars from accounts like 401(k)s into IRAs every year. As defined contribution plans become even more widespread, rollovers will as well.

If savers receive advice at that point that is truly in their best interests, they stand to retain more of their money, at least in theory. But current regulations allow advisors to suggest certain investments if they are "suitable," even if it means higher fees or lackluster performance for the investor.

"Both your doctor and your lawyer are obligated to look out for what is best for you," said Perez. "If you had an illness or cancer, you wouldn't want your doctor to tell you what's suitable for you."

The new rule comes after years of fierce wrangling over its terms. Large financial services firms and their advocates, like the Securities Industry and Financial Markets Association (known as SIFMA), figure prominently in the opposition. Among the advocates are consumer groups, AARP and the Financial Planning Coalition, a group that includes major financial planning organizations.

Opponents have argued that the new rule would impose a major bureaucratic burden on financial firms, and complying would push up the cost of providing advice and force firms to drop clients with smaller account balances.

"We think that there should be a uniform standard when you are providing personalized investment advice," said Kenneth Bentsen, chief executive of SIFMA. "But that should apply across the marketplace, and shouldn't be so prescriptive that it is going to raise costs to investors, or reduce their access to advice, or both."

"The rule is very prescriptive. It adds a whole host of new requirements," he said, and as a result, compliance will be expensive.

"Where it is really not cost-efficient with lower-balance accounts, firms may just decide they will exit that business and focus on their higher-margin accounts," Bentsen said, which could cut off smaller investors from personalized advice.

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Advocates counter that the rule will help investors on several fronts.

For one thing, consumers are often unclear about what standards their advisors follow, said Certner.

"You watch the commercials and they talk about 'your trusted advisor,'" he said. "That certainly makes people think they are acting in your best interest, when their standards are not at that level."

A study by the Rand Corp. for the Securities and Exchange Commission found that while broker-dealers and investment advisors have to follow different regulatory standards, "trends in the financial services market since the early 1990s have blurred the boundaries between them."

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As for serving clients with smaller accounts, a study published earlier this year for the Certified Financial Planner Board of Standards found that for certified financial planners, or CFPs, who have to follow a fiduciary standard, mass market clients make up slightly more than 10 percent of their clients, roughly the same share as for non-CFP practices.

"A common perception is that mass-retail clients are unable to afford a CFP professional's services, which implies that CFP professionals work with a smaller percentage of mass-retail clients. Our study refutes this point," the researchers wrote. Put another way, less-affluent clients account for only a small share of any advisor's client roster, not just those following the fiduciary standard.

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The CFP Board, as it is known, has already been through the process of imposing a conflict of interest standard. In 2008, it adopted a fiduciary standard requiring its planners to act in clients' best interests.

"We heard the same arguments: It's going to reduce the availability of services, and CFP professionals in our firm will have to rescind their certification," said Marilyn Mohrman-Gillis, head of public policy at the CFP Board. But since the board adopted it, profits for CFPs overall have increased more than 30 percent, she said.

In addition, a 2013 study for the CFP Board found that 46 percent of so-called fiduciary registered representatives saw assets under management increase an average of more than 10 percent annually over the five years since 2007, as did 55 percent of registered investment advisors, who also have to meet that standard. Only 29 percent of other registered representatives saw assets grow that much.

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Opponents of the rule may find that some of their concerns have been addressed in the final wording. For example, restrictions on the types of products advisors can recommend appear to have loosened, and the final version has simplified some paperwork requirements. In addition, certain advisors will be able to continue receiving payment in the form of commissions and revenue sharing agreements if they disclose conflicts and meet other some other standards.

Still, for now, Perez is voicing satisfaction. "This is a good day for the middle class," he said.