With the U.S. Department of Labor’s new Conflict of Interest Rule on retirement investment advice now final, members of the financial services profession must prepare to do business in a more challenging environment.
Craig Lemoine, PhD, CFP®, Director of the Granum Center for Financial Security at The American College of Financial Services, offers his thoughts on the new ruling:
What Impact Will the DOL Rule have on Retirement Advisors?
The DOL ruling effectively labels anyone providing advice to an investment plan or IRA account, or advice about distributing that account, as a fiduciary under ERISA.
This is significant because a fiduciary of an IRA is limited from engaging in prohibited transactions (i.e., anything that would breach a pure fiduciary duty), unless those transactions are specifically exempted. The rule goes on to provide relief from specific prohibited transactions under the Best Interest Contract Exemption, or BICE.
What is the Best Interest Contract Exemption?
The amendments to the Prohibited Transaction Exemption (PTE) 84-24 allow retirement advisors to make specific product recommendations to IRA participants, but raises a high bar on this type of advice. The BICE requires compensation and fee disclosure, greater transparency, public-facing websites and a written understanding of a fiduciary dutybetween client and advisor.
Proprietary products are tentatively allowed but must be in the best interest of the consumer. Advisors working under this exemption may receive reasonable commissions (not defined at this time) for using annuity contract or mutual fund shares.
Additionally, the new DOL rule draws a line between annuity contracts that are governed under federal securities law and annuities that are fixed contracts. Usage of either will require a retirement advisor to meet a fiduciary standard. Variable products appear to be covered under the BICE, while fixed products may continue to fall under PTE 84-24 and have fewer disclosures.
How Will Consumers Benefit from the New DOL Ruling?
Primary benefits to consumers include additional transparency and lower investment expenses for those who have significant retirement plan balances.
However, one concern is that as the cost of doing business increases, consumers with smaller investment accounts may be left aside from traditional planning models. Moving forward we will likely see some type of automated or truly innovative solutions which will accomodate smaller qualified plan balances.
How Might Product Portfolios Change?
We will see possible changes in offerings by mutual fund companies and insurers. Direct and easy-to-understand advisor compensation will be paramount to meet the BICE rules.
There will be more consumer transparency. This will likely mean the end of sales trips paid for by product-oriented companies. Fee-oriented accounts and new flat-fee business models will likely have lower overall business model expenses than traditional retirement solutions. Hourly planning may become more mainstream as a result of these changes.
Look for mutual funds that existed primarily in the third party retail space to move into direct consumer transactions. Think of a "Vanguard" model on funds that were previously sold only through advisors. Direct distribution makes fee and expense disclosure very clear and may be one of the innovative approaches used in spaces traditional planners find not profitable.
What Will Happen to Variable Annuities?
Any IRA recommendations will fall under an umbrella of fiduciary duty — be they variable, fixed or equity income. The difference lies in how usage of these products is exempted from being prohibited transactions. Currently annuity contracts in qualified plans are exempted under PTE 84-24.
The new rule will remove "variable annuity contracts and other annuity contracts that are securities under federal securities law" from PTE 84-24 and place them under the BICE.
The BICE has a much higher bar of disclosure and transparency, as well as an undefined standard of reasonable compensation. The BICE requirements include a written contract declaring fiduciary duty, defining proprietary contracts, policies, and procedures to prevent conflicts of interest and to ensure prudent decisions.
The decision will rest with insurers and the sophistication of the field force. Companies who currently utilize mutual funds in high-net-worth markets will continue to use VA products. However, expect a shift of middle market companies away from VAs, possibly away from IRAs entirely.
Agents must hold fiduciary standards of prudence, loyalty, communication and record keeping in any circumstance (fixed, variable or equity income products) when working in this new regulatory environment. The fiduciary standard extends to IRA distribution advice, so having a client fund a product using IRA dollars would fall under this umbrella.
How Might Distribution Channels Evolve Under the DOL’s Fiduciary Rule?
Younger advisors may benefit in the long run. This change — along with ballooning student loan debt of the millennial generation — will force agencies to move away from traditional "eat what you kill" compensation models.
Raising significant bars on commission compensation will force such a significant shift in training and recruiting that in a decade, we will only be talking about the companies who figured it out. Retirement income advisors who are true fee-only are better positioned, but even those folks will have to accommodate new standards of care.
Any Final Thoughts?
Taking all that into consideration, financial advisors will need to meet a high bar to continue operating in this space.
As the landscape changes for fee- and commission-based advisors, commission-based advice will see a higher burden. All advisors will need to develop a deeper understanding of the source of retirement funds, which is actually in the best interest of the client.
Stay updated on DOL rule news, information and courses with The College. Visit http://www.theamericancollege.edu/dol for more information on the DOL rule, including upcoming courses related to the DOL ruling.
