How to Handle the DOL’s New IRA Rollover Rule

I received 25 detailed responses, and at first it was bewildering because none of the disclosure forms or checklists looked like any of the others. But when I looked closer, there were some commonalities that I fit into a composite disclosure document that the profession can rally around. At the very least, it shows you the thinking of people who have put a lot of thought into this issue.

I can offer an even dozen of observations from the responses.

1. Only one of the respondents was willing to rely on my suggested approach (which I had heard from multiple advisors before I wrote the column): to outline the additional services the client would be receiving, and then allow the client to make an independent decision about whether to roll over the assets. There would be no actual rollover recommendation; therefore, no requirement to do all this documentation.

There were 24 responses which, to some degree, rejected this approach. “Regarding the strategy of ‘not recommending rollovers,’ wrote Jenna Holm, CCO of Accredited Investors Wealth Management in Edina, MN, “my personal opinion is that it would be hard to do in practice… We are usually one of the first calls a client makes when they start a new job and need to decide what to do with their old 401k.”

Susan John, managing director of financial planning at FL Putnam, Inc., was equally dismissive of my suggestion. “Avoiding the rule by not making a recommendation is just an abdication of fiduciary duty,” she wrote. “Either it is better for the client, or it is not.”

If you are making routine recommendations about the investments in a client’s various portfolios, then it’s hard to argue that, in another part of the relationship, you’re outlining choices and leaving it up to the client.

If you aren’t doing that in the other parts of the relationship, then perhaps the DOL would find it disingenuous that you would do it with the significant decision of whether to roll over 401(k) assets that just happens to increase your fees. Not making a recommendation in this one area of a client’s financial life might be considered, in itself, a breach of fiduciary duty.

2. Of course, some clients will make an unsolicited request that you do the rollover. Some of the forms I received included a checkbox at the top that said that the client initiated the rollover without a recommendation. (The second checkbox would say that the advisory firm recommended the rollover.) A best practice is, even if that first box is checked, to fill in the worksheet anyway and (toward the bottom) have the client sign it.

3. The checklist could include “reason the rollover or transfer is being considered,” and the checkboxes there would include:

Change of employment

Retirement

Termination of retirement plan

Company closure/layoff

In-service distribution

Other (describe)

4. Not all the disclosures I received included a statement of commitment that the advisor would follow a fiduciary approach to managing the rolled-over assets. The DOL requires this. The DOL provided some language you could use in its rule:

When we provide investment advice to you regarding your retirement plan account or individual retirement account, we are fiduciaries within the meaning of Title I of the Employee Retirement Income Security Act and/or the Internal Revenue Code, as applicable, which are laws governing retirement accounts. The way we make money creates some conflicts with your interests, so we operate under a special rule that requires us to act in your best interest and not put our interest ahead of yours.

5. Some of the checklists included a space with the title: “Describe how the retirement assets are currently invested” and the advisor would enter a description. My sense is that this isn’t necessary.

6. The most vexing part of the proposal, by a wide margin, is the cost comparison. The most detailed worksheets broke this down to the 401(k) plan’s current investment fees, commissions or sales charges, the TPA’s and sponsoring company’s plan administration/custodial expenses, and any additional individual service fees, all broken down as an expense ratio percentage and actual dollar cost. (Not everybody included the dollar cost, but it is especially helpful if the plan or TPA charges a flat per-account administration and/or custodial fee.)

You tote these various costs up to a bottom line, and then tote up the fees that the rolled-over IRA would be paying under your management – including the expense ratios of the various funds you would recommend plus your AUM fee, if applicable. (If applicable? More on that in item 12.)

7. Where do you get the information concerning the existing plan assets? There are several options, all of them frustrating. The DOL recommends that you ask the client for permission to log onto the employer website and look at whatever they’re disclosing, or ask for recent statements and back out the approximate costs through what I can only imagine would be a laborious calculation of individual fund returns versus what the statement shows over some time period.

In rare instances, there might be a plan disclosure document that the client can obtain for you, but none of the respondents reported seeing one of these. If the client can obtain one, we can consider it a “black swan” event.

In any case, you can probably get information on the individual 401(k) funds that the client is invested in by looking them up on Morningstar or on the web, though that wouldn’t tell you if the plan administrator is taking a markup or what the TPA is charging.

Commonwealth Financial provides its affiliated advisors with access to a form 5500 database, where you can input the plan name into the search tool and get back some very general information (number of investment options, but not what they are or what the client is invested in, and where the plan fees rank generally: 25th percentile: 0.391%; 50th percentile; 0.565% etc.).

An online software service called InvestorCOM.com provides similar access to form 5500 data, but with much more detailed cost information. If you subscribe to its service, the firm provides a rollover checklist form with prepopulated fields where you can compare expenses, and (next item) compare the services you would provide as the advisor versus what the employer is currently providing.

Note, however, that nothing will disclose the services that the employer, TPA and plan itself are providing. You have to ask the clients about what services they’re getting from their employer. Be prepared for them not to know.

However, the DOL rule doesn’t require a detailed cost comparison; it requires that the advisor make a good faith effort to identify the 401(k) costs and services. Several of the worksheets I reviewed had a box that is checked whenever (and this is frequent) the client declined to go to all the hassle of producing this information.

InvestorCOM.com addresses this issue for smaller plans that aren’t in the 5500 database by identifying the size of the plan and providing benchmark estimates of the costs and fees generally assessed with plans of that type and size, which can be inserted into the worksheet.

Dan Hawthorne of Hawthorne Financial Advisors made a great point in his response, when he noted that the DOL is requiring advisors to somehow dig out this information from plans. But doesn’t it (the DOL) have full authority under ERISA to require these plans to provide this information as a matter of business policy? Not only that, he says there is a double standard; with this new rule, it’s much less restrictive and bureaucratic to roll money into a new 401(k) plan than it is to roll it into an advisor-managed IRA.

“I have had clients tell me that, in their opinion, it just isn’t worth the time and effort to get the necessary documentation about their old or new 401(k) plans, and so they are going to roll their assets into a newly available 401(k) plan,” he says. “Evidently, getting someone to roll assets into a new 401(k) doesn’t have the same requirements as rolling them into an IRA. Maybe,” Hawthorne continues, “the industry could request/require that employees who are leaving a company be provided with all plan documents as well as all plan documents for the newly available plan. Then, all a client would have to do is forward them to their financial advisor for a fair comparison.” (I’m not going to hold my breath waiting for this to happen.)

8. The cost data is just one part of the comparison. You also want/need to compare the services that the client is receiving versus what would be provided if the assets were rolled over.

This is where the checklists that I received diverged rather dramatically – and it is also the crucial part of the disclosure, since virtually all the cost comparisons (unless the 401(k) includes only expensive actively managed funds) will show that the rollover will result in higher costs, due to your AUM fees. (Yes, your proposed investment options will probably have lower expense ratios than those in the 401(k), but the advisors I polled said that this seldom made up for their planning fees.)

After hearing from a number of advisors, this seems to be the most important thing to understand about the whole disclosure process: How much the client values the services the advisor would provide will, in virtually all cases, be the determining factor in whether or not to prefer the rollover.

In the vast majority of cases, the service section will outweigh the cost section.

I’m going to offer a composite of the service checklists here, because there’s a danger of leaving out some of the benefits and conveniences that the client would gain or lose if the assets were under your management. None of the checklists included everything listed here.

First: What benefits or services might be lost if the client left the current 401(k) plan? That list includes:

• • More creditor protection (IRAs are held to state creditor laws regarding malpractice, divorce or other lawsuits; their maximum caps can be lower than ERISA protections).
  • The ability to take loans from the plan (or there are existing loans).
  • The ability to take penalty-free withdrawals before age 59 1/2 (if the client is planning to retire between ages 55 and 59 1/2).
  • Ability to do back-door Roth contributions. (This can be a big issue.)
  • The ability to defer mandatory distributions if still working past age 72.
  • If the employee owns appreciated employer securities, potential loss of favorable tax treatment of net unrealized appreciation if the assets are all rolled into an IRA. (Advisors, of course, can mitigate this by taking out the NUA assets as a lump sum distribution along with the rollover.)
  • The potential to opt for guaranteed annuity-like payments from the plan at retirement (if available).
  • Death benefit (if available).

Then: What benefits or services would be gained by having the assets managed in a rollover IRA? That list includes:

• • Broader array of investment options in the rolled-over IRA portfolio.
  • Financial planning, tax and estate planning services, risk analysis etc. (for new clients)
  • Integrated investment management and asset location, allowing for strategic placement of certain assets in the most tax-advantaged accounts.
  • Cash and withdrawal management – distributions from employer plans are often done pro-rata, forcing liquidation of invested assets.
  • Ability to directly debit management fees.
  • Avoiding the hassle of remembering 401(k) login information.
  • Ability to make a clean break with former employer.
  • Ability to do partial Roth conversions in advance of RMDs.

• • Ability to tax-manage retirement distributions from various retirement accounts.
  • Ability to make qualified charitable distributions (QCDs), tax-free, directly from the IRA.
  • More timely responsiveness for requests, questions and support. (i.e., easier changes to beneficiary updates to support your ever-changing financial life).
  • Ability to consolidate accounts and the convenience of having all the account administration and performance reporting handled in one place. (This is usually the most compelling item on the list.)

9. This is where the process becomes extremely subjective. Do clients want to pay more and receive more services from the advisor? Some of the worksheets offer checkboxes next to the various features, both pro and con, and the simplest (and, I think, least scientific) process would be to add up the check boxes pro and con.

A better approach might be to evaluate the level of interest that the client has in each of these areas. How much do they value these services? A client might check the box for asset location but is not very interested in that (or even understands it), and check the creditor protection box, just because.

The most interesting aspect (in my mind) of the InvestorCOM.com service is that it asks clients to rate, on a scale of 1-100, their level of desire for each of the services that they checked, both under the “stay” and “rollover” parts of the checklist. The client might say 30% for creditor protection (no lawsuits pending), 30% for delaying mandatory distributions (probably won’t be working then anyway), and 70-90% each for the ability to make partial Roth conversions, tax-managed distributions and consolidating accounts.

You can add up the different figures to get an overall score on the yea and nay side.

Most advisory firms are accomplishing the same evaluation of client desires through a conversation, and the trick is to keep the conversation neutral – that is, you make a recommendation, but the discussion of the various tradeoffs should not be a sales pitch. A best practice would be, if the client is uncertain, to make the recommendation not to do the rollover – and have those instances documented in your files.

But be prepared for that not to be a voluminous file. “The interesting (or maybe frustrating) reality is that for a number of reasons we find that clients want to roll their 401(k)s 100% of the time,” says Brian Martin, chief operating officer of Accredited Investors. “Clients just do not seem to care about the fee piece.”

“In many cases, the decision to roll over a qualified retirement plan is primarily because our client wants all the accounts to be handled through one point of contact,” says Jeff McClure, of The Personal Wealth Coach. "Only rarely do the expenses rate high on their list of reasons.”

What does the objective assessment look like in real life? “If the client is primarily focused on fees, then we recommend keeping the funds in his/her current retirement plan or rolling the account over to the new employer’s retirement plan, since they’re almost always less expensive overall,” says Jessica Kmetty of Searcy Financial.

“However,” she continues, “if the client is more concerned with qualitative factors, such as: eliminating contact with old employer, concern over long-term viability & distrust of old employer, worries about misplacing login information, or unexpected change of plan provider/custodian, lack of education surrounding investment changes and paying for a benefit that is no longer relevant to the employee, then it would be in the client’s best interest to roll the funds to an IRA.”

“Furthermore,” she continues, “the client will gain access to a specific team member who knows the details of his/her accounts as opposed to contacting a call center. The client should receive more active management more closely aligned with his/her risk tolerance level, the consolidation of accounts and access to our team for financial planning-related discussions on cash flow and long-term retirement savings goals.”

The goal here is to figure out what the client prefers and determine what would be best for this particular client and make a recommendation that is honestly objective – which is what the DOL is, at heart, trying to encourage. Just understand that the typical client or prospect is leaning toward making the rollover regardless of your recommendation, and any clear articulation of your services, even if objectively presented, is going to be compelling.

10. If the client is changing jobs and moving to a new firm, then the checklist would need to include data on the new 401(k) that the client might be able to roll assets over to from the existing account.

The fact that people are changing jobs more frequently these days might raise another point in favor of the rollover.

“One of the items that is hardly ever mentioned is the fact that so many people change jobs and lose track of their retirement plans,” notes Gwen Garrison of LifePlan Financial Advisors, Inc. “I’ve seen situations where employers were bought out or merged, employers changed 401(k) providers, clients moved and forgot to update their address, clients changed names and so forth. One time,” she adds, “I simply took the client’s resume and researched the companies he’d worked for during the last 20 years. I drafted a letter for him to sign asking previous employers if they had an account for him. I found $100,000.”

11. Get a signed acknowledgment of what you presented in this rollover discussion. Ideally you would have the client sign the worksheet that you present and keep that in your files. That isn’t required by the DOL, but advisors who have created their processes with the help of an attorney say that they’ve been told it’s a best practice.

12. All of this goes away if you don’t charge via AUM, or if you are already charging on held-away client assets.

Come again? “I sorted through the list of clients where I may recommend rolling retirement money into IRAs eventually (e.g. retirement),” wrote Lesley Brey of LJ Brey, Inc. “It turned out that I was already advising/billing on the vast majority of the retirement plan money. Therefore,” she adds, “rolling over does not result in any increased fees – and usually reduces their overall costs, since the funds/ETFs that I use are usually less expensive than what is in their plan.”

No advantage to the advisor making the recommendation, therefore no prohibited transaction is involved.

“My reading is that since I charge a fixed fee retainer that is not dependent on the location of the money (e.g., I get paid the same whether it’s in the IRA or 401(k)),” says David Jacobs of Pathfinder Financial Services, “I don’t receive any fees incident to the rollover recommendation and therefore don’t need the exemption, since it isn’t a prohibited transaction for me.”

“Your request made me think how the AUM model inherently creates a conflict of interest here, and in many other cases,” says Ryan Firth, who happens to charge by the hour for his planning services. “Flat or hourly fee methods don’t magically make potential conflicts of interest go away, but they certainly reduce them, and this would be an instance where it’s significantly mitigated, in my humble opinion.”

“Can I be overly direct and say, ’Just don’t charge on AUM!’” adds Brent Weiss of Facet Wealth. “Changing your compensation model to a fixed, subscription fee really does allow you to give unbiased advice and help the client make the best choice for them, from investment options to fees to creditor protection.”

But the interesting thing is that even the advisors who are not subject to the exemption process still go ahead and carefully examine whether the rollover would benefit the client – or not. They are fiduciaries even though they aren’t forced to be.

“I still go through some 'due diligence', usually around cost/benefit (TIAA or TSP money sometimes stays put) or liability protection, then let the client choose,” says Brey.

Jacobs says that he goes down a checklist of items which might make the 401(k) more beneficial than the IRA. It includes:

• • Is the client planning to retire between age 55 and 59.5 (since 401Ks have special access provisions that IRAs don't have)?
  • Does the client have loans or needs a loan from the retirement funds? (IRAs don't do loans)
  • Is the client female and planning to annuitize a significant amount of the money? (401Ks use gender-neutral annuitization rates which helps women who live longer and hurts men)
  • Are the total investment fees (including the advisor's fee) higher after the rollover?
  • Is the marriage is on shaky ground or is it a second marriage? (IRAs allow the owner to unilaterally change the beneficiary, i.e., disinherit the spouse)
  • Does the client need the stronger liability protection the 401K provides?
  • Does the 401K offer a desirable investment opportunity not available in an IRA (e.g., TSP G Fund, Stable value funds, etc)?
  • Is there employer stock in the 401K (i.e., NUA eligible, if rolled into an IRA NUA distribution option goes away)?

Weiss sent me Facet Wealth’s IRA rollover checklist, and it was one of the most comprehensive that I received.

Even planners who are not subject to the DOL exemption guidelines, who don’t need the exemption, are still trying to determine what is best for their clients. That’s the spirit that the DOL is trying – I would say clumsily – to encourage.

I hope this review of different ways that advisors are handling the rollover disclosures is helpful as you determine how your firm should address this important issue.

Bob Veres' Inside Information service is the best practice management, marketing, client service resource for financial services professionals. Check out his blog at: www.bobveres.com.

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