The Biggest Retirement Issue in 2016Learn more about this firm
With the possible exception of market volatility, the biggest issue facing the retirement planning industry in 2016 is the Department of Labor's proposed fiduciary duty regulation. This proposal has the potential to upend the industry by extending the definition of "fiduciary" to include financial advisors of retirement savings vehicles such as 401(k) and individual retirement accounts.
The fundamental premise of the proposed regulation is that those selling or offering products through a 401(k), IRA or any other tax-qualified retirement account should adhere to a new, more stringent fiduciary duty obligation. So stringent I believe, that the additional costs and liabilities of the regulation may force many financial planners and advisors to change their business model, while others may be pushed to exit the industry altogether.
To learn more about the specifics of the proposal, I spoke with colleague Peter Lefkin, Senior Vice President of Government and External Affairs for Allianz of America. Based in Washington DC, Peter has been familiar with fiduciary duty regulation ever since it was first proposed as part of Dodd-Frank during the Financial Crisis. He provides unique perspective on how the new regulations could change the future of financial services.
New fiduciary framework
The proposed DOL regulation, which applies a fiduciary framework that takes effect almost at the point of first contact, requires:
- A contract, in which the product seller acknowledges their fiduciary status, must be signed with the client immediately after their first conversation.
- The product seller is required to reveal all potential conflicts of interest and all compensation that is to be received.
- Complete performance history of the product being recommended, as well as possible projections for the future.
- Full listing of alternative products offering similar attributes.
- Affirmation that the compensation being received by the advisor is reasonable.
- Quarterly electronic notifications of all compensation received.
- Nullification of mandatory arbitration clauses that exist in a current contract.
- A federal cause of action for any violations, however small or unintended.
Costs and burdens
The granular nature of the regulation imposes enormous new costs and burdens while vastly expanding the liability exposure of the industry. One of the most frequent criticisms against it is that it makes service to lower- and medium-size accounts cost prohibitive, and that this will result in financial advice being withdrawn from those who might need it the most. The fear is that without this advice, retirement plan participants who are changing jobs may be tempted to cash out of their plan rather than rolling it over to another qualified account.
The new regulation exempts large employers but imposes a new standard on those with less than 100 employees. Particularly hard hit will be small businesses with less than 10 employees, who may not be able to afford establishing a new plan given the prohibitive costs of doing so.
Bias toward passive management
There are concerns that the proposed requirement stipulating all compensation “be reasonable” creates a strong bias toward passively managed funds, which may be fine for some investors but certainly not all. It could also hurt those who sell annuities even if these products are better tailored to the individual needs of their clients. The regulation could also hinder the sale of proprietary products while paradoxically making it much easier to sell products offered by competitors.
The industry’s arguments are not merely academic. Similar regulations were adopted in the United Kingdom a few years ago and the negative consequences predicted did in fact occur. The cost of investment advice increased significantly and the people who were hurt most were low- and middle-income savers, some of whom had their accounts frozen or even rescinded. The UK is now revisiting the legislation in an effort to encourage more retirement savings.
Replaced by robots
Despite industry protests, the DOL believes the market will accommodate the new regulation, and if financial advisors, broker-dealers and insurance agents don't want the business, they could be replaced by so-called “robo advisors,” who operate on electronic platforms and oftentimes offer a lower fee schedule, at least for now.
While these robo advisors may be able to help some investors some of the time, I believe they are no match for the personal touch and understanding that human advisors can bring. These advisors will come under increased pressure in 2016 as the DOL’s proposal makes its way through Congress. Stay dialed-in to learn the latest in what looks to be a very eventful year for the retirement industry.
Glenn Dial is Head of Retirement Strategy in the US with Allianz Global Investors, which he joined in 2011. He has 23 years of defined contribution experience. Mr. Dial is a co-inventor of the method and system for evaluating target-date funds, and is also credited with developing the target-date fund category system known as “to vs. through.”
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The material contains the current opinions of the author, which are subject to change without notice. Statements concerning financial market trends are based on current market conditions, which will fluctuate. References to specific securities and issuers are for illustrative purposes only and are not intended to be, and should not be interpreted as, recommendations to purchase or sell such securities. Forecasts and estimates have certain inherent limitations, and are not intended to be relied upon as advice or interpreted as a recommendation.
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