How the Department of Labor's Fiduciary Rule Affects Retirement Savers

On June 9th, the long anticipated (and hotly debated) Department of Labor fiduciary rule goes into effect. The rule impacts investors in significant ways, especially those that are saving for retirement.

What is the Fiduciary Rule?

Simply put, the rule requires a financial advisor to act as a fiduciary when providing investment guidance for compensation on retirement accounts, such as Roth or Traditional IRAs. A fiduciary must, at all times, act in the best interest of their client, rather than their own.

For those advisors giving investment advice for compensation on retirement accounts, the advisor must adhere to an “Impartial Conduct Standard.” This standard requires that the advisor:

  1. Give financial advice that is in the retirement account holders’ best interest
  2. Charge reasonable compensation
  3. Make no misleading statements

Isn’t Acting as a Fiduciary an Obvious Approach?

Some wonder why this rule is coming out now, when it seems obvious that a fiduciary standard of care should have always been in place. While there is much debate over whether most advisors were already acting in their clients’ best interest, the fact remains that, until now, many financial advisors helping clients with retirement accounts were only required to adhere to a Suitability Standard.

A suitability standard of care only required that investment guidance be suitable for a client, but not necessarily in their best interest. What's the difference?

Suitability vs. Fiduciary Standard - An Illustration

Suppose you are meeting with a financial advisor to receive guidance on your Roth IRA. You’ve been saving aggressively, maxing out your contributions each year, and putting your money into a target date fund.

Wanting to work with an advisor rather than handle your investments yourself, you find an advisor to directly manage the account for you. When choosing which investments to put your money into, the advisor will typically have a large variety of choices. Several investments may accomplish the same goal, but one investment may carry a higher fee than the other.

Mutual Fund A may charge a small fee, while Mutual Fund B (which has very similar characteristics as Mutual Fund A) may charge a relatively large fee. These fees, such as a mutual funds expense ratio or a front-end sales load (paid to your advisor--like a commission) on a mutual fund, directly impact your investment returns. It’s the cost of investing in a particular mutual fund.

Under a Suitability standard, the advisor would only be required to ensure that the investment he is recommending is appropriate for you, given your investment objectives such as your willingness to accept investment risk and when you plan to retire. If the suitability standard is met, then the advisor is free to sell you any investment he wants--the lower fee mutual fund, or the one with a higher fee or a big front-end sales load.

If the suitability standard is met, then the advisor is free to sell you any investment he wants—the lower fee mutual fund, or the one with a higher fee or a big front-end sales load!

The Fiduciary standard, on the other hand, requires the advisor to always give retirement account guidance in their clients’ best interest. In the case of this illustration, a mutual fund which accomplishes the same objectives but for a lower cost must be the one selected by the advisor.

A Suitability-Standard Advisor Does Not a Bad Apple Make

It’s important to mention that even though some advisors were held to a different standard, doesn’t mean they’re all bad apples. I know many advisors who have always acted in their clients’ best interest and will continue to--whether they’re helping them with a retirement account or non-retirement account.

However, there’s little question that there have been some advisors who have used the lesser standard for their own personal gain. The primary motivation behind the Department of Labor’s ruling is to protect the financial interests of retirees by trying to keep fees in retirement accounts lower and advisors interests more closely aligned to their clients’.

An Invitation to Talk to Your Advisor

If you work with a financial advisor who manages your retirement account(s), you’ve almost certainly received some information in the mail about these upcoming changes. It would be worth your time to give your advisor a call and ask them any additional questions you have about how the new rule might affect your relationship with your advisor.

In addition, the new DOL fiduciary rule is a good reminder to ask your advisor how they are compensated. As I mentioned, the rule requires advisors of retirement accounts to charge reasonable compensation, but you should know what that compensation is and what services you’re getting for it.

Note: As a Registered Investment Advisor, Hale Financial Solutions has always held itself to a fiduciary standard, whether my clients have retirement accounts, non-retirement accounts, or no investment account at all. It’s always made the most sense to me, and is part of the reason I started Hale Financial Solutions.