Rule check: All you need to know about DOL's retirement regulation

April 30, 2024 1:06 PM

The stakes of the Labor Department's new retirement advice rule are high, as a comparison of potential industry compliance costs with the possible savings for 401(k) investors displays.

For Labor's Employee Benefits Security Administration and advocates of the updated Employee Retirement Income Security Act, independent research firm Morningstar's projection that the rule could save investors as much as $87.5 billion in the next 10 years easily justifies the agency's estimated compliance expenses of $3.5 billion over the same period. To opponents, Oxford Economics' calculation on behalf of the Financial Services Institute (an advocacy group representing independent brokerages and advisors) that implementation over the next 10 years could cost the industry more than $25 billion calls the whole rulemaking into question.

The final rule's cost-benefit analysis and other provisions that are likely to be disputed in an industry court challenge are outlined below.

The Biden administration contended the new regulation was necessary to protect retirement savers, asserting that conflicts of interest in the sales of fixed index annuities alone cost retirement savers as much as $5 billion a year — a figure that industry trade groups rejected as inaccurate.

Yet it sounded like "a reasonable estimate" to David Lau, CEO of DPL Financial Partners, a fee-only insurance consulting network that RIAs use for annuities and other products without commissions. Some of those products can carry "high fees and high commissions" with surrender periods as long as 15 or 20 years, Lau noted in an interview. He described the rule as a "basically common-sense regulation" reflecting how most consumers would answer if asked whether they were receiving fiduciary retirement advice.

"They'd say, 'Yes,' and it would probably be surprising to them if they knew that it wasn't required before this," Lau said.

He also described as a "pretty soft argument" the views of critics who claim applying the fiduciary duty to 401(k) rollovers and other advice to workplace retirement savers will lock them out of access to pivotal services. The rule requires rollover and fund recommendations to 401(k) plan participants to put those savers' interests first — a fiduciary duty that's already the modus operandi for registered investment advisory firms and certified financial planners.

"Regulation can spur innovation. … If there is a hole in the market, that's the great thing about capitalism. People will find ways of serving these clients, if it is in fact true. But I question whether it's true or not," Lau said. "I dont think it's going to impact RIAs very much at all. They're already very much acting as fiduciaries. It's more going to impact the one-off salesman trying to convert a 401(k) into an annuity."

To see key excerpts from the final version of the Labor Department's retirement advice rule, scroll down the slideshow. And stay tuned in coming weeks for a sampling of the accompanying amendments to the guidelines for prohibited transaction exemptions (PTEs).

For a summary of the main provisions of the initial proposal, click here. And for a roundup of the reactions to Labor's issuance of the final rule last week from key stakeholders, follow this link.

‘Better reflects’ ERISA and ‘better protects’ retirement savers

"As compared to the previous regulatory definition, which was finalized in 1975, the final rule better reflects the text and the purposes of ERISA and better protects the interests of retirement investors, consistent with the Department's mission to ensure the security of the retirement, health, and other workplace-related benefits of America's workers and their families. The final rule is designed to ensure that retirement investors' reasonable expectations are honored when they receive advice from financial professionals who hold themselves out as trusted advice providers."

Transactions currently without uniform coverage

"Requiring advice providers to operate in compliance with ERISA fiduciary protections will be especially beneficial with respect to those transactions that currently are not uniformly covered by fiduciary protections consistent with ERISA's high standards. Those transactions include recommendations to roll over assets from a workplace retirement plan to an IRA in those cases in which the advice provider is not subject to federal securities law standards and, as is often the case, has not previously advised the customer about plan or IRA assets on a regular basis. Other examples include investment recommendations with respect to many commonly purchased retirement annuities, such as fixed indexed annuities; recommendations of other investments that may not be subject to the SEC's Regulation Best Interest, such as real estate, certain certificates of deposit and other bank products; and investment recommendations to plan fiduciaries with authority or control with respect to the plan."

Final rule ‘narrows the context’ in response to public comments

"The department has made certain changes and clarifications in the final rule in response to public comments on the proposal and the testimony presented at the public hearings. The final rule narrows the contexts in which a covered recommendation will constitute ERISA fiduciary investment advice and makes clear that the test for fiduciary status is objective. Similarly, a new paragraph in the regulatory text confirms that sales recommendations that do not satisfy the objective test will not be treated as fiduciary advice, and that the mere provision of investment information or education, without an investment recommendation, is not advice within the meaning of the rule."

Effective date

"The final rule is effective Sept. 23, 2024. The amendments to the PTEs also finalized today are effective Sept. 23, 2024. Both amended PTE 2020-02 and amended PTE 84-24 include a one-year transition period after their effective dates under which parties have to comply only with the 'impartial conduct' standards and provide a written acknowledgment of fiduciary status for relief under these PTEs."

How retirement savings have changed in the past 40 years

"In 1981, private defined benefit plans held more than twice the assets in private defined contribution plans, and roughly 10 times more than IRA assets. By the third quarter of 2023, the order had reversed: IRAs held $13.0 trillion in assets, private defined contribution plans held $8.4 trillion, and private defined benefit plans held $3.7 trillion in assets.This trend is expected to continue as retirement investors are projected to move $4.5 trillion from defined contribution plans to IRAs from 2022 through 2027."

The extent of IRA rollovers

"A 2020 survey found that 46 percent of recent retirees who had at least $30,000 in retirement savings had rolled at least some of their savings into an IRA. In 2022, almost 4.5 million defined contribution plan accounts with $779 billion in assets were rolled over into an IRA. Additionally, 0.7 million defined contribution plan accounts with $66 billion in assets were rolled over to other employment-based plans. The department used IRS data from 2020 to estimate overall rollovers into IRAs and arrived at estimates of 5.7 million taxpayers and $618 billion. Adding in the figures for plan-to-plan rollovers, the department estimates the total number of rollovers at 6.4 million accounts with $684 billion in assets."

Research firm Morningstar estimates savings of $87.5B over next decade

"Morningstar submitted a comment that quantified potential benefits of the proposal in two areas. First, as a result of the proposal's coverage of recommendations to plan fiduciaries about the fund lineups in defined contribution plans, participants in workplace retirement plans would save over $55 billion in the first 10 years and over $130 billion in the subsequent 10 years, in undiscounted and nominal dollars, due to reductions in costs associated with investing through their plans. Second, retirement investors rolling over retirement funds into fixed indexed annuities would save over $32.5 billion in the first 10 years and over $32.5 billion in the subsequent 10 years, in undiscounted and nominal dollars, also due to decreased pricing spreads."

Revising estimated cost over the next decade upward by 59% to $3.5B from $2.2B

"The department estimated that the costs associated with the proposal would be $253.2 million in the first year and $216.2 million in subsequent years. In response to comments received in the proposal, the Department has increased the cost estimates to $536.8 million in the first year and $332.7 million in subsequent years. The largest contributions to the change in cost estimates from the proposal to the final rulemaking are an increase in time to review the rule as well as an increase in the number of independent producers and transactions by independent producers affected by the rulemaking."

Disputing FSI study on cost of the rule

"In its comment letter, the Financial Services Institute cited findings from a survey conducted by Oxford Economics. This survey interviewed members of the Financial Services Institute and was commissioned by the Financial Services Institute. The survey estimated that the costs of the proposal imposed on broker-dealers would be approximately $2.8 billion in the first year and $2.5 billion in subsequent years, 11 and 12 times the department's estimate in the proposal, respectively. They noted that their estimates include costs to upgrade software systems and incremental time of staff and broker-dealers. The department has revised this rulemaking, however, to make PTE 2020-02 largely consistent with the requirements of Regulation Best Interest, even more so in this final rulemaking than in the proposal. As most broker-dealers surveyed for these estimates would already be subject to Regulation Best Interest, the department questions the magnitude of additional burden on broker-dealers for complying with the closely aligned requirements of Regulation Best Interest."

Review and implementation alone will take 373K hours, cost $62M

"In the proposal, the department estimated that it would take an average of nine hours for a legal professional to review the rule. The department received several comments indicating that this was a significant underestimate with some commenters suggesting that the review would take a team of professionals. In response to these comments and in further consideration of what review processes affected financial institutions may employ, the department has updated its estimate. The department estimates that, on average, it will take a financial institution 20 hours to review the rule and develop an implementation plan, resulting in a total hour burden of 372,646 hours and an estimated cost of $61.8 million in the first year."

The loophole the rule seeks to close

"As a result of the five-part test in the 1975 regulation, and its limiting interpretation of ERISA's statutory, functional fiduciary definition, many financial professionals, consultants, and financial advisers have no legal obligation to adhere to the fiduciary standards in Title I of ERISA or to the prohibited transaction rules in Title I and Title II of ERISA, despite the critical role these professionals, consultants and advisors play in guiding plan and IRA investments. In many situations, this disconnect undermines the reasonable expectations of retirement investors in today's marketplace; a retirement investor may reasonably expect that the advice they are receiving from a trusted adviser is fiduciary advice even when, under the 1975 regulation's interpretation, it is not. If these investment advice providers are not fiduciaries under Title I or Title II of ERISA, they do not have obligations under Federal pension law to either avoid prohibited transactions or comply with the protective conditions in a PTE."

The new test determining when the fiduciary duty is applied to retirement advice

"The final rule covers recommendations made in the following contexts:

The person either directly or indirectly (e.g., through or together with any affiliate) makes professional investment recommendations to investors on a regular basis as part of their business and the recommendation is made under circumstances that would indicate to a reasonable investor in like circumstances that the recommendation:
is based on review of the retirement investor's particular needs or individual circumstances,
reflects the application of professional or expert judgment to the retirement investor's particular needs or individual circumstances, and
may be relied upon by the retirement investor as intended to advance the retirement investor's best interest; or
The person represents or acknowledges that they are acting as a fiduciary under Title I of ERISA, Title II of ERISA, or both with respect to the recommendation.

"In the final rule, and in response to public comments, the department has also made changes designed to ensure that it did not capture communications that were not properly viewed as fiduciary advice. Thus, for example, the final rule includes a new paragraph expressly declining fiduciary treatment for mere sales pitches that fall short of meeting the test above. Similarly, the rule makes clear that mere investment information or education, without an investment recommendation, is not treated as fiduciary advice."

Robo-advice treated like other types of advice

"While the department does recognize that robo-advice is not a completely conflict-free solution to providing low-cost, investment advice, based on these findings, the department believes that robo-advice can still play a vital role in the investment advice landscape for retirement investors, particularly for younger, lower-balance investors. Additionally, while the rate of adoption of pure robo-advice has slowed, firms have begun adding hybrid financial advice offerings that blend access to a human adviser with automated advice. These hybrid robo-advice alternatives may mitigate some of the concerns expressed regarding pure robo-advice. With the same fiduciary standard applying to all of these types of advice, this rulemaking ensures that different business models will be treated in a consistent manner and that different types of customers, including small investors, will be protected."

Asset managers’ guidance to advisors not covered by rule

"Additionally, the final rule makes clear that the rule is focused on communications with persons with authority over plan investment decisions (including selecting investment options for participant-directed plans), rather than communications with financial services providers who do not have such authority. Accordingly, the rule excludes plan and IRA investment advice fiduciaries from the definition of a retirement investor. As a result, an asset manager does not render fiduciary advice simply by making recommendations to a financial professional or firm that, in turn, will render advice to retirement investors in a fiduciary capacity. The department believes the final rule, with these revisions, appropriately defines an investment advice fiduciary to comport with reasonable investor expectations of trust and confidence."

Takeaways from public comments

"Commenters on the proposal generally agreed that as a result of the shift from defined benefit plans to 401(k)-type individual account retirement plans, retirement investors today face increased responsibility for ensuring their own secure retirement. Commenters cited studies indicating that many Americans are concerned that they will not have saved enough money to achieve that goal. Many commenters discussed the related importance of retirement investors' access to professional investment advice. In connection with these points, some commenters said the proposed update to the investment advice fiduciary definition would provide important protections that would support retirement investors' access to investment advice intended to advance their interests. Other commenters said the proposed update to the investment advice fiduciary definition was not necessary and that the scope of the proposed definition exceeded the Department's jurisdiction and could reduce access to advice."

Conflicts of interest, large commissions on annuity sales

"With respect to the insurance marketplace, several commenters described significant conflicts of interest associated with large commissions on some annuity sales, as well as abusive sales practices. Commenters also noted that the terms of annuity contracts, including surrender charges, may often be detrimental to retirement investors but may not be well understood. One commenter said recommendations of annuities for purchase inside retirement accounts deserve special scrutiny because the annuities are often marketed based on purported tax deferral advantages that would not be realized inside an already tax-preferred retirement account."

Other views of annuities

"A number of commenters said the proposal would have a negative impact on access to annuities, which are generally sold on commission. These commenters described annuities as an important option for retirement investors seeking a guaranteed lifetime income stream as part of their retirement plan. Some of these commenters said the department's proposal failed to recognize the value of these products and was inconsistent with congressional intent to promote lifetime income options, as evidenced by recent pension legislation in the Secure Act and the Secure 2.0 Act. Commenters specifically mentioned such features as protection against volatility, longevity and inflation risk through guarantees."

Fiduciary duties on salespeople?

"Some commenters said the department's proposal would impose ERISA fiduciary duties on financial professionals who are traditionally considered salespeople. The commenters said that when the financial professional is paid on commission it should be clear to the retirement investor that the professional is engaging in sales activity, as opposed to providing advice. Commenters said that under the Fifth Circuit's Chamber opinion, salespersons are generally not considered to have a relationship of trust and confidence with their customers. One commenter said: 'the fact that a broker-dealer or insurance agent acts in a manner that is trustworthy and provides guidance and recommendations in the investor's best interest does not alter the sales relationship and does not implicate or confer fiduciary status.'"

Skepticism of claims of lost access

"Other commenters generally urged the department to be skeptical of industry predictions of loss of access to advice and services. They believed providers would remain available to serve retirement investors irrespective of account balance size. They also said they were not aware of any decrease in access to advice and products following the recent adoption of other conduct standards including Regulation Best Interest. Rather, they said, the experience with Regulation Best Interest shows that financial professionals paid on commission can comply with an explicit best interest standard that requires conflict mitigation. A commenter also pointed to the fact that financial professionals paid on commission are among the CFP professionals who have adopted the CFP Board fiduciary duty."

More on impact of CFP Board fiduciary guideline

"The CFP Board reported that after its new standards were adopted, only 10 percent of their members raised required asset minimums and only 6 percent terminated client services.The new standards also did not discourage entry of new financial professionals with a record number of new CFP certificants in 2023 — also the most diverse class in the board's history."

Titles and consumer expectations

"Commenters said that marketing slogans and titles such as 'financial advisor,' 'financial consultant,' and 'wealth manager' are commonly and deliberately used to establish a sense of trust and confidence. One commenter cited several examples of marketing strategies employed in the insurance industry. One such example described a 'Trusted Advisor Success Training Workshop' showing insurance agents how they 'can have endless streams of new, repeat, and referral business' by 'mak[ing] the move from a salesperson to a Trusted Advisor!'"

Some fiduciary recommendations come with commissions

"In many instances, such as those involving advice on 'buy and hold' strategies, a commission-based model may be more appropriate for the investor, and a prudent fiduciary may recommend the use of a commission-based structure, rather than advise the investor to enter into an arrangement that requires the payment of ongoing fees without a commensurate need for ongoing advice. Nothing in the text of the statute, the text of the 1975 regulation, or previous guidance draws a distinction between commission-based compensation and other forms of compensation in determining whether a person is a fiduciary when making recommendations for direct or indirect compensation."

Public comment process

"The record generated by the public notice and comment process was robust and reflected strong input from a wide range of affected parties on a wide range of issues. Based on its careful review of that record, the department is confident that the process was full and fair, the process served its important goals, and the final rulemaking benefitted from the thoughtful input of the thousands of commenters, including firms, investment professionals, consumers and others who participated in the process."