On April 6th, the Department of Labor (DOL) released the final version of their Fiduciary Rule. This ruling impacts anyone who receives investment advice on their IRA or company 401(k) plan. The updated Fiduciary Rule has been described by some as the most significant change in the retirement and IRA marketplace since the Employee Retirement Income Security Act of 1974. The DOL itself stated in their release, “The basic rules governing investment advice have not been changed since 1975.”
For the last six years, there has been a heated debate about this rule within the investment and financial service industry. So, what is this new rule and how does it impact those of us with an IRA or 401(k) account?
Starting in April of 2017, any firm receiving compensation for providing investment advice on IRA or 401(k) accounts must adhere to a fiduciary standard. This standard requires investment advisers to act in the best interest of their clients. Currently, many investment firms work under the fiduciary standard already and are therefore already compliant under the new law. However, there are some firms that work under a less strict standard which simply requires the investments they sell to their clients to be “suitable” but not necessarily in their best interest.
In many ways, it’s surprising that advisors were not already required to work under the fiduciary standard. Currently, there are two primary ways in which financial advisers are compensated for managing their client’s assets. The first is referred to as a “fee-based” or “advisory” platform. Many firms, like Sustainable Wealth Management (SWM), prefer this approach and have used it for years because it eliminates many of the potential conflicts of interest an adviser may have in managing accounts. I believe this is the fairest approach and it also meets the new fiduciary guidelines. Under this arrangement, the adviser is compensated by way of a management fee that is deducted from the clients’ account on a regular basis.
The second approach many firms use is known as a “commission based” platform. Here, advisers generally receive commissions from the investment companies they choose to invest clients’ money in. I am certainly not suggesting that advisers who use this approach are not acting in their client’s best interest, but I believe there are more potential conflicts as certain advisers may use certain investment vehicles over others based upon the level of fees and commissions they receive.
The DOL is trying to address this issue in their new ruling by requiring these advisers to do what is in the client’s best interest, which was not the case before. Another part of the rule requires advisers to enter into a Best Interests Contract (BIC) agreement with their clients. BIC commits the advice provider to a fiduciary standard of giving advice in the “best interest” of the client, earning “reasonable compensation,” and providing appropriate disclosure and transparency about the products and compensation.
At the end of the day, I believe there is no “one size fits all” model when it comes to seeking investment advice. While I have always adhered to the fiduciary standard, I feel the new ruling by the DOL is great for clients as it makes the associated fees and expenses of investment advice more transparent.
This edition of Tip of the Week was written by Todd Pisarczyk, owner of Sustainable Wealth Management in Vancouver. He can be reached at 360-597-4570.