Recently the Department of Labor (DOL) put in force a rule (July 1, 2022) that would affect financial advisors ability to recommend rolling over a 401k, pension plan, or IRA account to another IRA account. The specific rule from the Department of Labor (DOL) is known as PTE 2020-02. The history of PTE 2020-02 has a long and windy road. Something I was completely unaware of is there is a whole website dedicated to the history and evolution of the rule here. The actual origins of the DOL rule started in October 2010 (Proposal 1.0). Later in April 2015 President Barack Obama in a speech mentioned it which then culminated in a April 2016 final rule which was supposed to have started June 9, 2017. The decision was then challenged 6 different times and was vacated in the Fifth Circuit Court in March 2018 (65 page decision is here). Currently there is a lawsuit in the Fifth Court in North Texas (more on this later).
First it is important to understand what government agencies are involved here. You have the Department of Labor (DOL), the IRS, the Securities and Exchange Commission (SEC). Generally speaking only the SEC regulates financial advisors. To make things a little more complicated there is a law called Employee Retirement Income Security Act of 1974 (also known as ERISA) that is administered by the DOL. ERISA covers for example 401k plans, pension plans, and even health care plans that company offer employees (think of employee benefits). When ERISA was created Title II was the actual legislation that created IRA accounts within the Internal Revenue Code (also known as the tax code). Generally speaking the IRS enforces tax rules related to 401k/IRA accounts. For example if someone takes a distribution from their 401k or IRA account before they are 59 1/2 they potentially could have a 10% penalty (the Department of Labor does not enforce this). It is important to know that Title II "did not authorize the DOL to supervise financial providers over ERISA plans". Common sense would say ERISA has authority over 401k plans however once a transfer is made from a 401k to another investment account (IRA/HSA) the power of ERISA is not carried forward to the IRA account or other account type.
The issue at stake is there is roughly $7.3 trillion dollars of assets in 401k plans and $13.2 trillion dollars of assets in IRA accounts. In 2016 the DOL tried to estimate the cost to comply with the fiduciary rule would be $31.5 billion over 10 years. The DOL goes on to have the breakthrough conclusion that the legislation would "save" $40 billion over a 10 year period. I tried to actually find a study of how the $40 billion was calculated. In a press release it is mentioned that consumers may be paying 1%/year more. By this what they are trying to say is that an individual who has a 401k plan who then rolls over that 401k plan to an IRA will end up paying 1% more. My favorite part of the whole press release is "Today, the DOL is finalizing rules retirement investment advisers to meet a "fiduciary" standard-putting their clients' best interest before their own profits". This is utterly foolish of course. This presumption is that a financial advisor provides little to no value. Studies from Vanguard show that an advisor actually adds about 3%/year of value. The main reason is financial advisor can often coach their clients against doing foolish things (like wanting to put all their money in cash when the stock declines). People are often not rational with their money. Also why would people work with someone that simply "steals" 1% of their money (real estate, agents, and recruiters take a far higher percentage yet I don't see any legislation for them).
Looking at actual data shows that for individuals who have under $250k in assets (you know the people the Department of Labor claims are being harmed) the cost that an advisor charges for managing the assets is 1.25%/year. Data from the 401k world shows that 401k plan fees are about .88%-1.19%/year (the fee depends on the size of the 401k plan as usually larger plans aren't as expensive since they have economies of scale). To make the math simple just rounding the average 401k plan fee to 1%/year and comparing it to a cost of 1.25%/year for what a financial advisor charges. This would say the difference is .25%/year or about a 75% less than what the DOL claims! Even being conservative and taking the all in fee of what a financial advisor charges (both the financial planning fee and investment fee) is still less than what the DOL claims. For instance for people that have assets of up to $250,000 their all in fee (financial planning plus underlying investment fees) is 1.85/year%. Again going back to the logic of the DOL if you take the average 401k plan fee of 1%/year and add the DOL's calculation of an extra 1%/year that financial advisors charge would get 2%. However, over time as individuals build wealth their assets under management fee (as a percentage) will decline. For example for individuals that have $500,000 to $1 million their all in fee (financial planning plus underlying investment fees) would be 1.5%/year. Again this is 25% less than what the DOL calculated. The only limitation to this study was this only focused on independent financial advisors and didn't for example include brokers, insurance agents, or people who just sell investment/insurance products. However, there has been a shift towards independent fee only financial advisor.
However, consumers over the years have been moving more to advisors who work as an independent fee only financial advisor. In addition to this the data shows that advisors are moving from working away from broker dealers/insurance agents who just sell investment products and shifting more towards independent financial planning firms (who sell advice and not products). The number of broker dealer firms has been declining rapidly. In 2002 there were 5,374 broker dealer firms. In 2021 there 3,394 broker dealer firms. This would say in almost a 20 year period the number there has been almost a 40% decline in the number of broker dealer firms.
Meanwhile at the same time the number of broker dealer firms has declined the number of registered investment advisor firms (RIA) has increased. In 2008 there were 25,073 registered investment advisor firms. In 2017 the number of RIA firms increased to 30,193 (a 20% increase). Given this is some old data I would be willing to say the number would be even greater today. There is a good reason for the growth in RIA firms. RIA firms have to put their clients needs ahead of their own and have to act as a fiduciary (broker/dealers only have to meet a suitability standard which is very vague and broad). As someone who has worked in the industry financial advisors who work for RIA firms are very client focused and are very transparent with how they charge (either an assets under management fee, hourly rate, or some other type of fee arrangement. Also it is important to note that the number of RIA firms increased without any government regulation (consumers choose this).
The new rules under PTE 2020-02 requires that financial advisors either make a recommendation (with analysis) of why it makes sense to rollover a 401k to IRA, a defined pension to an IRA, an IRA to an IRA, or health savings account (HSA) to an IRA. The alternative is financial advisors can just provide education to their clients on the advantages or disadvantages of making a recommendation. However if an advisor provides the education the advisor can in no way advise/influence/recommend what the client should do (even saying "if it were me I would do this" is prohibited). Each approach is filled with flaws that potentially get an advisor in trouble. If the advisor decides to make a recommendation they have to identify the reasons for the rollover along with the costs associated of doing so. For example when looking at the cost of holding the monies in a 401k plan should the lowest cost investment be used-even if the client doesn't currently doesn't own that investment? Also the advisor has to calculate the cost rollover of the 401k, pension plan, IRA, or HSA. Although the vast majority of financial advisors charge a percentage of assets they manage what if a advisor charges an annual retainer fee or an hourly fee. How is this analysis performed correctly? Also I am skeptical the DOL even would understand the nuance of this math since as I mentioned before they were completely off the mark on calculating the 1%/year long term cost of how much consumers would be paying in the long run. Also it is up to the advisor to ask the client to try to obtain information on fees/costs associated with the 401k plan/pension plan/HSA which in my experience is not only hard to obtain but more importantly even if you obtain the documentation from the plan it is almost impossible to decipher. Also another issue is that this cost benefit analysis has to be done for each 401k plan/IRA/HSA that is recommended which can be burdensome if a client has a dozen different accounts. Given the fact that people may have 12 different employers in their working career. Each individual account/plan has to be evaluated and analyzed for the total amount of fees based and services offered which could turn into a paper compliance hurricane for an advisor.
The penalties for violating PTE 2020-02 can be severe as well. Since the DOL considers advice related to rolling a 401k plan over to an IRA or an IRA to IRA as a prohibited transaction (thus the advisor has to receive permission from the government to receive compensation from the client). If it is found that a prohibited transaction has occurred the financial advisor can face penalties of up to 100% of the amount involved and penalties from the IRS as well. This is somewhat insane considering the financial advisor is taking a large risk to in essence just fill out paperwork to inform a client of their rollover options. Also I would point out that clients even before this were asking the questions of the advantages and disadvantages of rolling over their 401k/pension plan/or HSA to an IRA account. Also if a client has been working with an advisor for many years it could easily assumed that the client would trust the advisor and their recommendations (however if the advisor decides to go the education route of providing the advantages and disadvantages to rolling over the 401k/pension plan/IRA or HSA account would be legally barred from making any type of recommendation.
The last time I checked doctors/attorneys/or any other profession don't face a similar position of giving a patient/client information and the provider not being able to make a recommendation. Also doctors and attorneys deal with matters of life and death. As a result of these new rules some financial advisors will cease to give advice on 401k rollovers due the compliance burden faced. Also more importantly when I go out to a restaurant and consume food I am not required to sign any type of paperwork or be informed about the advantages or disadvantages to eating a nice steak (as the steak is a rollover from the restaurant to my stomach-the steak could kill me but the last time I checked a 401k has never been the cause of any death).
Once possible silver lining in this new DOL rollover rule is a recent court case decision. Recently the Supreme Court case West Virginia vs. EPA ruled the the EPA had overstepped it's regulatory authority. Since there was a large economic and political significance to what the EPA was trying to achieve (that was not legislated by Congress) the Supreme Court found the EPA didn't have the authority to act as a de facto Congress and make their own rules. The outcome of the West Virginia vs. EPA decision could have an impact on the DOL rollover rule. Fiduciary responsibility is under the purview of ERISA and ERISA was never given authority from Congress to apply this to IRA accounts. Currently there is a lawsuit in the Fifth Circuit Court challenging the DOL Rollover rule. The recent lawsuit includes arguments from the the EPA decision with Supreme Court Justice Neil Gorsuch making the comment "But the Constitution does not authorize agencies to use pen-and-phone regulations as substitutes for laws passed by the people's representatives".
The DOL has overstepped it's regulatory authority by trying to figure out how to creatively work around the legal system to draft rules that will as a result cause advisors to not want to work with clients that are about to retire, currently have 401k plans, IRA plans, pension plans, or HSAs, given they could possibly be subjected to penalties. The penalties include having to reimburse clients for the fees paid on these accounts, a penalty of 100% of the amount involved, and in the extreme case the advisor could be barred from advising on these type of accounts for 10 years! Current and future court cases will ultimately determine the outcome of PTE 2020-02 but the sheer overreach of the DOL should be a warning of government agencies gone wild.
