A prospective client is retiring and seeks out the assistance of a fiduciary adviser (however registered) with respect to the client's 401(k) plan. The client inquires, "What should I do?"
Currently, if the prospective client inquires of a discount brokerage firm or mutual fund company, often the answer is: "Rollover your 401(k) to an IRA with us." And the paperwork is initiated to do just that. Similar answers are provided by broker-dealer firms and insurance companies who, more often than not, operate under the suitability standard alone, and not as fiduciaries to the client. Under the suitability standard there exists no duty of due care, in advising the client to undertake a rollover. In fact, the suitability standard abrogates the duty of due care that nearly all other providers of services to Americans possess.
A 2013 GAO Report uncovered alarming evidence of the tactics that financial services firms engage in through the IRA rollover process to secure workers’ assets. For example, financial firms aggressively encouraged rolling 401(k) plan savings into an IRA, and did so with only minimal knowledge of a caller’s financial situation. They also often claim that 401(k) plans had extra fees and that IRA’s “were free or had no fees,” or argued that IRAs were always less expensive, notwithstanding that the opposite is generally true. The report also found that investment firms sometimes offer financial or other incentives to financial advisers who persuade workers to perform a rollover. [401(K) PLANS: Labor and IRS Could Improve the Rollover Process for Participants, GOVERNMENT ACCOUNTABILITY, OFFICE, March 7, 2013.
Disturbingly, many registered investment advisers, already bound by the fiduciary standard, don't appear to be adhering to their fiduciary duties of due care, loyalty, and utmost good faith, when advising upon IRA rollovers. For example, at one robo-advisor, if you click on IRAs, a “Do a 60-Second Rollover” link pops up. There is no indication in that robo-advisor's Form ADV, Part 2A, that financial planning advice is offered. Such firms might argue that the client has waived the firm's obligation to provide financial and/or tax advice pursuant to disclosures found in the firm's Form ADV, Part 2A and the terms of the clients fee agreement. Indeed, such waivers have arisen from the SEC's weak application of the anti-waiver provisions found in Section 215 of the Investment Advisers Act of 1940). Yet, as I've explained before, the concepts of waiver and estoppel possess limited application in fiduciary relationships under trust law (from which ERISA "sole interests" fiduciary standard is derived) as well as under state common law (from which the Advisers Act "best interest" standard is derived). Moreover, pursuant to the U.S. Department of Labor's proposed "Conflicts of Interest Rule," waivers of core fiduciary duties are not permitted.
The IRA rollover decision is a complex one, and it deserves the scrutiny of an expert adviser operating under the fiduciary standard of conduct. Instead of the representative of a mutual fund company, brokerage firm, or insurance company, automatically stating: "Yes, rollover that IRA with us," the reply should be: "Let's examine your circumstances, so that we may advise you to undertake the actions that are most prudent for you."
Any fiduciary adviser providing advice on an IRA rollover should fully understand, and be able to apply, the often complex tax and other considerations that may affect the decision, including but not limited to:
(1) the availability under many qualified retirement plans (QRPs) to undertake distributions commencing at age 55, rather than the age 59½ requirement imposed upon IRAs;
(2) the existence and best methods for undertaking a series of substantially equal periodic payments from traditional IRA accounts using the 72(t) election;
(3) the 2-year-from-inception restriction on distributions from SIMPLE IRA accounts;
(4) the ability to distribute appreciated employer stock from certain QRPs and receive long-term capital gain treatment upon its later sale, under the technique commonly referred to as “net unrealized appreciation;"
(5) the most tax-efficient manner to design, implement and manage a client’s entire portfolio, which might consist of QRPs, traditional IRAs, Roth IRAs, nonqualified annuities, life insurance cash values, taxable accounts, 529 college savings plans accounts, HSA accounts, and other types of accounts, generally, in order to best secure for the client the likely attainment of the client’s objectives;
(6) the ability to undertake due diligence on the investment options within a QRP account, including but not limited to the potential availability of guaranteed investment accounts (and the risks and characteristics of same, including the reduced exposure to interest rate risk which might be present);
(7) the restrictions which exist on the availability of foreign tax credits and/or deductions for foreign stock funds held in certain types of accounts;
(8) the best manner to minimize future potential income tax liability for both the clients and the client’s potential heirs, including the role of stepped-up basis;
(9) the availability of tax-managed or tax-efficient stock mutual funds in taxable accounts;
(10) the marginal rates of tax (federal, state and local) which might be imposed upon ordinary income and long-term capital gain income, and qualified dividend income, both in the current year and in future years;
(11) the ways to avoid realization of short-term capital gains and long-term capital gains;
(12) the harvesting of losses in accounts and how such losses may offset either various types of capital gains or ordinary income (up to certain annual limits);
(13) whether Roth IRA conversions should be considered, and if so when and to what extent, whether
separate Roth IRA accounts might be established during conversions for different investment assets, and whether re-characterizations might take place thereafter;
(14) whether distributions might be undertaken to generate additional ordinary income, in order to mitigate the effect in any year of the alternative minimum tax;
(15) the increased amount of premiums for Medicare Part A which might result should the client’s modified adjusted gross income exceed certain limits;
(16) the effect of additional income resulting from QRP or IRA distributions, or from other investment-related income, on the taxation of social security retirement benefits;
(17) the interplay between the timing of taking social security retirement benefits, income tax itemized vs. standard deduction strategies, the receipt of various forms of income, and the taking of QRP or IRA distributions, given the various marginal income tax rates the client is likely to possess, then and in the future, for both federal and state tax purposes;
(18) the ability to take investment advisory fees from certain types of accounts, the best methods to allocate fees and pay them from various types of accounts, the potential for deductibility of fees when paid from certain types of accounts, and avoidance of prohibited transactions which might otherwise result if fees for non-investment advisory services are incorrectly paid from QRP or IRA accounts;
(19) the ability to delay QRP distributions past age 70½ in certain circumstances, for certain clients;
(20) the availability of lifetime annuitization options for a portion of any QRP or IRA, both inside the QRP and in a rollover IRA, including an evaluation of the single life, spousal (with and without reduced benefits to the survivor), term certain, and combinations of the foregoing, and including further an evaluation of the possible use of CPI adjustments in the annuity contract to keep pace with increased spending needs, and including further the possible use of a staggered approach to annuitization, and including further the available of deferred annuities with payouts commencing at later ages, and including further the risks and return characteristics of certain annuities, the costs and fees associated with same, the possible applicability of premium taxes, the various riders which might be employed and their costs and benefits and limitations; and
(21) the best method to ensure asset protection of the rollover IRA, such as by segregating it from
contributory IRA accounts.
The foregoing is not a finite list of the issues that might come into play. I invite readers to post comments with other issues that might be considered when opining on a rollover to an IRA.
In a prior post I opined: "In essence, [fiduciary] investment advisers to individual consumers are financial planners, first, and investment advisers, second. We must understand that investment advice to individuals cannot be delivered in a vacuum. Hence, I would opine that some level of financial planning is therefore a necessary prerequisite to the investment of client funds." Applied to the 401(k) [or other qualified retirement plan] rollover to an IRA, there is clearly a need for financial planning to occur, prior to the IRA rollover decision.
Plan participants and IRA account owners seek to overcome the challenges of today’s far more complicated modern financial world, with its myriad of investment options and significant number of traps for the unwary. Our fellow Americans are in full need of the protections of the fiduciary standard of conduct.
As the U.S. Department of Labor progresses forward with the finalization of its "Conflict of Interest" rule, with a likely full implementation date in late 2016, those providing advice on IRA rollovers must adapt. Training will be required of call center employees. Additional time will need to be spent with prospective clients, to gather more information, undertake the analysis, and to provide advice, before the IRA rollover can proceed. In most instances, this will require less than an hour of additional time, by a person trained in the planning issues present. But in other situations, greater time will be required. New service methodologies will be required, along with possible new fee structures to reflect the level of advice provided.
The IRA rollover decision is one of the major financial and investment issues present in the lives of the American worker. Given such, it deserve the application of the requisite degree of knowledge and skill, to identify and provide advice upon possible opportunities presented that can significantly aid the client's financial future.
- Feb. 24-25, 2016: FPA of Oregon and S.W. Washington Midwinter Conference 2016, where Ron will discuss: "The DOL's Transformational Conflict of Interest Rule."
- Feb. 26, 2016: FPA of Puget Sound's 2016 Annual Symposium, where Ron will discuss: "Reducing Your Risks in the New Fiduciary Era."
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