Small Business Retirement Plans: Will New Regulations Help or Hurt?
Ten thousand Americans retire each day. There are significant societal implications if they are financially ill-prepared for their golden years, which makes retirement security an important topic of public policy debate. One of the easiest ways to encourage individuals to save is by offering retirement plans in the workplace. According to the Bureau of Labor Statistics, 89 percent of employees at large companies have access to retirement plans at work, but that number drops to 50 percent of workers in firms with fewer than 100 employees. So, it seems that as a matter of public policy, the government would want to make it easier for small businesses to offer retirement options to their employees. (See blog post: Small Business Retirement Benefits Made Easier — Three Reform Ideas) However, a proposed regulation by the Department of Labor (DOL) has some claiming that the government is actually undermining small business retirement plans.
The Regulation
Last year, the Department of Labor (DOL) proposed a new fiduciary rule that would apply a higher standard to financial advisors managing retirement accounts, including IRAs and 401(k) accounts. By making these advisors fiduciaries, the rule would require them to put their clients’ interests first (currently security brokers are required to make investment recommendations that are “suitable” for their clients). The government claims the rule is necessary because some bad-apple brokers are putting their own profits ahead of clients’ best interests, thus denying them of higher returns on their investments. The DOL seems to be pursuing a laudable objective. However, opponents of the DOL’s approach claim the rule’s attempt to protect consumers would have negative consequences that would, in practice, deny lower income investors and small businesses of retirement plan options and needed financial advice.
The DOL’s regulation has been in the works since 2010 and is the subject of much debate, even among different government agencies. The proposed rule attracted some 386,000 public comments filed by stakeholders, many of whom are concerned by the change in policy. The rule is complex, but here are some of the basic concerns:
Higher Costs:
The rule would change the way that advisors can charge for what they offer, increase their liability and require onerous new disclosures, all of which make the business of serving clients more costly. Presumably those costs would be passed along to clients, and serving smaller clients may not make financial sense for many advisors. An analysis by the investment research company Morningstar predicts that the financial industry faces costs of $2.4 billion annually at a minimum, which is twice the estimate of government researchers. A survey by Fidelity Investments reveals that due to an expected increase in costs under the rule, 75 percent of advisors plan to re-evaluate the clients they serve and 62 percent will likely let go of smaller clients.
Fewer Choices:
Not only could small businesses have fewer advisors to choose from, they also could have fewer investment options available to them, in part because the proposed rule would discourage commission-based fee structures (which may tempt conflicts of interest) and encourage fee-based arrangements. A study by the U.S. Securities and Exchange Commission explains the concern that “the increase in costs to broker-dealers could cause many to decide to no longer offer certain products and services to retail customers (e.g., due to risk of litigation under a new fiduciary standard or due to restrictions on principal trading), or would only offer them at increased prices, thereby limiting retail customers’ access to the currently available range of products and services.”
Less Advice:
The proposal also would regulate financial education. While some financial education using general terms would be safe, if a product is mentioned or any specific investment is used as an example to explain options, the education could become investment advice and trigger fiduciary responsibilities. The concern is that individuals and businesses may not be able to access the financial information they need for decision making as advisors may limit what they offer or say.
The Legislation:
Congress also has concerns with the DOL’s rule. Bipartisan legislation has been introduced in both the House and Senate that tries to achieve the DOL objective of protecting consumers, but in a way that does not inadvertently reduce retirement options. In the House, the Strengthening Access to Valuable Education and Retirement Support (SAVERS) Act and the Affordable Retirement Advice and Protection Act have been approved by the committees of jurisdiction. The bills would apply a best interest standard to investment advisors, require clearly communicated disclosure about products, and offer legal protections to make consumers whole for any damages suffered at the hands of bad actors. The authors claim their approach would not force consumers into fixed-fee arrangements, thus preserving affordability and choice. Importantly, under the bills, Congress would vote before the DOL’s rule could go into effect. On February 4th, the Senate introduced legislation that mirrors the House bills.
What to Expect:
The DOL submitted its final rule to the Office of Management and Budget for approval in late January, and there is an expectation that the final rule will be published sometime in April. Legislation to curb the rule may receive a vote in Congress, but it’s not likely to become law. The rule won’t take immediate effect, but once finalized, small businesses that use brokers to manage their retirement accounts may see changes in compensation structures, prices, advice given, and may even need to seek out a new financial advisor altogether.