The recent decision by the 5th Circuit Court of Appeals to vacate the Department of Labor’s fiduciary rule has created much-needed clarity on the subject of rollover recommendations. Unfortunately, it’s not necessarily what 401k advisors were hoping to hear.
The newly reinstated rules clearly outline the circumstances under which rollover recommendations are considered prohibited transactions. However, the change also eliminated the provision for a best interest contract exemption (BICE), creating serious concerns for plan advisors.
Those who fail to understand and follow the rules regarding rollover recommendations may quickly find themselves in hot water. Here’s what you need to know.
5-Part Fiduciary Test
Under the current rules, a five-part test is used to determine whether an advisor is a fiduciary on a plan. To qualify, each of the following five criteria must be met:
- Investment advice is provided to the plan for a fee or other compensation
- The advice is given on a regular basis
- The exchange of advice for compensation is provided under a mutual understanding
- It is understood that the plan will base its decision-making on the advice provided
- The advice is specifically tailored to the needs of the plan in question
If the five-part test determines the advisor is not a fiduciary on the plan, rollover recommendations are not considered a fiduciary act. Advisors who are not fiduciaries are free to recommend suitable rollovers without fear of repercussion.
If, however, an advisor is determined to have fiduciary status, the situation becomes more complicated. 401k advisors acting as a fiduciary on a company retirement plan must proceed with extreme caution when recommending rollovers.
Prohibited Rollover Transactions
Under the newly reinstated rules, if an advisor is a fiduciary on a plan at the time a rollover recommendation is made, he or she is subject to both the prudent man standard of conduct and ERISA’s (Employee Retirement Income Security Act) duty of loyalty.
Rollover recommendations that result in additional compensation to 401k advisors are considered prohibited transactions. For example, advising a client to take a distribution from his company retirement plan and roll it into an IRA on which the advisor will charge a fee is in violation of the rules.
Previously, an advisor could document the suitability of the rollover using the BICE and continue with the recommendation. Elimination of this protection is causing advisors around the country to re-evaluate their practices.
Potential Solutions for 401k Advisors
According to ERISA law experts, the two most effective courses of action at this time are to either stop recommending rollovers altogether or avoid becoming a fiduciary on the plan. Both options may cause a loss of revenue to advisors unless a better solution is found.
Avoiding Rollover Recommendations
When faced with the question of whether to roll funds out of a plan, advisors could simply avoid giving the client a definitive answer. Instead, the conversation would revolve around educating the client about all his options including keeping the money in the plan, transferring the funds to another employer plan (if applicable), completing a rollover, or taking a taxable distribution.
Although this approach is simple, it’s not easy. Clients typically look to their advisors for sound advice and clear recommendations. Most advisors will struggle with refusing to give them what they need.
Avoiding Fiduciary Status
Plan advisors can reduce the concern about rollover recommendations by modifying their services to avoid the meeting five-part criteria for fiduciary classification.
One alternative is to purposely provide investment advice only on an irregular basis. For advisors who have already committed to meeting with plan sponsors annually, this is not a viable solution.
A much better option is to avoid giving investment advice altogether and instead contract with plan sponsors to provide education and enrollment services only. You can make this simple by partnering with an outsourced administrative fiduciary like FiduciaryShield. Doing so allows you to offer your clients the resource they need, without taking on the liability yourself.
The Bottom Line
The rules for plan rollovers continue to evolve. On April 18th of 2018, the Securities and Exchange Commission (SEC) issued additional proposals to further clarify regulations regarding best interest and standard of care. It’s unclear at this time how these changes will impact the industry and whether any relief would be retroactive.
During this period of uncertainty, many advisors are choosing to proactively protect themselves by changing the way they work with retirement plans. Contact FiduciaryShield today to learn how we can help.