The Department of Labor has issued a new rule to address conflicts of interest in retirement advice by requiring advisors of 401(k) plans and individual retirement accounts (IRAs) to act in their client’s best interest. This “fiduciary” standard―putting their clients’ best interest before their own profits―has applied to advisors of employer-sponsored defined benefit plans since 1975. But at that time, 401(k) plans did not exist and IRAs had just been authorized.
The growth of 401(k)s and IRAs since the 1970s has created a loophole where investors in these accounts were not protected by the fiduciary standard but were rather subject only to the weaker “suitability” standard. The suitability standard requires only that an advisor’s investment recommendations be suitable―not optimal―for the client, and permits a conflict of interest. Because an advisor is not required to act in its client’s best interest, the suitability standard allows and even encourages advisors to recommend an investment that earns them a higher fee or commission, as long as the investment is suitable for the client, even if a lower-cost competing product exists. A White House Council of Economic Advisers’ report concluded that this conflicted advice reduces affected investors’ annual returns by one percentage point (about $17 billion per year). The fiduciary standard prohibits this conflict of interest.
The new rule applies only to advisors of tax-advantaged retirement accounts like 401(k)s and IRAs. It does not apply to advisors of taxable investment accounts, who remain subject to the suitability standard.
The new rule is scheduled to take effect on April 10, 2017.