Goodbye, commissions. Hello, fee-based accounts.
The Labor Department’s fiduciary rule doesn’t go into effect until April, but firms already are changing the way they do business with investors.
Merrill Lynch, the nation’s largest broker, last week said it would no longer give clients the option of opening commission-based IRA accounts starting in April. They will only be able to open fee-based IRA accounts. Plus, the firm plans to “encourage” its clients to switch existing commission-based IRAs to fee-based IRAs — if they want to continue to receive investment advice.
Under the Labor Department’s new rule, advisers must act in the retirement account owner’s best interest, as a fiduciary. In the past, investor advocates have suggested that it’s difficult, if not impossible, for advisers who earn commissions when buying and selling investments and insurance to act in the client’s best interest. By contrast, advocates say, it’s more likely that advisers who charge clients a flat fee to manage assets, say 1% of assets under management, are more likely to act in the client’s best interest. There’s less financial incentive for them to buy and sell investments, and if they do, they are unlikely to earn more money because of it, advocates say.
Under the new rule, advisers and firms could face legal action for not acting in their client's best interest. What's more, advisers will also have to ask clients to sign a best interest contract, or BIC, to agree to commission-based accounts. And it is the BIC that Merrill Lynch and many other firms want to avoid, fearing it will lead to more legal trouble than it’s worth.
The Labor Department’s rule will affect $7.5 trillion in individual retirement accounts (IRAs) and $7 trillion in 401(k) and other defined contribution plans.
Other firms to follow suit. Investors can expect other firms to follow Merrill’s lead. Cases in point: LPL Financial will standardize the commissions it charges clients, and Edward Jones and State Farm will stop selling investments and insurance of one sort or another to owners of retirement accounts, such as IRA and Roth IRAs.
“I would almost guarantee that other firms will follow suit,” says Jeffrey Levine, chief retirement strategist for Ed Slott and Co. Others agree. “This is very much a monkey-see, monkey-do industry,” says Jamie Hopkins, co-director of the New York Life Center for Retirement Income at The American College of Financial Services.
One possibly costly drawback for consumers. Investors might face higher, rather than lower, fees and expenses because of the Labor Department’s new rule, Hopkins says. For instance, those in commission-based accounts who trade infrequently or don’t need advice who switch into fee-based accounts will then have to pay an ongoing fee of, say, 1% of assets under management. So, someone with a $100,000 account could go from paying nothing per year to $1,000 per year.
“Firms cannot just use this as an excuse to raise fees and increase profits," Hopkins says. "Higher fees can occur, but the increase needs to be justified and related to the value of the services provided.”
Labor Department rule exclusion. One confusing issue that investors will soon face is this: The Labor Department’s new rule doesn’t apply to taxable accounts, just retirement accounts. So, it’s possible, if you have mutual funds outside of a 401(k) or IRA, an adviser could sell you insurance and investments that are not appropriate for you or have extra-high fees.
“I find it incredibly bizarre that there are going to be two different compensation regimes; one for IRAs and one for other (taxable) accounts,” Levine says. “I’m trying to figure out how you position that to a client. ‘Well, we have to act in your best interests in this account and to do that we believe only fees are appropriate, but in these accounts we’re not required to act in your best interest so we can charge you however we want.’ It just seems odd.”
Advice industry forever changed. What does seem certain is this: The advice profession of tomorrow will look quite different from that of today. “It could serve as one more nail in the coffin for ‘transactional brokers’ and 100% pure equity/pure bond brokers,” says Tom Mullooly of Mullooly Asset Management.Says Hopkins: "While the new rule did not ban commissions, it did make life a lot harder to justify and keep charging commissions.”
The bottom line for investors. So, what’s an investor to do? Weigh the costs and benefits of whether a fee- or commission-based retirement account is in your best interest.
In general, if you have a commission-based retirement account and don’t need ongoing investment advice and trade infrequently, consider staying in a commission-based account and signing a BIC. If you have a commission-based retirement account and need ongoing advice and trade frequently, consider a fee-based account. Likewise, if you have a fee-based account and don’t need advice, consider a commission-based or discount brokerage account.
Robert Powell is editor of Retirement Weekly, contributes regularly to USA TODAY, The Wall Street Journal and MarketWatch. Got questions about money? Email Bob at firstname.lastname@example.org.