The IRA market has grown into one of the largest and most strategic pools of assets in the U.S. financial sector. It holds $5.1 trillion in assets of 50 million U.S. households, representing a 28 percent share of total U.S. retirement assets. This share is sure to rise as baby boomers retire and roll over qualified plan balances to IRAs. McKinsey & Co. has estimated that more than two million defined contribution (DC) plan participants will each roll over an average of $50,000 per year, and IRAs will capture $1.5 trillion in new assets over the next five years. 

The FAQ that follows summarizes questions financial advisors are asking about this opportunity, and it offers answers that may be useful in planning your IRA/rollover market strategy. It also includes links to useful information.

Q.  Why is EBSA pushing this rule? What do they hope to achieve?

EBSA believes two specific loopholes in a 1975 regulation have contributed to "conflicted advice" delivered to retirement plans and participants. Conflicted advice includes recommendations from which advisors receive compensation linked to the products purchased. The loopholes EBSA wants to close now limit the definition of fiduciaries to those who offer advice on a "regular basis" or as the primary basis for investment decisions.

Q.  Does EBSA have jurisdiction over IRAs?

EBSA is responsible for administering and enforcing the fiduciary, reporting and disclosure provisions of Title I of ERISA, which covers employer plans and employer-sponsored IRAs (e.g., SIMPLEs, SEPs). Personal IRAs are not ERISA plans, and they are currently regulated by the Prohibited Transaction Rules of the Internal Revenue Code. EBSA has authority to regulate prohibited transactions in IRAs.

Q.  Why are IRAs important to EBSA?

Extending the new fiduciary rule to IRAs is important to EBSA for two reasons:

1. IRAs have become a linchpin of the U.S. retirement savings system, the ultimate destination for many DC plan assets, via rollovers. They also provide the "portability" between workplace plans for workers who change jobs, and they are the only type of account allowed in popular small-business plans (SEPs/SIMPLEs). EBSA believes the fiduciary definition for IRAs should be consistent with ERISA plans.
2. IRAs have been described as the "wild West" of the retirement plan realm, the place where investors are least protected by fiduciary standards and the most vulnerable to conflicted advice. As EBSA's Fiduciary Fact Fact sheet observes: "IRA holders shoulder a greater amount of investment responsibility, like 401(k) plan participants. But, unlike 401(k) plan participants, IRA holders are more vulnerable since no other plan fiduciary protects the IRA investments."

You can access the fact sheet here: www.dol.gov/ebsa/newsroom/fsfiduciary.html

EBSA's home page for the fiduciary definition proposal is here:  http://www.dol.gov/ebsa/regs/cmt-1210-AB32.html

Q.  Will EBSA integrate its new ERISA fiduciary definition with the SEC's work to create a uniform fiduciary standard for registered investment advisers (RIAs) and broker-dealers?

A.  No. Phyllis Borzi, assistant secretary in charge of EBSA, refers to an ERISA fiduciary as "the highest standard we know in the legal world." She acknowledges that it is higher than the SEC's standard may be and says her goal is to "harmonize" the new ERISA fiduciary with other regulations and standard. EBSA probably will lead the way in defining retirement plan fiduciaries, and the SEC will follow in regard to advice and recommendations delivered by broker-dealers.

Q.  What duties will fiduciaries be required to meet in the IRA/rollover market?

A.  It isn't clear. Currently, ERISA fiduciaries to employee benefit plans, but not IRAs, owe clients a duty of loyalty and a duty of care, and they are personally liable for losses that result from breaches of these duties. The IRS can enforce excise taxes on fiduciaries who engage in prohibited transactions and self-dealing in IRAs. Borzi has stated that EBSA's goal is to set forth a single consistent fiduciary definition for all retirement plans, while addressing practical differences between employer plans and IRAs through exemptions. 

In Congressional testimony, she has emphasized a desire to bring IRAs under the ERISA fiduciary standard. "Unlike plan participants, IRA holders do not have the benefit of a plan fiduciary … to represent their interests in dealing with advisers, Borzi said. "They cannot sue fiduciary advisors under ERISA for losses arising from fiduciary breaches, nor can the Department (of Labor) sue on their behalf. Compared to those with plan accounts, IRA holders have larger account balances and are more likely to be elderly. For all of these reasons, combating conflicts among advisors to IRAs is at least as important as combating those among advisers to plans."

Her testimony is located here: www.dol.gov/ebsa/newsroom/ty072611.html

Q.  Will the rule require all advisors who work in the IRA market to become fee-based RIAs?

A.  No. Under the original EBSA rule proposal, four categories of plan service providers can avoid ERISA fiduciary status:

1. Adversaries;
2. Employer educators;
3. Pure platform providers; and
4. Appraisers.

Adversaries do not represent themselves as ERISA fiduciaries. They make it clear that they are acting on behalf of a vendor on the opposite side of the transaction and do not provide impartial advice. Educators provide general financial, tax or investment information, and they are separately covered under DOL Interpretative Bulletin 96-1.

The original EBSA proposal is located here: http://webapps.dol.gov/FederalRegister/PdfDisplay.aspx?DocId=24328

DOL IB 96-1 is located here: http://www.dol.gov/ebsa/regs/fedreg/final/96_14093.pdf

Q.  How would an "adversary" work in the IRA rollover market?

This question is of critical concern to many broker-dealers and mutual fund groups, and the answer won't be clear until EBSA weighs in with its reproposal. Since some voices in the industry objected to being labeled "adversaries" to their own clients, EBSA now refers to this as the "seller's limitation." It's expected that pure sellers of financial products for IRAs or rollovers will need to clearly disclose that they do not provide objective advice, and they will not be allowed to wrap their products with advice or planning services, such as retirement income proposals or model portfolios. This may have the greatest impact on the sale of commission-based annuity IRAs, which often are sold through proposals or as part of retirement income plans. 

Q.  Will companies still be able to provide general education and guidance on rollovers/IRAs, without becoming fiduciaries?

Probably so, but under more clearly defined guidelines. EBSA is aware that many investment firms are using education/guidance services as "door-openers" to capture new IRA assets and relationships. Borzi has indicated that EBSA wishes to promote more education for plan participants, but it may require clear separation between these services and commission-based product sales. The mutual fund industry has argued for allowing "pure platforms" that do not provide individualized advice to deliver general education and guidance.

You can see the mutual fund industry's position, delivered by Investment Company Institute President and CEO Paul Schott Stevens, here:  www.ici.org/401k/statements/11_dol_fiduciary_tmny

Q. How many IRA account holders will be affected by the new rule?

Twelve large financial firms, representing 19 million IRA holders and $1.8 trillion in assets, participated in a study organized by consulting firm Oliver Wyman Inc., and its findings were submitted to EBSA and made public in April of 2011. They are located here: http://www.dol.gov/ebsa/pdf/1210-AB32-PH060.pdf

According to the study, 88 percent of all IRA accounts are with commissionbased brokerage firms and the other 12 percent are in fee-based advisory models. As IRA asset size increases, so does the fee-based share. For example:

• In the lowest asset tier measured (less than $25,000), 98 percent of accounts are commission-based and only 2 percent are fee-based.

• At the highest level ($250,000 or more), 66 percent of accounts are commission-based and 34 percent are fee-based.

Among more than 22 million IRA brokerage accounts evaluated, the study concluded that EBSA's new rule would cause 7.2 million (about 30 percent of the total) to have insufficient assts to qualify for their firm's advisory channel. For these accounts, Wyman said, most support services would disappear because they would no longer be available in the brokerage model. Another 4.4 million accounts (20 percent) would have to change firms to meet advisory channel minimums. The remaining 12 million (55 percent) would be able to migrate to advisory – usually at higher cost. The report also concluded that as many as 4 million accounts (about 18 percent) could exit the IRA business altogether, rather than accept low-support brokerage services.

Q.  Does this mean the rule could be a net negative for the investment industry?

No. The Wyman analysis does not predict (or account for) any changes in the industry – and there will be many because the IRA business is too large and important for most firms to lose. EBSA's reproposal will reshuffle the industry, creating impacts and opportunities.

The Wyman analysis does not account for:

1. The potential to combine clients' IRAs with their nonretirement assets under fee-based relationships,
2. The potential to consolidate multiple IRAs held with different firms to meet fee-based minimums; and
3. The expanding power of technology to deliver advice-based services or wrap-fee accounts more economically to clients with modest assets.

It also conflates two separate issues:

1. Whether existing IRA brokerage clients can meet current minimums for advisory accounts; and
2. What advisory accounts currently cost relative to brokerage accounts.

If clients can be enticed to bring more assets into advisory relationships (to meet minimums) and firms simultaneously find ways to deliver advisory services at lower costs, the game changes. Some observers believe the reproposal will create competitive pressures on broker-dealers to reduce advisory fees in the IRA market. If so, the current cost gap between advisory and brokerage accounts will shrink.

Q.  What are examples of opportunity the rule could create?

Example 1: An investor with a $200,000 brokerage account IRA, coordinated by a financial advisor, is given a choice by his firm of converting to an advisory account at a 1.25 percent annual fee or moving to a low-support brokerage platform. The client is currently paying about $700 per year in IRA commissions and trails, and does not wish to pay $2,500 a year in advisory fees. A competitive advisor offers to take over the account by tailoring a package of support services with a .75 percent wrap fee, which will be charged in a fiduciary account with professional advice.

Example 2: An advisor has about a dozen clients with IRA balances below $100,000 in brokerage accounts. She converts them to fiduciary accounts in which each client pays a level ("membership") fee of $500 per year to receive a package of computer-assisted educational and seminar support services, including computer-generated asset allocation models.

Example 3: A 62-year-old prospect has $1 million in investment assets, including $200,000 in a brokerage account IRA and $300,000 in a 401(k). An advisor agrees to create a comprehensive investment plan that coordinates all $1 million in an advisory account with a 60-basis-point wrap-fee. The client agrees to rollover the 401(k) into this account at retirement.

Q.  Will the new rule create opportunities for fee-based advisors who work in the small-employer market?

Yes. Small-business plans have been a special focus of EBSA. On why the market requires fiduciary protection, Borzi says: "This initiative will especially help small business employers in the design and implementation of a retirement plan. Selecting investment options for such plans is a fiduciary function under ERISA, and many small employers rely on advice from financial professionals to prudently select investment options. A revised fiduciary definition would protect these small employers by making it more difficult for advisers to steer small employers to investment options that pay the adviser higher fees. The proposed regulation will hold the advisers accountable for imprudent and conflicted advice, and the harm this advice causes to plans and participants."

In short, the small-plan advisor will need to be an objective guide to all available plan types and options, including IRA-based plans (SIMPLEs and SEPs). The advisor's compensation should be level, regardless which plan is chosen. The level fee should include educational and guidance service to plan participants, to help them make investment decisions.

Q.  Who is in the best position to take advantage of the new rule?

RIAs and dually-registered "hybrid advisors" will be in the best position to capture or retain advice-based IRA relationships. According to the Wyman, 64 percent of the advisors in firms it studied already are "dually-registered" as both securities representatives and RIAs or investment advisor representatives (IARs). There is enough existing advisor capacity available to serve IRA investors in fee-based fiduciary models, and the new rule will motivate more hybrid registrations.

Q.  What ideas should be shared with IRA clients, to help them prepare for the rule?

First, consolidate all IRAs into one. Consolidation has always made sense for clients approaching retirement, because it helps to coordinate retirement income and minimum distribution strategies. The more assets clients have in IRAs, the better position they will be in to receive an attractive package of advisory and guidance services at a competitive fee.

Secondly, start educating IRA clients on the extra value a fiduciary relationship provides. EBSA is advocating on behalf of investors and working to give them a better relationship and deal. However, many clients aren't aware of key benefits that fiduciary relationships offer, compared to brokerage relationships.

Finally, urge clients to take advantage of your advisory services to plan their way through many years of retirement. This is not a journey most clients should be taking without a professional navigator. The new rule creates a great opportunity to emphasize services that make you stand out from the pack.