Last April, the Department of Labor (DOL) issued new regulations making most financial advisers fiduciaries, thereby requiring them to “give prudent advice that is the customer’s best interest, avoid misleading statements, and receive no more than reasonable compensation.” The intent of these rules is to prevent 401(k) and other retirement account managers from offering financial advice that would earn them high commissions at the expense of their clients’ portfolios. But, policy never occurs in a vacuum. The unintended consequences of these regulations have hurt low-income retirees.
Only a few months after DOL issued these regulations, a number of retirement plans have been subject to lawsuits for allegedly charging excessive fees. This recent wave of cases has been filed against smaller plans, a significant break from previous litigation. It is likely that these new rules will increase the number of plaintiffs on similar lawsuits in the future.
Improving the quality of financial advice given to future retirees would, in a vacuum, be unambiguously good. However, there are still a number of possible outcomes that policymakers should keep a close eye on when evaluating the efficacy of these regulations.
First, these rules would change the way some financial advisers are compensated. Previously, advisers earned money from fees based on the total return of the portfolio, in addition to commissions, by recommending investment products. In many cases, this created a conflict of interest, where advisers earned more by recommending products that are worse for their clients’ portfolios. The White House estimates the total cost of this “conflicted investment advice” to be $17 billion, though some dispute this figure.
Financial advisers will likely try to make up for these losses, and two things may happen. First, they could raise the management fees. Though higher fees would be to the detriment of investors, it is not clear whether the money lost from management fees will be greater than the money lost from these commissions.
Worse, these investment funds could drop middle- and lower-income clients altogether. Because the fees are based on a commission, some advisers may feel that the returns aren’t high enough. This outcome likely undoes any benefits received by higher-income retirees, as lack of access to professionally managed accounts (even those that offer mediocre advice) puts their ability to retire at risk and widens the savings gap between the rich and the poor. The combination of a loss of retirement advice and increased fees for smaller investors could amount to $80 billion, according to Senate testimony by former Brookings Institution scholar Robert Litan.
While these regulations are still in their infancy, there is some evidence of their potential effects across the pond. The United Kingdom and Australia implemented similar regulations against financial advisers earning commissions. While regulations in the US are restricted to retirement account managers, the United States could see an “advice gap” where there is a slight reduction in the number of financial advisers.
Those who have access to financial advisers will likely benefit from their advisers being held to a higher legal standard when managing their money. However, it is unwise to let gains at the top come at the expense of those at the bottom. This problem has become a feature of retirement policy in the United States. In 2012 alone, the federal government lost over $100 billion in revenue due to the tax-deferred status of retirement plans. This policy has only become more regressive now that fewer low-income Americans will benefit from due to these new regulations.
On the margin, these regulations will squeeze out lower-income persons trying to save for retirement. It would be wiser to start out with more robust disclosure mechanisms, which would do far less to reduce access to retirement savings. While progressives may may jump for joy about better retirement advice for those who can afford it, these regulations are just one more piece in the regressive mosaic that is American retirement policy.
Daniel Takash is a Young Voices Advocate who works as a policy analyst in Washington, DC. Follow him @DanielTakash.