The Hill, April 30, 2015
The comment period is now open for new rules proposed by the Obama administration that require financial professionals to put workers’ interests ahead of their own when they make recommendations for retirement savings. Modernizing the rules to take account of the growth of worker-directed retirement savings plans such as 401(k) plans and IRAs is long overdue.
Loopholes in the current regulations let plan advisers and brokers consider what they will earn in higher fees and commissions when providing financial advice to workers about how to invest their retirement savings. This is especially true when workers roll over funds from a 401(k) or similar account to an IRA—making workers vulnerable to getting bad advice just at the point at when they begin to manage their retirement savings themselves. The Labor Department, which oversees these types of retirement savings accounts, is concerned that workers may not end up in the most advantageous investments and may pay excessive fees that cut into their savings, a double whammy that the White House estimates costs employees $17 billion annually.
The traditional employer-sponsored defined benefit pension plans that once provided retirement income to millions of workers appear headed for extinction. Money is flowing out of them as baby boomers retire, and there are few to no new companies making these plans available to employees. Instead, an increasing share of retirement savings is in 401(k) or similar plans or in IRAs. Together, these so-called “defined contribution retirement saving plans” now account for about $11 trillion of the $24 trillion in retirement assets in the U.S. This has not gone unnoticed by alternative investment funds—hedge funds and private equity funds—which are interested in getting in on the action. As BNY Mellon’s Pershing Prime Services put it in a recent piece on the future of alternative investment funds, “The retirement market may be the next frontier. It represents a large and growing pool of assets driven by the importance of retirement saving across multiple investment segments.” The opportunity, as Pershing sees it, is for alternative investment funds to create products suitable for packaging in diversified investment portfolios that independent and registered financial advisors can promote to 401(k) plans and to individuals with IRAs. These would presumably be more liquid than commitments made to these funds by their limited partners and could be embedded in so-called target date funds that are already popular with 401(k) plan investors. Instead of choosing individual investments and creating a portfolio, workers are able to choose a single fund that has a diversified portfolio of investments embedded in it. The goal is to have more risky alternative investment products included in such funds. Alternative investment products may be new and unfamiliar to workers saving for retirement now, but Pershing anticipates that over time they will become as familiar and pervasive in packaged investment portfolios as mutual funds.
Hedge funds and pension funds claim that including alternative investments in 401(k)s and IRAs will provide individuals with higher returns and higher income in their retirement years without much additional risk and, in addition, will provide a hedge against losses when the stock market turns down. Despite the hype surrounding these alternative investment funds, this is unlikely to be true. The California state public employees’ pension fund (CalPERS), the largest pension fund in the nation with $300 billion in assets, recently announced that it is withdrawing all of its investments in hedge funds and reducing its target allocation to private equity because of the disappointing returns and high fees associated with these investments as well as their failure to protect against losses when the stock market declined. Workers managing their own individual retirement savings accounts can hardly expect to do better.
Rollovers of 401(k)-type plans to IRAs now exceed well over $300 billion a year and are expected to continue increasing to more than $500 billion by 2019. Without tightening the rules for brokers and closing the loophole that allows them to put their personal gain above the interests of individuals when making recommendations for investing in these rollover funds, workers may get saddled with higher fees and riskier investments.
For most workers, the decision of what to do with their retirement nest egg when they roll over their 401(k) to an IRA is the biggest investment decision they will make. Under the new rules, brokers could still make recommendations to clients about where to invest their rollover funds. The difference is that under the Labor Department’s proposed rules, they would have to promise to look out for the best interests of the individuals they advise.