Financial Advisory Standards of Care and Rollovers to IRA's

The business practices of retirement plan service providers and financial advisors are coming under increasing fire.  A representative salvo came in a Bloomberg News article appearing in Financial Advisor magazine, which criticized many of the biggest brokerage firms for advising Government retirees to rollover their retirement plan accounts to IRA's.    

The Government retirement plan in question, the Thrift Savings Plan, is well-known for having investment options with razor-thin management expenses.  Consequently, the subject of the article, a former Dept. of Labor economist and current head of the Pension Policy Center, found it "a scandal" that brokers advised him to leave that plan in favor of a rollover IRA that would result in higher mutual fund management expenses.  In his view, this constituted clear evidence that these brokers were putting their own interests before his. 

Leaving aside for now whether expense ratios should be the sole criterion on which to base the rollover decision, brokerage firms aren't the main culprits in this "scandal".  As stated later in the same article:  

"The Labor Department has said it will propose rules in January [of 2015] that brokers and other advisers act in clients' best interest during rollovers, a so-called fiduciary standard.  Brokers are generally held to the lower standard of selling products that are suitable for their customers, meaning they don't have to put their clients' interests first as long as they select appropriate investments."

And the Labor Department did end up issuing a fiduciary rule to cover financial advice on retirement accounts in the following year of 2016, only to repeatedly delay the rule's implementation until it was finally struck down in court last year.   

Far be it for me to defend brokers, but how ironic is it that a former Dept. of Labor bigwig finds it scandalous that brokers, "...are trying to sell me an IRA clearly not in my interest" when these brokers are simply playing by the rules set by the DOL.  And the DOL had been working on its fiduciary rule for close to a decade, all the while dragging its feet and bowing to pressure from the financial advice industry.  (For the record, the SEC also has the power to impose a "fiduciary duty" on the brokers it regulates, but has continued to refuse to do so for years.)

The moral of the story?  If you want financial advice that's based on your best interests, skip the broker and find a registered investment advisor.  We've always had a fiduciary duty to our clients.

To Rollover or Not to Rollover: Value is in the Eyes of the Beholder

To address the tease above, the decision as to whether or not to rollover a retirement plan account to an IRA should be based on more factors than just the associated mutual fund management expenses.  On its website, the Dept. of Labor provides guidance to retirement plan participants, i.e. employees, on how to evaluate the fees and expenses associated with their plan.  The DOL concludes their report on 401(k) plan fees as follows:

"... don’t consider fees in a vacuum. They are only one part of the bigger picture
including investment risks and returns and the extent and quality of services provided.  Keep in mind the
importance of diversifying your investments."

This guidance is instructive for employees trying to decide whether or not to rollover their retirement plan accounts to IRA accounts.  For illustration purposes, let's go back to the article on the Thrift Savings Plan (TSP):  "Like most plans, the federal program offers general education on its website about investing but leaves decisions to workers."

While the subject account holder of the article, an economics Ph.D. from the University of Chicago, obviously finds this level of service sufficient for his purposes, it's equally conceivable that other workers might prefer to delegate the investment management process by rolling into a managed IRA account.  And it's also possible an IRA rollover might avail these workers of other non-investment-related financial services not provided in the TSP, e.g. retirement and education funding projections, insurance and employee benefits advice, tax minimization and debt management strategies, etc.  To them, paying higher investment-related expenses in return for more and better service can make sound financial sense.

Potential for Portfolio Diversification as a Factor in the Retirement-Plan-Account-to-IRA Rollover Decision

Now let's talk about investment options, and their importance in the rollover decision.  Portfolio Management 101 students learn that an "optimal portfolio" is a portfolio that provides the greatest expected return for a given level of risk, or equivalently, the lowest risk for a given expected return. The way to make a portfolio more optimal or "efficient" is to add holdings to it that contribute diversification.

IRA custodians (e.g. TD Ameritrade, Schwab, Fidelity, Vanguard, etc.) tend to offer exponentially more investment flexibility than that offered by the average 401k menu of investment options, and certainly more potential for portfolio diversification than offered by the Thrift Savings Plan's investment options.  If rolling into an IRA allows you access to asset classes or sectors unavailable in your retirement plan, (e.g. commodities, real estate, bank loans, inflation-protected or high-yield bonds, emerging markets, etc.), then risk-adjusted returns might benefit even if investment-related expenses increase.

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About the Author

Paul Winter, MBA, CFA, CFP® is a Fee-Only financial advisor and fiduciary in Salt Lake City, UT. His independent wealth management firm, Five Seasons Financial Planning, provides professional portfolio management and objective financial planning services to individuals and families, and to their related entities including trusts, estates, charitable organizations, and small businesses.

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