Is Conflicted Advice Costing You? – A New Study Says Yes
Conflicts of interest in the investment advice to workers who roll over their retirement savings from employer-sponsored defined contribution plans into Individual Retirement Accounts add new concern for middle class families coping with dwindling retirement savings. New findings from a report released by the President’s Council of Economic Advisers indicate that conflicted advice adds large and economically meaningful costs to Americans who are saving for retirement.
Since the late 1970’s, there has been a dramatic shift in the retirement landscape. In 1978, about 70 percent of retirement assets were held in defined benefit plans with only 20 percent in defined contribution plans and another 2 percent in IRAs. By 2013, only an estimated 35 percent of retirement plan assets were in defined benefit plans, while defined contribution plans and IRAs accounted for 60 percent.
The boost in IRAs brings to the surface a need for better alignment of interests in the advice financial advisors offer their clients. While the vast majority of Americans believe that all financial advisors are required to act in the best interest of their client, only registered investment advisors are held to what is called a fiduciary standard, which includes legal duties of loyalty and care and to serve the best interests of their clients.
However, financial advice is also provided by broker-dealers, who instead are held to a “suitability standard,” which means that they must offer advice that is suitable for the client’s investment profile, based on factors of age, income, net worth, risk profile and investment goals. While many broker-dealers hold themselves to high professional standards, the suitability standard does not necessarily ensure that they always act in the best interest of their clients when they give retirement investment advice.
Unfortunately, it is not uncommon for broker-dealers held to a suitability standard to recommend investment strategies that fit their own financial interests. For example, in a 2011 report, the Government Accountability Office of Congress said it found that some financial advisors may recommend inappropriate rollovers from employer-sponsored defined contribution plans into IRAs in order to collect fees for managing the assets, and that certain advisors could earn $6,000 to $9,000 if clients rolled over savings from 401(k) plans into IRAs as compared to $50 or $100 if their client remained in the 401(k) plan.
The CEA analysis found that these types of incentives cause some financial advisors to encourage middle class families to move from low-cost employer plans to IRAs that typically incur higher fees. The CEA found that savers receiving conflicted advice earned an investment return that was approximately one percent less than they could otherwise expect. The report states an estimated $1.7 trillion of IRA assets are invested in products that generally provide payments that generate conflicts of interest. Thus, CEA estimates the aggregate annual cost of conflicted advice is about $17 billion (one percent of $1.7 trillion) each year. A typical worker who receives conflicted advice when rolling over a 401(k) balance to an IRA at age 45 is projected to have 17 percent less in her account by age 65 as a result of the conflicted advice.
According to a White House press release issued in February 2015 about the CEA report, this means that if a worker has $100,000 in retirement savings at age 45, without conflicted advice it would grow to an estimated $216,000 by age 65 adjusted for inflation, but if she receives conflicted advice it would only grow to $179,000, representing a loss of $37,000 or 17 percent. A retiree who receives conflicted advice on how to invest an IRA at retirement also stands to lose an estimated 12 percent of the savings value if drawn down over 30 years compared to a retiree who does not receive conflicted advice.
In the press release, President Barack Obama directed the Department of Labor to move forward with a proposed rulemaking to protect families from conflicted retirement advice by requiring retirement advisers to abide by a fiduciary standard which puts their clients’ best interests before their own. On April 14, 2015, the U.S. Department of Labor issued its Conflicts of Interest Proposed Rule on a retirement investment advisor’s fiduciary standard and conflicts of interest.
As this issue further plays out at the federal level, CalSTRS will be monitoring its status. In the meantime, CalSTRS remains vitally interested in having our members participate in savings plans as California’s educators do not receive Social Security for their CalSTRS-covered employment. When our members retire and take distributions from their Defined Benefit Supplement and Cash Balance accounts, we know that many of them roll their account balances into IRAs. It would be of great benefit to see more safeguards around investment strategies offered by financial advisors as this is very relevant to not only our members receiving a fair deal in retirement, but all working families.