Suitable Versus Fiduciary: Seeking the Highest Level of Advice
As the current debate rages over plan sponsors’ roles and responsibilities in safeguarding employees’ retirement savings, it’s worth remembering the roots from which the present-day standards for “fiduciary” advice have sprung.
“A trustee is held to something stricter than the morals of the marketplace. Not honesty alone, but the punctilio of an honor the most sensitive, is then the standard of behavior … the level of conduct for fiduciaries [has] been kept at a level higher than that trodden by the crowd.”
– Judge Benjamin Cardozo, New York Court of Appeals, 1928
A Fiduciary Overview
What do we mean by “fiduciary” to begin with? Today, plan sponsors are obligated to serve a fiduciary role for their plan participants, which means the decisions they make in forming and managing their plan must demonstrably serve the highest interests of its participants.
The plan sponsor can entrust parts of the fiduciary role to other professionals – such as the duty to make appropriate fund selections available within the plan. But he or she cannot delegate away all fiduciary duties. For example, the plan sponsor retains the obligation to select and keep an eye on those entrusted professionals to begin with.
Whom Can You Trust?
Whatever the letter of the law, the spirit is clear in the above, early guidance from Judge Cardozo: In overseeing their plan, plan sponsors and the professionals they select to assist them should both be stretching for something finer than base standards. Plan participants deserve a fiduciary advisor because:
- A fiduciary advisor is legally obligated to advise according to the client’s best interests, above all else.
- Non-fiduciary recommendations can contain conflicts of interest, including the ability to promote sub-par investments as long as they clear the “suitable” hurdle.
- A fiduciary advisor is paid by the client (plan or sponsor) in exchange for his or her independent and objective advice.
- The non-fiduciary is a transactional sales person paid by and legally obligated to third-party product providers.
Unfortunately, merely suitable versus truly fiduciary levels of advice are precisely what most sponsors and participants alike are receiving from the household-name retirement plan providers to whom they most often turn. Recently, the Government Accountability Office (GAO) issued a telling March 2013 report on the misleading information being dispensed by many of the big-name retirement plan providers, encouraging departing employees to take their money out of their 401(k) plan — whether or not it’s in the participant’s best interests to do so.
When employees leave, they typically have four choices for their 401(k) assets:
(1) Leave the money where it is.
(2) Roll it over into a new employer’s 401(k).
(3) Roll it over into an individual IRA.
(4) Cash out (but likely face steep taxes and penalties).
Which option makes the most sense in each case depends on a complex confluence of factors, including the individual’s personal and taxable circumstances, other available options, and how those options compare to their current plan. Cookie-cutter counsel won’t cover it.
And yet, the GAO has uncovered a disturbing lack of sound advice available to most departing employees. In its March 2013 Congressional Report, the GAO reported on the results of an undercover operation, in which its representatives posed as departing employees calling their 401(k) plan’s money management firm for advice during the job change. Here’s what they concluded (emphasis ours): “GAO found that service providers’ call center representatives encouraged rolling 401(k) plan savings into an IRA even with only minimal knowledge of a caller’s financial situation.”
The sales pitch is working too. 401(k) rollovers into IRAs represent the overwhelming norm versus the exception. The GAO observed that they are the largest source of IRA contributions, with more than 90 percent of IRA fund flows coming from these sorts of rollovers.
Why are departing employees potentially being misinformed by plan providers? If you guessed that it might have to do with profits and incentives, we believe you’d be heading in the right direction. As the GAO stated: “[The Department of] Labor’s current requirements do not sufficiently assist participants in understanding the financial interests that service providers may have in participants’ distribution and investment decisions.”
Or, put more plainly, there often are invisible increased money management fees to be made when a departing employee rolls over his or her 401(k) assets into a money manager’s individual IRA offering.
Another related reason is the plan provider’s true role in the overall process. As described above, regulators consider non-fiduciary plan providers’ “advice” as secondary to their primary, transactional-based function, so they are essentially granted a hall pass from the requirement that the advice be strictly in the recipient’s highest interests. Their advice need only be suitable, falling short of the higher level of fiduciary.
Don’t get me wrong. Suitable advice is legally “trodden by the crowd.” Their obligations (or lack thereof) are no doubt described to you in your plan’s disclosures … via a fine-print reference on page 68, directing you to their primary web address from where you can seek more information, if you dare. Good luck on that.
Legal or not, in my opinion, suitable advice falls well short of what fully served plans deserve. That’s why we are pleased when the media calls attention to the advisory challenges that plague today’s retirement savings plans. We’d like to keep spreading the word, loudly and clearly, that it doesn’t have to be so. There are fiduciary-driven solutions that exist today that combat these issues head on. We are pleased to be part of advocating for and applying these solutions, one plan at a time.