When a job change is on the horizon, don’t forget to roll over 401(k) assets. That message apparently has gotten through to most workers. According to a recent Investment Company Institute study, 59 percent of households with a traditional individual retirement account had IRAs that included rollover assets in 2016, and 82 percent of those households had transferred their entire 401(k) balance.
[See: 7 Reasons to Invest in an IRA.]
The benefit of rolling over assets into an IRA is that they continue growing tax-deferred in an account you control, but the Department of Labor’s fiduciary rule may add a wrinkle: the best interest contract exemption. Financial advisors may ask you to sign one when retirement assets are rolled over.
“The best interest contract exemption permits financial professionals to continue earning commissions on certain financial products,” says Ryan Brown, a financial consultant and partner at CR Myers & Associates in Southfield, Michigan.
The fiduciary rule is designed to prevent conflicts of interest and curb advisors from selling investors certain products to get higher commissions. The exemption, however, offers a workaround, and depending on the circumstances, it may be beneficial or detrimental to an investor rolling over 401(k) assets. If you’re planning a 401(k) rollover, you’ll need to decide if signing the contract exemption makes sense.
Calculate costs. The exemption has the potential to raise costs for investors because it doesn’t prohibit advisors from charging higher fees than those in a 401(k) or similar retirement plan, says Aaron Schumm, CEO of New York-based Vestwell.
That effectively allows investment professionals to maintain fee structures that foster conflicts of interest, provided they’re disclosed in writing.
But Dave Alison, founding partner and executive vice president of Prosperity Capital Advisors in Westlake, Ohio, says signing the exemption contract may be more cost-effective in certain instances. Some advisors are more affordable when paid on commission, rather than by an hourly rate or a fee based on a percentage of assets under management, he says.
Depending on your investing horizon, you may pay less for an advisor earning a commission than one who only charges a fee. You’ll have to determine if signing the exemption — or avoiding it — would preserve more of your assets by minimizing costs.
Put commissions in perspective. Where you plan to reinvest 401(k) assets also will determine whether you should accept or reject the contract exemption. Alison says a fee-only advisor may be limited in how financial advice can be implemented without the ability to offer commission-based products. “Just because an advisor is earning a commission versus charging a fee doesn’t mean the recommendation isn’t in your best interest, or that you’re working with a bad advisor,” he says.
Signing the exemption could be the right choice if you’re interested in an annuity. Annuities fall under the umbrella of investment products that can only be offered when a best interest exemption contract is signed. “If a 401(k) investor is worried about market volatility and they want to receive principal and income guarantees from an insurance company, an annuity may be what serves their best interest,” Brown says. The key is to make sure your advisor fully explains the annuity and the associated fees.
Don’t let concerns about conflicts of interest dictate how you invest because that can upset your broader retirement strategy. Brown says it’s like turning down the chance to buy your dream home just because the agent makes a commission. Instead, consider how you’re invested currently and then ask yourself whether your advisor is equipped to help you meet those goals.
[See: 10 Long-Term Investing Strategies That Work.]
Terry Dunne, managing director for retirement services at Millennium Trust Co. in Chicago, says the circumstances differ for every investor. There may be situations when you need investments that you can only access by signing the best interest contract exemption. Or, it may be that signing the contract keeps your investments running smoothly by enabling you to continue working with an advisor who has been helping you. Ultimately, Dunne says, it depends on how much you trust the advisor.
Schumm says the exemption may also be desirable if you lack the time or inclination to manage your assets. In that case, you “may feel much more confident with the help of an advisor rather than going it alone.”
If you’re planning to roll 401(k) funds into more traditional investments, the exemption may not be required, but that doesn’t mean you’ll avoid higher fees. There’s nothing to stop an advisor from, say, recommending managed funds instead of a less expensive index fund.
An investor should ask why an advisor recommends certain funds, says Fred Creutzer, owner of Creutzer Financial Services in Baltimore. “Remember, there are over 20,000 mutual funds,” he says. “Make sure your advisor can show you a track record, and check that your selected risk level is accurate.”
Plan ahead. The exemption rule officially takes effect in January 2018, giving investors time to prepare, and Brown says investors shouldn’t shy away from asking advisors how they’re compensated. “It’s the 21st century and investors know that financial professionals don’t work for free,” he says, adding that if an advisor offers a product in line with your goals and objectives, the commission may be irrelevant.
Alison tells investors to stay away from generic advice and build a solid relationship with an advisor instead. That relationship and your advisor’s recommendations should reflect your goals, objectives, concerns and values.
He says if you’re shopping for a new advisor, consider conducting a background check first through BrokerCheck or the Security and Exchange Commission’s Advisor Search. Then examine an advisor’s professional credentials, fee structure and any processes in place for managing conflicts of interest.
[See: Your 7-Step Checklist to Choosing a Financial Advisor.]
Along with checking an advisor’s background, follow the rules for rollovers to avoid triggering tax penalties from early distributions of 401(k) assets.
“Making the wrong moves with your retirement account could end up costing you big time,” Alison says.
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