New Rule for Investment Advice About 401(k) Rollovers: How Does it Impact You?

A rollover refers to the transfer of your funds from one retirement account, such as a 401(k), to another, such as an Individual Retirement Account (IRA). This can be particularly advantageous in situations like changing jobs. 401(k) rollovers offer several benefits, including increased flexibility and control, flexible payouts, enhanced management, and the option to convert to a Roth account. However, they also come with certain limitations, such as hidden fees, lower contribution limits, and the absence of employer contributions, which must be considered.

Additionally, there have been some 401(k) rule changes in 2024 for rollovers that you should be aware of. A financial advisor can help you understand these changes and offer advice on 401(k) rollovers to IRAs. This article will also explain the new terms of the rule and how they might impact your rollover strategy.

What is the new rule for investment advice about 401(k) rollovers?

The Department of Labor (DOL) has introduced a new rule for 401(k) rollovers that mandates financial advisors handling 401(k) rollovers to be fiduciaries to ensure that they act in the best interest of the client. According to the new rule, financial advisors and institutions must provide more detailed disclosures about fees, conflicts of interest, and the potential pros and cons of rollovers as per the client’s personal needs and situation.

The rule aims to increase transparency and fiduciary responsibility so that the financial interests of 401(k) investors are protected and they receive unbiased advice on the matter. It is important to note that while the 401(k) rollover can be suitable in some situations and help investors manage their funds better, it may not be ideal for all investors. The rule aims to mandate fiduciary duty to help 401(k) investors understand the actual benefits, costs, limitations, and repercussions of moving their retirement funds to a new account. Under the rule, financial advisors may need to provide detailed documentation to justify that the 401(k) rollover is in the client’s best interest. This can include comparing the features and costs of the existing 401(k) versus the new retirement account.

Here are some things to know about the new rule regarding 401(k) rollovers:

1. ERISA fiduciary standards

The Employee Retirement Income Security Act (ERISA) was established in 1974 to regulate retirement plans and set fiduciary standards. ERISA fiduciary standards are considered more rigorous than other suitability standards. There are two types of standards that financial advisors may adhere to – fiduciary and suitability. Fiduciary standards require financial advisors to act in the best interest of their clients, while suitability standards only require recommendations to be suitable for the client. The former ensures that the financial advisor puts their interest last while prioritizing the client, and in the case of the latter, the advisor may put their own interests above the client, if need be. The new 401(k) rollover rule will expand the definition of ERISA fiduciary standards. This change means that more financial advisors will be legally required to act in the best interests of their clients when advising on 401(k) plans and rollovers. As a result, a higher number of financial advisors will have to adhere to this rule when providing retirement investment advice or face potential legal repercussions.

2. Prohibited Transaction Exemption (PTE)

The DOL is also revising certain exemptions that permit financial advisors to receive compensation that would typically be prohibited to ensure higher standards and greater transparency. Notably, except for PTE 2020-02 and PTE 84-24, which have been granted an additional one-year transition period, all other exemptions will now require advisors to provide a written statement of their fiduciary status and comply with impartial conduct standards. The key updates include the following:

Financial advisors and firms must now meet more stringent criteria to qualify for commissions or other forms of compensation.
Financial advisors must clearly demonstrate that they are meeting fiduciary standards and be transparent about their compensation structures to provide clarity to their clients.

The DOL has introduced the new rule for a range of reasons. Labor officials believe that when financial advisors are not held to a fiduciary standard, they might not offer their clients unbiased advice. The risk of receiving prejudiced advice that benefits the financial advisor and not necessarily the client is a possibility which can hinder the client’s growth. Without fiduciary protections, 401(k) investors may end up paying their advisors a higher fee. Additionally, they may impact their future returns by putting their hard-earned money into investment products that may not align with their financial needs. On the other hand, with vested interests, the financial advisor can earn more commission by recommending inferior investment options to their clients.

The new rule aims to protect investors from potential risks surrounding 401(k) rollovers, such as hidden fees, the possibility of rolling into plans with poor investment options, etc. The rule will impose strict regulations surrounding rollover recommendations to ensure that financial advisors only suggest rollovers when they genuinely serve the investor’s best interests, thereby eliminating recommendations that might not be advantageous for the investor. The rule will also ensure that investors roll over to suitable accounts with investments aligned to their needs and are not duped into making decisions that help advisors earn higher commissions or fees.

The new rule for 401(k) rollovers can impact employees, employers offering 401(k) plans, as well as the financial industry in the following ways:

1. Employee considering a 401(k) rollover

For employees, the new rule brings greater protections and more informed advice on 401(k) rollover to an IRA and other retirement accounts. Employees will also benefit from the enhanced scrutiny put on the advice they get. This will result in better-managed 401(k) plans and more reliable financial guidance, which can protect 401(k) investors and safeguard their retirement planning endeavors. With the rule in place, employees are less likely to be pushed into rollovers that do not serve their long-term goals. Moreover, the rule will also promote financial education among employees. Employees can know and understand the various investment options, the associated fees, and the implications of a 401(k) rollover on their long-term financial security. Educated employees are far more likely to make well-informed decisions about their retirement savings as they can understand the benefits and potential drawbacks of their investment choices without being misled.

2. Companies offering 401(k) rollovers

The rule also impacts employers. Companies will now have to be more diligent when selecting 401(k) financial advisors. They will need to ensure that the financial advisor is a fiduciary. This includes conducting background checks on individuals and advising firms that manage their 401(k) plans. Companies will have to verify that financial advisors are committed to transparency and fiduciary responsibility and not just look for professionals on the basis of cost-effectiveness. This includes reassessing plans involving commission-based advisors. Employers now need to shift to simplified fee arrangements, which can potentially reduce conflicts of interest. In addition to scrutinizing financial advisors and reassessing fee structures, employers will also need to re-evaluate the investment options offered within their 401(k) plans. The focus will likely shift towards prioritizing investment choices that have lower fees than those that offer better growth prospects. Apart from ensuring that the investment options are cost-effective, employers will also need to ensure that they are in the best interest of the employees and help them maximize their retirement savings.

3. Financial advising industry

The implementation of the rule will necessitate significant adjustments within the financial industry. Financial advisors will be required to modify their practices to comply with the new fiduciary standards. This could involve changes to their fee structures, shifting away from commission-based compensation to models that better align with fiduciary duties. Advisors may need to adopt transparent pricing methods to eliminate pricing conflicts. Additionally, the nature of the advice provided might shift to ensure it is more aligned with the client’s needs and objectives rather than being driven by the potential for higher earnings for the financial advisor.

Overall, the new rule aims to create a more transparent and investor-friendly environment. Imposing stricter standards can push financial advisors to act in their client’s best interests, which can enhance the quality of financial advice and protect investors from potentially harmful rollover decisions. Even though these changes require adjustment by the financial industry, they are intended to promote greater trust and reliability in retirement planning advice, ultimately benefiting the long-term financial health of investors as well as improving the reputation of the financial industry.

Important highlight on the new rule for investment advice about 401k rollovers

It is important to note that the DOL rule is a proposed rule that has not yet been implemented. The initiative to establish fiduciary responsibilities for investment advisors began in 2015 under the Obama administration, with the aim to prioritize clients’ best interests in investment recommendations regarding 401(k) rollovers. However, the enforcement of the rule faced a setback in 2017 when the Trump administration halted its implementation. In October 2023, the Biden administration introduced the Retirement Security Rule with the aim of re-establishing financial advisors’ fiduciary duty to act in their clients’ best interests, especially concerning 401(k) rollovers. Despite its intent to protect investors, the rule faced some legal challenges, with opposition arguing potential increased costs and limited access to financial advice.

The rule is proposed to come into effect from September 23, 2024. This means it can be subject to review and possible changes in the coming months. Therefore, companies and employees need to monitor regulatory updates and proactively make amendments to their retirement planning strategies with regard to the latest developments. Companies, in particular, can face legal and compliance challenges that they may need to consider.

To conclude

The DOL’s proposed fiduciary rule is a significant step towards ensuring that financial advisors prioritize the best interests of their clients regarding 401(k) rollovers. Expanding the definition of who is considered a fiduciary, increasing scrutiny on rollover recommendations, and bringing focus to newer compensation models can potentially enhance investor protection and provide better advice for retirement plan participants. However, since the rule has not yet been imposed and can be altered over the next few months, companies and investors must remain vigilant and proactive in adapting to these regulatory changes to ensure compliance. It is important for investors, employers, and the broader financial industry to stay informed and ultimately benefit from the rule.

Use the free advisor match tool to get matched with experienced financial advisors who can help clear your doubts about 401(k) rollovers. Answer some simple questions about your financial needs and get matched with 2 to 3 advisors who can best fulfill your financial requirements.

To learn more about suitable retirement planning strategies for your unique financial requirements, visit Dash Investments or email me directly at dash@dashinvestments.com.

About Dash Investments

Dash Investments is privately owned by Jonathan Dash and is an independent investment advisory firm, managing private client accounts for individuals and families across America. As a Registered Investment Advisor (RIA) firm with the SEC, they are fiduciaries who put clients’ interests ahead of everything else.

Dash Investments offers a full range of investment advisory and financial services, which are tailored to each client’s unique needs providing institutional-caliber money management services that are based upon a solid, proven research approach. Additionally, each client receives comprehensive financial planning to ensure they are moving toward their financial goals.

CEO & Chief Investment Officer Jonathan Dash has been covered in major business publications such as Barron’s, The Wall Street Journal, and The New York Times as a leader in the investment industry with a track record of creating value for his firm’s clients.