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The Obama administration has a plan to crack down on bad investment advice

Is your financial advisor delaying your happy retirement?
Is your financial advisor delaying your happy retirement?
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  1. The White House has asked the Labor Department to create new rules asking more retirement advisors put clients' interest first. That's not the standard all advisors follow.
  2. According to administration estimates, this "conflicted advice," in which financial advisors face a conflict of interest in the tips they give to clients, costs investors anywhere from $8 billion to more than $17 billion per year.
  3. The rule is a part of the White House's "middle-class economics" plan, announced around this year's State of the Union address.

Investment brokers don't always serve clients' interests

The White House is asking the Labor Department to change the rules on how financial advisers advising clients on retirement savings decide what to tell their clients. The department will today submit a draft rule saying advisors should all follow a "fiduciary standard." Under that standard, advisers have to put clients' interests first and disclose any conflicts of interest.

That is as opposed to the "suitability standard," in which advisors merely have to give clients advice that meets their broader needs and retirement goals.

Different types of financial advisors have to use different rules: there are what are called registered investment advisors, who follow the tougher fiduciary standard (and also tend to serve wealthier clients, as Investopedia writes). But brokers only need to follow suitability standards.

The cost of suitability

That means that a broker might, for example, push people to invest in plans with higher fees because those funds will also help the broker to get a higher commission. In a report released Monday, the White House uses the example of a broker that pushes a saver to roll an old 401(k) over into a (higher-fee) IRA, as opposed to leaving it with the old employer.

That conflicted advice can cost a worker in a huge way. "A typical worker who receives conflicted advice when rolling over a 401(k) balance to an IRA at age 45 will lose an estimated 17 percent from her account by age 65," the White House writes in a report released Monday. They add that if there are $100,000 in that account, it could grow to $216,000 in 20 years without the bad advice, as opposed to $179,000 with the conflict of interest.

A new rule will not take effect immediately, however, and as the Washington Post reports, the details of the rule won't be available for a few months.

Why it matters

In a report issued on Friday, the White House explained that $1.7 trillion in IRA assets are invested using "conflicted advice," costing around $17 billion a year.

This matters because the share of Americans with access to 401(k) is growing, as this chart form the Center for Retirement Research shows, while traditional pension coverage has fallen off:

Pensions vs 401k

(Center for Retirement Research)

And that means the share of people who need some sort of investment know-how in order to retire is growing, as well as the amount of money they are dealing with. Indeed, the shift in retirement savings has been massive, but the rules haven't followed suit. As Bloomberg reported prior to this announcement, the rules have been the same since 1975 — that's before 401(k)s even existed. Today, more than one-third of all workers are in defined contribution plans. The idea here is that when they ask for advice in managing their retirement, they're asking "experts" whose expertise is distorted by bias.

And that could affect a huge share of Americans, according to one expert.

"I think the likelihood of your average American encountering this at some point in their financial life is extremely high," says Greg McBride, chief financial analyst for Bankrate.com. "Whether it's questions about a 401(k), whether you leave the employer and you want to roll it over into an IRA, whoever you talk to to help you with that, you need to make sure the advice they're giving you is aligned with your best interests."

The financial industry, of course, is not likely to be pleased with the tighter rules. As Bloomberg also reported, "The industry has argued that it would be forced to move investors to accounts that charge a flat fee," and people with assets of less than $50,000 "would probably be dropped, forcing investors to handle their own savings, industry groups have said."

The politics of retirement rulemaking

The proposal is a part of the White House's "Middle Class Economics" package of proposals. That package has also included a tax proposal that would raise taxes on the wealthiest Americans, a proposal to give students two free years of community college, and plans to both push Congress to pass sick leave legislation and push states to create their own family leave programs.

Further Reading

  • For more information on defined contribution retirement plans, read Vox's explainer on 401(k)s.
  • Investopedia has a great breakdown of the fiduciary versus the suitability standard.
  • Bankrate explains how to pick an advisor who follows the fiduciary standard.
Update: This piece was updated since its original publishing to include comment from Bankrate's Greg McBride.