Beginning in July, advisors and firms must follow new requirements issued by the Department of Labor (DOL) related to rollover transactions.
While the DOL finalized new fiduciary rules applying to rollovers in February, some elements were delayed until July 1, 2022. Among the delayed provisions were requirements for documenting rollover transactions. Beginning in July, advisors and firms recommending a rollover must document for the plan participant why the rollover option is in their best interest.
Fiduciary advice and rollovers
Retirement law under ERISA generally prohibits fiduciaries from receiving compensation associated with a retirement plan or IRA. To help determine whether a recommendation was considered fiduciary investment advice, the DOL introduced a five-part test in 1975. If an advisor could operate without satisfying all elements of the five-part test under ERISA, he or she would not generally be considered a fiduciary and thus avoid a prohibited transaction when receiving compensation.
Elements of the five-part test are:
- Advice is provided making recommendations on investing in, or purchasing, securities or other property
- The advice is provided on a “regular basis”
- There is a mutual agreement
- The advice will serve as the primary basis for the investment decision
- The advice will be individualized based on the needs of the participant
Historically, advisors recommending rollovers have been able to avoid fiduciary status by avoiding one of these elements. Additionally, the DOL issued an advisory opinion in 2005 stating that most rollovers would not meet this advice standard since they are typically one-time transactions, and not done on a “regular basis.”
As part of the regulatory process to re-examine fiduciary rules around rollovers, this 2005 opinion was formally withdrawn and elements of the original five-part test have been reinterpreted. For example, the “regular basis” requirement has been broadened to include the rollover transaction if it’s anticipated that there will be an ongoing relationship after the rollover. Essentially, under the new interpretation, most rollover transactions will likely fall under the new advice guidelines and technically be considered a prohibited transaction.
To remedy this and allow advisors and firms to receive compensation, they may comply with Prohibited Transaction Exemption 2020-02. In general, certain steps such as mitigating conflicts of interest can be taken to utilize the exemption and avoid a prohibited transaction under ERISA.
For rollover recommendations going forward, advisors will generally need to gather information about the retirement plan and IRA (expenses, investments, services), include relevant details about the participant/client, and analyze this information as the basis that the recommendation is in the best interest of the participant. Lastly, they will need to provide documentation to support the recommendation. Material conflicts of interest must be disclosed, and any compensation received by the advisor must be “reasonable.” This determination depends on a number of factors, including the nature of services provided, market price of services, underlying asset(s), scope of monitoring, and complexity of product.
When an individual changes jobs or retires they face a choice: whether to roll over assets into an IRA, keep the assets in an existing plan, or transfer to a new 401(k).
Sometimes it makes sense to rollover the assets. An IRA may provide:
- Broad investment and product choice, including access to products designed to provide lifetime, guaranteed income
- The ability to convert an IRA to a Roth IRA, which may not be an option with an employer-sponsored plan
- The ability for investors at age 70½ to donate tax-free IRA withdrawals to a qualified charity
For some savers, a 401(k) plan may have more advantages. A 401(k) may offer investment options, services, and cost-saving provisions that may not be available outside of the plan, including:
- Lower expenses, such as special institutional pricing in some plans
- Access to loans for current employees
- Penalty-free distribution at age 55 (compared with 59½ with an IRA), if the plan participant separated from service from the company after reaching age 55
Savers may want to consider seeking expert advice when reviewing this decision. For a detailed look at considerations when making a rollover, read our investor education piece, “When it’s time to move 401(k) assets.”
IRA rollovers on the rise
According to LIMRA’s Secure Retirement Institute, retirement plan participants who change jobs or retire roll over more than $500 billion annually into IRAs. The organization predicts this total will surpass $760 billion annually within five years. It is imperative that firms and advisors understand the changing regulatory landscape when discussing or recommending rollovers to clients.
For informational purposes only. Not an investment recommendation.
This information is not meant as tax or legal advice. Please consult with the appropriate tax or legal professional regarding your particular circumstances before making any investment decisions. Putnam does not provide tax or legal advice.