When the Labor Department finalized the conflict-of-interest rule last April requiring retirement advisers to act as fiduciaries, some industry groups issued dire warnings. Upending the existing business model, they claimed, would cause American households to lose access to retirement advice.
But as the industry began implementing the rule, it has defied these predictions. Financial products are evolving, and advisers are competing more on price and quality. Although much of the cost of complying with what many call the “fiduciary rule” already has been incurred, the benefits are only beginning. That’s why President Trump’s February 3 memorandum potentially setting the stage for an unnecessary reversal of the rule would be so costly to consumers.
Because the tax code subsidizes retirement savings, the government has an important role to play in ensuring their safety and security. The conflict-of-interest rule built on earlier efforts to provide basic protections for American pension and retirement benefits, going all the way back to the 1974 Employee Retirement Income Security Act (ERISA). Notably, neither ERISA nor the conflict-of-interest rule applies to investments outside of the subsidized and regulated retirement system.
That system has changed dramatically since ERISA was enacted, shifting away from traditional pensions and toward defined-contribution plans like 401(k)s and individual retirement accounts. This change reflected workers’ desire for their retirement savings to be more flexible, portable, and transparent.
But the new landscape also has many pitfalls. Perhaps the biggest is that when people leave their employers, they are forced to make one of the most important and complicated financial decisions of their lives: whether and how to roll over their retirement savings into an individual retirement account (IRA). One challenge was that under the old rules advisers were held to different standards: Advice from a 401(k) provider was required to be “prudent and loyal” to participants’ interests—in other words, it had to meet a fiduciary standard.
Brokers of IRAs, on the other hand, were merely required to “avoid conflicts.” The definition of these conflicts was very narrow, allowing most brokers to receive a variety of conflicted payments—commissions, for instance—from the sellers of the products they recommended.
How much do these conflicts matter? A 2015 report I supervised as chairman of President Obama’s Council of Economic Advisers, drawing on over a dozen peer-reviewed studies, estimated that the lower returns caused by conflicted advice amounted to $17 billion annually in IRAs alone. Clients who received conflicted advice when rolling over at retirement could exhaust their savings five years earlier than they should have.
A 2015 report, drawing on over a dozen peer-reviewed studies, estimated that the lower returns caused by conflicted advice amounted to $17 billion annually in IRAs alone.
Many retirement advisers are honest, work hard to provide sound guidance, charge transparent fees, and offer solid recommendations. Emerging business models, including so-called robo-advisers, harness technology to reduce costs and provide high-quality advice. But the brokers who make large commissions by providing conflicted advice have a powerful financial incentive to stifle these alternative models.
After receiving extensive input from the industry, the Obama administration wrote the conflict-of-interest rule to include an exemption allowing a wide variety of payments to brokers as long as firms established strict safeguards against conflicted advice. The rule is more flexible and permissive than the approach taken by the United Kingdom, Australia, and other countries. Most major brokers chose to continue receiving compensation from the funds they recommend, but put in place procedures to reduce conflicts of interest and increase transparency. This is leading to a more competitive and diverse market for retirement advice, with benefits for consumers and brokers alike.
Even with this careful design, the rule still created compliance costs: an estimated $5 billion upfront, along with $1.5 billion annually thereafter. But the goal of sensible regulation should be to maximize net benefits, not to minimize gross costs. The boon to consumers of minimizing conflicted advice is considerably larger than the upfront costs, and it will grow over time as more assets come under the rule’s purview.
Critically, much of the expense of the new consumer protections reflects one-time transition costs as firms developed new approaches to providing advice with fewer harmful conflicts of interest. As a result, the net benefits of continued implementation of the consumer protections are even larger than those estimated at the time the protections were announced.
President Trump’s move to undo the conflict-of-interest rule could reduce costs for some industry actors. But the flip side would be higher fees and worse returns for American savers—along with an additional set of transition costs as industry adapts once again. If the Labor Department takes seriously the president’s instructions to examine the rule’s effect on investors and retirees, it can only conclude that the rule is a benefit to Americans and ought to stay in place.