Reforms Needed to Reduce IRA Fees

February 20, 2013 (PLANSPONSOR.com) – A research paper contends that additional reform is needed to protect participants who roll over retirement plan assets into individual retirement accounts (IRAs) from high investment fees.

In an Issue Brief released by the Center for Retirement Research (CRR) at Boston College, researchers point out that assets held in 401(k) plans are protected by Employee Retirement Income Security Act (ERISA) fiduciary rules, and fees are under a spotlight. However, assets rolled into IRAs enter a world where suitability becomes the standard of care, and broker/dealers are paid commissions that encourage the sale of high-priced mutual funds. “If a fiduciary standard and attention to fees are appropriate for retirement assets when they are in a 401(k) plan, then such safeguards are clearly still appropriate when they are rolled over,” the researchers wrote.  

The report explains that the Department of Labor (DOL) has proposed changes that would result in broker/dealers being classified as “fiduciaries” under the Internal Revenue Code when providing investment advice for IRAs. As such, they would be subject to Internal Revenue Service (IRS) prohibited transaction rules. Specifically, under this anti-self-dealing provision, the proposal would prevent broker/dealers from receiving third-party payments such as 12b-1 fees. The prohibition on 12b-1 fees would apply only to the approximately 20% of total mutual fund assets held in IRAs.   

The researchers note that the DOL proposals do not change the general standard of conduct required of broker/dealers. They can continue to operate under a suitability standard rather than the “solely in the interest” standard required of ERISA fiduciaries. In addition, they found that in the short run, the direct impact of such a change would be rebates to IRA investors of about four basis points. Gains could be greater if broker/dealers responded by shifting investments to low-cost index funds.

The report put forth several bolder reforms than the DOL proposal. At a minimum, participants should be encouraged to keep their money in the 401(k) system when switching jobs, rather than rolling balances over into IRAs, the researchers said. They suggested two changes to help: First, workers switching jobs should always be allowed to keep their 401(k) assets with their previous employer, requiring a change in the provision that allows employers to cash out account balances of less than $5,000; Second, workers should always be allowed to move their 401(k) assets from a previous employer to a new employer, requiring a change in the provision that gives employers the option to deny a rollover from a previous plan.   

Another option the researchers suggest is to make any rollover transaction subject to ERISA, given that the assets in 401(k)s come from the employer plan arena. Such a change would mean that an adviser could recommend a rollover only when it was solely in the client’s interests, as the adviser would be subject to the higher standard required of 401(k) fiduciaries. Participants considering a rollover could also be presented with disclosure forms comparing fees in their 401(k) plan with those in their proposed IRA and showing the respective impacts on projected wealth at retirement. Finally, if a 401(k) participant does decide to go ahead with an IRA rollover, policymakers could set a default investment vehicle of a life-cycle index fund.    

Four additional options researchers suggested to improve the fee situation include establishing benchmarks for 401(k) fees; requiring reporting and benchmarks for IRA fees; requiring 401(k) plans to offer index funds; and eliminating high-cost, actively managed funds.   

The CRR Issue Brief, “Will Regulations to Reduce IRA Fees Work?” can be downloaded here.

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