A new Labor Department rule could help millions of workers make better choices on how to invest in their workplace retirement plans.
I had the opportunity recently, as part of a financial literacy ministry I direct at my church, to see and hear how many people allocate the money they put in their 401(k)s or other plans. And this made me very concerned that many employees don’t know what they’re doing when it comes to investing for their retirement.
People need specific guidance. Without it, they often guess at what they should do. Or they copy the investment choices of a co-worker, friend or family member. The result is that their retirement plans aren’t right for them. One young woman during the workshop’s question-and-answer period told me she was so unsure about how to invest her 401(k) that she just copied what her mother did. The problem was that her mother was close to retirement, so her conservative choices weren’t appropriate for the daughter.
Employees like that young worker are the ones the Labor Department is trying to help. In an effort to increase access to high-quality and unbiased advice, the department’s Employee Benefits Security Administration issued a final regulation this week that will allow financial companies that manage 401(k) and similar plans or IRAs to give investment advice to workers and retirees in response to their need for professional help.
This rule has the potential to improve greatly the amount of money people end up having at retirement by eliminating common investor mistakes. But it depends on how many employers begin offering the advice to their employees.
“Retirement security depends on the kinds of decisions an individual makes,” said Phyllis C. Borzi, assistant secretary for the EBSA. She added that quality investment advice can help avoid costly errors.
Financial companies have been able to provide investment education consisting of generic asset allocation models that are not tailored to a particular individual. Employers also have been able to make arrangements for employees to get investment advice — from an independent third party.
That’s what’s changing. Now companies, under the new exemption, can arrange for workers to get specific advice from the firm running their plan as long as the advice is based on a computer model certified as unbiased and as applying generally accepted investment theories, or the adviser is compensated on a “level-fee” basis, meaning the fees do not vary based on investments selected by the plan participant.
Whichever way the advice is given, several other conditions have to be met to ensure participants are protected, including disclosing the fees paid to advisers and an annual audit of the arrangement.
In a report released earlier this year, the Government Accountability Office warned employees to watch out for biased investment guidance from the financial companies paid to set up and run 401(k) plans. The GAO, the investigative arm of Congress, said companies managing the plans might not be fully disclosing to participants that they are receiving third-party payments from investment-fund companies through deals sometimes called revenue sharing. These payments create a conflict of interest because some advisers may get more money from certain investment vehicles. And for the less scrupulous, that’s incentive to steer people to those investments even if they cost more or perform worse.
Borzi said she’s confident that the new rule provides strong safeguards to prevent advisers from slanting investment recommendations or steering people into options that pay the adviser higher fees. If an employee gets individual investment advice, it has to be in that person’s best interest and tailored to his or her particular needs.
The Labor Department is counting on this new rule, which becomes effective Dec. 27, to encourage more employers to offer personalized, individual investment advice to their workers. Doing so could improve investment results by eliminating errors such as poor trading strategies and inadequate diversification. The department estimates that increased use of investment advice would reduce investment mistakes by between $7 billion and $18 billion annually.
The new rule just makes common sense. We know, not just from anecdotal evidence but also from various surveys and studies, that people are unsure how to invest for retirement. I’m hoping employers will make the effort to give their workers affordable access to good and unbiased advice.
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