Fiscal Hawks Should Love Cheaper Retirement Plans
Changes in rules governing retirement-plan managers and advisers will lower their fees, increase retirees’ savings and help limit tax increases.
Bloomberg, February 24, 2015
I wanted to spend a bit of time on the Labor Department’s proposal to place a fiduciary obligation on those who manage or provide investment advice on retirement plans. These include individual retirement accounts and 401(k)s (including 403(b)s). The new rules require the broker or adviser to “operate in the best interest of the client.”
I don’t want to rehash all of the reasons why this is a very good idea — I did that last year in an article with the headline “Find a financial adviser who will put your interests first.” Instead, I want to explain why fiscal conservatives should rally around this idea as a way to hold down taxes.
I first discussed the lack of a fiduciary duty in 2013. The context was a proposal in the U.K. that was going to cap retirement-plan fees. Those rules were passed, and starting in April, annual charges on British workplace pension plans with automatic enrollment are capped at 0.75 percent.
The conservative ruling party in the U.K. did this to save future taxes, as you will see below.
The proposed fiduciary rules are not an explicit fee cap, but they would require that “any fees and costs paid by the client be reasonable for the services provided.” It is probable that the “best interests of investors” will mean athat fees will be reduced from today’s often-excessive levels. If you doubt this, then perhaps you might explain why Wall Street has spent millions of dollars lobbying against the fiduciary standard. They KNOW just what the net result will be — lower fees to brokers and advisers.
The fiduciary debate has been going on for many years. In 2011, the Securities and Exchange Commission published a report titled “Study on Investment Advisers and Broker-Dealers,” which recommended that ALL financial advisers be subject to a uniform fiduciary standard. Placing $1.7 trillion in retirement accounts under the fiduciary standard is an incremental move (most of the rest of the $5 trillion in retirement accounts already is under that standard). That is less than 4 percent of the total U.S. stock and bond markets. That seems like a reasonable compromise.
But what about taxes?
In the U.K., the pension-fund fee cap proposal came not, as you might imagine, from the left-wing Labour party; rather, it was the brain-child of the right-wing Tories. Why? The conservative party has figured out that shortfalls in retirement savings ultimately will be picked up by the government. Pensioners — who like their U.S. counterparts vote in greater numbers than the young — won’t tolerate an impoverished retirement. Hence, high pension fees today simply mean higher government spending in the future
And that means tax increases.
I wish that U.S. fiscal conservatives understood the obvious reasoning behind this. As my Bloomberg View colleague Matt Levine noted yesterday, there’s about “$1.7 trillion in individual retirement accounts invested in funds that pay brokers to recommend them. The people who invest in those funds could improve their performance by about 1 percentage point a year by switching to other funds that don’t pay brokers.” That means there is $17 billion a year — compounded — that won’t be in Americans’ collective retirement accounts 30 years from now. Over time, that adds up to trillions of dollars in increased future government spending — and higher taxes.
Again, this is old news. The Vanguard Group has done numerous studies on the impact of fees on returns, and found that compounded over time, they are quite substantial. In general, the fees on many funds in the typical retirement investment vehicle are too high.
The Brits understand this. We should take a page from their conservatives, and lower our future tax burden.
(Corrects to delete reference in 10th paragraph and footnote to U.S. Senator Orrin Hatch’s position on Labor Department plans to craft fiduciary rules for individual retirement accounts.)
The big irony that I have found with politicians is that the more they espouse “survival of the fittest” using the “invisible hand of the market” to “self-regulate”, the more likely they are to also want “creationism” taught in schools instead of evolution. Apparently natural selection only occurs in financial markets where their campaign contributors make the big bucks.
Ditto.
If you argue for the long-term benefits of policies of climate change to defense technology to education to nutrition they are ALL good in the long run.
The GOP likes the short term and ideological dictates of the lemmings they’ve created out in talk radio land.
but they they themselves and their …..bosses wont stand to have to be in the same situation.
Social Darwinism is full of ironies.
http://en.wikipedia.org/wiki/Social_Darwinism
Barry, I’m all for these new rules. The fiduciary standard will go a long way to reduce churning and other troll advisor activities. But I’m less clear on how it will save clients money. How exactly will that work without an explicit cap on fees? A broker manages a rollover IRA with C share funds or something similar with expense ratios around 1.5% along with a $50 annual account fee. That broker gets pushed into a fee based model or something similar to comply with this new reality and charges 1% plus ETF or I share expenses plus account fees. How does that client win from an expense standpoint. I get that large households can negotiate lower fees, but what about the everyday client with 250K aum?
Computerized advisors. TRB and Barry are both noting those in increasing detail.
They also note that the major value of an advisor is advising you not to change your plan in the heat of panic. I am not sure those computer advisors will be able to do that,
but that is all the low aum clients can afford.
@ catclub:
I am proof that that panic is not always the case. I invest primary in my defer comp plan at work. When the stock market collapsed around 2008 I had been putting extra cash into paying down debt. Not only did I not sale but stop paying down debt and squeeze my budget hard to buy as much as possible. I knew I had just received a once in a lifetime opportunity. I have no advisor but have self educated myself. Education will help smaller investors not to make that mistake. Right now am enduring over all investment fees of about 1.5%. And that after a thorough look at my plan to reduce the fees as much as possible. When I retire next year and can roll over my money it is going into Vanguard low fee funds.
Complaints to regulators and/or civil litigation. There would be lawyers slobbering to get at class action lawsuits against financial institutions that clearly don’t meet a reasonable standard of care.
Vanguard, Schwab etc. have shown how low fees can be for index funds. While the standard of care may not necessarily be that low, it is unlikely to be an average of 1%+ annual fund fees with 1%+ advice/sales charge fees. The most important savings for the typical person will be the rollover transfer from a 401k to IRA where current 401k fees are generally getting to be reasonable to something that can make a lot more money for the financial firm. That rollover would now have to be in the “best interests” of the investor as opposed to “suitable”. Right now many retirees are getting hosed.
So retirees would be forbidden from rolling over into an IRA because “Pappa knows best”? Investors would be forbidden from doing anything other than putting their money into “one size fits all” Funds Of Funds based solely on their age? God save me from my saviors?
No, they would not be forbidden. However, many of the “advisor” firms are looking to roll over the 401ks into much higher fee IRAs. Unsophisticated investors will follow that advice to their detriment. Fiduciary rules would effectively require the IRA fees to look much more like the lower cost 401ks, which will make many of the “advisors” quite unhappy. Much of the pressure on the sales force to convince people to do rollovers would likely drop off as the big difference in profit would go away.
Sorry, that’s not usually the case. Clients pay asset based fees with low associated ETF or I share expenses or own other products like c share funds, annuities, UITs, etc. very rarely both. So are we talking about fiduciary standards or compensation issues? They are separate but related issues. So now all a douche broker will need to do is fill out some bullshit 401k rollover suitability form signed by the client. The broker will cite increased investment options, etc and it’s done. Or a bunch of series 7 only REIT/annuity peddlers running out to get their 66 and throw people into some crap model stolen from the back of a BlackRock glossy with no backtesting.
What is the effective tax rate on income made in a profitable corporation, then passed on to its executives?
Why wouldn’t it apply to the $17 billion annually?
The corporation will hold the profit offshore so they are not taxed on it in the US. The executives will get it in deferred compensation with options that will then be taxed at the capital gains rate years later.
That is how trickle-down economics actually works.