Proposed DOL Fiduciary Regulation May Lead to Unintended Roadblocks for 403(b)s

What’s all the fuss about surrounding the Department of Labor’s (DOL’s) proposed fiduciary regulation?  After all, the DOL and proponents of the regulations say that it’s simply about having the financial services industry act in the best interest of plans and individuals.

In reality, however, the financial services industry has always championed the best interest of clients. In fact, the vast majority fulfills this aim thanks to existing regulations and just plain old good business practice.

Now, however, the DOL is attempting to accomplish this objective by broadening the scope of who becomes an “investment advice fiduciary.” That may not sound like such a bad idea on the surface. But if you dig a little deeper, you’ll see the problem.

Limits on fiduciaries

ERISA requires that a fiduciary must not only act in the best interest of those for whom they’re responsible but places a wide array of prohibitions on fiduciaries. One example is a requirement that fiduciaries may not personally benefit from decisions they make on behalf of a plan.

These prohibitions work well for independent fiduciaries; that is, those plan sponsor representatives charged with overseeing and managing the plan.  These same prohibitions, however, make it extraordinarily difficult for financial services companies and their representatives to provide services to retirement plans in a way that’s helpful to plan participants.

How does this affect 403(b) plans?  Read on…

403(b) plan sponsors have made progress

In the two decades I’ve worked with tax-exempt organizations, I’ve seen a lot of evolution, particularly with 403(b) plans. A significant number of 403(b) plans have been modernized by their independent plan fiduciaries by replacing individual variable annuity contracts with a more efficient group arrangement and consolidating multiple plans into one.

This is an appropriate and a usual outcome of a fiduciary due diligence review under an ERISA 403(b) plan. Unlike a 401(k) plan, where plan fiduciaries can simply direct the replacement of one investment option with another, 403(b) plans often present a greater challenge.

Participants must authorize an exchange of their individual variable annuity contracts to another investment vehicle. A fiduciary cannot simply direct that the assets be transferred. These are generally not simple transactions for plan participants. They usually require a great deal of assistance and education to understand their current individual variable annuity contract as well as the new investment vehicle that the plan fiduciary has already determined is more prudent. The employer’s human resources personnel usually do not have the expertise to help participants with the specifics of an investment product; that’s why they look to their financial professional or service provider for assistance.

Preventing progress

The DOL has traditionally been very supportive of this modernization. In fact, they’ve encouraged it.  That’s why it is particularly curious that the DOL’s proposed fiduciary regulation seem to introduce prohibitions that will likely prevent future modernization.

Under current rules, education personnel can speak with clarity and depth about the old and new investment vehicles. They can also encourage employees to sign the paperwork to transfer into the investment vehicle and applicable investment options that the independent fiduciary has determined are appropriate.

Under the DOL’s proposal, the definition of financial education no longer allows references to specific investment options.  That means that an educational professional who is affiliated with a financial services company can no longer reference specific investment options without becoming an investment advice fiduciary, with all of the associated prohibitions.

Impact on independent plan fiduciaries

There are a great many pages of comments devoted to the changes in the definition of “investment education.” But there’s very little discussion about the negative effect it will have on independent plan fiduciaries’ ability to implement positive changes to their client’s plans.

Without the ability to educate participants, the effort to encourage them to transfer assets to more efficient group products that can improve overall plan administration and compliance—as well as lower overall fees—will be much less successful.  This could not possibly be a deliberate result, since it runs exactly counter to the DOL’s current and historical positions.

DOL should consider the consequences

It remains to be seen what changes result from comment letters and the public hearings. I certainly hope, however, that the DOL considers the negative ripple effects of the proposed rule changes and adjusts the final rule accordingly so that ERISA plans can continue to modernize to the benefit of participants and their beneficiaries.

In addition to blogging here, I also tweet regularly about topics of interest to tax-exempt plans.

Affiliation Disclosures

The subject matter in this communication is provided with the understanding that The Principal® is not rendering legal, accounting, or tax advice. You should consult with appropriate counsel or other advisors on all matters pertaining to legal, tax, or accounting obligations and requirements.

Insurance products and plan administrative services are provided by Principal Life Insurance Company a member of the Principal Financial Group®, (The Principal®), Des Moines, IA 50392.  l  t1509160bhs – 09/2015