Over the past few decades, the way Americans save for retirement has changed dramatically. Pension funds with defined benefits contributed by employers and managed by professionals, which were widely available in the late 1970s, are far less common in today’s workplace.
Instead, most Americans are individually responsible for contributing to their retirement accounts. Equally important, they’re also responsible for managing those investments.
“Unfortunately,” says Brookings Senior Fellow Gary Burtless, “there is a great deal of evidence workers do not know much about investing.” Financial advisors, therefore, are playing an increasingly important role in the future of Americans saving for retirement.
A new rule from the Department of Labor
This spring the Department of Labor (DOL) released a proposed rule designed to protect people saving for retirement from receiving financial advice that benefits their advisor more than it benefits them.
The rule proposes a tougher legal standard—called the “fiduciary standard”—that advisors must meet when giving advice to their clients. Under the proposed rule, advisors must recommend investments that would be financially smart for their clients, even if recommending other investments would be more financially beneficial for the advisor. And it makes that advisor responsible for the client’s losses—so they have skin in the game.
Brookings experts debate the “fiduciary standard”
Brookings Economic Studies experts have studied the rule, helping to break down its components, highlight its strengths, and flag potential problems that need to be addressed.
In a summary of the proposed rule and its purpose,
Gary Burtless examines the decades-long shift in retirement savings patterns
. Burtless, the John C. and Nancy D. Whitehead Chair, also highlights arguments against the newer, stricter standard:
“A counter-argument to imposing a fiduciary standard on all advisors is that the commission system, which creates adverse incentives for advisors, is necessary in order to pay for financial advice to retirement savers, especially savers who have modest accumulations.”
Burtless dismisses the argument, writing, “This claim does not seem terribly compelling. There are alternative ways to compensate financial advisors that do not create an obvious conflict between the interests of advisors and retirement savers.”
In a new paper on the proposed rule,
Martin Neil Baily and Sarah E. Holmes argue for cautious optimism
. While acknowledging that safeguards must be implemented in order to protect clients and to eliminate potential conflicts of interest among financial advisors, Baily and Holmes also point out that the new rule could have some adverse impacts.
First, they suggest the DOL take steps to ensure compliance costs are minimized. Otherwise, there is the risk that there will no longer be profit in advising small-scale clients and those savers will be abandoned. The authors also call on the DOL to close a loophole that doesn’t currently distinguish the difference between education and advice, which they note is already in the process of being corrected. Finally, they express concern that advisors may become overly risk averse, even when the risk is generally appropriate (e.g., for the young) and the investor has healthy expectations, a problem which the DOL would be wise to consider.
As the debate over the DOL’s rule continues among economists, policymakers, and advocates,
Economic Studies Fellow Jane Dokko discusses the importance of looking at the sources of research
pointing out either the rule’s merits or deficiencies.
“To no surprise, those benefiting from current practices have paid for research to try to discredit the proposed rule. Such research claims that people don’t lose as much money from biased advice as careful, independent research has shown. Research not funded by special interest groups concludes that when they are paid to recommend certain financial products over others, advisors tilt their recommendations so that they receive higher pay.”
“The public discussion should thus focus on how best to curb practices that harm people and how best to assure that retirement savers receive advice that is in their best interest.”
On August 11, Martin Baily testified at a public hearing on the new rule.
In his statement
, Baily highlights several reasons Americans struggle to adequately prepare for retirement and the important role financial advisers can play in educating clients at various income levels.
According to Baily, the proposed rule could “provide a net benefit to the country,” but “in its current form, may open the door to some undesirable or problematic outcomes.”
Baily highlights adverse impacts the rule could have on small-scale savers, concerns of increased risk aversion in some advisors, and the rule’s problematic emphasis on MyRA as a guide for savers, among other concerns.
Nicholas Buchta contributed to this post