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Could the New Fiduciary Rule Help your 401(k) and IRA?

With the new Fiduciary Rule in place, could you see lower fund fees and simpler fee-structures in your 401(k) plan and IRA?

Mutual fund shares with lower costs and more disclosure about how much fees and expenses you’re paying could be coming soon to a retirement plan near you.

Thanks to the Department of Labor’s Conflict of Interest Rule, also known as the fiduciary rule that went into effect on June 9, 2017, investment management firms have been creating and rolling out two new classes of mutual fund shares known as “T shares” and “clean shares.”

T-shares aim at helping financial advisors maintain their traditional model of selling mutual funds on commission while complying with the new rules. Clean shares offer financial services companies a “level fee” structure so that advisors’ compensation is derived from a level charge on clients’ assets and not from varying third-party payments.1

“Both of these share classes involve significant changes to the pricing structure of mutual funds and the way investors pay for advice, and we believe these changes will ultimately improve retirement investors’ outcomes and their experiences investing,” Aron Szapiro, Morningstar’s director of policy research said in an April 2017 comment letter on the fiduciary rule sent to the Department of Labor.

Among the intentions of the fiduciary rule is eliminating potential conflicts of interest among financial advisors working with investors. The new rule, among other things, requires financial services companies to structure advisors’ compensation so they don’t benefit from recommending one mutual fund over another in retirement accounts like IRAs.

Even before the fiduciary rule became effective, employers, retirement plan sponsors and other providers of employee benefits already had specific obligations to consider with regards to retirement plans under the Employee Retirement Income Security Act (ERISA) of 1974. They include establishing a prudent process for selecting investment options and service providers, ensuring that fees and other expenses paid to providers are reasonable and selecting investment options that are prudent and adequately diversified.

And, in recent years, plan sponsors and other providers of employee benefit plans have been the targets of lawsuits and enforcement actions for breach of fiduciary duty under ERISA. In February 2015, Lockheed Martin Corp. agreed to pay $62 million to settle a lawsuit in which employees accused the company of mismanaging its 401(k) plan and charging excessive fees which dampened investment results. The following November, Boeing Company agreed to settle a class action lawsuit for $57 million alleging its 401(k) plan charged excessive fees and included expensive and risky investment options.

Paying attention to fees and expenses in your 401(k) plan makes sense. Over the years, those fees are paid off of a higher account balance, so they take a bigger bite out of your retirement nest egg each year. The Employee Benefits Security Administration (EBSA) provides an example. It assumes a 7% average return and no further contributions for an employee with 35 years until retirement and a current 401(k) account balance of $25,000.

The employee could expect that account balance to grow to $227,000 at retirement – with annual fees and expenses totaling 0.5%. If annual fees and expenses are 1.5%, however, EBSA says the account balance will grow to only $163,000. The 1 percentage point difference in fees and expenses would reduce the account balance at retirement by 28%.2

The emerging move to rolling out newer mutual fund share classes is occurring since the “A shares” that most investors bought through a broker typically included a front-end load representing an immediate fee as a percentage of the purchase. Management fees and ongoing 12b-1 fees for distribution expenses are also included. Some fund families’ A shares also tie in incentives and arrangements between the fund and advisory firm, making it beneficial for an advisor to favor selling one fund over another.

In its April report, Morningstar said it anticipates that mutual fund companies will create more than 3,500 new T shares in the coming months for advisors to sell to IRA investors. Investors will likely benefit, too.

T shares charge a uniform commission across all funds and Morningstar believes that most T shares could have a 2.5% maximum front-end load, meaning the most investors could pay 2.5% in up-front fees, of their investment. A shares, in contrast, average a maximum front-end load of 4.85% based on the more than 3,000 A shares with loads that Morningstar tracks in its database.

Clean shares don’t have any sales loads so they’ll be cheaper for investors to purchase. They also strip away the costs that fund companies pay to third-party providers for indirect services, such as marketing, operating call centers and websites, and broker compensation for advising investors (known as 12b-1 fees). Some fund companies have already launched clean shares and others are expected to follow suit. Australia and the United Kingdom have also already moved to a clean-share model.

Clean share classes could be appealing to firms that want to qualify as level-fee fiduciaries since they strip out third-party payments. Those firms that want to continue to sell on commission could set their own fees and offer level compensation, Morningstar says.

Investors already pay more than $15 billion annually in 12b-1 fees on open-end mutual funds, money market accounts and variable annuity sub-accounts, and clean shares aren’t expected to eliminate fees for these services. They could, however, lead to greater competition in that fund companies will have to clearly list what investors pay for each service other than asset management advice, according to Morningstar.

 

 

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Citations.

1-“Early Evidence on the Department of Labor Conflict of Interest Rule: New Share Classes Should Reduce Conflicted Advice, Likely Improving Outcomes for Investors,” April 2007, Morningstar Inc.

2-“A Look at 401(k) Plan Fees,” August 2013, U.S. Department of Labor, Employee Benefits Security Administration.: https://www.dol.gov/sites/default/files/ebsa/about-ebsa/our-activities/resource-center/publications/a-look-at-401k-plan-fees.pdf (accessed July 7, 2017).

Securities offered through World Equity Group, Inc. Member FINRA/SIPC. Advisory Service offered through BCJ Capital Management. World Equity Group, Inc. and BCJ Capital Management are independently owned and operated. BCJ Capital Management is a (SEC) registered investment adviser. Information presented is for educational purposes only. It should not be considered specific investment advice, does not take into consideration your specific situation, and does not intend to make an offer or solicitation for the sale or purchase of any securities or investment strategies. Investments involve risk and are not guaranteed. Be sure to consult with a qualified financial adviser and/or tax professional before implementing any strategy discussed herein. BCJ FG 17-510

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