Making individual retirement accounts safer for investors will take more than just getting rid of 12(b)-1 fees.
That's the conclusion reached by Boston College's Center for Retirement Research in a recent report in which the authors questioning whether eliminating the incentive payments on mutual funds investors buy when they roll out of their 401(k)s would ultimately protect investors.
Fund expenses take a massive toll on investors' ability to save, as an extra 100 basis points in fees over a 40-year period could chop down final assets by about 20%, according to the CRR. The report also noted that mutual funds sold by brokers are particularly terrible in terms of performance, estimating that they underperform average actively managed equity funds by 23 to 255 basis points per year.
A windfall of assets has gone into IRAs, totaling to $5.1 trillion during the second quarter of 2012, compared to $4.1 trillion in defined-contribution plans.
Enacting the Labor Department's proposal to expand the range of professionals under a fiduciary umbrella and eliminating 12(b)-1 fees wouldn't necessarily rob broker-dealers of much of their profit, the CRR argues.
The report noted that 12(b)-1 fees added up to $9.5 billion for all mutual funds in 2009, a year when mutual funds assets were at levels similar to those of today.
In fact, assuming that 20% of those 12(b)-1 fees are attributable to IRA customers, broker-dealers in total stand to miss out on $2 billion — equivalent to about 1% of their total revenue, according to the study. Firms can make up for that amount by raising the price of transactional commissions, increasing their trade volume or moving to a fee-based advisory model.
“Substantial confusion appears around the prohibition of commission payments,” the CRR noted in its paper. “At this point, the DOL [fiduciary] proposal prohibits only the ongoing payments from mutual funds.”
David Bellaire, general counsel at the Financial Services Institute Inc., disagrees.
“Based on what we know from the past proposal, our reading is that it would eliminate commission compensation,” he said. “The result of that is much more profound than a 1% decrease in broker-dealer revenue.”
“There is a fundamental misunderstanding of the important role that financial advisers play,” Mr. Bellaire added. “I think at every turn the paper minimizes that role. It's important that we have a better understanding of the role advisers play in helping people plan for retirement and educating clients on the need to invest.”
The CRR proposed alternatives to eliminating 12(b)-1 fees. For instance, the DOL could consider changes to control fees in 401(k)s and IRAs, perhaps by requiring that plans and IRAS use index funds. Passively managed funds have estimated fees of 14 basis points, compared to the 93-basis-point price tag on actively managed equity funds and 66-basis-point cost for bond funds.
“Virtually all researchers agree that most actively managed equity funds can be expected to underperform index funds once fees are considered,” the CRR noted. “It makes no sense to expose the average participant to these options.”
The federal government also could give a seal of approval to low-cost funds that meet certain criteria.
Other ideas included making it easier for workers to keep their money in 401(k) plans, where they benefit from institutional pricing and ERISA protection. Currently, participants may be forced to cash out their balances if they are holding less than $5,000 when they're leaving the plan.
Alternatively, the DOL could regulate rollovers themselves, so that an adviser's recommendation that a client roll over 401(k) assets falls under fiduciary advice — or apply ERISA to all rollover IRAs.
“Most likely if the enactors of ERISA had envisioned that most defined- contribution money would end up in IRAs, they would have ensured ERISA-type protections for these accounts,” the CRR noted in the paper.