The U.S. Department of Labor (DOL), has changed how financial advisors are paid to provide investment advice. These new rules require financial advisers to consider your best interests when making investment recommendations regarding retirement savings. Retirement investors could save thousands each year with the new rules.
A key goal is to reduce situations in which advisers are paid excessively or make it more attractive to give advice that is not in your best interest. This is known as "conflicted advice compensation". A second important goal is to ensure advisers are paid reasonable compensation for their services. This does not necessarily mean that advisers should be paid the lowest fees, but the compensation must be appropriate for the service they provide.
Investors will need to be provided with lengthy and complex disclosures under the new rules in 2018 and beyond. These disclosures will explain how the financial institution acts in your best interest, how your advisor is being paid, and any compensation for conflicted advice.
You don't have to wait for 2018 to ask your adviser questions about potential conflicts or compensation. Understanding the basics of adviser compensation can help you understand the disclosures that you might be asked to sign.
The bottom line is that advisers can be paid in three different ways. Each of these could have a significant impact on the advice you receive.
1. Commissions or sales charges. Your adviser may be paid a percentage of what you invest in investment products or insurance. Advisors may try to steer you to high-paying investments or policies. You may be tempted by them to churn you account. This means that they will buy and sell investments often to earn commissions for every sale or purchase. With its new fiduciary rules, the DOL hopes these situations will be avoided.
The commissions paid can be anywhere from 2 to 10 percent. For example, if you do a $100,000 transaction your adviser could get $2,000 to $10,000. Sometimes, the commission is taken out of the total amount invested. However, some products are described as "no cost" so that all your savings can be applied to the investment or insurance product. These products are billed as "no cost" and the commission is paid to the adviser on the basis of the revenue it earns.
Asking how much your adviser is paid is a mistake. Don't ask if the commissions are applied to your investment. Ask if your adviser receives a commission for your investment. Ask your adviser if they are getting a commission. This will help you to understand how your best interests can be considered when making recommendations.
The new rules allow commissions and sales fees to continue, but the financial institution will require you to sign the "Best Interest Contract," also known as the BIC.
Advisors may give you a contract stating that they cannot start working for your company until you sign the BIC. You may be tempted not to read the entire document and sign it quickly, but you should take the time to understand the basics. Ask your advisor if you have any questions.
2. A percentage of assets under management is the fee. A percentage of assets under adviser's control is the most common fee arrangement. Although a common charge of one percent is the norm, there are other charges that may be more or less. Although an advisor should be impartial when buying or selling investments, there are still risks of conflicts in certain situations, such as:
Although 1% may seem like a small amount, the cost can add up over time. Let's take an example. Let's say you have $500,000 to invest in retirement. You would pay about $5,000 per year if you were paying 1 percent fees. Your adviser would have received $50,000 after 10 years. You'll be paying $100,000 if you retire after 20 years. Are you really required to pay one percent each year?
It is unclear whether advisors who charge a percentage for assets under management will require that you sign a BIC or if they can use a more straightforward disclosure called a Level Fee Fiduciary.
3. Flat fee or hourly. In this case, the adviser is paid by the hour for the project or a flat fee. The hourly rate is typically $150 to $300 and the project fee can be as high as $1,000, $2,000, or more. These flat fees or hourly rates may seem high but they could be less than 1% of your assets.
These fees are comparable to what you would pay an attorney to help with estate planning, tax advice, or any other legal matter. A fee quote will be provided by an hourly fee advisor in most cases. This will allow you to get a good idea of how much you'll pay.
This compensation method is the most favorable for conflicted advice. However, the DOL rules require that charges be reasonable for the services rendered. An adviser who charges an hourly fee or flat fee will not ask you to sign a BIC. Instead, they will be considered Level Fee Fiduciaries.
Bottom line: Asking about compensation for services received by advisers is just good consumer behavior. You don't need to wait for new rules to take effect.
Many skilled advisors who are honest earn commissions, or charge a percentage of assets under management. They will be able to provide great value to you. It is your job to search carefully for that person.
It is a sign to be cautious when you are asked to sign a BIC. Ask your advisor to explain in plain English why your interests are important. Do not be afraid to ask your adviser questions. It's your money and your retirement.