By Sheryl Rowling
SAN DIEGO — Let’s face it: investments are confusing. Your company offers a 401(k) plan, so you contribute to it – knowing that this will save you tax dollars. You randomly choose from the investment options offered and periodically look at your statements to see how you’re doing. But do you really know how you’re doing? Do you know what you are being charged for the privilege of saving your own money?
If you look at the fine print of the investments offered, you can learn some interesting facts. If there are funds that are marked A, B, or C (share classes), the plan’s broker is making big bucks off of you. An “A” fund means that the broker is collecting an up-front commission (sometimes up to 7.5%) and small trailing fees in later years through an annual 12(b)-1 fee charged in the fund. “B” shares give the broker a commission when you sell out of the fund as well as 12(b)-1 fees each year. “C” shares means no up-front commission, but a higher 12(b)-1 fee each year (typically 1%). If you have these funds in your 401(k), you are getting ripped off. Try to find institutional shares (no indication of A, B, or C), which are “no-load.” These funds have no commissions and no 12(b)-1 fees.
When you leave a job, you might decide to roll your 401(k) balance into an IRA. Often, this is at the recommendation of a broker, who will invest your money into A, B or C shares. If you ask about commissions, they will typically skirt around the answer. You have a choice when investing your IRA money – don’t jump into anything without knowing what you are buying.
The big news is that the Department of Labor and the courts are attempting to prevent these predatory practices on retirement savings. This could be the beginning of the end for commission-based 401(k) and IRA investment choices.
On April 14th, the U.S. Department of Labor released its much-anticipated proposed rules applying fiduciary requirements to those providing investment advice to IRA owners and qualified plan participants. In its news release, the DOL stated: “Under the proposals, retirement advisers will be required to put their clients’ best interests before their own profits. Those who wish to receive payments from companies selling products they recommend and forms of compensation that create conflicts of interest will need to rely on one of several proposed prohibited transaction exemptions.”
Although there are exceptions, the rules mean that providers cannot push for funds with commissions or 12(b)-1 fees. This is huge for investors – especially those that don’t know what is hidden beneath the surface of their investments. Also huge is that these regulations apply to rollovers of 401(k) assets to IRAs as well.
On May 17th, the Supreme Court held that 401(k) providers cannot rely on the statute of limitations to avoid legal action as long as the “inappropriate” funds are still offered and held in the plan. In Tibble v. Edison, 20,000 employees filed a class action suit claiming that it was imprudent for their plan to offer retail fund classes when less expensive products were available in the institutional class. This case is being remanded back to the Ninth Circuit, which will address the issue of offering retail vs. institutional share classes in retirement plans.
The DOL regulations are not final nor has the Ninth Circuit ruled on the Edison case yet. But, the handwriting is on the wall: Commission brokers need beware!
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Sheryl Rowling is a certified public accountant, personal finance specialist, and principal of Rowling & Associates. She may be contacted via sheryl.rowling@sdjewishworld.com