Creating a Safe Harbor for Rollovers

Want to see industry insiders instantly divide? Ask if a retirement plan adviser can assist participants in rolling assets out of the plan and into an IRA.

Despite specific guidance from the Financial Industry Regulatory Authority (FINRA) in December, it is not clear that the regulator has a firm understanding of the retirement plan industry. (See “FINRA to Examine IRA Rollovers.”) According to a section on conflicts of interest, FINRA said, “An investment adviser who recommends an investor rollover plan assets into an individual retirement account (IRA) may earn an asset-based fee as a result, but no compensation if assets are retained in the plan.”

The statement is obviously incorrect in cases where an adviser’s fee is based upon a percentage of plan assets. Instead, the compensation the adviser receives from the plan will necessarily be reduced as assets are rolled out of it. Furthermore, if the adviser charges the participant the same fee to manage the funds in an IRA as it does to manage the assets within the plan, the rollover would not result in any difference in the compensation received by the adviser.

In a previous article (Fiduciary Status Could Be Big Rollover Plus), I noted the current policies of the Department of Labor (DOL) may be at least partially responsible for the very practice that caused Phyllis Borzi, assistant secretary employee benefits, to complain about brokers who “sell products that financially benefit themselves without considering whether those investments are really in their clients’ best interests.”

The very act of discouraging financial advisers—who are already required under the Employee Retirement Income Security Act (ERISA) to act in the participant’s best interests—from assisting participants with their rollover options, leaves the field wide open for non-fiduciaries who merely want to sell products, such as annuities, or IRAs loaded with the broker’s proprietary offerings and qualified private placements, such as real estate investment trusts (REITs).

Rollover Safe Harbor

But what if a required extra step in the process made it more difficult to roll over assets into an annuity? What if the DOL offered a safe harbor to plans that automatically rolled participant accounts into an IRA rather than distributing lump sums to the participants?

The concept has a precedent. In 2001, Congress amended ERISA section 401(a)(31) to require plan administrators to transfer certain plan distributions into an IRA, rather than in a lump sum payment, if the participant failed to make a contrary election. In 2004, the DOL implemented rules to provide safe harbor protection for such rollovers.

There was a catch, though. The safe harbor applies only to distributions of less than $5,000. If the account value is $5,000 or more, ERISA section 411(a)(11)(a) prohibits a mandatory distribution without participant consent.

However, the consent requirement ends once the participant reaches mandatory retirement age. As a result, the DOL could provide safe harbor relief for plans that require a distribution into an IRA once a terminated participant reaches mandatory retirement age (typically 62) even if the value of the account exceeds $5,000.

So why would the DOL want to encourage this type of automatic rollover? Because without it, a plan has onlyl two options: keep the assets in the plan and continue to track a departed participant’s whereabouts so it can begin making the required minimum distributions when the participant turns 70½. The alternative is to distribute the funds to the participant in a lump sum payment.

While the latter option provides more protection to the plan, it is the equivalent of throwing the participant into shark-infested waters. With limited time to find an alternate investment option to avoid early distribution penalties, the participant is a prime target for those seeking to sell an investment product to generate a commission.

Size Plays a Part

Granted, the DOL would have to be more creative in drafting safe harbor for such accounts. Under the 2004 rule, the rollover funds must be invested in products designed to minimize risk and preserve capital, such as money market or stable value funds, CDs or savings accounts. Such a strategy might not create much risk for accounts containing less than $5,000, but it’s doubtful a 62-year-old with a $500,000 retirement account would choose to invest the entire amount in a money market fund generating less than a 1% annual return.

For larger accounts, the DOL could require the funds to be rolled into a qualified default investment alternative (QDIA). Alternatively, an investment adviser (or other adviser) could be permitted to manage the IRA until the client makes other arrangements. In order to ensure the participant does not incur a significant increase in cost, the safe harbor could require the investment adviser, for the 12 months following the rollover, to use the same advisory fee being charged to the plan. At the first anniversary, the adviser could mandate a higher fee to continue providing the advice. However, by that time, the participant would have had an entire year to cash out the IRA, use the funds to purchase a different investment product, or replace the adviser as opposed to receiving a lump sum distribution with only 60 days to take action in order to avoid a penalty.

If the DOL is serious about ensuring participants obtain unbiased advice during a distribution event, it can begin by encouraging retirement plan advisers, who already have a fiduciary duty to the participants, to be involved in the process.

Phil Troyer is an attorney and vice president of compliance at Bukaty Companies Financial Services (, which has locations in Kansas City, Denver and Spokane. The firm is managed by Vince Morris, who was included in PLANSPONSOR magazine’s list of Top 100 Plan Advisers and twice nominated for Adviser of the Year. Phil can be reached at

This article is not intended to provide legal advice and should not be relied upon as such.