The Department of Labor’s re-proposal of rules that would define who is a fiduciary could end up costing $20 billion to $32 billion in retirement savings, according to a study by Quantria Strategies in Washington, D.C.
The study found that Americans who cash out their retirement accounts when they leave a job are hurting their future retirement security, but their retirement security could be jeopardized even more if the DOL expands its fiduciary definition to include brokers and call centers that work with IRAs.
The Quantria Strategies study looked at the impact the fiduciary rules would have on retirement savings if they applied to brokers and call centers.
“There’s definitely a relationship between what people do with retirement savings based on whether they receive independent advice or not,” said Judy Xanthopoulos, one of the report’s authors and an economist and managing partner with Quantria Strategies in Washington, D.C.
There are about 50 million job terminations each year among wage and salary workers in the United States, according to the report. Terminating employees often need to make decisions about the money they have saved up in their company-sponsored retirement plan.
“Our empirical model indicates that losing access to financial assistance at job termination could have significant impacts on long-term retirement savings; our results found that retirement savings balances are 33 percent higher for individuals who have access to financial assistance,” the report found.
According to a 2011 survey, 42 percent of terminating employees take a cash distribution from their retirement savings; 29 percent roll their retirement savings to another plan or an IRA; and 29 percent leave their assets in the employer’s plan.
Terminating employees cashed out about 7.3 percent of their total retirement assets. Individuals who have a low account balance, are under age 30 or have lower wages are the most likely to cash out their retirement savings when they leave a job. Higher cash-out rates are also an issue for African-Americans and Hispanics, the report found.
The retirement industry has been less than thrilled with the Department of Labor’s re-proposal of its fiduciary rules. The biggest bone of contention has been whether or not brokers or advisors who work with IRAs should have to follow the same strict fiduciary guidelines as their fee-for-service registered investment advisor counterparts.
Both Democrats and Republicans have expressed concern that any new fiduciary mandate will hurt lower income people because they are the ones most likely to look to their broker for advice instead of paying a high fee for the advice of a registered investment advisor.
The difference between the two professions is that brokers get commissions on the sales they make and RIAs are expected to base all of their investment decisions on what is in the best interest of their clients.
Broker-dealers argue that they also do what’s in the best interest of their clients. Yes, they accept commissions, but they still have to follow guidelines that prohibit them from taking advantage of someone just to get a commission.
Quantria surveyed some of the country’s larger financial institutions and found that when people actually talked to call centers they were more likely to roll over their assets rather than withdraw them when they changed jobs, Xanthopoulos said.
“Retirement savings, particularly for lower income and younger workers, tends to be their only form of savings. At job turnover it is not unrealistic to assume a lot of people without guidance or encouragement would take the money out or they might not have that advice or encouragement to retain the money in their account,” she said. “A lot of the leakage occurs at that time.”
Lower income people are harder hit by the lack of advice that is available. As people move up the income chain, they save more for retirement.
“Your ability to save is correlated positively with your income,” she said. People who make less money or who are new to the workforce don’t usually have a lot of money so when they change jobs they are particularly vulnerable for taking these cash-outs at the time of their job change, she added.
Felicia Smith, regulatory counsel for the Financial Services Roundtable, a lobbying group for financial institutions, told BenefitsPro that her organization is opposed to the fiduciary rules but she had never thought about how much money moves out of retirement plans when people change jobs.
“Apparently the challenge is to make sure people that are changing jobs don’t decide to cash out of their plans and spend the money on something else, but to make sure they keep that money in some sort of qualified retirement plan,” she said.
“If the fiduciary rule is written in a way that says you can’t be compensated for the advice or services you provide, then without violating the rules, there’s no way that service can be provided,” Smith added.
She gave an example of someone at a call center making a recommendation about how someone could roll over their 401(k) distribution into an IRA, but if any of the recommendations the call center gives would result in some sort of financial benefit coming back to the financial services provider, it would be a prohibited transaction.
“If you don’t have some sort of exemption for that type of conversation/interaction you’ve got a violation,” she said.
So what happens if people change jobs frequently and they withdraw their retirement savings each time? Many people believe that the amount of money they are withdrawing is so small, it isn’t something they need to worry about. They can make it up later.
“I have seen studies that show the earlier you save and the more consistently you save the better off you are. It is much harder to save a larger amount at an older age and have the same benefit you would have had if you had been saving all along,” Smith said, “even if it was only a small amount of money when you were just starting out.”
She pointed out that when people cash out of their plans before the minimum age of 59.5, they are also being taxed on that money — including early withdrawal penalties.
Quantria Strategies found that speaking with a financial representative can make departing employees 3.2 times less likely to cash out their retirement savings, demonstrating the substantial role financial representatives can play in enhancing retirement security.
“Any regulation that limits an individual’s access to investment information when leaving a job could have a substantially adverse impact on retirement savings, reducing those savings by as much as 40 percent for affected individuals,” said Xanthopoulos. “When you’re looking at $100,000 in retirement savings vs. $167,000, it makes a big difference.”