What is a fiduciary? The answer could impact your retirement

Now that the Department of Labor has finally wrapped up its long-awaited "fiduciary" regulations, many Americans must be wondering: What's in it for me? Consumer advocates claim the new rules will save retirement investors billions of dollars each year, but many in the financial industry argue that the new rules will harm American workers, particularly savers with small accounts.

It's important to note that the new rules don't go fully into effect until 2018, and industry objections to them could lead to changes resulting from lawsuits or follow-up legislation from Congress. But it's even more important to understand what the fiduciary rules are all about and how they might affect your retirement planning.

What's a fiduciary?

Under current laws and regulations, financial advisors and institutions can choose to be held to one of two standards -- the more strict fiduciary standard and the more lax suitability standard.

A fiduciary must put your best interests first when making investment recommendations. A fiduciary's recommendations aren't influenced by the amount or type of compensation he or she gets paid.

By contrast, the suitability standard is a pretty low bar: A recommended investment needs to be merely "suitable" given your circumstances. The advisor doesn't need to try to recommend the best possible investment for your goals and circumstances and is free to select investments that pay above-average fees or commissions to the advisor.

An investment might be considered suitable for you if it isn't totally inappropriate for your goals and circumstances, doesn't have egregiously high costs or could be reasonably expected to achieve mediocre returns or better for the specific type of investment.

Where do the new rules apply?

Advisors who make recommendations for tax-advantaged retirement savings such as 401(k) plans, IRAs and Health Savings Accounts must act as a fiduciary on your behalf. Since the government is bestowing tax advantages to these vehicles, it has a say in how the accounts are invested.

The new rules don't apply to investments held outside retirement savings accounts, such as bank savings accounts, stocks, bonds and mutual funds held in after-tax accounts, as well as real estate and reverse mortgages.

It's possible that you might work with a single advisor with your retirement and nonretirement assets. Such an advisor could be subject to the fiduciary standard for your retirement accounts and the suitability standard for your other investments. If this situation applies to you, you'll want to ask your advisor to comply with the fiduciary rule for all your investments.

Can advisors still recommend investments that pay them a commission?

You might think the new rules would prohibit commissions paid as a percentage of your investments. You'd be wrong. Advisors can still take commissions as long as you sign something called the "best interest contract exemption," which will become known as a BICE. This is a disclosure form that describes the manner in which the advisor is paid and states why the product is in your "best interests."

But you have to read it carefully -- not like the lengthy disclosures that you usually quickly click "OK" to, such as other online financial disclosures or software updates for your computer or smartphone.

Your best bet is to avoid investment and insurance products that pay a commission and instead simply pay the advisor a flat fee or a fee that's a percentage of assets under management. Make sure to ask your advisor how he's paid, and be very cautious and ask a lot of questions if you're asked to sign a BICE.

Where can the changes make a critical difference?

Here are two important decisions that come into play:

  • You terminate employment and are considering rolling your 401(k) account into an IRA.
  • You are retiring and need to decide how to deploy your savings to generate retirement income, choosing between insurance or investing products.

In these situations, you'll want to pay close attention to how your advisor is paid and whether the manner of compensation might influence her recommendations. Don't feel shy about asking these compensation questions. After all, most likely you find out the price of virtually everything else you buy. If you bargain hard when buying a car, buy clothes on sale or look for the best deal for cable TV or a smartphone, you should feel comfortable asking an advisor how much you're paying for the service.

In addition to making sure your advisor is unbiased by compensation method, you'll want to investigate his credentials. These steps won't guarantee that you'll achieve financial security in retirement, but they'll surely increase the odds.

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    Steve Vernon helped large employers design and manage their retirement programs for more than 35 years as a consulting actuary. Now he's a research scholar for the Stanford Center on Longevity, where he helps collect, direct and disseminate research that will improve the financial security of seniors. He's also president of Rest-of-Life Communications, delivers retirement planning workshops and authored Money for Life: Turn Your IRA and 401(k) Into a Lifetime Retirement Paycheck and Recession-Proof Your Retirement Years.