Best Interest Reasons for a Rollover

Fred Reish and Joan Neri (Art by Tim Bower)

Question: I’m a registered investment adviser who advises 401(k) plan participants about distributions and plan rollovers. I know that, under the Department of Labor’s expanded interpretation, a rollover recommendation to an individual retirement account I manage is considered fiduciary advice, and I’ll need to use DOL Prohibited Transaction Exemption 2020-02 to avoid a prohibited transaction. The PTE says I must determine that the rollover recommendation is in the participant’s best interest. What is considered a best interest reason for a rollover?

Answer: Although the DOL doesn’t offer a list of acceptable best interest reasons for a rollover, its guidance explains an approach for determining a best interest reason. We have some ideas as to what doing that may include.

The PTE requires that the rollover recommendation be in the best interest of the plan participant, and, beginning July 1, the specific reason(s) why this rollover is thus must be provided to the participant in writing before the rollover is implemented. In determining the best interest reasons, you need to evaluate five key components:

1) The participant’s financial needs and investment objectives. Under the PTE, the best interest standard requires that the recommendation be “based on the investment objectives, risk tolerance, financial circumstances and needs” of the participant. In other words, the best interest process is not a one-size-fits-all approach, but instead requires that you assess what is important for satisfying that specific participant’s needs—e.g., active management, asset-allocation services, periodic withdrawals, sustainable income, etc.

2) The participant’s current plan investments, services and fees. The plan investment and fee information is available on the plan’s 404a-5 disclosure, and the participant should be able to obtain it from the plan’s website or the company’s benefits office. In its FAQ, the DOL explains that, if the participant fails to supply you this information, even after you’ve explained its significance, and it’s not otherwise readily available, then you can make a reasonable estimation of expenses, asset values, risk and returns; for that, you will utilize publicly available information—e.g., Form 5500, reliable benchmarks—and document the assumptions used and their limitations. Obtaining the plan’s summary plan description is also helpful because it describes the plan features and services, such as the availability of plan loans and the withdrawal and distribution options.

3) Your managed IRA program. Your managed IRA program, according to your fees and the investment expenses, may cost more than the fees the participant pays in the plan; however, costs are just part of the equation. In its FAQ, the DOL explains that the different levels of services and investments under the plan and IRA must be factored in. That said, you should consider the array of investments and services you offer.

4) Whether your managed IRA is in the participant’s best interest. The DOL explains that the alternatives to the rollover should be considered, including leaving the participant’s retirement funds in the plan or taking a lump-sum distribution. In comparing your managed IRA with the plan, you should be guided by which alternative best aligns with the participant’s investment objectives, financial circumstances, risk tolerance and needs. If the rollover IRA will be more expensive than the plan is, your services may provide substantial additional value to the participant that could offset the cost differential. The key is to evaluate your services in light of that individual’s needs and circumstances.

5) The best-interest reasons. Once the first four steps are completed, identify and document the specific reasons that person’s best interest will be served. Here are examples that might apply to some participants:

• Your managed IRA offers financial and retirement planning services otherwise unavailable under the plan, and the participant needs those services.
• The participant lacks investment experience and will be unable to devote time to management of his own investments due to work demands. As a result, the participant would benefit from active management of his IRA.
• The participant needs help in managing investments in a manner that’s consistent with withdrawing income at a sustainable level, and you provide that service.
• The participant has a large plan account that would benefit materially from an allocation to alternative or other types of investments unavailable in the plan, which provide reduced volatility or the potential for increased returns.
• You are already managing other accounts for the participant, and she would benefit from an integrated approach to managing those investments—e.g., tax-efficient allocations to different accounts and/or overall portfolio allocations where each account may be considered.

Fred Reish is chairman of the financial services ERISA practice at law firm Faegre Drinker Biddle & Reath LLP. Joan Neri, a nationally recognized expert in employee benefits law, is counsel in the firm’s financial services ERISA practice.