In early June 2019, the Securities and Exchange Commission (SEC) made the most significant changes to investment advice standards in more than two decades.
Among the biggest changes were made to investment advice standards related to rollovers of qualified retirement plans (including the Thrift Savings Plan or TSP) to individual retirement arrangements (IRAs).
The SEC issued Regulation Best Interest (BI), which imposes a new standard for investment brokers, registered representatives or any financial professional licensed to move retirement assets from one qualified retirement plan to another retirement plan or to an IRA (traditional IRA or Roth IRA).
It is important to understand that rollovers from qualified retirement plans to traditional IRAs or Roth IRAs represent a potential source of significant revenue to financial professionals such as investment brokers and registered representatives working for broker-dealers who depend on fee and/or commission income as a major source of their annual income.
The TSP is no exception. With federal employees and annuitants having TSP accounts totaling well into the billions, investment brokers, registered representatives and insurance agents see the TSP as a potential “goldmine” for the purpose of managing a TSP participant’s account. It is important for TSP participants to realize that no commissions or sales charges are paid to anyone when an employee contributes to the TSP. When an employee retires from federal service, many investment advisers see the participant’s TSP assets as a source of revenue in the form of rollovers from the TSP to IRAs that these advisers can manage.
It is also important to note that under the new TSP withdrawal rules taking effect on Sept. 15, 2019, TSP participants will be allowed to perform TSP rollovers on a more frequent basis than they are currently. Under current TSP rules, only one TSP rollover is allowed from the traditional TSP to a traditional IRA or to a Roth IRA, and one rollover is allowed from the Roth TSP to a Roth IRA. It is therefore important that TSP participants, in particular those who will be retiring starting this year (and employees over age 59.5 who can request “age-based” TSP rollovers to IRAs), to be aware of the new SEC rollover rules and how the new rules will affect them with respect to their TSP accounts.
Most financial professional experts would agree that the new “best interest” standard for rollovers under Regulation BI is more intensive than the existing “suitability” standard for registered representatives. Regulation BI elevates the standard of conduct for investment brokers, registered representations and anyone else licensed to perform these rollovers in distinct ways. The new rules encompass three elements of a rollover, namely: (1) recommending to take money out of a qualified retirement plan (including the TSP); (2) putting those assets into an IRA via a rollover or transfer; and (3) once the retirement assets are in the IRA, investing the rolled over retirement plan assets.
A major point of the Regulation BI is that an investment broker, registered representative or anyone else who recommends a rollover from a retirement plan must compare the client’s retirement plan (including the TSP) and the IRA to which plan assets will be rolled over, in several areas of cost and service, including:
(1) fees and expenses;
(2) level of service;
(3) investment options;
(4) ability to take penalty-free withdrawals;
(5) application of and addressing the issue of required minimum distributions (RMDs);
(6) protection from creditors and legal judgments; and
(7) any “special features” of the existing accounts.
The SEC also emphasized that broker-dealers and investment firms cannot rely on an IRA having more investment options than a qualified retirement plan or the TSP as the basis for recommending a rollover.
Those factors are in addition to other general requirements under Regulation B1 such as consideration of an individual’s investment profile and the potential risks, rewards and costs of a particular investment asset or strategy should the plan assets be rolled over.
“Cost” of an Investment – An Extremely Important Factor When Deciding to Rollover Retirement Plan or TSP Assets
The “cost” of an investment – particularly an IRA investment – can be a fairly significant factor in determining whether or not to rollover funds from the TSP to an IRA. This is because IRAs are almost always more expensive than the TSP. For example, every IRA has an annual custodial or maintenance fee which can range in cost from perhaps $50 to as much as $500 a year. On the other hand, the TSP has no such annual custodial or maintenance fee.
The Financial Industry National Regulatory Authority (FINRA), which enforces SEC rules on broker-dealers and registered representatives, will need to update its rules and regulations to include Regulation BI. Until now, FINRA has enforced the “suitability” standard, meaning that a rollover from the TSP or other qualified retirement plans to an IRA must be “suitable” for the retirement plan owner or TSP participant. Under Regulation BI, broker-dealers and registered representatives need to consider the factors listed above before recommending a rollover of retirement plan assets to an IRA. The problem is that Regulation BI potentially gives broker-dealers and registered representatives the roadmap to rationalize what they are recommending and doing, while failing to properly address conflicts of interest that may arise.
An example of conflict of interest that may arise when it comes to broker-dealers and registered representatives is with respect to broker-dealer and investment firm sales contests and quotas. Specific sales contests in which a licensed financial representative who sells a sufficient amount of a particular investment, such as a stock, mutual fund or an exchange-traded fund, will be rewarded with an all-expense paid trip to a foreign country. But under Regulation BI in which a registered representative has made sure that all of the factors above have been considered, sales related to investment asset accumulation via a sale or a rollover from a retirement plan to an IRA would be permitted. This is true even if the rollover is in the “best interest” of the qualified retirement plan owner or TSP participant.