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Why "Free" Financial Advice Can be Very Costly

For most people, the money saved in their 401(k) is their single largest retirement asset aside from the equity in their home. It’s no wonder the Department of Labor (DOL) recently made an important ruling regarding how these assets are handled by financial advisors.

In its original form, the DOL fiduciary rule required anyone selling financial products for retirement plans to act as fiduciaries—meaning they would be legally bound to always act in the best interest of the client.

It even went so far as to propose banning the sale of certain high-commission products into these plans. As a fee-only registered investment advisor, I already am committed to putting our clients’ best interests above our own, so I was all for the proposed changes. I’ve seen too many people buy insurance products without knowing that the salesperson did not have the client’s best interest in mind.

A new client, Brenda, emailed me last week. At 35, she recently changed jobs, and as is often the case, an insurance company contacted her to offer her “free assistance” to help her through the transition. Even though she is relatively young, she’s been smart about funding her 401(k) and has been putting in 8% of her salary since her first day on the job, so she has just under $110K in her account.

The salesman suggested Brenda roll over her existing 401(k) into an annuity inside an IRA. He also suggested she purchase a $1M term life insurance policy which would eventually be converted to permanent life insurance. And while he suggested she continue to fund the 401(k) at her new employer, he recommended additional contributions to an IRA, even though, unlike her 401(k) contributions, these would not be tax deductible.

Brenda was hesitant. “I understand they get paid commissions on these insurance policies, and that they’re not always a good idea,” she wrote. “But I’ve also heard that the DOL rule that’s been in the news lately doesn’t allow anyone to sell me a policy that isn’t right for my situation. Any input? I appreciate your advice and guidance.”

The first thing I told Brenda was that the new rules don’t go into effect until at least April of 2017. Second, only retirement products such as 401(k)s and IRAs are covered by the ruling, so the $1M life insurance policy is specifically excluded from the fiduciary requirement. So while the salesman’s actions are legal (a least for the time being), they may not be entirely ethical. Here’s why:

Rolling over Brenda’s 401(k) into an annuity IRA earns the salesman an up-front commission of about $6,600 (6% of $110,000). As well, Brenda is subject to surrender penalties for 15 years if she takes out an amount over the “allowable” penalty-free rules. In contrast, by rolling over her 401(k) directly into her new employer’s 401(k) plan, Brenda would avoid these fees and commissions completely, and 100% of her retirement would be in one place with solid investment choices. As her financial advisor, I will advise her on which funds to select in her new account at no charge.

As for the recommended life insurance policy, at Brenda’s age, a term policy is what she needs—no need to pay for a convertible, commission-based product which would increase her monthly premium from $50 to $250. Plus, I know Brenda’s personal situation well, and a $1M policy is more coverage than she needs. Again, it seems that selling a higher-priced product is taking a front seat to Brenda’s real needs.

After I walked Brenda through her options, she was relieved—not only did she have a better picture of the best path forward, but she also felt she had new knowledge to make better decisions in the future. “Unfortunately, this is all a foreign language to me,” she told me. “He was so persuasive, and even though I knew enough to be wary, I didn’t have all the facts.” I assured her she wasn’t alone: most people simply don’t know what they don’t know. Not all insurance and life insurance salespeople are swindlers, but they’re usually coming from a different perspective than an independent registered investment advisor (RIA). As the old saying goes, “If you only have a hammer, you tend to see every problem as a nail.”

At Guerin Financial, we’ve been serving our clients as fiduciaries for more than 20 years. That means we offer objective, fee-only advice based on one thing only: the specific needs of each client. Whether you work with us or another advisor, take the DOL’s attention to the issue as a warning—but certainly no guarantee—and get your guidance from a fiduciary who has a lot more tools in his or her toolbox and, most importantly, is committed to always working in your best interest.