Tax Monitor
Involuntary Rollovers – Reg BI - What You Need To Know When Participants Have Balances Of $5,000 Or Less And Don't Take Out Their Monies From Retirement Plans
May 18, 2020
By: Elizabeth Osenton Lord and Robert G. Tweel
In June 2019, the U.S. Securities and Exchange Commission adopted Regulation Best Interest. Regulation BI (as it is known) imposes a new standard of conduct for broker-dealers when making recommendations of any securities transaction or investment strategy (including account recommendations) to a retail customer. Regulation BI also applies to associated persons of broker-dealers that are natural persons.
Under the new Regulation, a broker-dealer or associated person making a recommendation to a retail customer must act in the best interest of the retail customer without placing the broker-dealer’s or associated person’s financial or other interests ahead of the retail customer’s interests. The general obligation requires a broker-dealer or associated person to satisfy four component obligations: disclosure, care, conflict of interest, and compliance.
Under Regulation BI, the new standards of broker-dealer/associated person conduct extend to 401(k) rollover situations because the Regulation includes rollovers in its definition of “account recommendations.” The Regulation does not specifically address whether there is any distinction between rollovers in general and involuntary rollovers. So, at least for now, Regulation BI’s heightened duty applies to involuntary rollovers as well.
Involuntary rollovers occur when a plan participant with a balance of $5,000 or less does not take money out of his or her retirement plan, despite the plan administrator’s efforts to contact the participant. If the participant does not respond or cannot be located, the money in the plan is simply rolled into an IRA. As this money sits unclaimed in the IRA, fees accrue thus ultimately draining the amount out of the account.
When determining what to do with such accounts, broker-dealers/associated persons need to keep in mind that Regulation BI now creates a new standard of conduct for rollover recommendations. This new standard of conduct is higher than the traditional suitability standard. The new, higher standard requires broker-dealers and their associated persons to conduct a comparative analysis between a client’s 401(k) account and the anticipated rollover account (i.e., an IRA) based on the following:
- Fees and expenses
- Level of service available
- Available investment options
- Ability to take penalty-free withdrawals
- Application of required minimum distributions
- Protection from creditors and legal judgments
- Holdings of employer stock
- Any “special features” of the existing account
This is a non-exhaustive list, and the relevance of any item depends on the particular client and his or her situation. Additionally, under the Regulation, a broker-dealer or associated person cannot rely on an IRA having more investment options than the 401(k) plan as the basis for recommending or conducting a rollover. Other factors the broker-dealer/associated person should consider in addition to the other requirements of Regulation BI include the client’s investment profile, potential risks and the rewards of the particular IRA, and the investment strategy of the account being recommended. Also, broker-dealers/associated persons should carefully consider the cost of the IRA relative to the 401(k) recognizing that costs of IRAs typically exceed the costs of similar 401(k) investment options.
The effective date of Regulation BI was September 19, 2019, and the compliance date is June 30, 2020. So, with respect to involuntary rollovers on or after June 30, 2020, additional care and analysis must be taken to comply with the heightened standard of care that Regulation BI imposes.