Can You Trust a Broker's 401(k) Advice?

Should a broker be able to advise you on your 401(k)? That’s the ongoing tussle among some Washington lawmakers as they debate how to reform the $2.7 trillion 401(k) industry. After 401(k) investors lost billions in last year’s downturn, the Department of Labor, which regulates retirement plans, is looking into ways to give 401(k) recipients more access to investment advice. But Congressional Democrats aren’t convinced the proposed remedies will be any better for investors.

Right now, the only advice most 401(k) plan providers, such as Fidelity, Putnam and Charles Schwab, can give employees comes in the form of “general education”—you know, those generic seminars, web tools and pamphlets. But in January, the Bush administration introduced rules, now pending approval by the DOL, to loosen those standards so that brokerages could offer more targeted advice, such as recommending specific funds based on employees’ individual needs.

Democrats in Congress think that’s a bad idea, and hope to pre-empt adoption of the new rules into the 2006 Pension Protection Act with new legislation that proposes just the opposite. They argue that advice from brokerages would do more harm than good, since brokers would steer 401(k) investors into products that have higher fees. “When the people giving advice have a conflict of interest in the product they’re selling, bad things happen,” says Congressman Robert Andrews (D., N.J.). Andrews thinks companies should only be allowed to offer employees 401(k) advice through independent investment advisors, whose fees don’t depend on the products being sold.

The brokerage industry, of course, disagrees. In a recent letter to Congress, the Securities Industry and Financial Markets Association, a securities industry trade group, said that Andrews’ legislation would bar “well-qualified firms” from providing advice and “result in fewer American workers receiving critically important investment advice.” SIFMA says there is no proof that brokers’ advice so far has harmed 401(k) recipients and that existing advice programs work well. But a recent study by the Government Accountability Office (GAO) found that investors who took advice on 401(k) plans where the conflicts of interest weren’t disclosed earned 1.2 to 1.3 percentage points less than employees in other plans. Another study by Fidelity found that the average 401(k) investor lost 48% of their retirement savings last year, 10 percentage points more than the loss in the S&P 500 over the same period.

To some observers, that loss actually proves the need for more professional guidance on 401(k) investments. “The conflict of interest is worrisome, but advice is critical and the DOL regulations strike an appropriate balance,” says Andrew Oringer, an attorney specializing in 401(k) benefits at law firm Ropes & Gray. Requiring companies to only use independent advisors would be more costly and time-consuming, they say.

Meanwhile, brokerages are already toiling with ideas on how to offer the advice. Any improvements to Putnam’s 401(k) model would make “access to advice and guidance a core feature,” says Putnam CEO Bob Reynolds. But 401(k) investors aren’t likely to see changes anytime soon. The House Committee on Education and Labor passed Rep. Andrews’ bill last week, but it still has to get through a full House and Senate vote to become law. And after heated debates in Congress, the DOL has postponed a final verdict on the Bush administration’s proposed rules until November. Until then, advice on 401(k)s will be business as usual.