Regulation Best Interest: Rollover Recommendations for Pension Plan Benefits (Rollovers Part 8)

The SEC has issued its final Regulation Best Interest (Reg BI), Form CRS Rule, RIA Interpretation and Solely Incidental Interpretation. I am discussing the SEC’s guidance in a series of articles entitled “Best Interest Standard of Care for Advisors.”

This is the 8th of my series of articles about rollover recommendations and rollover education under the SEC’s Regulation Best Interest and its Interpretation for Investment Advisers. (For the first seven, see Best Interest for Advisors #’s 15, 16, 17, 18, 19, 20, and 21.)

The first seven of these rollover articles have, by and large, related to rollover recommendations and education for participants in 401(k) plans. But, of course, there are other types of plans…for example, ESOPs, cash balance plans, profit sharing plans, and defined benefit pension plans. This article looks at rollover recommendations to participants in defined benefit plans and concludes that rollover “education” may be the more practical approach.

Briefly stated, a best interest rollover recommendation, by either a broker-dealer or an investment adviser, would likely include these four steps:

  • Participant Information: The first step is to gather information about the needs and circumstances of the participant. The SEC refers to this as an investment profile. In effect, it requires that an advisor obtain the information needed to determine whether a recommendation is in the best interest of the participant.
  • Plan Information: The next step is to gather information about the plan. For our purposes, I’m assuming that the defined benefit plan offers only a lump sum distribution and an annuity (both single life and joint and survivor annuity). I’m also assuming that the participant is retiring at the plan’s retirement age and does not want to take a taxable distribution. (I make those last two assumptions so that, in this case, the advisor does not need to consider the alternatives of a taxable distribution and a rollover to the plan of a new employer.) As a result, the advisor will need to, at the least, have information about the lump sum amount and about the plan’s single life and joint and several annuity options that the lump sum will “purchase.” (Most large defined benefit plans annuitize, that is, they don’t purchase annuity contracts.)
  • IRA Information: The third step is for the advisor to understand of the account types and investments offered by the advisor’s firm (e., the broker-dealer or the RIA, or if dually licensed, by both). Realistically, the advisor wouldn’t need to consider account types and investments that weren’t reasonably appropriate for the participant’s circumstances.
  • Analysis: The fourth step is to analyze the plan information (step 2) and the rollover IRA information (step 3) in light of the investment profile (step 1), and develop a recommendation that is in the best interest of the participant.

Unfortunately, there is some complexity involved in the fourth step—the analysis. For example, if the participant’s investment profile indicates a clear need for guaranteed retirement income, the advisor should compare the annuity in the plan to the amount of annuity that the lump sum, as a rollover, would purchase in an IRA (e.g., an individual annuity).

Another consideration would be the financial strength of the annuity “provider.” For example, if a pension plan annuitizes the benefits, the “annuity” is backed by the assets in the plan. The annuity in a well-funded plan may be secure and, in any event, for most ERISA-governed defined benefit plans, a certain level of benefits is insured by the Pension Benefit Guaranty Corporation (PBGC). On the other hand, some plans are underfunded (e.g., some of the multi-employer pensions in declining industries) and a participant may have benefits that exceed the guaranteed amounts. If it’s a government pension plan, it is backed by the taxing power of that government (e.g., the state, county or city). When looking at the insurance company that provides an individual annuity, an advisor should assess the financial strength of the insurance company. Another factor would be the backing of any state guaranty funds.

And, there are other, more common, considerations. For example, does the participant have other assets that would fund variable spending, that is, if the participant annuitizes all of his or her benefits in the plan, will the participant have other asset5s to pay for variable expenses in retirement?

As I consider that facts that need to be gathered, and the complexity of the assessment, it strikes me that it may be hard to obtain the plan information and to properly analyze it.

As a result, advisors (and their broker-dealers or RIAs) may want to consider an educational approach to help defined benefit participants decide whether to leave their money in the plan or roll it to an IRA. An educational approach provides information to the participant about the advantages and disadvantages of leaving the money in the plan or rolling it to an IRA, so that the participant can make an informed decision. For risk management purposes, it should be supported by written materials to be given to the participant. The role of the advisor would be to deliver those materials, explain them, and answer any questions.

It probably goes without saying that the materials should discuss the need to consider relative costs (because of the SEC’s emphasis on costs in it recent guidance). But, the materials should also explain the services that the advisor and the firm will provide to the participant. Since defined benefit plans are effectively “free” for participants, services offered by advisors and their firms are the factors that may offset the higher costs in IRAs.