Take-Away: Effective June 30, 2020, the SEC’s Best Interest Regulations will govern broker-dealers. These Regulations require a broker to ‘exercise reasonable diligence, care and skill when making recommendations to their client’, which includes ‘understanding the risks and rewards of their recommendation, as well as the inherent costs in those recommendations.’ Consequently, a broker must properly evaluate the advantages and disadvantages of all options when making a recommendation. The SEC’s Regulation also covers recommendations that apply to rollovers of distributions from a qualified retirement account to an IRA, the decision to leave retirement funds in a qualified plan, the decision to take a lump sum distribution from a qualified plan account, or any combination of these decisions. These are not new responsibilities to Greenleaf Trust,  as it has been following these rules for over 21 years in light of its key organizational pillar of always putting the client’s interest first. A lot more will be required going forward, than just ‘picking stocks.’

Example of Rollover Recommendation: Consider many of the factors and analysis that go into a decision to rollover a qualified plan account balance to an IRA.

  • IRA Benefits: Normally the universe of investment options is far greater with an IRA in contrast to the limited investment choices in an employer sponsored qualified plan. Rolling out the funds to an IRA will usually simplify recording keeping. In addition, an RMD can be taken from any one of many IRAs, while if the retirement funds stay in the qualified plan, an RMD must be taken from both the qualified plan account and also from any separate IRA maintained by the owner. Moreover, often access to funds held in a qualified plan are restricted to certain ages, times or events; there are no limitations on when an IRA owner can access his or her retirement funds. Also, if the owner is charitably inclined, it is important to remember that qualified charitable distributions (QCDs) that satisfy RMD obligations can only be made from IRAs, not qualified plan accounts. Finally, anyone can be named as the beneficiary of an IRA, in contrast to assets held in a qualified retirement account, which are subject to ERISA’s joint-and-survivor rules designed to protect surviving spouses.
  • Qualified Plan Benefits: Balanced against a rollover from a qualified plan to an IRA are some of the unique rules that are available to qualified plan participants. For example, the ‘still working’ exception to RMDs applies to an older working participant in a qualified plan, which is not available to delay taking RMDs from an IRA. Many qualified plans also permit loans to be taken by the participant from their account; loans are not permitted to be taken from an IRA. Or, the plan participant purchased life insurance using their qualified plan account; life insurance is not eligible to be held in an IRA. Penalty-free distributions can be taken by a former plan participant who separates from service after age 55; with an IRA, any distributions from the IRA prior to age 59 1/2 are subject to the 10% early distribution penalty.
  • Example of Lump Sum Recommendation: Some qualified plans permit the participant’s account to own the company-sponsor’s stock. If the stock in the qualified plan is distributed and liquidated as a part of a lump sum distribution of the participant’s account, the former participant pays income tax only on the cost-basis in the company stock(i.e. when it was acquired) that is liquidated. The post-acquisition appreciation of that company stock, called net unrealized appreciation, or NUA, is not taxed until the company stock is finally sold, and that appreciation will be taxed at long-term capital gain rates, not ordinary income. The ability to pay much lower long-term capital gains taxes on that stock appreciation is lost if the company stock is rolled from the qualified plan account into an IRA as part of a lump sum rollover.

Conclusion: These new SEC rules will not change how Greenleaf Trust handles its clients’ wealth or how it makes recommendations to its clients. However, these rules could prove to be a big ‘wake-up’ call to many broker-dealers who are not familiar with the disparate rules applied to qualified plan accounts and IRAs, and the nuances of each when they exercise “reasonable diligence, care and skill when making a recommendation to their client.”