Mullooly Asset Management
Fiduciary Fee-Only Financial Planner | Investment Advisor in Wall, NJ
Mullooly Asset Management
Junk Fees and the Truth About Fiduciary Duty
Embark on a journey with me, Tom Mullooly, and discover the surprising truth behind the financial industry's approach to client relationships. As someone who's navigated the murky shift from broker to fee-only investment advisor, I'll unfold the story of how the Department of Labor's fiduciary rule is reshaping the responsibilities of financial professionals. You'll be shocked to find that the priority of client interest isn't a given in the world of investment advice. During our talk, we expose the hesitancy of brokerage firms to fully adopt a fiduciary mindset, largely driven by the fear of legal repercussions, and how fee transparency could be the game-changer this debate needs.
In a landscape peppered with complex fees and questionable rollover practices, I put the spotlight on the ominous presence of "junk fees" and how they impact your investments. We scrutinize the concerning trend of transferring 401(k) funds into IRAs and subsequently into annuities—a maneuver often muddled in economic value and lacking in clarity for the unsuspecting investor. This episode is not just a deep-dive into the nitty-gritty of financial advisory—it's a clarion call championing the need for unambiguous fee disclosure and the adoption of a genuine fiduciary standard, echoing the recent support from the political realm. Tune in for an enlightening session that promises to arm you with the knowledge to navigate the opaque waters of investment advice.
Welcome back to the podcast. This is episode number 468. I am Tom Malouli and let's talk today about the fiduciary rule and junk fees. The Department of Labor unveiled its latest version of the fiduciary rule a few months ago, in October of 2023. Supporters of the latest changes argued that it fell in line with what they were expecting, but, on the flip side, industry groups warn that it could have a negative impact on advisors and on their clients, and we're going to talk about this today. The Department of Labor has issued, reissued, suspended, restated their terms for a fiduciary rule over nearly a 10 year window of time. They've made several edits to this.
Speaker 1:The fiduciary rule. When you boil it down to brass tacks, it basically says that advisors need to behave in the best interests of their clients. They have to put clients before commissions. When you explain this as an advisor to investors, most of them look at you a little cock-eyed and say I don't understand. I thought that the advisor was always working in the best interests of clients. I have to say that I thought that that was always the case when I was a broker, going back to the mid 1980s. You always acted in the client's best interest. That wasn't necessarily always the case with all advisors, and it was a little stunning when I became a manager at a very large firm that they clearly defended the point that a financial consultant at their mega brokerage firm was not a fiduciary, not acting in a fiduciary capacity. They were merely effecting the transaction for the client, meaning they were just acting as a broker where they were putting in the buy order or the sell order and that they were not relying on the broker's advice, which, when you sit back and think about a term like that, it really makes you scratch your head, because most people want to work with an advisor for advice, for guidance. But yet the brokerage firms spent a lot of time and a lot of money on legal fees defending the fact that they were not acting in a fiduciary capacity. And it makes sense. If you're a large brokerage firm and you've got 5000 salespeople out there, you've got 5000 unguided missiles and you are ripe for potential litigation. So I completely understand where they defend the point where they did not want to assume the fiduciary mantle. They didn't want their salespeople acting in a fiduciary capacity or letting the clients know that they were potentially acting in a fiduciary capacity. It's messy, it's messy and that messiness led me to leave that entire world once I discovered that there was another avenue that could be taken where we can act in a fiduciary capacity at all times and always work in the client's best interest.
Speaker 1:I really think that the fiduciary rule, or the fiduciary standard that everyone is trying to employ, would take care of itself if everybody just disclosed what they were getting paid. The fiduciary rules would not need to exist if our industry were simply a little more transparent about what things cost. And that's really what this is all about. We have this fiduciary rule that we always abide by as a fee only investment advisor, the sales People in our industry financial consultants, insurance people often object to being subject to the fiduciary rule because they work on a commission, and there's nothing wrong with working on a commission. I just think that the commission when the fees that are being generated ought to be disclosed and they ought to be transparent. That would make this entire thing go away until we won't have politicians standing up on a soapbox saying we have to crack down on junk fees. That's where this whole story began in the last few weeks. Is that now we're getting our friends in Washington who are chiming in saying we need to crack down on junk fees. Well, what they're talking about Are situations where individuals have a balance in the 401k, they retire and then they are compelled to roll the money out of their 401k and into an IRA.
Speaker 1:Unfortunately, what happens many, many times is the money gets rolled out of the 401k retirement plan, then gets rolled over into an IRA and often times gets then rolled into an annuity, a deferred annuity. For some of our listeners, they may not understand that a deferred annuity is a tax deferred investment, meaning you put the money into your annuity, you don't get a 1099 for anything that happens inside the annuity and that's great because you're deferring taxes until you take the money out. The problem that we have is that you're putting a tax deferred investment inside of an IRA, an individual retirement account. An IRA, by its structure, is a tax deferred investment. The money that is in an IRA is not taxed until you take the money out as ordinary income when it comes out. It will be ordinary income when it gets distributed to you. Even though you may put it into some growth investments and enjoy some long term capital gains, it's not taxed as a capital gain. It's taxed as ordinary income when it comes out.
Speaker 1:The answer I've been seeking for nearly 40 years in this industry is you have a tax deferred vehicle like an IRA, an individual retirement account. Why in the world would you put a tax-deferred investment like an annuity inside of a tax-deferred investment like an IRA? It makes there is no economic benefit to the end user, to the client, to do something like that, and I've yet to hear a satisfactory answer in my over my entire career why you would own an annuity inside of an IRA. Yet billions, billions of dollars get poured into annuities inside IRAs year after year after year that is invested this way. Kudos to all the sales folks in the insurance industry who have convinced individuals that they need to own an annuity inside of their IRA. To me, it makes no sense whatsoever. So where the politicians get involved in when they talk about junk fees, folks are taking their rollover dollars from their 401k and they're putting the money into an annuity. What's not being disclosed are the fees that they are paying when this transaction takes place.
Speaker 1:What most people are not aware of is that when you invest in an annuity, the salesperson will be compensated. They will get a commission. The commissions on the annuity sales are high. They're higher than any other investments that are out there. In most cases, but not all cases, it's possible that you could purchase an annuity from an insurance company that's structured to work with fee-only advisors, or a low-cost annuity that you'd have to do on your own, where you could find a product that has a 1% charge or something small like that. But most annuities that are sold by insurance representatives, commissions, are often starting at 4% or 5% and sometimes as high as 9%. It's a lot. If you had a $900,000 nest egg in your 401k $900,000 and you took this money when you retired and rolled it into an IRA and then purchased an annuity inside it, the salesperson would be receiving a commission, just say, 7% of $63,000. The salesperson would also be receiving some type of small trailing commission every year that you are in the investment.
Speaker 1:I should say that you stay in the investment because a lot of folks don't understand and this is hardly ever mentioned, but don't quote me on the exact number but something in the neighborhood of 82% of all deferred annuities don't make it to the annuitization stage where they turn into a lifetime stream of income. That's what annuitization means. You've got this situation where people get paid a lot of money upfront that's not disclosed. That ought to be transparent, because I think people would make different choices if they knew that. I'm not begrudging someone who earns a living on commission. I did it for 16 years before I started this firm, over 20 years ago. I know working on commission to Tough Road to Ho, but it can be very, very rewarding. I think that large transactions like this need to have more transparency, more disclosure, so that people are aware where the incentives are. Charlie Munger, who recently passed away, always talked about tell me where the incentive is and I'll tell you whether this is a good deal or not. I'm not saying that deferred annuities are inappropriate for everyone. There are situations where it really does make sense. Those are very few, but yet billions of these investments are made each year.
Speaker 1:The politicians and I'm not picking one side or one color, it's not a red thing or a blue thing you know the red team and the blue team are both crying about junk fees, but that term junk fees is a sales pitch in itself. It's a political ploy because it positions the politician on your side. It becomes an us against them sort of conversation and that's very misleading. There are fees that come with investing. You're going to find that, anywhere you go, you want to keep them as low as possible. To call them junk fees, I think is not very fair. We talk about the fiduciary rule. We talk about these junk fees. It's interesting that supporters of the fiduciary rule seem to say that, hey, this seems good. What's what we have now?
Speaker 1:The industry thinks that these changes will have a negative impact on advisors and on clients. The head of the National Association of Insurance and Financial Advisers, nafsa, their CEO, kevin Mayew, decried the misleadingly named retirement security rule in a statement, arguing that the rule would unfairly saddle advisors with unnecessary regulations. I don't think they're really unnecessary. The need for this fiduciary rule is pretty clear. There are folks who are just getting simply ripped off and misled and not being informed of the costs that are involved with their particular investments. As we've said to many, many clients when we meet with them, when they have an annuities, they're not terrible. They're just an extremely expensive way to invest. In many cases we find that it's not the best investment option that the clients could have taken advantage of and in some cases you'll find this is a product that is not suitable or unsuitable for their particular situation.
Speaker 1:There's a group called the Public Investors Advocate Bar Association. This group, along with the CFP board, threw their support behind the efforts of the Department of Labor to clarify the fiduciary rule. In fact, the president of the Public Investors Advocate Bar, joseph Piper. He came out with a statement saying that the rule would ensure that advisors will have to put retirees ahead of commissions. This goes right to the point of what this work on the fiduciary rule is all about.
Speaker 1:Just be transparent and tell your prospective client hey, mr Jones, we're going to take your $900,000, we're going to roll it into an IRA, which is a tax deferred vehicle. Then we're going to put it into a tax deferred investment. Your $900,000 will go into an annuity backed by an insurance company. At some point you can turn that on and receive a guaranteed stream of income for life. All of this sounds really pretty good and it might be exactly what the client wants and I'm going to receive. As the salesperson on this transaction, I'm going to be transparent and tell you that I'm receiving 7% of every dollar that's invested. So, mr Jones, when you do this rollover from your 401k that you've saved your entire career in, and now we're going to roll it into an IRA and then we're going to put the money into an annuity, I'm going to receive a commission of 7% or $63,000.
Speaker 1:I don't think there's anything wrong with that and, again, I'm not begrudging anybody who works on a commission. I did it for a very long time. I just think that there needs to be some transparency because some people may say, okay, that makes sense, but gee, $63,000 seems like a lot of money. Does it really need to be this way? It may be an appropriate product for them. So the answer might be no.
Speaker 1:But you'll also realize that if you purchase an annuity, or if you have purchased an annuity before, there's something that is tacked on to this called a surrender charge, and the surrender charge is important. You'll learn a lot just by looking at the table in the contract of the annuity and hopefully you do receive the contract and hopefully you do read it, because very early on, in the first couple of pages, there will be a table that says this is the surrender charges. If you surrender the contract meaning you got into this investment and say a year later you've changed your mind or said this isn't really for me, it's not very suitable, I want to do something else with the money I want to get out of the contract, you're going to pay a surrender charge. In most cases, you are going to have a surrender charge that declines from year over year, but the first year your surrender charge may be as high as 10%. Why is it 10% or 8%? Why is it so high? Because the insurance company needs to recoup the fees, the commissions, that they paid the salesperson at the time of the transaction. That is why you have a declining surrender charge. So the longer that you're in the contract, the less it costs them to unwind this particular contract. People just don't seem to understand that they need to recoup the money that they paid the salesperson at the time of the sale, at the time of the transaction.
Speaker 1:I think the more that this gets talked about the costs that are involved with investing, the more that this gets talked about, the more it will be out in the open, the more people will be aware of this and there will be more informed consumers, better consumers out there that can make a decision that this is right for me or this is wrong for me, instead of trying to tap, dance around this and make up these nonsense rules.
Speaker 1:The fiduciary rule and acting in the best interest of clients has been a very confusing, cloudy topic for everybody in our industry. I actually spoke at a panel on this at NASDAQ several years ago and the rules have changed a few times since then. I simply don't understand why. A little bit of transparency and being forward and telling folks exactly what's involved in the transaction. I don't understand how that could be bad for people, but people want to hide behind curtains and not disclose what's going on. I think, as an investor, you're going to be better off when you know all of the details heading into a particular investment. That's going to wrap up podcast episode number 468. Thanks, as always for tuning in.
Speaker 2:Tom Malouli is an investment advisor representative with Malouli asset management. All opinions expressed by Tom and his podcast guests are solely their own opinions and do not necessarily reflect the opinions of Malouli asset management. This podcast is for informational purposes only and should not be relied upon as a basis for investment decisions. The opinions of Malouli asset management may maintain positions and securities discussed Party.