The following is methodology for EPI’s comment on the proposal to extend the applicability date to the fiduciary rule.
EPI estimates that the proposed 60-day delay of the fiduciary rule would cost workers saving for retirement $3.7 billion over the next 30 years.
Our methodology and assumptions were adapted from the 2015 report The Effects of Conflicted Investment Advice on Retirement Savings by the White House Council of Economic Advisers (CEA). The findings of the CEA report were cited extensively by the Department of Labor when the final Conflict of Interest Rule was published in April of 2016. The report finds that savers receiving conflicted advice earn annual returns that are roughly 1 percentage point lower each year than returns that savers would have earned if they had not received conflicted advice, and that an estimated $1.7 trillion of IRA assets are invested in products in which savers receive conflicted advice. These two estimates together yield an aggregate annual cost of conflicted advice to savers of about $17 billion each year.
The CEA report focuses only on IRA assets. Their “middle estimate,” which is what we base our main estimates on, focuses even more narrowly on load mutual funds and variable annuities held in IRAs. But the fiduciary rule also applies to other plans subject to Section 4975 of the Internal Revenue Code, including Keogh plans, as well as 401(k)s and other plans governed by the Employee Retirement Income Security Act. In 2015, there was a total of $4.7 trillion held in 401(k)s alone.1 Moreover, the assets in retirement plans covered by the fiduciary rule and potentially affected by conflicted advice are not limited to load mutual funds and variable annuities, but also include, for example, fixed annuities. Therefore, the CEA estimate considers only a subset of assets potentially affected by the rule. Despite the fact that the CEA’s approach thus generates a substantial underestimate of the total costs of delay, we follow their approach.
In developing the estimate of the cost to retirement savers of a 60-day delay of the fiduciary rule, we believe that looking at the entire stock of IRA assets that are invested in products in which savers receive conflicted advice is inappropriate, due to inertia on the part of savers. It is unlikely that a meaningful share of savers who already hold IRA assets for which they received conflicted advice would move their investments into lower cost funds during those 60 days. Instead, we focus on new investments rolled over into IRAs during the 60-day delay that are potentially affected by conflicted advice.2
In 2014, $429.6 billion was rolled over into Traditional and Roth IRAs.3 Rollovers have been increasing steadily over time; for example, between 2000 and 2014, rollovers into traditional IRAs increased by 4.6 percent annually on average (and increases were even greater in the later part of that period). Applying the growth rate of 4.6 percent to IRA rollovers, we estimate that at least $491.8 billion will be rolled over into IRAs in 2017. This annual figure is equivalent to $80.8 billion every 60 days.
Following the methodology in the CEA paper, and using updated numbers where available, we assume that somewhere between 14 percent and 47 percent of that $80.8 billion in new IRA rollovers will be subject to conflicted investment advice, with a middle estimate of 22 percent. Putting these together, we estimate that during the 60-day delay, somewhere between $10.9 billion to $37.9 billion will be newly rolled over in IRAs in which savers receive conflicted advice, with a middle estimate of $18.1 billion.
To estimate the cost to investors, we assume that the amount rolled over to IRAs and invested in assets affected by conflicts of interest is drawn down over 30 years. The 30-year horizon is based on the approximate life expectancy of investors and their spouses who roll over funds into IRAs. The average age of these investors is 58.4 The remaining life expectancy of 58-year-olds is 27.0 years and the life expectancy of the longest-surviving spouse of a 58-year-old couple is 33.7 years.5 Our 30-year assumption is conservative since it is likely that more than half of savers engaging in rollovers are married and many of them have somewhat younger spouses. Moreover, many IRA investors take only required minimum distributions beginning at age 70 rather than drawing down their savings over their remaining life expectancy, which roughly half of them will outlive. The empirical evidence suggests that the draw-down rate is much lower than we assume in our model.6 We also assume that rolled-over funds remain in underperforming assets.7
Following the methodology in the CEA paper, we assume that savers receiving conflicted advice earn returns that are roughly 1 percentage-point lower each year than they would have been without the conflicted advice. In particular, we assume that savers receiving conflicted advice earn 3 percent per year in real terms, and savers who do not receive conflicted advice earn 4 percent per year in real terms. We find that the $18.1 billion invested in IRAs in which savers receive conflicted advice during the 60-day delay will yield $3.7 billion less (in inflation-adjusted terms) when drawn down over 30 years than if those same savers had not gotten conflicted advice.8,9
In other words, we find that the cost of a 60-day delay to retirement savers is $3.7 billion dollars over 30 years. Every additional week of delay will increase that figure by $431 million and every additional 30 days of delay will increase that figure by $1.85 billion.
1. Investment Company Institute, “2016 Investment Company Fact Book,” (http://www.icifactbook.org/ch7/16_fb_ch7), Figure 7.9.
2. Note that rollovers into Traditional and Roth IRAs do not capture all new investments in a given period. Our focus on just Traditional and Roth IRAs is one of the ways in which our estimates are conservative.
3. Investment Company Institute, “The US Retirement Market, Third Quarter 2016” (https://www.ici.org/research/stats), Tables 9 and 10.
4. Figure 19 in Craig Copeland, “2014 Update of the EBRI IRA Database: IRA Balances, Contributions, Rollovers, Withdrawals, and Asset Allocation” (https://www.ebri.org/pdf/briefspdf/EBRI_IB_424.Aug16.IRAs.pdf), Employee Benefit Research Institute Issue Brief, 2016. The average age of rollovers is a weighted average, weighted by total rollover amounts by age.
5. Source for individual life expectancy: Internal Revenue Service, “Distributions from Individual Retirement Arrangements,” Appendix B, Table 1 (https://www.irs.gov/publications/p590b/). Source for joint life expectancy: “Male/Female Joint Life Expectancies Based on Annuity 2000 Mortality Table” (https://www.pgcalc.com/pdf/twolife.pdf).
6. According to Figure 27 in Craig Copeland, “2014 Update of the EBRI IRA Database: IRA Balances, Contributions, Rollovers, Withdrawals, and Asset Allocation” (cited earlier), the median withdrawal rate from an IRA is 5.8 percent, not counting those not taking withdrawals, while our method results in an average draw-down rate of close to 15 percent.
7. It is possible that savers will shift toward better-performing funds rather than leaving the same amount in underperforming funds for 30 years—that is, that inertia on the part of savers isn’t as strong as we are assuming. However, if we were to take into account reduced inertia in this context, we would also have to revisit our earlier assumption of full inertia vis-à-vis the entire stock of IRA assets held in conflicted accounts. There we assume that inertia on the part of savers means that savers who already hold IRA assets for which they received conflicted advice would not be more likely to move their investments into lower-cost funds if the fiduciary rule were implemented without delay. Relaxing the inertia assumption could substantially increase our cost estimates, since there is more than $1.5 trillion held in conflicted IRA accounts.
8. These figures are adjusted for expected inflation over the next 30 years. However, they do not account for the possibility that people may discount future income relative to current income due to the opportunity cost of forgoing investment earnings or for other reasons. If future income is discounted by assumed rates of return, the cost of a 60-day delay to retirement savers is $2.1 billion and every additional 30-day delay will increase that figure by $1.06 billion.
9. There are several differences between the methodology used in the Department of Labor’s (DOL’s) Regulatory Impact Analyses (RIA) and EPI’s methodology, including different time horizons and discount rates. The analyses also differ in the assets that are assumed to have worse performance net of fees as a result of conflicts of interest disallowed by the rule. For example, the DOL only considers front-end-load mutual funds, whereas our estimate (based on the CEA’s “middle” estimate) includes all load mutual funds and variable annuities. Because the scope of DOL’s analysis is limited to front-end load funds, its methodology can be tailored to investor losses on these funds based on the direct and indirect effect of such loads on net investor returns, taking into account turnover rates. The DOL also assumes that the fiduciary rule would take effect gradually and that there are declining costs even in the absence of the rule, whereas the CEA methodology that we base our estimates on assumes, based on a broad review of the literature, that conflicted advice reduces net returns on affected funds by 100 basis points annually.
