While implementation of these new regulations has been postponed until 2019, understanding the rules on annuities, and the different kinds of annuities, now may be helpful
The Employee Benefits Security Administration
(“EBSA”) is the Department of Labor’s unit responsible for overseeing portions
of ERISA, including any new fiduciary rules.
EBSA recently published new Prohibited Transaction Exemptions (“PTE”s) that
include, among other things, amendments concerning annuities. The new amendments change how advisors can
earn commissions and impose other requirements. While implementation of these
new regulations has been postponed until 2019, understanding the rules on
annuities, and the different kinds of annuities, now may be helpful. The DOL
has stated that the new change updates definitions and revokes the exemption
under the PTE previously established in 2016 for fixed indexed annuity
contracts and variable annuity contracts.
What changed? In the past, the exemption to
prohibited transactions on annuities (PTE 84-24) covered recommendation and
sale of annuities and life insurance policies. The revocation now applies to
more types of annuities and imposes some additional written requirements,
including that the
insurance agent or broker must disclose their compensation as a percentage of
the commission payments. Receipt of that information has to be confirmed in
writing. Importantly, financial advisors who sell variable annuities and indexed annuities will
need to satisfy the conditions of the “Best Interest Contract Exemption” (BICE)
instead of the earlier requirements of PTE 84-24. While most of the BICE requirements
follow the fiduciary rules for investments, the portions relating to, receiving
no more than reasonable compensation may prove slightly more difficult to apply
in practice, as discussed below.
How are they annuities different? Most
discussions of annuities break them down into categories based on payment of
compensation. First, there is immediate versus deferred annuities which differ
based on timing, e.g., whether you receive the payments presently or obtain
them later. In an immediate annuity, a client gives the broker a lump sum of
money and receives payments over time.
Longevity annuities are those where payment is deferred until a specific
age, and then provides a specific, predictable amount. Some clients use
longevity annuities as a planning method to prevent under funding retirement
accounts or outliving investments.
Next, annuities differ based on the payment
calculation, whether that amount is fixed payment to payment or varies. Variable annuities, while having the
potential for higher returns, also sometimes come with administrative fees that
collectively can add up to 2 or 3%. A
fixed annuity trades predictability for income.
An equity-indexed annuity can be thought of as
blending a fixed annuity with a variable annuity. The idea is to offer a client
a fixed base, with a potential that if the stock market increases, the payment
on the equity could also increase. However, there is no decrease past the fixed
amount: in other words, an equity-indexed annuity has a floor (the fixed rate)
but virtually no ceiling.
Annuities have slightly different tax treatment
than other investment products, and timing of payments may be crucial: the
amount invested is not taxed, but the earnings on the annuities may be taxed as
income. However, unlike 401Ks, there is
no limit on the amount you can contribute to an annuity, so for folks who need
to catch up or who started on retirement planning late, an annuity might have
also differ from other investment products in the amount of commission that
insurance brokers receive through their sales: many commissions on annuities
can amount to 10%.
Lastly, annuities fall into individual versus
group plans. Individual annuities are as they sound, a contract between an
individual and an insurer. Group annuity plans fall into defined benefit plans.
Dating prior to the Social Security Act, Group annuity plans involve a master
contract between the employer and the insurer that guarantees a benefit to
employees and defines calculation and length of payment.
noted above, the impartial conduct standards impose traditional fiduciary
requirements of prudence, impartiality and acting on behalf of the beneficiary
(for more on the basics of fiduciary duties, see our blog post on: https://www.bcgbenefits.com/blog/fiduciary-services-rules-321-338-and-316).
The new PTE on annuities may be in response to consumer groups who called for treating investment annuities with more caution, asking for imposition on conflicts of interest rules rather than increasing disclosures about advisors and sales of annuities. Annuity issuers, on the other hand, have argued that imposing the fiduciary rule on their commission-based sales would be unnecessarily complex. Additionally, those annuity issuers also argue that the additional regulations on the financial advisors will shut smaller investors out of the annuity market.
Before leaping into the unknown, we recommend a thorough examination of your plan. Because we are experts in the field, we know the marketplace and know what your existing vendor is capable of offering. Through this examination, we can help you optimize the service you receive.get xpress proposal