Annuities and New EBSA Prohibited Transaction Rule

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 benefits.

Annuities 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.

As 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: 

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.

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