Weak Standards Make Annuities Prohibited Transactions in ERISA Plans

September 15, 2025November 2, 2025 / ChrisTobe / 2 Comments

Introduction

ERISA was enacted to impose strict fiduciary, accounting, and investment performance standards on retirement plan assets. SEC-registered mutual funds must meet these standards through transparent reporting, daily pricing, and oversight by independent boards. By contrast, insurance-based annuities operate under weaker fiduciary standards, opaque accounting rules, and undisclosed performance spreads, making them unlikely to qualify for an exemption from ERISA’s prohibited transaction rules.¹

As my earlier analyses demonstrate, annuities have become a gateway drug that opened the door to non-standard accounting and conflicted arrangements in retirement plans.²

I. Fiduciary Standards: ERISA §404(a) vs. NAIC Rule 275

ERISA §404(a) imposes explicit duties of prudence and loyalty, requiring fiduciaries to act solely in the interest of participants and beneficiaries. By contrast, NAIC Rule 275, the state insurance ‘best interest’ standard, does not include a loyalty duty and permits conflicts of interest if disclosures are made.³ Plan fiduciaries cannot rely on NAIC compliance to meet ERISA duties. A product that satisfies Rule 275 may still violate ERISA’s exclusive benefit rule, making it a prohibited transaction.

II. Accounting Standards: Book Value vs. Market Value

Mutual funds must report daily mark-to-market NAVs under SEC rules, fully reflecting gains and losses. Annuities, especially General Account or Separate Account contracts, are governed by statutory accounting. Assets are often held at amortized cost, meaning losses are hidden unless realized. Portfolios frequently contain 30–50% private credit and alternatives.⁴ Book-value accounting disguises true risk, making annuities appear ‘safe’ when underlying portfolios may be volatile or impaired.

III. Investment Performance Standards: Spreads and Opaqueness

Mutual funds disclose expense ratios, portfolio holdings, and benchmark comparisons. Annuities credit 2–3% to participants while earning 6–7% on general account assets. The undisclosed spread—sometimes over 400 basis points—represents pure insurer profit.⁵ This opacity prevents fiduciaries from assessing the reasonableness of compensation, triggering ERISA §406(b) self-dealing prohibitions.

IV. Conflicted Providers and “Party in Interest” Risks

In many 401(k) plans, the recordkeeper is also the annuity provider. As Cunningham v. Cornell highlighted, this dual role creates inherent conflicts of interest. When insurers steer plan assets into affiliated annuities, fiduciaries face direct exposure under the prohibited transaction rules.⁶

V. Transparency Suppression: Prudential and NAIC RBC Proposal

Prudential, domiciled in New Jersey, shields its quarterly solvency filings under N.J. Stat. §17-23-1, denying plan fiduciaries access to critical risk data.⁷ The NAIC Capital Adequacy Task Force has proposed banning public disclosure of insurer Risk-Based Capital (RBC) scores, even though the Society of Actuaries warns that transparency is essential.⁸ Fiduciaries cannot evaluate insurer solvency without this data, a critical factor in selecting annuities.

VI. Litigation Outlook

The Supreme Court has already narrowed available exemptions from prohibited transaction rules.² Combined with weak fiduciary standards, opaque accounting, undisclosed spreads, and active suppression of solvency data, annuities present a litigation time bomb: plaintiffs will argue that fiduciaries cannot prudently select annuities without access to solvency and fee data. Courts will increasingly view annuities as per se prohibited transactions absent full transparency. Most annuities do not have downgrade provisions, so their liquidity risks go up simultaneously with their credit risk. Fabozzi, in the 1998 Handbook of stable value, says that General Account fixed annuities have 10 times the risk of synthetic diversified stable value.

Conclusion

Annuities fail across three pillars: fiduciary duties, accounting standards, and performance transparency. SEC-registered mutual funds meet all three; annuities meet none. By continuing to rely on these weaker standards, insurers are ensuring that their products will be viewed as prohibited transactions under ERISA, and plan fiduciaries who adopt them will face heightened litigation risk.

Footnotes

¹ ERISA §406; see also https://commonsense401kproject.com/2025/06/13/annuities-are-prohibited-transactions-via-chat-gpt/
² https://commonsense401kproject.com/2025/05/10/annuities-flunk-prohibited-transactions-exemption-scotus-ruling-will-open-floodgates-of-litigation/
³ Comparison of ERISA §404(a) with NAIC Rule 275; see also https://commonsense401kproject.com/2025/07/27/diversification-abandoned-why-plan-fiduciaries-must-rethink-fixed-annuities-and-pension-risk-transfers/
⁴ https://commonsense401kproject.com/2025/08/12/4-sets-of-books-how-trumps-401k-push-opens-the-door-to-accounting-chaos/
⁵ Spread profits analysis; see https://commonsense401kproject.com/2025/06/24/state-guarantee-associations-behind-annuities-are-a-joke/
⁶ Cunningham v. Cornell Univ., 86 F.4th 961 (2d Cir. 2023).
⁷ N.J. Stat. §17-23-1.
⁸ NAIC, Capital Adequacy Task Force, Special National Meeting Packet (2025), p.56.

SOURCES

The Handbook of Stable Value Investments 1st Edition by Frank J. Fabozzi 1998 Jacquelin Griffin Evaluating Wrap Provider Credit Risk in Synthetic GICs pg. 272 https://www.amazon.com/Handbook-Stable-Value-Investments/dp/1883249422

National Association of Government Defined Contribution Administrators. 2010. 2010 Issue Brochure – What Plan Sponsors Should Know About Stable Value Funds (SVF) www.nagdca.org/documents/StableValueFunds.pdf

Shames, Mitch. 2022. “Annuities: The straw that breaks the back of retirement plan fiduciaries,” Benefits Pro. May 3, 2022. https://www.benefitspro.com/2022/05/03/annuities-the-straw-that-breaks-the-back-of-retirement-plan-fiduciaries/?slreturn=20240312164319 . Accessed on March 12, 2024.

Tobe, Christopher B. 2004. “The Consultants Guide to Stable Value.” Journal of Investment Consulting, 7(1), Summer 2004, Available at SSRN: https://ssrn.com/abstract=577603 . Accessed on March 12, 2024.

Federal Reserve Bank of Minneapolis Summer 1992 Todd, Wallace SPDA’s and GIC’s http://www.minneapolisfed.org/research/QR/QR1631.pdf

“Safe” Annuity Retirement Products and a Possible US Retirement Crisis Journal of Economic Issues Accepted 2024 Dr. Tom Lambert and Chris Tobe https://papers.ssrn.com/sol3/papers.cfm?abstract_id=4761980

Testimony by Ben S Bernanke, Federal Reserve, US House of Representatives, Washington DC, 24 March 2009 https://www.bis.org/review/r090325a.pdf

Keep Private Equity out of 401(k) Target Date Funds

September 4, 2025November 2, 2025 / ChrisTobe / Leave a comment

Over half of all 401(k) assets are invested in Target Date Funds (TDFs), the default investment for most workers. Proposals to embed 15% allocations to private equity (PE) in these TDFs raise severe fiduciary, legal, and policy concerns.

Private equity’s opaque self-valuations, smoothed returns, and layered fees (≈600 bps) make it wholly unsuitable for retirement savers—particularly in default funds where workers have no choice. This is not innovation; it is regulatory arbitrage designed to funnel billions in hidden fees out of participant accounts.

Key Findings

1. Fees 100x higher than index funds.

PE all-in costs: ~6.0% annually (Phalippou 2020).
Index funds: 0.03%–0.05%.
A 15% sleeve adds 0.90% annual drag to the entire TDF—cutting lifetime wealth by 20–25%.

2. Fraudulent return smoothing.

PE funds self-price and delay write-downs.
Reported volatility and correlations are artificially low.
Asset allocation models therefore over-allocate to PE, embedding mispriced risk in retirement glidepaths.

3. Liquidity mismatch.

TDFs promise daily liquidity.
PE funds lock up capital for 10+ years.
Participants could face redemption delays, gates, or markdowns inconsistent with plan representations.

4. Weakest regulator wins.

SEC and OCC rules demand transparency and independent valuation.
Sponsors are instead turning to state-chartered CITs, where oversight is minimal and disclosure optional.
This is textbook regulatory arbitrage.

5. Fiduciary red flags.

ERISA requires prudence and reasonable fees.
Supreme Court precedent (Tibble; Hughes) obligates ongoing monitoring and removal of high-cost options.
Embedding PE in QDIAs (defaults) is especially egregious because workers never affirmatively opt in.

Policy Recommendations

DOL & SEC Joint Guidance: Prohibit private equity allocations in QDIAs until independent valuation and full fee disclosure are mandatory.
State CIT Oversight: Close the loophole by requiring federal standards (SEC/OCC level) for any retirement-plan CIT.
Fee Disclosure Reform: Mandate reporting of all fees, including portfolio company monitoring and transaction charges.
Participant Protections: Require opt-in consent, with plain-English disclosures, before allocating participant funds to PE.

Conclusion

Private equity in 401(k) Target Date Funds is not diversification—it is defaulting American workers into opaque, fee-rich products they cannot understand or escape. This violates fiduciary duty under ERISA and undermines retirement security. Regulators and policymakers should act now to prevent a massive transfer of wealth from retirement savers to private equity sponsors.

With Annuity Rates in 401(k) Plans: You Get What You Negotiate

July 28, 2025July 29, 2025 / ChrisTobe / Leave a comment

Welcome Back to the Dealership—Without the Internet

There was a time not too long ago when buying a car meant walking into a dealership and bracing for a battle. You knew better than to pay the sticker price. There was no CarFax, no Kelly Blue Book at your fingertips—only your grit and your negotiating skills stood between you and a bad deal. Fast forward to today, and while consumers have gained power in most financial transactions thanks to transparency and competition, one part of the retirement world remains stubbornly stuck in that old sales model: fixed annuities in 401(k) plans.

When it comes to these insurance-based investments, especially general account fixed annuities, the rate you receive isn’t always about the market—it’s about your leverage. Your negotiating power. And for too many plans, that means quietly accepting returns well below what other, savvier plans are earning. The result? A two-tiered system where uninformed or unempowered fiduciaries leave millions on the table while others cash in.

Sticker-Price Rates for the Uninitiated

Let’s start with what most plan sponsors and fiduciaries are seeing: general account fixed annuity 2 to 3% rates with some less than 2%. In most cases, these rates have been locked in for years. Plan fiduciaries assume that’s the best available. They’ve never asked for better. They trust the insurance company’s glossy marketing and ratings and their consultants.

Prudential, for example, publicly posts general account rates of 3%–4% on consultant platforms like FI360/Broadridge. Some like TIAA and Mass Mutual post rates of 4%-5% for basically the same or less risky product. But the rates with many insurers like Prudential can vary from 1.5% to nearly 7%, with little rhyme or reason. In at least one case, a savvy union plan in New Jersey negotiated a general account fixed annuity rate of 6.8%—within the same 401(k) framework.

Yes, you read that right. Nearly five full percentage points higher than what other plans were receiving from the same insurer for the same product type. The only difference? They knew they could ask.

A Broken Marketplace

What we’re seeing is not an efficient marketplace. It’s a holdover from a time when product pricing was opaque and negotiation was king. But here’s the problem: this isn’t used car sales. These are retirement assets regulated by ERISA, with fiduciary standards that prohibit arbitrary pricing structures that benefit one plan over another without justification.

If an insurance company retains total discretion over annuity rates, then it also retains the ability to allocate higher yields to preferred clients—possibly to reward larger assets, political influence, or favored consultants—and lower yields to everyone else. This unequal treatment is not only unfair; it’s potentially unlawful under ERISA.

As I argued in this recent piece, annuities in 401(k) plans often constitute prohibited transactions when they are offered with non-transparent, discretionary pricing structures. If plan fiduciaries do not negotiate, they are not fulfilling their duty of loyalty or prudence under ERISA.

Consultants Are Not Always Your Friend

A deeper concern is that some consultants—the very advisors plan sponsors rely on to protect them—are complicit. Rather than push for higher negotiated rates or run competitive bids, some simply accept posted rates or worse, recommend insurers where they may have their own compensation arrangements or conflicts. Some consultants have insurance licensees where they can receive hidden insurance commissions. Sometimes rates are burned off to pay for recordkeeping fees, consultant fees etc.

Some consultants may use databases like FI360/Broadridge, which show insurer-published general account rates many conflicted consultants do not even do that. But unless they go further—soliciting competitive proposals or uncovering the higher rates being granted to others—they are not doing their job. Worse, in some cases they actively steer plans toward underperforming fixed annuities while pocketing fees from the insurers themselves.

A Fiduciary Wake-Up Call

The key message for fiduciaries of 401(k) plans is this: you get what you negotiate.

If your plan holds a general account annuity yielding 2%-4%, and you’ve never asked for more, you may be in violation of your fiduciary duty. Your peers—especially in larger or union-affiliated plans—may be earning triple your rate simply because they demanded better terms.

That’s not just a bad deal. It’s a fiduciary breach.

The Solution: Demand Transparency and Competition

Require Competitive Bids – Treat your annuity provider like any other investment manager. Get multiple quotes. Benchmark rates.
Disclose the Spread – Insist on full transparency on how the insurer earns money. What’s the gross yield on their general account? What are they keeping?
Use Independent Experts – Be cautious of consultants who may have undisclosed relationships with insurers. Get independent advice or a second opinion.
Document the Negotiation – Keep records of the steps you took to secure the best rate. It’s your defense in any potential ERISA litigation.
Over time get rid of your Conflicted Non-Transparent fixed annuities, switch to a diversified Synthetic based stable value fund like the Vanguard RST, or Fidelity MIPS, this may take time because many fixed annuities are known as “Roach Motels” you easily get in but getting out may require a substantial penalty

Conclusion

Fixed annuities in 401(k) plans should not be sold like used cars. They should reflect a competitive, prudent process.

In the end, it’s simple: when it comes to annuity rates, you get what you negotiate—or what you fail to.

Hiding Private Equity in 401(k) Target Date Funds risks the entire TDF as a Prohibited Transaction- ChatGPT

July 5, 2025November 2, 2025 / ChrisTobe / Leave a comment

Hiding Private Equity in 401(k) Target Date Funds risks the entire TDF as a Prohibited Transaction- ChatGPT

Because Private Equity is clearly an ERISA prohibited transaction, https://commonsense401kproject.com/2025/07/02/private-equity-is-a-prohibited-transaction-via-chat-gpt/ it can create the false illusion that it adds value to a portfolio like a Target Date fund by overstating performance and understating risks. As I testified to the ERISA advisory committee last year, SEC-registered mutual funds will not allow this ruse, but that weak state-regulated Collective Investment Trusts (CIT’s) would. https://commonsense401kproject.com/2025/06/29/erisa-advisory-council-testimony-released/

Target Date funds that allocate to Private Equity, can become Prohibited Transactions.

I asked ChatGPT how Private Equity cheats on performance and risk.

⚠️ Core Concern:

Private Equity (PE) self-reports inflated returns and artificially smooths volatility, which distorts inputs used in mean-variance optimization (MVO), risk-parity models, and target-date glidepaths.

🔍 How the Distortion Happens:

1. Self-Reported, Marked-to-Model Valuations

Unlike publicly traded equities, PE funds are not marked to market.
General Partners (GPs) have wide latitude in determining “fair value” using Level 3 inputs under GAAP/IFRS.
There’s no external price discovery like in public markets—creating upward bias in reported IRRs and TVPIs.

Example: GPs may hold a portfolio company at $2.3B valuation for 12 months—until a sale occurs at $1.8B, but all the prior return models assumed $2.3B.

2. Return Smoothing Reduces Apparent Risk

PE firms smooth returns by reporting only quarterly, and avoiding mark-downs in downturns unless forced (e.g., in LP secondaries).
This lowers measured standard deviation, making PE appear less risky than it truly is.

Ludovic Phalippou, in multiple SSRN papers, shows that real economic volatility of PE is closer to or greater than public equities, but accounting practices mask this.

3. Low Correlation Is Largely an Illusion

PE is often shown to have low correlation with the S&P 500 or public equity indices.
This is not because the underlying assets are fundamentally different—but because quarterly smoothed valuations fail to reflect the real-time economic correlation.

Empirical studies (e.g., Ang, Chen, Goetzmann 2013) show that lagged public-equity returns can explain much of PE fund performance.

📉 Implications for Asset Allocation Models:

1. Misleading Inputs into MVO and Risk Budgeting

MVO and Black-Litterman-type optimizations overweight PE due to inflated Sharpe ratios (high returns / low volatility).
Allocators wrongly assume PE offers high return with diversifying low risk.

2. Target-Date Funds and Pension Glides Paths Are Over-Allocating

Plan sponsors may use PE-heavy CITs or TDFs based on deceptively low risk and attractive correlation stats.
This is especially problematic in state-regulated CITs, where oversight of inputs is weak.

3. Stress Testing Fails to Capture Liquidity & Downside Risk

Smoothing hides tail risk and liquidity gaps during downturns (e.g., GFC, COVID).
PE dry powder and capital calls may spike just when public markets are down.

🔎 Supporting Academic and Regulatory Sources

Ludovic Phalippou, “An Inconvenient Fact: Private Equity Returns & the Billionaire Factory”
→ Calls out manipulated IRRs, opaque fees, and correlation illusions.
Andrew Ang (Columbia/BlackRock)
→ PE appears low beta only due to infrequent marking; in reality, it is leveraged equity.
U.S. SEC under Gensler has warned of valuation opacity and risk-model distortions in private funds.
CFA Institute (2021 paper):
“Asset Allocation to Alternative Investments” (CFA Institute, 2025):
Highlights that illiquid assets often have stale and artificially smoothed returns, recommends testing for serial correlation, and states clearly that analysts “need to unsmooth the returns to get a more accurate representation of the risk and return characteristics of the asset class.” blogs.cfainstitute.org+13cfainstitute.org+13
2019 SSRN paper “Unsmoothing Returns of Illiquid Assets” by Couts, Gonçalves, and Rossi, which critiques existing methods and proposes a novel three-step unsmoothing technique—highly relevant for private equity modeling. papers.ssrn.com+2

🧨 Bottom Line:

Private equity appears safer and more diversifying than it really is because it controls its own marks.
This undermines the integrity of asset allocation models and can lead to over-allocation, particularly in pensions, endowments, and TDFs.

This misrepresentation may expose fiduciaries to legal risks under ERISA’s Impartial Conduct Standards or trust law’s duty of prudence—especially if they’ve failed to adjust for these distortions.

These distortions also apply to private debt, hedge funds, real estate, and other ERISA prohibited transactions like Crypto https://commonsense401kproject.com/2025/07/03/crypto-is-erisa-prohibited-transaction-chatgpt-do-not-use-in-401k/

And Annuities https://commonsense401kproject.com/2025/06/13/annuities-are-prohibited-transactions-via-chat-gpt/

Target Date funds that use any inputs that are prohibited transactions are at a high risk of making the entire TDF a Prohibited Transaction.

ERISA Advisory Council Testimony released

June 29, 2025 / ChrisTobe / 2 Comments

Our (Chris Tobe, CFA,CAIA & James Watkins Esq) summary of our testimony from July 24 on QDIAs in 401ks to the ERISA Advisory Council was released. Of the many witnesses I believe Jim and I urged the most caution and emphasized the need for transparency. You can read the full reports at https://www.dol.gov/sites/dolgov/files/EBSA/about-ebsa/about-us/erisa-advisory-council/2024-qdia.pdf https://www.psca.org/news/psca-news/2025/5/full-qdia-report-released-by-erisa-advisory-council/

Our portion is below –

Investment Fiduciaries James Watkins and Chris Tobe

James Watkins is an attorney with Invest Sense LLC. His current practice provides forensic fiduciary audits for plans and other trustees. Chris Tobe is the Chief Investment Officer for the Hackett Robertson Tobe Group. He works as a consultant to retirement plans and serves as a litigation consultant.

Mr. Watkins stated there are three cases that he refers to as the “responsibility trinity,” that defines the area of fiduciary responsibility right now: 1. Tibble v. Edison – recognized the Restatement of Trusts (Restatement) as a legitimate resource in resolving fiduciary issues and ruled that a plan sponsor has an ongoing fiduciary duty to monitor plan investment options for prudence 2. Hughes v. Northwestern – ruled that a plan sponsor has a fiduciary duty to ensure that each investment option within a plan is prudent and to remove any that are not 3. Brotherston v. Putnam – ruled that comparable index funds can be used for benchmarking purposes, citing Section 100 b(1) of the Restatement, that index funds are proper comparators Mr. Watkins stressed that he is a big proponent of cost benefit analysis and believes the math is not that hard to do, especially as it is being used to determine whether an investment is in the best interest of a participant. Mr. Watkins stated that the industry does not support his focus on cost benefit analysis given studies that show the majority of actively managed funds are not cost efficient.

Regarding annuities within a QDIA, Mr. Watkins noted that he most often is asked by the plan sponsor considering an in-plan annuity solution whether a participant can get out of it, and if so, how. Mr. Watkins’s understanding is the only way a participant can get out of an annuity without harsh tax penalties is to do a 1035 exchange (a tax-free exchange of an existing annuity contract, life insurance policy, or endowment for another of like kind). Mr. Watkins stated that he is aware of a lot of annuity providers trying to embed annuities into target date funds within qualified plans. He suggested that this raises the question about the 50 feasibility of a 1035 exchange in a qualified plan, and whether it is the only way you can make this move or can a participant make an exchange from a like product to another like product.

Mr. Watkins thinks that enhanced disclosures should be provided to participants with the appropriate information to ensure that they understand the annuity product, which should include the conditions for them to “break even” and how that would work if they were to surrender the annuity contract. Mr. Watkins stated that, if annuities are embedded in QDIAs, there needs to be much more meaningful, clear, and simple disclosures provided to enable the participant to make an informed decision and comply with IRC section 404(c). Mr. Watkins concluded by stating he does not believe annuities should be offered in a plan nor specifically in a QDIA. If ERISA does not require that a plan offer guaranteed income products or annuities, he does not see a reason to do so. His biggest concern is that once a participant is in an annuity, they lose control and are locked in. Mr. Watkins was asked if he has seen any ERISA 3(38) fiduciaries (those who have the authority to buy and sell assets, make strategic decisions, and otherwise handle all aspects of account investing) implementing annuity solutions in collective investment trusts or in unregistered products. He indicated that many plan sponsors are encountering products embedded in collective investment trusts and a lot of proprietary products. He believes that collective investment trusts are not transparent enough and participants do not understand or have access to information, as they would in a mutual fund that posts information in a newspaper or Morningstar. He stated that collective investment trusts typically do not publicly publish their performance results or their fees.

Mr. Tobe began his testimony by stating that target date funds hold 50% of all 401(k) assets and thinks they deserve more fiduciary oversight by regulatory agencies. Historically, TDFs have been primarily offered in mutual funds registered with the Securities and Exchange Commission (“SEC”), but the trend is that more target date assets are flowing into weakly regulated state collective investment trusts. The SEC does not allow investments in annuities, crypto currency, and private equity, for example, in mutual funds. By contrast, state-governed collective investment trusts do permit these types of investments, and do not offer the same level of disclosures and transparency as mutual funds. They also have lower capital requirements as well. 51 Mr. Tobe suggested the Council should examine federally-regulated investment vehicles being used as they are more transparent. He believes that collective investment trusts should become federally-regulated rather than being regulated at a state level. He noted that there are some collective investment trusts that are superior to mutual funds because they are “clones of a mutual fund” but have lower fees.

In his opinion, the collective investment trusts being offered by insurance companies are deploying illiquid investments (annuities, private equity). He stated that this is just a way to get highpriced annuities into the mainstream target date fund solutions. He raised concerns that there are no requirements for the insurance companies to disclose interest spreads, and that there is no transparency into the revenue that the insurance companies are earning. Mr. Tobe believes that QDIAs should be held to the highest standard, that all investments should be held to the highest federal standards, such as compliance with Global Investment Performance Standards, and that the Department should be pushing for more transparency for collective investment trusts. Mr. Tobe testified that he would not recommend annuities, private equity or crypto currency in any DC plan or embedded in a QDIA as those investments are too expensive and risky right now. When asked how participants should protect themselves from market volatility, Mr. Tobe suggested that a participant should move into the lowest risk target date fund; annuities bear embedded risks that are not readily transparent to the holder. He believes that annuities could be downgraded and that insurance companies have high default risk that translates to high risk for that component of a participants’ investment. He stated that the risks for partial annuitization are the same until there is more transparency and information on annuities.

Mr. Watkins stated that a lot of the concerns could be addressed if the insurance companies could guarantee that annuities could provide a commensurate return, but historically that has been very expensive.

Some Council members noted this was inconsistent with their professional experience and 52 suggested it should be researched further. Members of Council also questioned the witnesses’ opinions regarding the insurance companies default risks, noting that historical failure of insurance companies has been very low and less than 0.03%.

When asked where they would want to see changes that would provide them with comfort with the annuity products, Mr. Tobe suggested federal regulations that oversee the insurance agencies, coordinated in partnership with the Department for ERISA-based assets. When asked what level of fees and risk would satisfy the witnesses that a product is worthwhile, Mr. Watkins responded that the issuer would need to provide a cost benefit analysis that shows the return and guarantee. Mr. Tobe also offered a detailed example of how to diversify over 4 to 5 insurance companies to minimize the default risk and use synthetic stable value-like solutions for annuities to keep the fees low.

When asked if defined contribution plans should only use mutual funds due to their greater transparency, Mr. Tobe replied no and that he would rather see greater transparency requirements for collective investment trusts.

Annuities Exposed as Prohibited Transaction in 401(k) Plans

October 10, 2024 / jwatkins / Leave a comment

By Christopher B. Tobe, CFA, CAIA

Annuities should not be allowed in 401(k)s. ERISA created the concept of Prohibited Transactions to prohibit any investments with clear Conflicts of Interest. I testified to the ERISA Advisory Council – US Department of Labor in July of 2024 on the danger of allowing annuities to be hidden inside of Target Date Funds. [i] I have co-written a paper with Economics Professor Tom Lambert on the excessive risks of annuities.[ii]

Perhaps with the exception of Crypto and Private Equity no investment better describes what should be a prohibited transaction more than annuity contracts.

Annuities are a Fiduciary Breach for 4 basic reasons.[iii]

Single Entity Credit Risk
Single Entity Liquidity Risk
Hidden fees spread and expenses
Structure -weak cherry-picked state regulated contracts, not securities and useless reserves

So why do we still see annuities in 401k plans? The reason is intense lobbying by the insurance industry, that has blocked any transparency or oversight.

Annuity providers claim to be barely legal by relying on an Prohibited Transaction Exemption (PTE 84-4) a “get out of jail free card” obtained by $millions of lobbying by the insurance industry.

Biden Fiduciary Rule

The new Biden Fiduciary rule would provide transparency that would further expose these annuity products’ conflicts of interests. The insurance industry has forue shopped in Texas in the Fifth Circuit for judges who agree with blocking transparency to block it for now.

At the Certified Financial Planner Board of Standards Connections Conference in Washington October 2024, DOL officials called out annuities as prohibited transactions. [iv] Ali Khawar, principal deputy assistant secretary for the Employee Benefits Security Administration, laid out the reasons why the Biden Labor Department continues to fight for a fiduciary rule ““To me it continues to be kind of nonsensical that you’re expecting any of your clients to walk into someone’s office and have in their head: ‘I’m dealing with this person who’s going to sell insurance to me, this person is relying on [Prohibited Transaction Exemption] PTE 84-24, not [PTE] 2020-02. Those things shouldn’t mean anything to the average American. And we shouldn’t expect them to.”

broker-dealer space transformed what it means to be in the advice market,” Khawar said. “When we looked at the insurance market, though, we didn’t quite see the same thing.”

Under the National Association of Insurance Commissioners’ model rule, for example, “compensation is not considered a conflict of interest,” Khawar said. “So there are pretty stark differences between what you see in the CFP standard, the Reg BI standard, and what has now been adopted by almost every state, one notable exception of New York, which has adopted a standard that is significantly tougher than the NAIC model rule.” [v] That process is “the CFP standard, the DOL standard, it’s the SEC standard for investment advisors and it’s Reg BI,” Reish continued. What it’s not? “The NAIC model rule,” Reish said.

“The NAIC model rule does not require the comparative analysis[vi]

Khawar added: “It’s not going to matter whether you’re providing advice about an annuity, a variable annuity, fixed income annuity, indexed annuity, security or not.” The goal with the 2024 rule, Khawar added, is to “have a common standard across the retirement landscape so that all retirement investors would be able to make sure that when someone is marketing up front best-interest advice, that that’s the standard they’d be held to by the regulator and the customer.”

Under the Employee Retirement Income Security Act, “being a fiduciary is critical to the central question of whether or not the law or consumer protections have fully kicked in or not,” Khawar added.

The Government Accounting Office wrote a piece in August in support of the Biden Fiduciary rule. They saw the problem as so severe that they suggested that IRS step in to help the DOL Better Oversee Conflicts of Interest Between Fiduciaries and Investors especially in the Insurance Annuity Area. [vii] Senator Elizabeth Warren in defense of the Biden Fiduciary rule prepared a report on the numerous conflicts of interest in annuity commissions and kickbacks. [viii]

Annuities days of hiding behind PTE 84-4 are over

Prohibited transaction exemptions are subject to meeting certain requirements. They include

The Impartial Conduct Standards.
Written Disclosures.
Policies and Procedures
Annual Retrospective Review and Report

The Impartial Conduct Standards have 4 major obligations.

A. Care Obligation

B. Loyalty Obligation

C. Reasonable compensation limitation

D. No materially misleading statements (including by omission)

Care Obligation

This obligation reflects the care, skill, prudence, and diligence – similar to Prudent Person Fiduciary standard. Diversification is one of the most basic fiduciary duties. Fixed annuities flunk this with single entity credit and liquidity risk. Diligence is nearly impossible with misleading nontransparent contracts, and the lack of plan/participant ownership of securities. The Federal Reserve in 1992 exposed the weak state regulatory and reserve claims.[ix]

Loyalty Obligation

Annuity contracts are designed to avoid all fiduciary obligation with no loyalty to participants. Secret kickback and commissions place the financial interests of the Insurers and their affiliates over those of retirement investors.[x]

The exemption requires the advisor to show their loyalty with a “Fiduciary Acknowledgement Disclosure.” Annuity contracts avoid any fiduciary language or responsibility.

Reasonable compensation limitation

Annuities have a total lack of disclosure of profits, fees and compensation. They have secret kickback commissions.

A number of lawsuits have settled with claims of excessive secret fees and spreads. An Insurance executive bragged at a conference of fees over 200 basis points (2%) in 2013. [xi]

No materially misleading statements (including by omission)

Annuities have numerous material misleading statements, including the total lack of disclosure of spread/fees. They claim principal protection, but some fixed annuity contracts recently have broken the buck and violated their contracts. The written disclosures under weak state regulations omit critical information on risks and fees.

Most plans with annuities do not have Investment policy statements, since most fixed annuities would flunk them on diversity and transparency and not be allowed. Annuities cannot provide the transparency to follow CFA Institute Global Performance Standards (GIPS) so they do not comply.[xii] Most 401(k) committees with insurance products do not review such annuity products, since they clueless on what they are. Consultants for plans with annuities do not review the annuities most of the time since they are conflicted and they themselves receive kickbacks from annuity providers.

Annuities as a Prohibited Transaction

Annuities hide most of their compensation. They are typically secret no bid contracts with no transparency and numerous conflicts of interest. They are subject to weak state regulations (sometimes categorized as NAIC guidelines). Many times they are a party of interest and shift profits from annuities to make other fees appear smaller.

Annuities are clearly prohibited transactions, but have used their lobbying power in Washington and in states to exempt themselves from all accountability.

[i] https://commonsense401kproject.com/2024/07/31/chris-tobe-dol-testimony/

[ii] https://commonsense401kproject.com/2024/03/26/just-how-safe-are-safe-annuity-retirement-products-new-paper-shows-annuity-risks-are-too-high-for-any-fiduciary/

[iii] https://commonsense401kproject.com/2022/05/11/annuities-are-a-fiduciary-breach/

[iv] https://www.thinkadvisor.com/2024/10/07/top-dol-official-sees-a-nonsensical-reality-at-heart-of-fiduciary-fight/

[v] https://www.thinkadvisor.com/2024/10/07/top-dol-official-sees-a-nonsensical-reality-at-heart-of-fiduciary-fight/

[vi] https://www.thinkadvisor.com/2024/10/07/top-dol-official-sees-a-nonsensical-reality-at-heart-of-fiduciary-fight/

[vii] GAOJuly24 Retirement Investments: Agencies Can Better Oversee Conflicts of Interest Between Fiduciaries and Investors

Click to access FiduciaryConflictsofInterest_OMB.pdf

https://www.thinkadvisor.com/2024/08/28/conflicted-ira-advice-widespread-as-fiduciaries-lack-oversight-watchdog-finds/

https://www.gao.gov/products/gao-24-104632

[viii] Warren Study – Annuity kickbacks

Secret kickback commissions https://consumerfed.org/annuity-industry-kickbacks-cost-retirement-savers-billions/