prohibited transactions

SCOTUS 9-0 ERISA decision – confirms my view on Annuities as Prohibited Transactions

By Chris Tobe, CFA, CAIA

The Supreme Court ruled unanimously in favor of 401(k) Transparency, while also placing the burden of proof on plan sponsors alleging that they are protected under an exception to the Prohibited Transaction rules. This rule facilitates forcing disclosures on conflicts of interest and hidden fees.[i] Investments that the managers have the potential for a conflict of interest are labeled “Parties of Interest” in the DOL/IRS 5500 forms attached financials for ERISA plans. These parties in interest have the burden of proof that they have an exemption from the Prohibited Transactions rules.

Fixed Annuities, known as IPG’s, are prevalent in large ERISA DC plans. The largest IPG is TIAA Retirement Choice Annuity which is central in the Cornell plan and, along with Fidelity, the focus of the SCOTUS decision.

I believe that all annuities are prohibited transactions due to the inherent conflict of interest issues, and in most cases, the annuity issuer and annuity salesperson are labeled in plans as parties in interest. Prohibited transaction exemptions are subject to meeting certain requirements. But the DOL does not even attempt to enforce them. Many plans just blindly accept the claims of annuity salesmen that these contracts have a “get out of jail free card” in the form of a PTE.

Prohibited Transactions Exemption PTE 84-24

Annuities for decades have claimed Prohibited transaction exemptions behind PTE 84-24. However, plans are responsible for verifying that the prohibited transaction exemptions apply to the insurance products they put in their plans. This SCOTUS decision and future similar cases may force accountability for the first time.

ERISA PTE 84-24, which is based on the Restatement of Trust, states the annuities must meet the following requirements called the Impartial Conduct Standards and Written Disclosures and Policies and Procedures backing up these standards. Most annuities I have seen do not even come close.

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.[ii] The Federal Reserve in 1992 exposed the weak state regulatory and reserve claims.[iii]

Loyalty Obligation Annuity contracts are designed to avoid all fiduciary obligation with no loyalty to participants. Secret kickbacks and commissions place the financial interests of the Insurers and their affiliates over those of retirement investors. In most cases, the annuity investor has little chance of even breaking even on the investment. 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 – effectively denying any chance for a prospective purchaser to make an “informed decision.” They also have secret kickback commissions.[iv] 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. [v]

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 also prevents any opportunity for an “informed decision.”

GOING FORWARD

While Annuities are by far the largest area involved, I believe SCOTUS’ Cunningham decision will result in some significant consequwemces:

ERISA class action 401k litigation will explode especially against conflicted products like annuities[vi]
Plans are now talking about taking legal action against vendors, who tricked them into these non-transparent products[vii]
Plans will be more reluctant to take on non-transparent products like annuities[viii]
Plans will be more reluctant to take on non-transparent products like crypto and private equity[ix]
Plans will be more reluctant to do non-transparent administrative practices like revenue sharing[x]

Plan Sponsors with fixed annuity contracts should demand
: 1. A MFN clause to make sure they have the best rate. A MNF (Most Favored Nation) clause is a clause that states that money managers are getting the lowest fee for their pension clients.
2. A downgrade lause that allows liquidity at full book value if the insurance company issuing the annuity is downgraded.

Annuities are clearly prohibited transactions that do not qualify for an exemption but have used their lobbying power in Washington and in states, to exempt themselves from all accountability. This recent SCOTUS decision may help get accountability and transparency in plans through litigation.

[i] https://www.fingerlakes1.com/2025/04/18/supreme-court-cornell-erisa-401k-fees-decision-2025

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

[iv] https://consumerfed.org/annuity-industry-kickbacks-cost-retirement-savers-billions/

[v] https://www.bloomberg.com/news/articles/2013-03-06/prudential-says-annuity-fees-would-make-bankers-dance?embedded-checkout=true

[vi] https://commonsense401kproject.com/2024/11/19/burden-of-proof-is-on-plan-sponsors-hoping-to-qualifyfor-annuity-prohibited-transactions-exemption/

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

[viii] https://fiduciarywise.com/cunninghamvcornelluniversity/

[ix] https://www.linkedin.com/pulse/retirement-plan-sponsors-investment-advisors-should-take-ron-rhoades-zfp8c/?trackingId=cl6WVzR8TvCNYE2H6M59WQ%3D%3D

[x] https://commonsense401kproject.com/2022/04/02/revenue-sharing-in-401k-plans/

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/