The proposed fiduciary rules from the Department of Labor (DOL) are complex and far from settled, but reports from recent meetings on the issue indicate that additional classes of annuity products may be pulled under the umbrella of the new, more strict, fiduciary standards.
Advisors who offer annuities need to be aware of the proposed revisions that the DOL is currently considering—especially since they potentially involve holding the broad class of fixed indexed annuities to the heightened standards previously reserved for variable annuity products.
From a planning perspective, this means that advisors will need to take additional precautions to ensure that sales practices with respect to these popular products comply with the fiduciary rules to avoid liability. Despite this, compliance with the new prohibited transaction exemptions (PTEs) has the potential to save these annuity sales for advisors.
Fixed vs. Variable Regulation
Under the rules as currently proposed, fixed (including fixed indexed) and variable annuities are divided into separate classes, each governed by a different regulatory scheme—fixed annuities are treated more like insurance, while variable annuities are governed by rules similar to those governing securities. New reports suggest that the DOL is considering moving fixed indexed annuities (which are tied to the performance of market indices) into the same category as variable annuities.
This would mean that fixed indexed annuities would no longer be covered by the PTE 84-24 exemption. PTE 84-24 is a currently existing exemption that protects compliant advisors from IRS penalties that may apply if the advisor enters a prohibited transaction (though not from litigation initiated by a client), and is generally considered to be less stringent than the best interests contract exemption that is expected to govern variable annuities once the rules are finalized.
The DOL’s proposed revisions to PTE 84-24 require that advisors who sell annuity products through IRAs and other tax-qualified retirement plans adhere to an “impartial conduct standard,” meaning that they will be required to provide certain disclosures (involving both product features and advisor compensation) to clients.
Despite this, the rules do not require the advisor to enter into a formal contract with the client. The proposed revisions further revoke the exemption as it applies to variable annuities and other contracts that are treated as securities.
If the DOL does decide that fixed indexed annuities should be governed by the same rules that apply to variable annuities, advisors who sell these products will need to abide by the best interests contract exemption (discussed below) in order to avoid liability.
The Best Interests Contract Exemption
The best interests contract exemption, or BICE, which is expected to govern variable annuity sales and potentially fixed indexed annuity sales, allows financial advisory firms to continue to set their own compensation practices as long as certain requirements are met. Specifically, the exemption requires that the advisor enter into a formal contract with the client that commits the advisor to act in the best interests of the client. The advisor must avoid any misleading statements about fees, commissions and conflicts of interest generally.
Further, the advisor must warrant that the firm has adopted policies designed to mitigate any conflicts of interest (meaning that the firm has identified conflicts and compensation structures that could cause the advisor to fail the bests interests standard, and has adopted procedures to mitigate their impact). Any conflicts, including hidden fees, must be clearly disclosed to the client. The exemption also specifically requires that compensation charged by advisors be “reasonable.”
While the final version of the DOL fiduciary rules is not expected until at least the spring of 2016, advisors and firms must begin preparing for the possibility of their application now in order to avoid potential conflicts down the line.
Originally published on Tax Facts Online, the premier resource providing practical, actionable and affordable coverage of the taxation of insurance, employee benefits, small business and individuals.
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