Back to Prohibited Transactions

Prohibited Transactions

  • 3980. What are prohibited transactions?

    • Any transaction, whether direct or indirect, between a plan and a disqualified person (see Q 3981) constitutes a prohibited transaction under the IRC. These transactions include:

      (1) a sale, exchange, or lease of any property, including a transfer of property subject to a security interest assumed by the plan or placed on it within ten years prior to the transfer;1

      (2) lending of money or other extension of credit;

      (3) furnishing of goods, services, or facilities; and

      (4) the transfer of plan assets or income to, or use of them by or for the benefit of, a disqualified person.

      Note, however, that there are statutory and regulatory exemptions from what would ordinarily be a prohibited transaction.

      Planning Point: Before a plan enters any transaction, counsel should scrutinize the transaction to determine whether it is prohibited. If the transaction is prohibited, counsel should first determine whether a statutory exemption is available under ERISA Section 408. If so, counsel should make sure that each requirement is met, that the trustees approve the transaction and document the decision-making process in the plan’s minutes, and that the transaction is adequately documented in writing. If no statutory exemption is available, then counsel should check class action exemptions to determine if one applies. Finally, if no other exemptions are available, counsel can apply for an individual exemption.2

      It is a prohibited transaction for a disqualified person who is a fiduciary to deal with income or assets of a plan in his or her own interest or to receive consideration for his or her own personal account from a party dealing with the plan in connection with a transaction involving plan income or assets.3

      Title I of ERISA prohibits a fiduciary from acting, in any transaction involving the plan, on behalf of anyone having interests adverse to those of the plan or plan participants or beneficiaries.4

      The Department of Labor has issued final regulations on ERISA Section 408(b)(2) required fee disclosures by service providers to plan fiduciaries and participants (Q 4124).5

      The definition of a plan for this purpose includes not only any qualified pension, profit sharing, stock bonus, or annuity plan, but also an individual retirement plan (Q 3641), health savings account (“HSA”) (Q 399), Archer medical savings account (“MSA”) (Q 431), or Coverdell education savings account. The term “plan” includes such plans even after they are no longer qualified. Government and church plans are excluded.6

      1. See IRC Sec. 4975(f)(3).

      2. Final Department of Regulations on Prohibited Transaction Exemption Procedures are available at 29 CFR §§2570.30 – 2570.52.

      3. IRC Sec. 4975(c)(1).

      4. ERISA Sec. 406(b)(2).

      5. 29 CFR §2550.408b-2(c).

      6. IRC Sec. 4975(e)(1).

  • 3981. What is a “disqualified person” for purposes of the prohibited transaction rules?

    • A disqualified person is:

      (1)    a fiduciary (see Q 3982);

      (2)    a person providing services to the plan;

      (3)    an employer or employee organization, any of whose employees or members are covered by the plan;

      (4)    a 50 percent owner, directly or indirectly, of an employer or employee organization described in (3);

      (5)    a family member of any person described in (1) through (4);

      (6)    a corporation, partnership, trust, or estate that is 50 percent or more owned by any person described in (1), (2), (3), or (5);

      (7)    an officer, director, 10 percent or more shareholder, or highly compensated employee of a person described in (3), (4), or (6); or

      (8)    a 10 percent or more (in capital or profits) partner or joint venturer of a person described in (3), (4), or (6).1

      Family Member

      A family member is defined as a spouse, ancestor, lineal descendant, or any spouse of a lineal descendant.2

      Highly Compensated Employee

      A highly compensated employee is defined as any employee earning 10 percent or more of the yearly wages of an employer.3

      1.      IRC § 4975(e)(2).

      2.      IRC § 4975(e)(6).

      3.      IRC § 4975(e)(2)(H).

  • 3982. Who is a fiduciary for purposes of the prohibited transaction rules?

    • A fiduciary is a person who has discretionary authority or control over plan management or administration or disposition of plan assets, or who renders investment advice for a fee or other compensation, direct or indirect, with respect to any money or other property of the plan.1

      A person renders investment advice if advising trustees as to the value of property or making recommendations about the advisability of buying or selling property and, directly or indirectly (1) has discretionary authority with respect to buying or selling property, or (2) renders advice on a regular basis to the plan, pursuant to a mutual understanding that (x) the services will be the primary basis for investment decisions, and (y) he or she will render individualized advice regarding investment policies.2 Whether advice and recommendations regarding plan purchases of insurance contracts and annuities constitute investment advice depends on the facts in each situation.3 A fee or other compensation can include insurance sales commissions.

      A final rule issued by the Department of Labor (DOL) in 2016 broadened the definition of fiduciary, effective April 10, 20174 to include a person who gives fiduciary investment advice to a plan, plan fiduciary, participant, beneficiary, or IRA owner. It was vacated on June 21, 2018 after the Fifth Circuit Court of Appeals issued a mandate. The DOL did not appeal, and instead proposed a new class exemption. See Q 3986.5

      Under earlier DOL regulations, a person who develops a computer model or who markets a computer model or investment advice program used in an ‘‘eligible investment advice arrangement’’ is a fiduciary of a plan by reason of the provision of investment advice and is treated as a ‘‘fiduciary advisor.’’6 The regulations specify the conditions that must be met for a fiduciary to elect to be the sole fiduciary advisor under the investment advice program.

      ERISA does not modify the definition of a fiduciary under IRC Section 4975; consequently, an individual who is not a fiduciary under ERISA still can be a fiduciary for purposes of IRC Section 4975.7

      1.      IRC § 4975(e)(3).

      2.      Treas. Reg. § 54.4975-9(c).

      3.      Prohibited Transaction Exemption (PTE) 77-9 (Discussion of Major Comments).

      4.      29 C.F.R. § 2510.3-21(a).

      5.      Chamber of Commerce v. Acosta, No. 17-10238 (5th Cir. June 21, 2018).

      6.      DOL Reg. § 2550.408g–2; IRC § 4975(f)(8).

      7.      Flahertys Arden Bowl, Inc. v. Comm., 115 TC 269 (2000), aff’d, 262 F. 3d 1162, 88 AFTR 2d 2001-5547 (8th Cir. 2001).

  • 3983. What exemptions to the prohibited transaction rules are provided by the Internal Revenue Code?

    • The IRC lists specific exemptions from the broad prohibited transaction rules. These include:

      (1)    the receipt of benefits under the terms of the plan;

      (2)    the distribution of the assets of the plan meeting allocation requirements;

      (3)    loans available to all plan participants or beneficiaries under certain circumstances (see Q 3984);

      (4)    a loan to an employee stock ownership plan (ESOP, see Q 3817); and

      (5)    the acquisition or sale of qualifying employer securities by an individual account profit sharing, stock bonus, thrift, savings plan, or ESOP for adequate consideration and without commission.1

      Another statutory exemption is for the provision of office space or services necessary for the establishment or operation of the plan under a reasonable arrangement for no more than reasonable compensation.2 This exemption shields only the provision of services that would be prohibited transactions under (1), (3), and (4) in Q 3980, not fiduciary self-dealing. Thus, if an insurance agent is not a fiduciary, the agent’s sale of insurance to a plan and receipt of a commission is within this statutory exemption. If an agent is a fiduciary (for example, if the trustee relies on his or her investment advice) receipt of a commission for sale of insurance or annuities to a plan may be a prohibited transaction.3

      Certain administrative exemptions (see Q 3985) permit receipt of fees or commissions by fiduciaries in connection with the sale of insurance and annuity contracts to plans and the transfer of insurance contracts between plan and plan participants or employers.

      Final DOL regulations provide that compensation paid to certain service providers will not be considered reasonable for purposes of the prohibited transaction exemption unless the covered service provider satisfies a fee disclosure mandate.4 Failure to comply with the disclosure mandate will mean that compensation paid to the covered service provider does not qualify for the statutory prohibited transaction exemption.

      The service providers covered by the mandate are fiduciaries, registered investment advisors, platform providers for participant directed defined contribution plans, and other indirectly compensated service providers who reasonably expect $1,000 or more in direct or indirect compensation in connection with providing covered services. Indirectly compensated services include accounting, auditing, actuarial, appraisal, banking, certain consulting related to the plan or plan investments, custodial, insurance, investment advisory, legal, recordkeeping, investment brokerage, third party administration, or valuation services provided to the plan for which the covered service provider, an affiliate, or subcontractor reasonably expects to receive indirect compensation.5

      Direct compensation is compensation received directly from the plan. Indirect compensation is compensation received from any source other than the plan, the plan sponsor, the covered service provider, or an affiliate. Compensation received from a subcontractor is generally indirect compensation.6

      The disclosure must include the following information:

      (1)    A description of the services to be provided;

      (2)    If applicable, a statement that the services will be provider as a fiduciary, as a registered investment advisor, or both;

      (3)    A description of all direct and indirect compensation expected to be received;

      (4)    If recordkeeping services will be provided to the plan, a description of the compensation expected to be received for the services and information about any arrangement where the recordkeeping services will be provided without explicit compensation;

      (5)    Information about fiduciary services provided to investment products that the plan has a direct equity investment in;

      (6)    Information about investment products made available through a platform in connection with recordkeeping and brokerage services; and

      (7)    A description of the manner in which the compensation will be received, such as whether the plan will be billed or the compensation will be deducted directly from the plan’s accounts or investments.7

      Except for the first two exemptions listed above, these statutory exemptions do not apply where a plan that covers owner-employees (1) lends assets or income, (2) pays any compensation for personal services rendered to the plan, or (3) except as described in the following paragraph, acquires property from or sells property to (x) an owner-employee (Q 3932) or an employee who owns more than 5 percent of the outstanding shares of an S corporation, an individual retirement plan participant, beneficiary, or sponsoring employer or association, as the case may be, (y) a family member of a person described in (x), or (z) a corporation controlled by a person described in (x) through ownership of 50 percent or more of total combined voting power of all classes of stock or 50 percent or more of total shares of all classes of stock of the corporation.8

      A transaction consisting of a sale of employer securities to an ESOP (Q 3819) by a shareholder-employee, a member of his or her family, or a corporation in which he or she owns 50 percent or more of the stock generally will be exempt from the prohibited transaction rules. For this purpose, a shareholder-employee is an employee or officer of an S corporation who owns or is deemed to own, under the constructive ownership rules of IRC Section 318(a)(1), more than 5 percent of the outstanding stock of the corporation on any day during the corporation’s taxable year.9 For special rules applying to S corporation ESOPs that the IRS views as abusive, see Q 3825.

      The Pension Protection Act of 2006 created an exemption from the prohibited transaction rules for certain fiduciary advisors who provide investment advice under an eligible investment advice arrangement (Q 3793).10

      1.      IRC § 4975(d).

      2.      IRC § 4975(d)(2).

      3.      PTE 77-9 (Discussion of Major Comments); see also Treas. Reg. § 54.4975-6(a)(5).

      4.      Labor Reg. § 2550.408b-2.

      5.      Labor Reg. § 2550.408b-2(c)(1)(iii).

      6.      Labor Reg. § 2550.408b-2(c)(1)(viii)(B).

      7.      Labor Reg. § 2550.408b-2(c)(1)(iv).

      8.      IRC § 4975(f)(6)(A).

      9.      IRC §§ 4975(f)(6)(B)(ii), 4975(f)(6)(C).

      10.    IRC §§ 4975(d)(17), 4975(f)(8), ERISA § 408(g).

  • 3984. When is a plan loan exempted from the prohibited transaction rules?

    • Loans made to plan participants and beneficiaries generally are exempted from the prohibited transaction rules if the loans:

      (1)    are made available to all participants and beneficiaries on a reasonably equivalent basis,

      (2)    are not made available to highly compensated employees (Q 3930) in an amount greater than the amount made available to other employees,

      (3)    are made in accordance with specific provisions regarding such loans set forth in the plan,

      (4)    bear reasonable rates of interest, and

      (5)    are adequately secured.1

      A reasonable rate of interest is one that provides the plan with a return commensurate with the interest rates charged by persons in the business of lending money for loans made under similar circumstances.2

      Security for participant loans is considered adequate if it may reasonably be anticipated that loss of principal or interest will not result if default occurs.3 The effect of this no loss requirement varies depending on the type of plan; a plan in which the investment experience of the plan’s assets is shared by all participants may require additional loan conditions, such as mandatory payroll deduction repayment on stated events or additional collateral.

      No more than 50 percent of the present value of a participant’s vested accrued benefit under a plan generally may be considered as security for the outstanding balance of all plan loans made to the participant.4 Except in the case of directed investment loans, this loan exemption is not an exemption from the other fiduciary standards of ERISA. The prohibited transaction rules apply to a loan that does not meet the exemption requirements, even if it is treated and taxed as a distribution (Q 3953).5

      Loans from a qualified plan to S corporation shareholders, partners, and sole proprietors generally are exempt from the prohibited transaction rules (Q 3953),6 although there are rules applying to certain S corporation ESOPs that the IRS views as abusive (Q 3825).

      The Tax Court determined that a loan between a plan and a corporation partially owned by a disqualified person did not constitute a prohibited transaction where the loan was approved by and made at the sole discretion of the plan’s independent bank trustee.7 A transfer of property to a plan in satisfaction of a participant loan was treated as a prohibited transaction where the borrower was a disqualified person.8

      1.      ERISA § 408(b)(1); IRC § 4975(d)(1); Labor Reg. § 2550.408b-1.

      2.      Labor Reg. § 2550.408b-1(e).

      3.      Labor Reg. § 2550.408b-1(f)(1).

      4.      Labor Reg. § 2550.408b-1(f)(2).

      5.      Medina v. U.S., 112 TC 51 (1999).

      6.      IRC § 4975(f)(6)(B)(iii).

      7.      Greenlee v. Comm., TC Memo 1996-378.

      8.      Morrissey v. Comm., TC Memo 1998-443.

  • 3985. What is the prohibited transaction exemption that allows life insurance agents, brokers, or pension consultants (including fiduciaries) who are disqualified persons to receive commission or effect transactions related to certain life insurance and annuities?

    • Administrative Exemption: 84-24

      Prohibited Transaction Exemption 84-241 provides administrative relief in addition to the statutory provisions. It permits a life insurance agent, broker, or pension consultant and affiliates, including a fiduciary, who is a disqualified person (1) to receive sales commissions for certain insurance and annuity sales to a plan, or (2) to effect a transaction for the purchase of an insurance or annuity contract from an insurance company. The exemption also permits an investment company principal underwriter to effect a transaction for the purchase of an insurance or annuity contract. Furthermore, it allows the purchase of insurance or annuities from an insurance company that is a disqualified person. This class exemption is available only if certain conditions are met.

      Planning Point: Note that the exemption was significantly changed by the Department of Labor Fiduciary Rule, which was scheduled to become effective January 1, 2018 (although the impartial conduct standards were effective June 9, 2017)).2 However, the rule was vacated in the courts in March, 2018, and the DOL has replaced it with a new PTE (see Q 3986 for details).

      First, the transaction must be effected in the ordinary course of business of the agent, broker, or consultant on terms at least as favorable to the plan as those that would be negotiated in an arm’s length transaction with an unrelated party. The total fees and commissions also must not be in excess of reasonable compensation, determined on a facts and circumstances basis.

      Second, the agent, broker, consultant, or insurance company may not act as a plan trustee (other than a nondiscretionary trustee who does not render investment advice with respect to any assets of the plan), plan administrator, a fiduciary authorized to manage, acquire, or dispose of plan assets on a discretionary basis, or an employer, any of whose employees are covered by the plan. PTE 84-24, as amended, extends the same relief to situations where an affiliate of the insurance agent or broker, pension consultant, or investment company principal underwriter is a trustee with investment discretion over plan assets that are not involved in the transaction.3

      The term affiliates includes (1) any person controlled by or under common control with the agent, broker, consultant, or insurance company, (2) any officer, director, employee, or relative of or a partner in (but not of) the agent, broker, consultant, or insurance company, and (3) any corporation or partnership of which the agent, broker, consultant, or insurance company is an officer, director, or employee, or in which he or she is a partner.

      The transaction must be approved, in writing, by an independent fiduciary, who may be the employer. Prior to the sale, the agent, broker, or consultant must disclose to the independent fiduciary:

      (1)    the nature of the affiliation between the agent and the insurer whose contract is being recommended;

      (2)    any limitations on the agent’s ability to recommend insurance or annuity contracts;

      (3)    the amount of sales commission, expressed as a percentage of gross annual premium payments for the first and renewal years; and

      (4)    a description of any charges, fees, discounts, penalties, or adjustments that may be imposed in connection with the purchase, holding, exchange, termination, or sale of such contracts.

      Finally, the agent, broker, or consultant must retain records relating to the transaction for six years, but no filing is required with either the IRS or the Department of Labor. The records must be available for examination by those two federal agencies, plan participants, beneficiaries, and any employer or employee organization whose employees or members are covered by the plan.

      An insurance company that is a service provider or fiduciary solely because it sponsors a master or prototype plan need satisfy only the first set of conditions. An agent, broker, or consultant who is a fiduciary and who sells insurance in connection with the master or prototype plan must meet both sets of conditions.

      See Q 3986 for a discussion of the new PTE 2020-02. Unlike with the 2016 DOL fiduciary rule, PTE 84-24 was not amended in connection with release of the new PTE.

      1.      1984-2 CB 231 (formerly PTE 77-9, 1977-2 CB 428, as amended by 1979-1 CB 371).

      2.      See Amendment to and Partial Revocation of PTE 84-24, 81 Fed. Reg. 21147 (Apr. 8, 2016).

      3.      See Amendment to PTE 84-24, 71 Fed. Reg. 5887 (Feb.1, 2006).

  • 3986. What requirements must be satisfied for an investment advice fiduciary to qualify under the DOL's new fiduciary PTE 2020-02?

    • Editor’s Note: After the Fifth Circuit vacated the 2016 DOL fiduciary rule, the DOL removed the Best Interest Contract Exemption (BICE) in 2020.1 In June 2020, the DOL released a fiduciary PTE 2020-02 to replace the 2016 rule (see the heading below for a discussion of BICE, as it would have applied under the 2016 DOL rule). The DOL has also extended the nonenforcement policy under FAB 2018-02 through January 31, 2022. As a result, the DOL will not pursue prohibited transactions claims against investment advice fiduciaries who are working in good faith to comply with the impartial conduct standards under PTE 2020-02. It will also not treat these fiduciaries as violating the prohibited transaction rules during this period. The DOL will not enforce the “specific documentation” and disclosure requirements for rollovers under PTE 2020-02 through June 20, 2022. Aside from the rollover exception, all other requirements will be subject to full enforcement as of February 1, 2022.

      In 2020, the DOL released its long-awaited follow-up to the Fifth Circuit’s removal of the 2016 fiduciary rule in the form of a new class exemption. The exemption grants relief to financial advisors and institutions who provide investment advice (including retirement-related and rollover advice, see Q 3977.01) if the terms of the PTE are satisfied.2

      In creating the new exemption, the DOL’s stated goal was to provide impartial conduct standards that are in line with guidance released by other regulators, including the SEC Regulation Best Interest and state-level fiduciary rules. To qualify under the new fiduciary PTE, advisors must provide advice in accordance with impartial conduct standards, which generally include standards related to: (1) acting in the client’s best interests, (2) reasonable compensation, (3) refraining from misleading statements, (4) disclosure, (5) conflict mitigation and (6) retroactive compliance review.3

      The exemption, which was finalized late in 2020, is available to registered investment advisers, broker-dealers, banks, and insurance companies (financial institutions) and their individual employees, agents, and representatives (investment professionals) that provide fiduciary investment advice to retirement investors.


      The exemption defines retirement investors as plan participants and beneficiaries, IRA owners, and plan and IRA fiduciaries.  In determining whether an advisor is a fiduciary who may take advantage of the exemption, pre-2016 standards apply (i.e., the “five-part test”). The exemption’s relief also specifically applies to otherwise prohibited transactions related to investment advice about retirement plan rollovers.

      Planning Point: The DOL has proposed a new rule that would make the process for obtaining a prohibited transaction exemption much more difficult. If passed, the changes will apply only prospectively, 90 days after the publication of the final rule in the Federal Register. The proposed regulations would require that communications with the DOL prior to submitting a formal application for exemption will become part of the administrative record that can be requested by the public. Applicants would not be permitted to approach the DOL on an anonymous basis.  The regulations would impose new terms with respect to the independent fiduciary or appraiser that may be required. The current regulations provide information about when the fiduciary or appraiser will be considered “independent”, providing that the fiduciary or appraiser is independent if less than 2% of their revenue is derived from parties to the transaction (though it is currently possible that they could achieve independent status if the revenue is less than 5%).  The new rules would make the standard stricter, and require analysis of the revenue from the prior tax year and projected revenue for the current year.  If an appraiser and a fiduciary are required, the appraiser must be independent of both the fiduciary and the applicant. It would also be possible that the individual could be deemed not “independent” if they have an interest in the transaction or future transactions of a similar type.

      A person is an investment advice fiduciary to the extent he or she renders investment advice for a fee or other compensation, whether direct or indirect, with respect to any money or other property of a plan, or has any authority or responsibility to do so.

      For fiduciary investment advice standards to apply, a person who is not otherwise a fiduciary must (1) render advice as to the value of securities or other property, or make recommendations as to the advisability of investing in, purchasing, or selling securities or other property (2) on a regular basis (3) pursuant to a mutual agreement, arrangement, or understanding with the plan, plan fiduciary or IRA owner that (4) the advice will serve as a primary basis for investment decisions with respect to plan or IRA assets, and that (5) the advice will be individualized based on the particular needs of the plan or IRA. This is the five-part test that applied prior to the 2016 DOL fiduciary rule.

      In the final rule, the DOL offered insight into how it will interpret each of these five elements. With respect to the “regular basis” prong, the advisor’s objective conduct will be determinative. The DOL clarified that if the advisor is explicit in their communications that the advice is a “one-time” interaction, the advice is not provided on a regular basis.

      Similarly, the mutual agreement prong is evaluated based upon the entirety of the advisor’s conduct. The advisor cannot simply use boilerplate language disclaiming fiduciary status in order to avoid responsibility. It is the reasonable understanding of both parties that will be relevant.

      With respect to the “primary basis” prong, the advisor’s advice is not required to be the “sole” basis for the investor’s decision—it is sufficient that it is important to the investor, and could determine the outcome of the investor’s decision.

      Impartial Conduct Standards

      Relief under the exemption is conditioned on adhering to impartial conduct standards, as follows:

      Best Interests Standard. The best interest standard follows longstanding legal concepts. It is generally satisfied if investment advice “reflects the care, skill, prudence, and diligence under the circumstances then prevailing that a prudent person acting in a like capacity and familiar with such matters would use in the conduct of an enterprise of a like character and with like aims, based on the investment objectives, risk tolerance, financial circumstances, and needs of the investor, and does not place the financial or other interest of the [advisor/firm] or any affiliate, related entity or other party ahead of the interests of the investor, or subordinate the investor’s interests to their own.” The preamble is careful to note that the PTE does not create a duty to monitor—although a duty to monitor could be generated depending upon whether an investment could prudently be recommended to the investor absent ongoing monitoring.4

      Planning Point: Late in 2020, the DOL finalized a rule that would limit consideration of environmental, social and governance (ESG) factors when retirement plan fiduciaries are selecting plan investments without violating their fiduciary duties.  Plan fiduciaries are obligated to act solely in the interest of plan participants and beneficiaries when making investment decisions. Under the final rule, the DOL said that plan fiduciaries must select investments based on pecuniary, financial factors and that it would apply an “all things being equal test”–meaning that fiduciaries were not prohibited from considering or selecting investments that promote or support non-pecuniary goals, provided that they satisfy their duties of prudence and loyalty in making the selection. This rule was seen as limiting fiduciaries’ ability to consider ESG factors in investing. However, earlier in 2021, the EBSA announced that it would not enforce this Trump-era rule, so that plan fiduciaries may once again consider ESG factors in making investment decisions.

      On November 22, 2022, the DOL released a new final rule on ESG investing.  The rule retains may prior elements, yet is generally expected to make it easier for plan fiduciaries to consider ESG factors in determining investment strategy.  According to the rule, a plan fiduciary’s determination with respect to an investment or investment strategy must be based on factors that the fiduciary reasonably determines are relevant to a risk and return analysis.  The DOL further states that the analysis should use appropriate investment horizons consistent with the plan’s investment objectives and should account for the funding policy of the plan established under ERISA. Under the final rule, however, fiduciaries will not be prohibited from considering collateral benefits aside from investment returns when there is an essential “tie” in the context of the investment analysis.  Fiduciaries will also not violate their duty of loyalty merely because they take participant preferences into account when building their menu of otherwise prudent investment options.  The new rule does not contain any separate standard for QDIAs.

      Reasonable Compensation Rule. The reasonable compensation standard requires that compensation not be excessive, as measured by the market value of the particular services, rights, and benefits the advisor is delivering. The reasonableness of fees will depend on the particular facts and circumstances at the time of the recommendation. Several factors inform whether compensation is reasonable, including the market price of services provided and/or the underlying assets, the scope of monitoring, and the complexity of the product. No single factor is controlling in determining whether compensation is reasonable. The important question is whether the charges are reasonable in relation to what the investor receives. Firms and advisors have no obligation to recommend the transaction that is the lowest cost or that generates the lowest fees without regard to other factors.5

      The exemption also requires financial firms and advisors to seek to obtain the “best execution” of the investment transaction reasonably available under the circumstances. This duty is satisfied if the advisor complies with applicable federal securities laws, including those imposed by the SEC and FINRA, that are beyond the scope of this discussion.6

      No Misleading Statements. This element requires that statements by the both the financial firm and the advisor to the investor about the recommended transaction and other relevant matters are not materially misleading at the time they are made. The preamble to the PTE states that “other relevant matters” include fees and compensation, material conflicts of interest, and any other fact that could reasonably be expected to affect the investor’s investment decisions.7

      Disclosure Requirement. Financial firms are required to make written disclosure of their fiduciary status to investors prior to engaging in any transactions covered by the exemption. The disclosure must contain a written description of the services to be provided and material conflicts of interest arising out of the services and any recommended investment transaction. The disclosures should be in plain English, considering the investor’s level of financial experience. The PTE does not require specific disclosures to be tailored for each investor or each transaction as long as a compliant disclosure is provided before engaging in the particular transaction.8

      Financial Firms’ Policies & Procedures Requirement. The exemption requires financial firms to establish, maintain and enforce written policies and procedures prudently designed to ensure compliance with the impartial conduct standards. These policies and procedures should be designed to mitigate conflicts of interests generally and avoid incentives to violate the impartial conduct standards.9

      Administrative Details

      The final PTE adds a self-correction procedure.  Advisors and firms will not be treated as violating the prohibited transaction rules if the advisor corrects the violation, notifies the DOL via email within 30 days and the correction occurs within 90 days of when the advisor learned of the violation.  The advisor will also be required to make the investor whole again for any losses that occurred because of the violation.  The financial institution is also required to notify the person responsible for conducting retrospective compliance reviews under the PTE.

      This retrospective review must be conducted at least annually. Under the final PTE, it must be certified by a senior officer of the financial institution. That officer must certify that the financial institution has procedures and policies in place designed to ensure compliance with the PTE. The officer must further certify that the firm has procedures in place to both test the effectiveness of their policies and modify them to ensure ongoing compliance.

      The final PTE introduces a new disclosure document that must be provided to retirement investors before recommending a rollover transaction. The written document must describe the specific reasons for recommending a rollover between two accounts—as well as acknowledge the advisor’s status as a fiduciary.

      BICE: Administrative Exemption: 2016-01

      Prohibited Transaction Exemption 2016-0110 added the Best Interest Contract (BIC) Exemption as part of the Department of Labor’s 2016 Fiduciary Rule (now repealed), designed to minimize conflicts of interest and provide that advisors act in the employee or participant’s best interests. Under the BIC Exemption, financial institutions and advisors could receive variable compensation by acknowledging they were fiduciaries in providing investment advice and adhere to impartial conduct standards. In addition, the financial institution was required to have policies and procedures in place designed to ensure compliance with the impartial conduct standards, detect and record any material conflicts of interest, and designate a person responsible for compliance with the impartial conduct standard. Specified information had to be disclosed to participants prior to or at the time transactions based on the advice occur. That information was also required to be posted on a website maintained by the firm.

      1.      See Amendment to and Partial Revocation of PTE 84-24, 81 Fed. Reg. 21147 (Apr. 8, 2016).

      2.      See “Improving Investment Advice for Workers & Retirees,” ZRIN 1210-ZA29.

      3.      Sec. II(d).

      4.      Sec. II(a)(1).

      5.      Sec. II(a)(2).

      6.      Sec. II(a)(2)(B).

      7.      Sec. II(a)(3).

      8.      Sec. II(b).

      9.      Sec. II(c).

      10.    81 Fed. Reg. 21002, corrected by 81 Fed. Reg. 44773.

  • 3987. When does the 2020 DOL investment advice fiduciary PTE apply to rollover transactions?

    • The new DOL exemption for fiduciary advice specifically applies to rollover advice, assuming the circumstances qualify under the five-part test for determining whether the advisor is an investment advice fiduciary (see Q 3986). Rollovers from a 401(k) to an IRA, IRA to IRA, or one type of account to another (i.e., from a fee-based account to a commission-based account) are all potentially covered by the exemption.

      However, the DOL commentary included with the exemption makes clear that not every rollover triggers investment advice fiduciary status. A facts-and-circumstances analysis will be required in every case to determine whether the transaction is subject to the new standard. Specifically, the DOL notes that it does not intend to apply the guidance in DOL Advisory Opinion 2005-23A (the Deseret Letter), which would have found that rollover advice generally does not constitute investment advice.

      All five prongs of the test must be satisfied for the advisor to be an investment advice fiduciary under the DOL definition. Advice to execute a rollover transaction can potentially be an isolated event that would not satisfy the “regular basis” component of the five-prong approach. On the other hand, rollover advice can be given as a part of an ongoing relationship between client and advisor, or an anticipated future ongoing relationship between the parties.

      Further, determining whether there is a “mutual understanding” between the parties is based upon the reasonable understanding of both parties—even if no formal agreement is found. In fact, the DOL notes that advice to roll over plan assets is often given for the purpose of establishing an ongoing relationship where advice is provided on a regular basis outside of the plan (in return for a fee/commission). In other words, the rollover advice can be the first step in an investment advisory relationship that continues on a regular basis.

      Planning Point: A federal lawsuit filed in early 2022 seeks to vacate the current DOL fiduciary interpretation on the basis of its application to insurance agents who provide rollover advice to clients.  The Federation of Americans for Consumer Choice filed a lawsuit on behalf of advisors who advise clients about annuity purchases made with assets that the client has rolled into an IRA.  The current interpretation of the 1975 five-part test for who qualifies as an investment advice fiduciary (see Q 3985) specifically focuses on rollover-related advice.  The complaint alleges that about half of the annuity contracts sold by insurance agents are tax-qualified or IRA-related products.  More specifically, the plaintiffs challenge whether a single instance of advice can subject the advisor to fiduciary liability–because the first piece of advice provided could be construed as the beginning of an ongoing relationship.  The plaintiffs point out that every investment professional aims to establish an ongoing relationship with a potential client.  If these insurance agents are classified as investment advice fiduciaries, they may be restricted from collecting commissions or compensation when providing advice about the purchase of an annuity within an IRA.

      The exemption requires financial firms and advisors to document the reasons for recommending the rollover, including why the rollover is in the client’s best interests.

  • 3988. What is the PTE that permits certain insurance agents or brokers who are employers (or related) maintaining a plan to sell insurance or annuity contracts to the plan and receive commission?

    • Administrative Exemption: 79-60
      Prohibited Transaction Exemption 79-60 permits an insurance agent or broker who is the employer (or related, in certain ways listed below, to the employer) maintaining a plan to sell an insurance or annuity contract (including a contract providing only for the provision of administrative services) to the plan and receive a commission. A general agent who is the employer (or related to the employer in one of the listed ways) may receive override commissions on such sales by another agent.
      The following three conditions must be met for a transaction to come within this exemption.
      First, the agent or broker must be:
      (1) an employer with employees covered by the plan (including a sole proprietor who is the only plan participant);
      (2) a 10 percent or more partner of such an employer;
      (3) an employee, officer, or director (or an individual having powers or responsibilities similar to those of officers or directors), or a 10 percent or more stockholder of such an employer;
      (4) a 50 percent or more owner of the employer; or
      (5) a corporation or partnership that is 50 percent or more owned by a plan fiduciary, a person providing services to the plan, the employer, a 50 percent owner of the employer, or an employee organization with members covered under the plan.
      Second, the plan may pay no more than adequate consideration for the policy or contract.
      Finally, the total commissions received in each taxable year of the agent or broker as a result of sales under this exemption must not exceed 5 percent of the total insurance commission income received by the agent or broker in that taxable year. There are no record-keeping requirements.
  • 3989. What is the PTE that permits disqualified persons other than a plan to make unsecured interest-free loans to a plan to pay ordinary operating expenses?

    • Administrative Exemption: 80-26

      Prohibited Transaction Exemption 80-261 permits a disqualified person other than another plan to make unsecured interest-free loans to a plan to pay ordinary operating expenses (including the payment of benefits and periodic premiums under an insurance or annuity contract) or, for a period no longer than three days, for a purpose incidental to the ordinary operation of the plan. The Department of Labor adopted a temporary amendment to PTE 80-26 to include interest-free loans made to plans affected by the 9/11 terrorist attacks.2 In 2006, the Department amended the regulation to eliminate the three-day limit, provided that if the loan is for longer than 60 days, the terms of the agreement are written.3 An amendment proposed in 2013 would provide retroactive and temporary relief for certain guarantees of the payment of debits to plan investment accounts (including IRAs) by parties in interest to such plans as well as certain loans and loan repayments made pursuant to such guarantees.4

      1.      1980-2 CB 323.

      2.      Temp. Amendments to PTE 80-26. 67 Fed. Reg. 9485 (Mar. 3, 2002).

      3.      67 Fed. Reg. 17917 (Apr. 7, 2006).

      4.      78 Fed. Reg. 31584.

  • 3990. What are the PTEs that establish conditions for the transfer of life insurance and annuity contracts to and from plans?

    • Administrative Exemptions: 92-5 and 92-6

      Prohibited Transaction Exemptions 92-5 and 92-61 establish conditions for the transfer of life insurance and annuity contracts to and from plans. PTEs 92-5 and 92-6 extended the relief granted under PTEs 77-7 and 77-8 to owner-employees and to shareholders owning more than 5 percent of the outstanding stock in an S corporation. PTE 92-5 permits individual contracts to be transferred to a plan by participants or employers, any of whose employees participate in the plan. The plan generally must pay no more than the lesser of the cash surrender value of the contract or the value of the participant’s accrued benefit at the time of the transaction (or account balance, in the case of a defined contribution plan), and the contract must not be subject to any loan that the plan assumes. The DOL has stated that where participants transfer individual policies that have no cash surrender value, the transfer will not violate the prohibited transaction rules where the plan pays no consideration for the policies.2

      PTE 92-6 enables a plan to sell insurance contracts and annuities to a plan participant insured under the policies, a relative of such participant who is a beneficiary under the contract, an employer whose employees are covered by the plan, or another employee benefit plan for the cash surrender value of the contracts, provided certain conditions are met. In the absence of these exemptions, these transfers would be prohibited transactions.

      PTE 92-6 first was clarified in 1998 so that, if all of its other conditions are met, two or more relatives who are the sole beneficiaries under a contract may be considered a single relative and an individual life insurance contract may be read to include a contract covering the life of the participant and his or her spouse (if permitted by applicable state insurance law, other applicable law, and pertinent plan provisions). In addition, a sale of a partial interest in a life insurance contract qualifies as a sale of an individual life insurance contract if certain requirements are met with both the portion sold and the portion retained.3

      In 2002, PTE 92-6 was retroactively amended to permit transfers of life insurance contracts directly to life insurance trusts and certain other trusts.4 In addition, the DOL clarified that second-to-die policies covering spouses are included within the scope of PTE 92-6.5

      Planning Point: This expansion and liberalization by the Department of Labor adds trusts to the list of those to whom life insurance owned by a qualified plan can safely be sold. It is important to note that the exemption is conditioned on the fact that, but for the sale, the plan would have surrendered the life insurance contract. Furthermore, the plan must be paid what the policy is worth at the time it is sold.

      The preamble to PTE 77-86 (which was replaced by PTE 92-6) noted that, for federal income tax purposes, the value of an insurance policy is not the same as, and may exceed, its cash surrender value, and that a purchase of an insurance policy at its cash surrender value therefore may be a purchase of property for less than its fair market value.

      In 2004 guidance, the Treasury Department clarified that under new proposed regulations, any such bargain element will be treated as a distribution under IRC Section 402(a) as well as for other purposes of the IRC, including the limitations on in-service distributions from certain qualified plans and the limitations of IRC Section 415.7

      The DOL also has extended the application of PTE 92-6 to the transfer of a second-to-die policy owned by two spouses from a self-directed profit sharing plan account, provided certain requirements are met. Generally, the requirements are that the participant must be the insured under the contract, the contract would be surrendered but for the sale by the plan, and the amount received by the plan as consideration must be at least equal to the amount necessary to put the plan back in the same position as if it had retained the contract, surrendered it, and made any distribution owed to the participant on his or her vested interest under the plan.8

      1.      57 Fed. Reg. 5019, 5189 (formerly PTEs 77-7 and 77-8, 1977-2 CB 423, 425).

      2.      DOL Adv. Op. 2002-12A.

      3.      See DOL Adv. Op. 98-07A.

      4.      See 67 Fed. Reg. 56313.

      5.      DOL Adv. Op. 2006-03A (Feb. 26, 2006).

      6.      Citing Rev. Rul. 59-195, 1959-1 CB 18.

      7.      See REG-126967-03, 69 Fed. Reg. 7384 (Feb. 17, 2004).

      8.      DOL Adv. Op. 2006-03A (Feb. 26, 2006).

  • 3991. What is the PTE that allows banks and brokers to offer no or low cost services based on account balances in IRAs and Keogh plans?

    • Administrative Exemption: 93-33 and 97-11

      Prohibited Transaction Exemption 93-331 and Prohibited Transaction Exemption 97-112 allow banks and brokerages, respectively, to offer no or low cost services based on account balances in IRAs and Keogh plans, if certain requirements are met:

      (1)    the services offered must be those that could be offered under applicable state and federal law and that are available in the ordinary course of business to other customers who do not maintain an IRA or Keogh plan;

      (2)    the eligibility requirements, based on the account value or the amount of fees incurred, must be as favorable as any such requirements imposed on any other account included in determining eligibility to receive such services;

      (3)    the IRA or Keogh plan must be established for the exclusive benefit of the participant, his or her spouse, or their beneficiaries;

      (4)    the investment performance of the IRA or Keogh plan must equal or exceed that of a like investment made at the same time by a customer ineligible to receive such low or no cost services.

      In addition, PTE 97-11 requires that the services offered by brokerages be the same as those offered to non-IRA or non-Keogh plan customers with like account values or like fees generated and that the combined total of all fees for the provision of services to the IRA or Keogh plan may not exceed reasonable compensation within the meaning of IRC Section 4975(d)(2).

      The Department of Labor subsequently adopted amendments expanding these exemptions to Coverdell education savings accounts and SIMPLE IRAs (Q 3706).3 PTE 97-11 was similarly amended to extend its provisions to Roth IRAs, assuming they are not part of an employee benefit plan covered by Title I of ERISA, other than an SEP or a SIMPLE IRA.4

      1.      58 Fed. Reg. 31053.

      2.      62 Fed. Reg. 5855.

      3.      See 64 Fed. Reg. 11042 and 64 Fed. Reg. 11044 (Mar. 8, 1999).

      4.      See 67 Fed. Reg. 76425 (Dec. 12, 2002).

  • 3992. What are the penalties for engaging in a prohibited transaction?

    • A first tier tax equal to 15 percent of the amount involved is imposed on each prohibited transaction for each year or part thereof from the time the transaction occurs until the earliest of the date: (1) it is corrected, (2) a deficiency notice is mailed, or (3) the tax is assessed.1 An employer fined under this provision for failing to make timely 401(k) transfer deferrals was assessed the 15 percent penalty only on the amount of interest the employer would have paid for a bank loan for the same amount, not 15 percent of the amount of the late deposit.2

      All disqualified persons who participate in the prohibited transaction, other than a fiduciary acting only as a fiduciary, are jointly and severally liable for the full amount of the tax. A trustee was held liable for the tax even though the trustee did not vote to approve the payment that was determined to be a prohibited transaction; the Seventh Circuit Court of Appeals determined that the trustee had benefited from the payments and thus had participated in the transaction.3

      An act of self-dealing involving the use of money or property (for example, the leasing of property) may be treated as giving rise to multiple transactions – one on the day the transaction occurs and separate ones on the first day of each taxable year within the above period – and, thus, may result in multiple penalties.4

      Second Tier Tax

      If a transaction is not corrected within the above period, there is a second tier tax of 100 percent of the amount involved. This tax will be abated if the transaction is corrected within 90 days after the notice of deficiency with respect to the additional tax is mailed. This 90-day period may be extended in certain circumstances.

      To be corrected, the transaction must be undone to the extent possible, but, in any event, so as to place the plan in a financial position no worse than it would have been in had the disqualified person acted under the highest fiduciary standards.5

      A prohibited transaction was held to be self-correcting, and thus not subject to the second tier tax (or to the first tier tax in subsequent tax years), where the extraordinary success of the investment was such that to undo the transaction would have put the plan in a worse position than if the disqualified persons had acted under the highest fiduciary standards. Essentially, the transaction involved a sale of mineral rights that were producing over a million dollars a year in royalties to an ESOP by the employees of the employer in return for a private annuity.6 The Tax Court considers this case to be an anomaly and has stated that, in general, prohibited transactions cannot be self-correcting.7

      If the owner of an individual retirement account, or the owner’s beneficiary, engages in a prohibited transaction and, as a result, the account ceases to be an individual retirement account, the tax does not apply (Q 3649). Similar rules apply to beneficiaries of health and Archer medical savings accounts (Q 390 to Q 422) and to beneficiaries of and contributors to education savings accounts.8

      The IRS has the authority to impose tax penalties as a result of prohibited transactions, even when the Department of Labor has entered into a consent judgment concerning the plan.9

      Other Consequences

      In addition to the potential tax penalties discussed above, there can be other consequences to a prohibited transaction. IRAs cease to qualify as IRAs as of the first day of the taxable year in which the prohibited transaction occurs and the account is treated as distributing all of its assets on that date.10

      A self-directed IRA purchased land and contributed it and cash to a partnership with an LLC solely owned by the IRA owner and his wife that owned the adjacent property. It allowed the IRA owner to use the IRA assets for his personal benefit. Because the IRA owner was a fiduciary with regard to the IRA, this was a prohibited transaction and immediately terminated the IRA’s exempt status. As a result, the IRA assets were not protected when the IRA owner filed for bankruptcy.11

      1.      IRC § 4975(a); IRC § 4975(f)(2).

      2.      See Rev. Rul. 2006-38, 2006-29 IRB 80.

      3.      O’Malley v. Comm., 972 F.2d 150 (7th Cir. 1992).

      4.      Treas. Reg. § 141.4975-13. See Lambos v. Comm., 88 TC 1440 (1987).

      5.      IRC §§ 4975(b), 4961.

      6.      Zabolotny v. Comm., 7 F.3d 774 (8th Cir. 1993), nonacq. 1994-1 CB 1.

      7.      See Morrissey v. Comm., TC Memo 1998-443.

      8.      IRC § 4975(c)(3).

      9.      Baizer v. Comm., 204 F.3d 1231 (9th Cir. 2000).

      10.    IRC § 408(e)(2).

      11.    In Re Kellerman, 115 AFTR 2d 2015-1944 (Bktcy. Ct. AR 2015).