What Do the SECURE Act and COVID-19 Have to Do With Your Retirement?

Posted on November 30, 2021


Author: Nadia A. Havard

Originally published in October 2021

Copyright © 2021 Knox McLaughlin Gornall & Sennett, P.C.

SECURE Act of 2019

Retirement Benefits Distribution Changes Under SECURE Act

Individual retirement accounts, qualified retirement plans and other retirement arrangements (the “retirement benefits”) represent a significant percentage of wealth accumulation by individuals. Research shows that “people are most interested in getting professional guidance about how to prevent running out of money before they die (66%), and understanding the impact of a market downturn on savings (64%)”. (Majority of Americans are Reluctant to Discuss Retirement Concerns | Allianz Life)

On December 20, 2019, President Trump signed into law the Setting Every Community Up For Retirement Enhancement Act of 2019 (the “SECURE” Act), which became effective on January 2, 2020.

SECURE, among other things, changed certain requirements applicable to retirement benefits.

  • First, the required beginning date for minimum distributions changed from April 1 of the year following the participant’s 70 ½ birthday to April 1 of the year following the participant’s 72nd birthday.
  • Second, allowing contributions to an IRA after age 70 ½, provided the taxpayer has “taxable compensation” (i.e. have wages, salaries, bonuses, tips or net income from self-employment).
  • “For 2020 and later, there is no age limit on making regular contributions to traditional or Roth IRAs. For 2019, if you are 70 ½ or older, you can't make a regular contribution to a traditional IRA. However, you can still contribute to a Roth IRA and make rollover contributions to a Roth or traditional IRA regardless of your age.” More here.

SECURE requires qualified defined contribution plans (such as covered by Internal Revenue Code (Code) section 401(k) or Code section 403(b), profit-sharing plans and employee stock ownership plans, but not defined benefits plans or cash balance plans) to provide, at least annually, a lifetime stream of income disclosure (Lifetime Income Disclosure).

On September 18, 2020, Department of Labor (“DOL”) published its interim final rule regarding Lifetime Income Disclosure. In July of 2021, DOL published temporary FAQ related to Lifetime Income Disclosure rule. On September 18, 2021, Lifetime Income Disclosure rule became effective. Plan administrators for calendar year plans will have until September 18, 2022 to provide Lifetime Income Disclosures. As a practical matter, if the plan issues benefits statements on a quarterly basis, the Lifetime Income Disclosure will have to be included with the 2nd quarter statement for 2022 (i.e. July) in order to be issued by September 18, 2022.

DOL requires a plan administrator to provide an annual estimate of the participant’s retirement savings illustrated as both: (i) a single life income stream, and (b) a qualified joint & survivor annuity. The disclosure is required regardless of whether the plan actually offers an annuity as a form of payment and whether the participant is actually married or not.

Finally, SECURE changed the landscape for payout periods for retirement benefits distributions. It replaced the two-tiered qualification system (i.e. based on whether retirement benefits are payable to a designated beneficiary or not) by a three-tiered system (i.e. based on whether retirement benefits are payable to a designated beneficiary or not, and whether the designated beneficiary qualifies as an eligible designated beneficiary). The status of an eligible designated beneficiary is determined at the participant’s death with the exception for a minor child. If a minor child of the participant is disabled, upon reaching the age of majority, such beneficiary will continue to be an eligible designated beneficiary (as disabled, rather than as a minor).

Since SECURE became effective only as of 2020, there are a lot of retirement plans and IRAs that are subject to pre-SECURE rules. Also, SECURE rules are more relevant as to what happens upon the participant’s death, since stretch options have become quite limited. A close look needs to be taken at the plan/IRA beneficiaries, both, primary and successor beneficiaries. If the plan/IRA is already making distributions to the beneficiaries or participants who died before 12/31/2019, such distributions are calculated under the old rules (at least until such beneficiary dies). After such beneficiary’s death, the new rules under SECURE determine the payout of the remaining plans/IRA assets.

There is more certainty when retirement benefits are paid to charities and estates since those rules have not been changed by SECURE. As a general rule, unless the beneficiary is “eligible”, the payout period for designated beneficiaries is 10 years after the participant’s death. A charity or an estate will NOT be considered a designated beneficiary or an eligible designated beneficiary. If there is no “designated beneficiary”, a 5-year rule applies when the participant dies BEFORE his/her required beginning date, and the remaining life expectancy of the participant, if such participant dies AFTER his/her required beginning date.

There are five categories of eligible designated beneficiaries.

The first category is the surviving spouse of the participant. Good news is that SECURE did not directly change rules for surviving spouses. A surviving spouse still has the option to (i) rollover the assets into his/her plan/IRA and take distributions at age 72 over her/his life; (ii) treat it as his/her inherited IRA and take distributions over his/her life after the deceased spouse would have turned 72 or, if needed, start immediately, and (iii) treat it as his/her own IRA and take distributions at age 72 over his/her life. However, upon death of the surviving spouse the payout period is shortened to 10 years instead of the surviving spouse’s remaining life expectancy, unless the successor beneficiary is also an eligible beneficiary. Also, planners need to be mindful whether trusts already created for the benefit of a surviving spouse will continue to qualify for stretch over the surviving spouse’s life expectancy. (See Planning Opportunities below for more information.)

The second category applies to beneficiaries who are disabled, chronically ill and less than 10 years younger than the participant (the likely group of individuals covered by this exception is siblings). For all three of these groups payout periods may stretch over their life expectancies. Upon death of the eligible designated beneficiary, the payout period is 10 years.

SECURE specifically carved out rules for disabled and chronically ill beneficiaries. As a starter, SECURE does not define either of these terms. The term “disabled” is defined in Section 72(m)(7) of the Code as “(i) unable to engage in any substantial gainful activity by reason of any medically determinable physical or mental impairment (ii) which can be expected to result in death or to be of long-continued and indefinite duration”. The proof of “disability” shall be furnished as the Secretary of Treasury may require. Upon death of a disabled individual, the payout period is 10 years. Further guidance will be provided whether determination of disability needs to be done annually.

The term “chronically ill” is defined in Section 7702(B)(c)(2) of the Code as related to qualified long-term care insurance and services. Upon death of the chronically ill individual, the payout period is 10 years. Further guidance will be provided by the Internal Revenue Service (“IRS”) whether determination of chronical illness needs to be done annually and if so, in what form.

The fifth category of eligible designated beneficiaries is kind of a hybrid and deals with minors. Minor beneficiaries can take distributions over their life expectancy until such minors turn of the age of majority. Depending on the state, the age of majority may vary between 18, 19 and 21. (In Pennsylvania, minors are those who have not reached the age of 18.)

Also, the IRS issued regulations stating that if, among other requirements, a person has not completed a specific course of education and is under the age of 26, then such person will be considered a minor. (See 26 CFR 54.9815-2714 – Eligibility of Children until at least age 26)

In any case, whether it is the age of 18, 19, 21, or 25, after the beneficiary turns this specified age the payout period is only 10 years.

Finally, the last category of beneficiaries, and the most confusing category, is a trust. The focus of the pre-SECURE rules was on whether a trust could qualify to receive stretched distributions. The oldest beneficiary’s life expectancy was used to stretch the distributions. Under SECURE rules, it is still important to determine whether a trust is a designated beneficiary. If so, the next step is to determine the period over which the distributions may be stretched. As a result, post SECURE a trust can be subject to (i) a five-year rule, (ii) remaining life expectancy of the deceased participant, (iii) a ten-year rule, or (iv) the life expectancy of the eligible designated beneficiary.

The IRS issued its publication Pub. 590-B in early 2021 - Pub. 590-B (Distributions from Individual Retirement Arrangements for 2020 returns). Among other things, it provided examples on required minimum distribution (RMD) rules under Code Sec. 401(a)(9), as revised by SECURE. Since RMD apply to employer defined contribution retirement plans and traditional IRA plans, such examples are of great importance. Because SECURE shortened the payout period from life expectancy (in many cases) to 10 years for inherited IRAs, it was not clear whether inherited IRA must distribute benefits in 10 (equal or unequal) increments or allow a lump sum distribution by the end of the 10-year period. The initial example included in Pub. 590-B called for pro-rata distribution over 10 years. However, on May 27, 2021, the IRS issued a revised Pub. 590-B, confirming that a lump sum distribution at the end of a 10-year period is allowed for inherited IRAs.

The IRS issued the final regulations on November 4, 2020 (T.D. 9930, Federal Register dated November 12, 2020), making revisions to The Single Life and Uniform Life tables for calculating required minimum distributions (Treas. Reg. 1.401(a)(9)-9(b)(-(c)), effective as of January 1, 2022.) As a general rule, the revised tables will reflect longer life expectancy (by about 1-2 years) than the tables under the exiting regulations.

During the summer of 2021 the IRS confirmed that regulations addressing required minimum distributions under SECURE will be issued shortly. Apparently, the regulations will address not only RMD, but also questions related to trusts being named as beneficiaries of IRAs. The IRS warned that the regulations may be complex since taxpayers would like to have flexibility. (See Nathan Richman, Proposed SECURE Far Along but Not Imminent, TAX Notes (June 1, 2021).

The CARES Act

On March 13, 2020, the President declared a national emergency related to COVID-19. Under Section 501(b) of the Robert T. Stafford Disaster Relief and Emergency Assistance Act, a national emergency related to COVID-19 pandemic existed in the United States beginning March 1, 2020.

The Coronavirus, Aid, Relief and Economic Security Act ("CARES Act") was signed into law on March 27, 2020.

As related to retirement benefits in light of COVID-19 and most recent IRS and DOL announcements related to COVID-19 pandemic, it is important to remember that:

  • Unless the payment of the benefits is annuitized, RMD for 2020 were waived. The plan sponsors may consider whether to amend their plans to allow participants to forgo RMDs in 2020.
  • On May 4, 2020, the IRS issued 14 FAQs on Section 2202 of the CARES Act whereby it provided, among other things, for special rollover rules with regard to Coronavirus-related distributions. They apply to repayments made to retirement plans within three years from the date of receipt of such distributions.

Impact of SECURE Act on Existing Estate Plans

Typical Estate Plans for Single and Married Individuals

Single Individuals – No Children, Living Siblings (no special needs)

For an individual with no children but living siblings, a typical estate plan will include outright gifts to siblings with some charitable gifts.

Prior to SECURE, if retirement benefits were left outright to the siblings, each sibling could have stretched payments over their life expectancy regardless of whether they are older or younger than the plan owner. Alternatively, each sibling could have used the decedent’s remaining life expectancy, if it was longer than the beneficiary’s life expectancy.

After SECURE, siblings’ ages matter. Those who are older, the same age or not more than 10 years younger than the plan owner may still stretch payout period over their life expectancy or use the decedent’s remaining life expectancy, if it is longer. However, those who are younger by more than 10 years must take retirement benefits within 10 years of the decedent’s death. Charities named as IRA beneficiaries, must cash out retirement benefits within 5 years of the decedent’s death, if the decedent died BEFORE the required beginning date, and over the remaining life expectancy if the decedent died AFTER the required beginning date. SECURE did not change the time for distributions to charitable beneficiaries.

Alternative estate plan will have trusts for the benefit of each sibling and their living descendants, with possible charities as ultimate beneficiaries.

Prior to SECURE, if retirement benefits were left to trusts for the benefit of surviving siblings and their descendants, stretch would have been allowed over the life of the oldest beneficiary (usually, it would have been the surviving sibling), provided that the trust itself would have met the IRS requirements as a designated beneficiary. What mattered was the life of the oldest trust beneficiary in comparison with the other trust beneficiaries and whether the trust had individuals as beneficiaries.

After SECURE, unless the trust requires the trustee to distribute to or for the benefit of the sole trust beneficiary all the distributions received by such trust from retirement accounts (a so-called a “conduit trust”), trusts for a sibling and such sibling’s bloodline will have 10 years to take retirement benefits.

Single Individual – Living Children (no special needs) and Grandchildren (no special needs)

Individuals with living children and grandchildren would either leave the assets outright to their children with some specific gifts for grandchildren, or, for a better asset protection, leave the assets to the trusts for their children and their bloodline.

Prior to SECURE, each child receiving retirement benefits outright could have stretched the payout over their life expectancy, or, the decedent’s life expectancy, if longer. After SECURE, unless such child is a minor, disabled, or chronically ill, the payout is 10 years from the date of the decedent’s death.

If the retirement benefit were left to trusts for the benefit of children and their bloodline, stretch would have been allowed over the life of the oldest beneficiary (usually, it would have been the oldest child), provided that the trust itself would have met the IRS requirements as a designated beneficiary. What mattered was the life of the oldest trust beneficiary in comparison with the other trust beneficiaries and whether the trust had individuals as beneficiaries.

After SECURE, unless the trust is a conduit trust, trust for a group of individuals will have 10 years to take retirement benefits.

Married Couple (First Marriage) with Minor Children (no special needs)

A typical young couple would have modest assets and will be more concerned about protecting their children while minors. It is not unusual to have each of the spouses leaving assets to each other outright with one pot family trust for the benefit of their minor children.

Prior to SECURE, retirement benefits left to the surviving spouse could have been (i) either rolled over into the spouse’s own IRA, (ii) elected to be treated by the surviving spouse as his/her own IRA, or (iii) held by the surviving spouse as an inherited IRA. (These options are still available under SECURE). If rolled over into the spouse’s own IRA, the spouse would wait until reaching the age of 72 to start taking IRA distributions. If the spouse held the IRA as an inherited IRA, the spouse would be required to take IRA distributions when the decedent would have reached the age of 72. The stretch for the surviving spouse was and is the surviving spouse’s life expectancy.

The situation is different with a pot trust created for minor children. Prior to SECURE, stretch would have been allowed over the life of the oldest beneficiary (usually, it would have been the oldest surviving child), provided that the trust itself would have met the IRS requirements as a designated beneficiary. What mattered is the life of the oldest trust beneficiary in comparison with the other trust beneficiaries and whether the trust had individuals as beneficiaries.

After SECURE, a pot trust for minor children will likely have a stretch over the life expectancy of the oldest minor child and upon at least one of the minors reach the age of majority, the stretch will likely shrink to 10 years. This still needs to be clarified by the IRS.

Married Couple (Second Marriage, Blended Family) – Children from each Marriage (no special needs)

Second marriages are always ripe with questions how to take care of your spouse without disinheriting your own children. The best way to accomplish this was (and is) to leave assets to the spouse in trust (structured as a marital trust for estate tax marital deduction or credit shelter trust to take advantage of estate tax exemption). After the spouse’s death, the trust would have either continued for the benefit of the descendants of the decedent or would terminate and be distributed to the descendants of the decedent. Prior to SECURE, if the surviving spouse turned out to be the oldest beneficiary of the marital trust (or credit shelter trust, as applicable), retirement benefits could have been paid over the life expectancy of the surviving spouse.

After SECURE, unless the trust for the surviving spouse is a conduit trust (again, the trust requiring the trustee to pass all distributions, not just income, received from retirement plans by the trust to the surviving spouse), the payout period is 10 years. (Classic QTIP trusts that qualify for marital deduction and requiring all income to be paid to the surviving spouse will have 10 year payout period unless they also require the trustee to pay out (or apply for the benefit of) to the surviving spouse all distributions received by the trust from the retirement plans).

Married Couple (parents) – Children with special needs

If a taxpayer has a child with special needs, gifts or bequests to such child will likely be made in a form of a special needs trust. Prior to SECURE, retirement benefits left to a special needs trust will be stretched over the life expectancy of the oldest trust beneficiary. (Presumably, the disabled child would have been either the oldest trust beneficiary or the remainder beneficiaries will be very close to such child’s age, the stretch, in effect, will be over the life of the disabled child.)

After SECURE, a special needs trust still can qualify for a stretch (whether or not it is a conduit trust), provided that the trust beneficiary is disabled AND distributions from such trust can be made solely for the benefit of such disabled child. Moreover, if the parents left their retirement benefits to one pot trust and one of the beneficiaries is a disabled child, the pot trust can be divided into separate shares, with one separate share for the benefit of the disabled child, and such separate share can stretch the payout over the life expectancy of the disabled child. (The other separate shares will have to take retirement benefits by the end of the 10th year of the date of death, provided, that none of the other stretch rules apply.)

What if the trust was set up for minor children and at that time, no child was disabled or chronically ill? After SECURE, the lifetime stretch based on the age of a minor child is allowed only (i) until such child reaches the age of majority (in most states, age of 18), and (ii) such trust is a conduit trust. After the child reaches the age of majority, provided such child does not become chronically ill or disabled, the remaining stretch is 10 years. If, prior to reaching the age of majority, such child becomes chronically ill or disabled, then the lifetime stretch will apply over the remaining life of such disabled individual (provided that distributions can be made solely for such beneficiary and the beneficiary remains disabled or chronically ill).

Married Couple (grandparents) – Grandchildren with special needs

Prior to and subsequent to SECURE, grandparents (and anybody else) may create special needs trust for their disabled or chronically ill grandchild or other person. Since the lifetime stretch will be based on the condition of the trust beneficiary (i.e., disabled or chronically ill) and the provision that such person is the sole beneficiary of the trust, it becomes irrelevant whether the disabled person is a minor child or a grandchild of the grantors. Special needs trusts for disabled or chronically ill beneficiaries (regardless of their relationship to the grantors) will be permitted to stretch retirement benefits over the life expectancy of the trust beneficiary.

Planning Opportunities

Some planning opportunities that existed prior to SECURE have become even more important than before. One of the planning tools is a charitable remainder trust (CRT). The best part is there is no need to stretch retirement benefit distributions for retirement benefits payable to CRT. When a retirement plan/IRA is paid to a CRT, there is no income tax liability due. The Congress statutorily exempted CRTs from paying income taxes (see Section 664 of the Code) because its assets will ultimately go to a charity. A CRT can have an individual as the income beneficiary and the CRT payments (whether a fixed dollar amount or a percentage) can be made over the life expectancy of the individual income beneficiary. This “stretch” has nothing to do with the “IRA stretch”, but is based on the statutory requirement to pay annuity or a unitrust amount over the life expectancy of the income beneficiary (or a term of years up to 20 years).

In essence, the clients will achieve the stretch effect that they would have had under the old rules. Of course, before a CRT is set up, it is important to run calculations whether (i) a CRT will qualify as such, and (ii) the benefits and costs related to the net payout for the individual beneficiaries and CRT administration. CRT compliance rules are very strict and impose quite a number of thresholds to meet. As a starter, the value of the charitable remainder interest must be worth at least 10% of the value contributed to the trust. If CRT is created for a number of years instead of the beneficiary’s lifetime, the maximum number of years it can last is 20. There are situations when CRT will make sense, however, such situations are very fact specific and will require true charitable intent by the person creating such CRT.

If retirement benefits are left to a trust with multiple beneficiaries, further questions should be asked whether any of these beneficiaries are disabled or chronically ill. (NOTE: It is not yet clear what the requirements are to substantiate the annual on-going determination of disability or chronical illness.) If so, SECURE specifically allows such trust (provided it would have qualified as a designated beneficiary under old law) to be divided (uf it has not already been divided prior to) AFTER the participant’s death into separate share trusts for each beneficiary, and the separate share trust for a disabled or chronically ill beneficiary can qualify for the stretch payout over the life expectancy of such disabled or chronically ill beneficiary.

Another option is to convert existing IRAs into Roth IRAs, if the client has disposable income to cover immediate income tax liability. Upon the owner’s death, beneficiaries will receive tax-free distributions. If such distributions are accumulated in the trust, the payout to beneficiaries can be stretched over their lifetime. This is a judgement call on the taxpayer’s part, depending, among other things, on the current income tax situation of the taxpayer, risk taken with regards to any future changes to the law, and the desire to prepay income tax now rather than at a later time.

It may be a good idea to shift focus of charitable giving to IRA assets. Either during lifetime through qualified charitable distributions from IRAs (up to $100,000 per year) or by naming charities as IRA beneficiaries, the taxpayer may be able to maximize gifts to charitable and non-charitable donees through income tax savings. Some commentators suggest naming donor-advised funds at local community foundations as beneficiaries of IRA instead of specific charities. (Since IRA custodians will request a lot of information regarding charities’ board members under the PATRIOT Act, it is much easier for community foundations to comply with such requests instead of small charities.)

Planning Pitfalls

“A study by wealth management firm United Income says that, in 2016, one in four recipients were older than 61 when they received their inheritance. That includes spouses who don’t have to worry about the 10-year rule. But with plenty of folks now living into their late 80s and 90s, it’s reasonable to assume plenty of children will be in their late 50s or early 60s when they receive an inheritance.”

In the past, conduit trusts were widely used to provide both, asset protection for retirement benefits and enabling to stretch such benefits over the life expectancy of the sole trust beneficiary. However, since SECURE, conduit trusts, as a general rule, might not be desirable, unless they are intended for a surviving spouse. Since conduit trusts require all retirement benefits received by such trusts to be immediately paid out to (or applied for the benefit of) the trust beneficiary (in most situations, in 10 years after the participant’s death), retirement benefits will be paid out and no asset protection will be available to the beneficiary who received all of the trust distributions. It is important to revisit not only the beneficiary designations on the retirement accounts, but also to confirm what type of trusts, if any, are named as beneficiaries and whether it continues to make sense.

Traditionally, a married individual will leave his or her assets to the surviving spouse in a form of a marital trust (a so-called QTIP trust) and/or a credit shelter trust. The QTIP trusts are drafted to qualify for federal estate tax marital deduction and provide for payment of all income to the surviving spouse at least annually during such spouse’s lifetime. QTIP trusts are NOT, in most cases, conduit trusts (that is, they allow for accumulation). Prior to SECURE, if retirement benefits are left to a QTIP trust, the trustee could stretch payout over the surviving spouse’s lifetime, not because the QTIP beneficiary was a spouse, but because the surviving spouse was, usually, the oldest beneficiary whose life expectancy was used. Since SECURE, this is not enough to qualify QTIP for stretch. The QTIP trust must be drafted as a conduit trust. This is a very important detail that can be overlooked in reviewing the existing estate plans. Again, if it makes sense to leave retirement benefits to a trust for the benefit of the surviving spouse and the payout should be the life expectancy rather than 10 years, the trust must require the benefits as received by the trust to be paid out to (or applied for the benefit of ) the surviving spouse.

Conduit trusts for minors is another pitfall to be aware of. Prior to SECURE, the payout period could have been stretched over the life expectancy of a minor. At that time, it did not matter whether the minor was a child of the participant or a grandchild, or any other related or unrelated minor. Since minors, as a general rule, have a long life expectancy, the requirements to pay received RMD and other retirement benefit distributions from the trust to a minor did not dramatically drain retirement benefits. After SECURE, it does matter whether the minor is the participant’s child or not. If the minor is NOT the participant’s child, then no lifetime stretch applies (unless such minor is disabled or chronically ill.) For example, a conduit trust set up for a minor grandchild will be paid out in 10 years with all benefits actually ending up in the minor’s name (held by legal guardians). If, however, the minor is the participant’s child, then the stretch will be only until such child reaches the age of majority and thereafter there will be 10 years to wrap up the distributions. Again, it is important to double check what type of trust is set up to receive retirement benefits and if the beneficiary is a minor, the relationship between the minor and the participant.

Potential Impact of Proposed Build Back Better Act of 2021

On September 15, 2021, the House Ways and Means Committee proposed an amendment to the Build Back Better Act of 2021 that, if enacted, will affect, among other things, retirement benefits.

IRA Contributions. If enacted, effective after 2021, high-income taxpayers (with taxable income for single taxpayer of $400,000, married filing jointly of $450,000 and a head of household of $425,000) would be prohibited from making annual contributions to IRAs (both, traditional and Roth, except contributions to SEP and SIMPLE IRAs will be allowed), if such high-income tax payers have, in aggregate, more than $10 million of vested accounts in all defined contribution plans (401(k), 403(a) and (b), governmental 457(b), and IRAs).

Required Distributions. If enacted, defined contributions plans and IRAs would be required to make minimum distributions to high-income taxpayers if, on aggregate basis, such taxpayer’s defined contribution plans and IRAs exceed $10 million. The amount of minimum distribution will depend on the aggregate value of the defined contribution plan and the IRAs and will equal to 50% of the amount needed to reduce such balance to $10 million and 100% of the amount needed to reduce such balance to $20 million.

Reporting to the IRS. If enacted, defined contributions plans and IRAs would be required to report to the IRS on an annual basis any participants who have balances of at least $2.5 million.

No After-Tax Roll Overs or Conversions. If enacted, for all individuals, regardless of their income level, no after-tax contributions can be rolled over or converted into Roth. For high-income taxpayer there will be further restrictions prohibiting them from contributing or rolling over any non-Roth accounts into Roth IRAs or Roth designated plan accounts.

Restrictions on IRA Investments. If enacted, IRAs will be restricted from holding investments in private placements (including small business and real estate LLCs), where the issuer of the security requires the investor to be an accredited investor. The Act would also prohibit investments in holdings where the IRA owner owns 10% or more of the entity or where the IRA owner is an officer or a director. The bill will also clarify that the IRA owner is a disqualified person for purposes of prohibited transaction rules. One of the typical transactions targeted under this Act will be so-called ROBS (Rollover as the Business Start-up). It entailed creating a C-corporation, setting up a self-directed 401(k) under the C-Corporation, employing the IRA owner by the C-Corporation as an officer, transfer of retirement benefits to the self-directed 401(k) sponsored by the C-corporation, and as an officer of the corporation and trustee of 401(k) plan, directing 401(k) plan to buy stock in the C-corporation.

Dept. of Labor Fiduciary Rules as Related to Investment Advice

Fiduciary Advice Exemption - PTE 2020-02 – Improving Investment Advice for Workers & Retirees

As a general rule, under ERISA and Code Section 4975, parties providing fiduciary investment advice to plan sponsors, plan participants, and IRA owners may not receive payments creating conflicts of interest, unless they comply with conditions in a prohibited transaction exemption (“PTE”).

In 1975, DOL issued the regulations determining who is an investment advice fiduciary. Under these regulations, a person rendering advice will be considered fiduciary if such person advises the plan, plan fiduciary, or an IRA owner on:

  • Value of securities or other property, or recommends to invest in, buy or sell securities or other property;
  • On a regular basis;
  • Pursuant to a mutual agreement, arrangement, or understanding that
  • Such advice will serve as a primary basis for investment decisions with respect to the plan or IRA assets; and that
  • The advice will be individualized based on the particular needs of the plan or IRA.

In 2016 DOL issued a regulation (commonly known as the “Fiduciary Rule” – 2016”) that updated the 1975 regulation as well as granted new associated prohibited transaction class exemptions and amended certain pre-exiting class exemptions.

In 2018, the U.S. Court of Appeals for the Fifth Circuit vacated the rulemaking, including both the rule defining fiduciary advice and the new and amended exemptions. (Chamber of Commerce of the United States v. U.S. Department of Labor, 885 F. 3d, 360 (5th Circ. 2018).

Later in 2018 the DOL issued Field Assistance Bulletin (FAB) 2018-02, a temporary enforcement policy providing prohibited transaction relief to investments advice fiduciaries who complied with “Impartial Conduct Standards” (based on (i) a best interest standard, (ii) a reasonable compensation requirement, and (iii) no misleading statements about investment transaction and other relevant matters).

In 2019, the Securities and Exchange Commission (“SEC”) finalized its regulations (known as Regulation Best Interest) for SEC-regulated broker-dealers and investment advisers.

On July 7, 2020 the DOL proposed PTE 2020-02 (and on December 18, 2020, DOL adopted PTE 2020-02) (“Fiduciary Rule – 2020”), dealing with a new prohibited transaction exemption under ERISA and the Code for investment advice fiduciaries with respect to employees benefit plans and IRAs. The exemption expressly covers prohibited transaction resulting from both rollover advice and advice on how to invest assets within a plan or IRA.

On July 7, 2020, the DOL issued a technical amendment to the Code of Federal Regulations, and restored the text of the 1975 regulation defining an investment advice fiduciary under ERISA and the Code. It also clarified the exemptions as they were prior to 2016 amendment to be relied upon on their pre-amendment terms.

Even though PTE 2020-02 allowed the investment advice rule, written by the Trump administration, to take effect, it is believed that the Biden administration may return to the fiduciary rules published by the Obama DOL in 2016. Notice of new ruling making may be issued as early as December of 2021.

The main purpose for issuing PTE 2020-02 is to ensure prudent and loyal investment advice that is in the best interests of retirement investors (i.e. plan participants and beneficiaries, and IRA owners) by mitigating the conflict of interest. It applies to investment advisors, broker-dealers, banks, and insurance companies and their employees, agents and representatives (investment professionals). The PTE 2020-02 is broader and more flexible than pre-existing PTE. It provides relief for a variety of transactions (including advice to roll assets out from a plan to an IRA and transactions resulting from it). It also addresses compensation that may not have been covered by prior exemptions.

In addition to other requirements, financial institutions and investment professionals relying on the exemption must:

  • Acknowledge their fiduciary status in writing;
  • Disclose their services and material conflicts of interest;
  • Adhere to Impartial Conduct Standards (i.e. consumer protection provisions requiring fair dealings and adherence to fiduciary norms). Impartial Conduct Standards require that advisors (i) investigate and evaluate investments, provide advice and exercise sound judgment as a knowledgeable and impartial professional would be (“prudent”); (ii) act with undivided loyalty to retirement investors when making recommendations (“loyal”); (iii) charge no more than reasonable compensation and comply with federal securities laws re “best execution”; and (iv) avoid making misleading statements about investment transactions and other relevant matters;
  • Adopt policies and procedures prudently designed to ensure compliance with the Impartial Conduct Standards and to mitigate conflicts of interest;
  • Document and disclose the specific reason that any rollover recommendations are in the retirement investor’s best interests; and
  • Conduct an annual retrospective compliance review.

Preamble to PTE 2020-02 identifies the decision to roll over assets from an ERISA governed plan to a non-ERISA IRAs is “the single most important financial decision a plan participant makes, involving a lifetime of retirement savings”. Since advice to roll assets out of a plan is advice as to the sale, withdrawal, or transfer of plan assets, and therefore, is covered as fiduciary advice to the extent that 1975 fiduciary advice definition is satisfied.

PTE 2020-02 became effective as of February 16, 2021. Even though DOL indicated that it may consider additional protections or clarifications, the Impartial Conduct Standard and the requirements for strong policies and procedures are fundamental investor protections that would stay.

As a matter of enforcement policy, the DOL will NOT pursue claims for breaches of fiduciary duty or prohibited transactions for the period between 2005 and February 16, 2021, or treat parties as violating the prohibited transaction rules based on rollover recommendations that would have been considered nonfiduciary advice covered under (now revoked) the Deseret Letter, Advisory Opinion 2005-23A. (The Deseret Letter, Advisory Opinion 2005-23A treated advice to rollover plan assets as nonfiduciary advice.) DOL indicated that rollover recommendations are a primary concern of the DOL because of their extraordinary importance to retirement investors.

PTE 2020-02 is only a step forward towards further regulatory actions by the DOL as related to the fiduciary investment advice. The DOL indicated that it anticipates taking further regulatory and sub-regulatory actions, including amending the investment advice fiduciary regulation, amending PTE 2020-02, and amending or revoking some of the other existing class exemptions available to investment advice fiduciaries.

Rollover advice becomes fiduciary investment advice rendered on a regular basis if rollover advice occur as part of an ongoing relationship or as the beginning of an intended future ongoing relationship. The DOL applies the 1975 regs to the entire advice relationship and does not exclude the first instance of advice since a recommendation to roll plan assets to an IRA may, in most circumstance, be rendered in ongoing advice relationship.

Insurance Agents (PTE 84-24)

In preamble to PTE 2020-02, the DOL stated that in addition to relying on PTE 2020-02 for relief from prohibited transactions, insurers and agents may also rely on PTE 84-24, which provides relief for a smaller range of compensation practices, including the insurance agent’s receipt of a sales commission from an insurance company, and the insurance company’s receipt of compensation and other consideration in connection with annuity sales, provided the conditions of the exemption are satisfied.

In order to comply with PTE 84-24, the following is required:

  1. The transaction must be carried out in the ordinary course of business;
  2. The terms must be at least as favorable to the participant as an arm’s length transaction with an unrelated party would be;
  3. The combined total of all fess, commissions and other consideration received by the insurance company or agent must be reasonable;
  4. Disclosures must be made to an independent fiduciary or the plan (e.g. the plan sponsor or committee), including any affiliation between the agent the insurance company, whose policy is being recommended, the sales commission payable with the recommended transaction, and any other costs associated with the purchase, holding, exchange, termination or sale of the recommended contract; and
  5. The recommended transaction must be approved by the independent fiduciary in writing.

A quick search revealed that most of the financial institutions already have canned Disclosure and Acknowledgement Forms that comply with PTE 84-24. As mentioned above, PTE 84-24 is narrower in scope than PTE 2020-02 and reliance on exiting Disclosure and Acknowledgement Forms under PTE 84-24 should not be taken lightly.

PTE 84-24 is much narrower than PTE 2020-02. PTE 84-24 only applies to insurance sales (life insurance and variable, fixed indexed and fixed rate annuities) and only applies to the receipt of commissions.


Author: Nadia A. Havard

Originally published in October 2021

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