Compliance May 8, 2024

IRA to IRA Rollovers Pose Legal Vulnerability for Retirement Security Rule

Legal experts with varying perspectives on the rule agree that DOL likely does not have jurisdiction over IRA to IRA rollovers

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Rollovers between individual retirement accounts might be low hanging fruit for opponents of the Retirement Security Rule, finalized by the Department of Labor in April.

Legal experts with varying perspectives on the rule agree that the DOL likely does not have authority to apply fiduciary duties under Title I of the Employee Retirement Income Security Act to individual retirement accounts.

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When discussing the meaning of a recommendation as it relates to rollovers, the final rule says that it would cover recommendations concerning the “rolling over, transferring, or distributing assets from a plan or IRA, including recommendations as to whether to engage in the transaction, the amount, the form, and the destination of such a rollover, transfer, or distribution.”

This area of the rule does not distinguish between sources of a rollover, provided they are “from a plan or IRA.” According to Chantel Sheaks, the vice president of retirement policy at the U.S. Chamber of Commerce, this means that any rollover or transfer from an IRA is covered regardless of its original source. This would include a rollover from what Sheaks calls a “pure IRA” or an IRA that was funded from a source other than a retirement plan rollover, such as from cash drawn from a bank account.

Kendra Isaacson, a principal at Mindset and former Senate pension policy director for Senator Patty Murray, says that the DOL’s jurisdiction is shakiest over rollovers that do not involve an employer-sponsored plan under Title I, such as between IRAs or from an IRA to an annuity. Sheaks says IRA-to-IRA transfers can be common in cases where an adviser changes jobs and recommends an existing client move between IRA providers so they can continue to serve them. Such a rollover would likely be covered by the final rule, but this most likely goes beyond DOL’s authority.

Isaacson says, “the IRA is a creature of the [Internal Revenue] Code,” and under the authority of the Treasury Department. She adds, “If DOL wanted to cover these rollovers, it should have been a joint rulemaking.” The DOL likely would have jurisdiction over a rollover originating from a qualified plan, as well as IRA to plan “roll-ins,” since those do involve plans governed by the Employee Retirement Income Security Act. DOL has “clear authority to regulate money flowing out of qualified ERISA Title I plans,” Isaacson says.

Carol McClarnon, a partner with Eversheds Sutherland, concurs and says, “The DOL is imposing ERISA fiduciary duties on IRA fiduciaries, which is without question contrary to the intent of Congress in enacting ERISA. The DOL can issue conditional prohibited transaction exemptions, but there are limits to how far they can go.”

Sheaks explains that the Treasury Department can impose an excise tax on IRA fiduciaries who engage in a prohibited transaction, and the final rule does not disturb this. However, by amending the prohibited transaction exemption 2020-02, which an IRA fiduciary adviser would depend on, the DOL has effectively set the criteria by which IRA fiduciaries would be penalized by the Treasury. Sheaks calls this “indirect enforcement,” against IRA advisers, and like McClarnon, says it imposes ERISA Title I obligations on IRAs, which are covered in Title II of ERISA and were not intended by Congress to have the same duties.

Sheaks wrote in Chamber of Commerce’s comment letter to DOL, when the rule was still a proposal, that “Individual Retirement Accounts (IRAs) were included in Title II and not in Title I because they are not employer plans, and Congress did not intend for DOL to have jurisdiction over IRAs. The duties of loyalty and prudence do not apply under Title II.”

Court Challenges

So far, there is one legal challenge to the rule in the federal courts, brought by the Federation of Americans for Consumer Choice on May 2. The lawsuit makes a similar argument, among others.

“Notably, the DOL does not have supervisory regulatory authority with respect to IRAs comparable to its authority over ERISA Title I plans, and the Code does not impose statutory duties of loyalty and prudence on fiduciaries,” the plaintiff’s complaint states. “Instead, the Code allows the IRS to impose an excise tax on prohibited transactions involving either ERISA or IRA fiduciaries.”

Sheaks argues that these provisions of the rule are not severable from the full rule because they are “fundamentally woven together.” Isaacson says that it is “up for debate” if a court simply strikes down this element of the rule, but leaves the rest intact.

 

 

Products & Services May 8, 2024

Stable Value Funds Amid High Interest Rates

Money markets may be attractive options in the short term, but stable value funds’ case may be poised to strengthen when rates finally come down.

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At a time of low interest rates, stable value funds were a clear option in defined contribution plans for a low-risk investment focused on capital preservation and liquidity. After numerous interest rate hikes that started in March 2022, however, money market funds started fetching better returns with many of the same traits and less complexity.

At the start of this year, with the Federal Reserve poised to lower interest rates, it appeared stable value’s day may be returning—but persistent inflation and a strong job market have the market now questioning when rate cuts will happen.

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Even so, the value of a low-risk, insurance-backed investment option should still be a consideration for plan advisers and sponsors considering that stable value should start outperforming money market funds by as soon as next year, says David Cohen, head of stable value and head of institutional and retirement investment product for John Hancock Investment Management.

“I can point you to maybe only two times in the last 30 years where money markets for short spurts of time have outperformed stable value,” he says.

Cohen is quick to note that, for retirees operating on a short time horizon, seeing a stable value fund with a return of 2.5% versus a money market yielding 5% would certainly tilt them toward the money market. But for a plan fiduciary serving a wide participant pool, the general trend of stable value funds to outperform as they buy and sell short and intermediate bonds, along with their insurance-backed guarantees, make them a good tool to have in DC plans.

“It’s more about making sure people understand that there is an insurance component to this that protects them when things go bump in the night,” he says.

Cohen notes that in a stable value fund new bonds are consistently being purchased, so as they mature the fund is bringing on higher-yielding credit that will eventually catch up and then exceed money market returns.

“That’s exactly what has happened over the last 30 years,” he says. “The difference now is that things spiked a lot quicker, and when that happens, it takes a little bit longer to play catchup.”

Know Their Value

Stable value funds, which are only available for tax qualified plans, are offered by some 82% of plan sponsors as a capital preservation option, according to a 2022 MetLife study, the most recent available from the insurer. At that time, a whopping 98% of sponsors offering them planned on continuing to do so.

According to the most recent data from the Stable Value Investment Association, there was about $882 billion invested in stable value as of the end of 2023 across four types of offerings. Insurance company products were responsible for $455 billion of those investments, and investment manager products via individually managed accounts and pooled funds made up the rest at $426 billion.

Cohen preaches education about stable value funds for plan fiduciaries. The portfolio manager says he oversees four stable value funds for John Hancock, but also advises on third-party funds for the firm’s recordkeeping business.

“Stable value is not so different than Baskin-Robbins,” Cohen says. “There are 31 flavors of stable value. Understanding the nuances between those products to help best support our clients is where we start and end from an education perspective.”

Cohen argues that, while stable value funds may be more complex at the plan level, participants “never really see any of that noise” outside of a 90-day equity wash provision. That stipulation requires that a participant transferring assets from a stable value fund must first move their assets into a non-competing fund for 90 days before transferring it over fully to a competing fund, like a money market fund or another stable fund.

In a post published by UBS’s workplace wealth solutions divisions, the firm reiterates that plan sponsors need to educate themselves on the various stable value fund options available.

When it comes to collective investment trust stable value funds, for instance, the products are set up in a way that if the issuing insurance went bankrupt, the plan sponsor would “not be listed first among the creditors of the insurance company.” It’s important, the firm notes, for plan sponsors to assess the insurance company ultimately underpinning the funds.

Product Innovation

Cohen also notes that stable value funds, which are not a long-term qualified default alternative investment option, are now offered through a QDIA-vehicle in the form of target date funds. He said John Hancock started offering this investment product around 2019 and sees it as a way for plan sponsors to provide a low-risk investment option as part of the glide path.

“You are seeing more and more stable value presence in target date funds to make sure that we are protecting wealth and preserving it as well as creating a hedge against market volatility,” he says, noting the product evolution is moving into 529 education saving plans and health savings accounts.

How plan fiduciaries evaluate stable value fund use will, to some extent, depend on where the Federal Reserve takes interest rates in coming months and years. But Cohen stresses that plan sponsors and fiduciaries should fully understand the exit provisions that may be applied to a plan level withdrawal and also consider the long term performance history of stable value funds versus money markets when considering the appropriate capital preservation option for their investment lineup.

“If [Federal Reserve Chair Jerome] Powell goes back to zero interest rates at some point, then money market funds are going to be performing at .04% again, which clearly won’t be able to keep up with inflation,” he says.  

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