Prohibited transactions and your 401(k)…
The Internal Revenue Service (IRS) website clearly states the following… prohibited transactions are transactions between a retirement plan (which includes a 401(k) plan), and a disqualified person that is prohibited by law. Prohibited transactions generally include the following transactions:
a transfer of plan income or assets to, or use of them by or for the benefit of, a disqualified person;
any act of a fiduciary by which plan income or assets are used for his or her own interest;
the receipt of consideration by a fiduciary for his or her own account from any party dealing with the plan in a transaction that involves plan income or assets;
the sale, exchange, or lease of property between a plan and a disqualified person;
lending money or extending credit between a plan and a disqualified person; and
furnishing goods, services, or facilities between a plan and a disqualified person.
The Department of Labor (DOL) has granted class exemptions for certain types of investments under conditions that protect the safety and security of the plan assets. In addition, a plan sponsor may apply to the DOL to obtain an administrative exemption for a particular proposed transaction that would otherwise be a prohibited transaction.
The IRS goes on to state the following:
Who is a disqualified person for purposes of the prohibited transaction rules? (1) a fiduciary of the plan; or (2) a person providing services to the plan…..
Prohibited Transactions and your service provider…
An insurance company that offers plan services to the plan sponsor aka employer of a 401(k) retirement plan is “a person providing services to the plan…” and is therefore a “disqualified person under IRS rules. And yet, according to Iowa regulations, any insurance company domiciled in Iowa that provides 401(k) plan services must not hold themselves out as a trustee, and that same insurance company “must own all plan assets!”
If this is the case, then how can the federal government state that a prohibited transaction includes the “sale, exchange, or lease of property between a plan and a disqualified person?” The answer is simple…. remember the DOL can grant class exemptions “that protect the safety and security of the plan assets.” They can also provide an “administrative exemption” for a particular proposed transaction that would otherwise be a prohibited transaction. In other words, the protective language of the IRS and ERISA is quickly negated by perhaps one individual within one government agency that can be an insider for the so-called “disqualified person under IRS rules.”
Principal Life Insurance Company has repeatedly circumvented the law for years by submitting class and administrative exemption requests to the Department of Labor. The language in their group annuity also positions Principal Life to not only own and control your plan assets, but also manipulate those same funds to their personal benefit, another violation under IRS regulations.
If you report a violation to the IRS for Principal Life’s unethical and fraudulent activities, you can expect to be ignored. The IRS regulations are not designed to protect the investor, but instead to provide the IRS with added authority to enforce their tax exemption laws and levy tax liens and administrative damages for themselves.
In fact, no federal or state agency will be your advocate in a case against an insurance company involving prohibited transactions. The various agencies will enforce, investigate, than levy fines against the wrong-doer; but to demand restitution for the victim of financial crimes is not on their agenda. On the other hand, if your 401(k) retirement is with a financial institution regulated by the Office of the Controller of the Currency, you can expect the courtesy of that agency demanding restitution when you sustain a financial loss.
On January 1st, 2018, it is likely that the Department of Labor will begin enforcing the new Conflict of Interest Final Rule, otherwise known as the new fiduciary standard. One provision in the Best Interest Contract (BIC) Exemption and the Principal Transactions Exemption that was delayed to January 1, 2018, required disclosure of fiduciary status by financial institutions and advisers who use the exemptions. Most investment firms staffed by independent advisers are recognizing the risks associated with prohibited transactions and the sale of insurance company mutual funds. These funds often include hidden fees and proprietary funds that create a conflict of interest for disqualified persons under the IRS rules. Today, insurance companies continue to use their own staff of advisors to market these funds, but beginning January 1st, 2018, those same advisors will be considered fiduciaries under the new rule, and the service providers will no longer be exempted by the courts as non-fiduciaries.
In order to add an “arm’s length” relationship between the insurance company (aka service provider) and the investing public, those same advisors are being “sold” to independent advisory firms so that insurance companies like Principal Life can avoid the “fiduciary” label. Principle Life will continue to”sell” proprietary funds, and will continue to charge hidden fees, but under the veil of protection afforded by the independent relationship with advisory firms.
Wikipedia has the best definition of an arm’s length principle:
“The arm’s length principle (ALP) is the condition or the fact that the parties to a transaction are independent and on an equal footing. Such a transaction is known as an “arm’s-length transaction”. It is used specifically in contract law to arrange an agreement that will stand up to legal scrutiny, even though the parties may have shared interests (e.g., employer–employee) or are too closely related to be seen as completely independent (e.g., the parties have familial ties).”
One known hazard that will continue to exist is the fact that the so-called independent advisory firm will continue to maintain a close and personal relationship with the service provider, leaving one to question whether or not the true “best interest” of the investor is being served. There will exist on the investment advisory website disclosures that few if anyone actually reads. Fee “disclosures” will take on the form of financial perks offered by companies like Principal Life which simply mask the hidden fees paid to the advisors to market certain products.
Today, LPL Financial is one of the largest advisory firms in the nation. LPL is currently purchasing ownership of advisors from insurance companies. I suspect Principal Life will soon be divesting their agents as well. While LPL is essentially assuming fiduciary responsibility of prohibited transactions, as an investor you must continue due diligence efforts to take charge of your investments.
Over the past decade or longer, Principal Life has engaged in questionable tactics to take control of investor’s funds, and in some cases, literally stealing from those retirement accounts to protect the integrity of their own investment errors. This practice will not change, and if the economy fractures, your retirement account will crumble as well. If your funds are held in any insurance company separate account where the service provider can initiate a withdrawal restriction, ie. freeze the account, get your money out of that account as soon as possible. Once that account is frozen, you lose control, and your money will be lost!
Ask your Plan Sponsor or employer to confirm in writing that none of the investments offered in your 401(k) plan can be frozen or have a withdrawal restriction. If he does not understand the question, then demand a letter in writing from your service provider. At this time, I understand that ALL of Principal’s separate accounts offered as 401(k) investments can have withdrawals delayed for up to 2 years at the sole discretion of Principal Life management!