Conflicts of interest are a “common part of many financial transactions involving products recommended to retirement investors,” and the IRS’ fiduciary oversight for individual retirement accounts is lacking, putting investors at risk, according to a Government Accountability Office report publicly released Aug. 28.
The IRS has sole enforcement authority over firms and financial professionals acting as fiduciaries under the Internal Revenue Code for IRAs. Currently, the IRS relies on the IRA fiduciary self-reporting to IRS and paying the applicable excise tax when they engage in prohibited transactions, according to IRS officials cited in the report.
The IRS is responsible for enforcing the prohibited transactions provisions in the Internal Revenue Code but is bound by the regulations, rulings, opinions and exemptions issued by the Department of Labor, the report noted. IRS officials told the GAO that their policy is to enforce prohibited transactions that the Labor Department refers to them.
However, the Labor Department “does not have authority to audit IRAs for prohibited transactions and, therefore, is generally unable to refer IRA fiduciaries to IRS for excise tax enforcement,” according to the report.
The GAO recommended that the IRS develop and implement a process independent of Labor Department referrals for identifying non-exempt prohibited transactions involving firms or financial professionals who are fiduciaries to IRAs and assessing applicable excise taxes.
According to the IRS, the excise tax is intended to safeguard income for retired workers by taxing transactions deemed particularly objectionable because of the potential for abuse of fiduciary responsibilities by parties having conflicts of interests, the GAO said.
Prohibited transactions generally fall into two categories, transactions involving interested parties and transactions involving fiduciary self-dealing, the report said. Transactions involving interested parties, such as a fiduciary, certain family members of a fiduciary, or a service provider to an employer plan or IRA, are generally prohibited unless the interested party complies with an exemption, the GAO said.
Also, the GAO recommended that the IRS coordinate with the Labor Department on non-exempt prohibited transactions involving firms and financial professionals who are IRA fiduciaries and owe excise tax.
The IRS agreed with the report’s recommendations.
As part of its investigation, the GAO said it interviewed financial industry associations, examined disclosures from more than 15,000 firms and conducted undercover calls to 75 financial professionals to identify conflicts and determine how they are communicated. In making the undercover calls, the GAO said it found that conflicts can be “numerous, complex and dynamic."
The GAO report also examined how financial professionals responded to a 2016 Labor Department rule that expanded the definition of fiduciary investment advice but was later vacated in federal court in 2018.
To comply with the rule, the GAO found that some firms moved toward standardized compensation for financial professionals and away from compensation that can depend on recommendations. But after the rule was vacated, some firms reversed certain practices established under the rule, and other firms kept their new practices, according to the GAO.
In April, the Labor Department finalized the Retirement Security Rule that changed the test used to determine when someone is an investment advice fiduciary under ERISA. The changes make it so one-time advice, such as rollovers to IRAs or annuity purchases, must be in an investor’s best interest.
The rule has faced steep industry pushback and is being challenged in federal court in multiple lawsuits. In July, two separate judges halted the rule’s implementation.
