Definition
A prohibited transaction is a category of dealings between an ERISA-covered plan and a specified list of related parties that ERISA and the Internal Revenue Code bar as a matter of bright-line rule, without regard to whether the transaction is otherwise fair or beneficial to the plan, unless a statutory or administrative exemption applies.
Why it matters
The prohibited transaction rules are the structural mechanism ERISA uses to prevent the most predictable categories of conflicted dealings from occurring at all, rather than relying on case-by-case analysis of whether particular transactions violated fiduciary duty. For lifetime income arrangements offered in-plan, the rules matter because arrangements between plans and the insurers, recordkeepers, and other service providers involved in delivering the arrangement must be structured to fit within an available exemption.
How it works
ERISA Section 406 identifies two broad categories of prohibited transactions. Section 406(a) prohibits certain transactions between a plan and a "party in interest" — including the sale, exchange, or leasing of property; the lending of money or extension of credit; the furnishing of goods, services, or facilities; the transfer of plan assets to a party in interest; and the acquisition of employer securities or real property in excess of specified limits. Section 406(b) prohibits certain fiduciary self-dealing — a fiduciary cannot deal with plan assets in the fiduciary's own interest, cannot act in a transaction on behalf of a party adverse to the plan's interests, and cannot receive consideration from a party dealing with the plan in connection with a transaction involving plan assets. The parallel provisions in Internal Revenue Code Section 4975 impose an excise tax on prohibited transactions involving qualified plans, applying similar categories to a slightly different list of "disqualified persons." Statutory exemptions in Section 408 permit specified categories of otherwise-prohibited transactions — for example, reasonable arrangements for necessary plan services (Section 408(b)(2)), loans to participants (Section 408(b)(1)), and various technical exemptions for common plan operations. The Department of Labor also grants administrative exemptions — individual (for a specific transaction) or class (for a category of transactions) — through a formal process under Section 408(a).
In practice
For a plan participant, the prohibited transaction rules operate in the background to shape what arrangements the plan's service providers can enter into on behalf of the plan, but are not typically visible in ordinary interactions. For a plan sponsor and the plan's fiduciaries, prohibited transaction analysis is standard whenever a plan enters into any dealing with a related party, including service provider engagements, and requires either a fit within a statutory exemption (most commonly the reasonable service arrangement exemption) or reliance on an administrative exemption. For a professional advising the plan on adding an in-plan lifetime income option, the prohibited transaction analysis of the transaction between the plan and the insurer providing the arrangement — including any related recordkeeping, distribution, or advisory arrangements — is a threshold legal question that should be worked through with counsel before the arrangement is adopted. Individuals encountering the term should recognize that prohibited transaction violations carry excise tax exposure under IRC Section 4975 and fiduciary breach exposure under ERISA Section 502, and that neither exposure is discharged by demonstrating that the transaction was fair or beneficial to the plan.
In the Longevity Standard Framework
Prohibited transaction rules are the structural constraint under which any in-plan lifetime income arrangement is negotiated and adopted in the Longevity Standard framework's plan-level analytical work.
Related terms
- Employee Retirement Income Security Act
- ERISA fiduciary
- Party in interest
- Disqualified person
- Fiduciary breach
- ERISA Section 408
- Internal Revenue Code Section 4975
- Fee disclosure