The Politics of Retirement

A Washington Update

1 Marcia S. Wagner, Esq.

Not FDIC Insured • Not Bank Guaranteed • May Lose Value

2

Introduction

– Impending Retirement Plan Crisis • Social Security • Employer-Sponsored Plans • Private Savings – Current Private Pension System • Half of workers have no plan.

• Plans have low saving rates and hidden costs.

• Fewer than half of workers will have adequate retirement income.

– Role of Policymakers

3 1. Increasing Savings 2. Protecting Returns 3. Decumulation Planning 4. Tax Reform 5. Industry Groups

4

Increasing Savings Thru Automatic Features

– Pension Protection Act of 2006 • Auto-Enrollment • Auto-Escalation – Plan Sponsor and Advisor Initiatives • Re-Enrollment • Re-Allocation – Automatic IRAs

5

Automatic Enrollment and Escalation

– Negative Elections • IRS issued guidance in late 1990’s.

• Pension Protection Act of 2006 expands IRS guidance and offers fiduciary protection.

– Problems • Most plans set auto-contribution rates at 3%.

• 6% safe harbor rate provides “free pass” from discrimination testing.

• But few plans use safe harbor or auto-escalation.

– Automatic enrollment can significantly increase savings.

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Emerging Initiatives and Practices

– Re-Enrollment Program • Auto-enrollment and auto-escalation typically apply to new employees, not incumbent employees.

• Consider re-enrolling all employees with low contribution rates to default rate (e.g., 6%).

• May be implemented on ad hoc basis.

– Re-Allocation Program • Consider re-allocating participant accounts and new contributions to QDIA (unless they opt out).

• May be implemented at re-enrollment or ad hoc basis whenever elections become stale.

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Automatic IRAs

– Legislative History • Auto IRAs proposal appears to be partisan.

• But had bi-partisan support in prior years.

• Increasing retirement plan coverage is shared policy goal.

– Three Key Features • Default contribution rate set at 3%.

• Post-tax Roth IRA would be default, but employee could choose pre-tax Traditional IRA.

• Multiple alternatives available for selecting Auto IRA provider.

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Prospects for Auto IRAs

– Objections to Auto IRAs • Burdensome mandate for small businesses with more than ten employees.

• Federal government control overs assets.

• Role of private sector.

– Partisan politics will continue in short term.

• But bipartisanship support typically emerges on retirement issues.

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Summing Up

– Push for auto investments expected to continue.

– Auto IRA legislation unlikely in current form.

– But some reform can be expected in future.

• Retirement needs of aging middle class will force lawmakers to act.

• $5,000 cap on Auto IRA contributions would not discourage formation of qualified plans.

• Auto IRAs would help close retirement gap.

10 1.

Increasing Savings 2. Protecting Returns 3. Decumulation Planning 4. Tax Reform 5. Industry Groups

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Introduction

– Policymakers focusing on protection for investment returns.

• Disclosing hidden fees.

• Meaningful information for participants.

– Regulatory Agenda • Improving fee transparency.

• Encouraging participant-level advice.

• Broadening “fiduciary” definition.

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Fee Transparency

– Policymakers want plans to get fair price for services.

– Plan Sponsor-Level Disclosure Regs • Effective July 1, 2012.

• Service providers must disclose direct and indirect (“hidden”) compensation.

– Participant-Level Disclosure Regs • Effective August 30, 2012 (for calendar year plans). • Must compare investment options and provide quarterly fee disclosures.

– Disclosures are expected to drive down fees.

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Fee Litigation and Case Law

– 2006 Wave of 401(k) Fee Litigation • Alleged breach of fiduciary duty to monitor indirect compensation.

• Trial courts cautious and did not dismiss lawsuits.

– Hecker v. Deere • Case dismissed on “efficient markets” theory.

– 408(b)(2) Fee Disclosures • May support new theories of 401(k) litigation.

• Monetary settlements to date have been significant.

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Encouraging Participant Advice

– Many participants unwilling or unable to make investment decisions.

• Advisors receiving variable fees (e.g., 12b-1) generally cannot provide fiduciary advice.

– DOL provides fiduciary relief. • Advice based on computer model.

• Level fee for affiliate providing advice.

– Fiduciary relieve unhelpful to many advisors.

– DOL expected to work with private sector.

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Proposal to Broaden “Fiduciary” Definition

– ERISA’s Functional Definition • If fiduciary advice provided, fiduciary status arises.

• It is fiduciary advice only if it is

primary basis

for plan decisions and given on

regular basis

.

• Ellis v. Rycenga Homes – DOL’s Initial Proposal • It is fiduciary advice if it

may be considered

for plan decision.

• One-time, casual advice may trigger fiduciary status.

• Re-proposed definition pending.

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Emerging Practices and Levelizing Fees

– Fiduciaries must not receive variable fees.

• Non-fiduciary advisors may receive 12b-1 fees.

• DOL proposal to broaden “fiduciary” definition would stop receipt of variable fees.

– Plan Expense Accounts • Typically, funded by recordkeeper’s indirect compensation for gross-to-net pricing.

• May be used to levelize advisor’s compensation.

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Summing Up

– Administration has launched initiatives.

• Fee disclosures for plan sponsors and participants.

• Tried to encourage participant-level advice.

• Pushing boundaries of fiduciary status.

– Pressure on Fees • Interest in levelized fee arrangements.

• Downward pressure on 401(k) pricing .

18 1.

Increasing Savings 2. Protecting Returns 3. Decumulation Planning 4. Tax Reform 5. Industry Groups

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Administration’s Goals

– Help retirees take plan distributions without outliving them.

• Motivate retirees to annuitize accounts.

• Retirement paycheck for life.

– Encourage plan sponsors to voluntarily offer annuity options.

• Permit longevity annuities.

• Remove regulatory hurdles.

• Facilitate default annuities.

• Promote education and disclosures.

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Longevity Annuities

– IRS proposal would relax required minimum distribution (RMD) rules for plans.

– Longevity annuities provide income stream for later in life.

• But RMD rules mandate start at age 70 ½.

– Proposed Regulations • Exception from RMD rules for longevity annuity investments.

• Limit investment to $100,000 or 25% of account.

• Must start no later than age 85.

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New Tax Rules Favoring Annuities

– Rollovers to DB Plans • Rev. Rul. 2012-4 • 401(k) accounts may be rolled over and converted to DB plan annuity benefits.

• Provides favorable annuity rates for participants.

– Relief for DC Plans With Deferred Annuities • Rev. Rul. 2012-3 • 401(k) plans typically exempt from onerous death benefit rules.

• Ruling confirms that 401(k) plans with deferred annuities can still avoid them.

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Default Annuities

– Should annuity option be default for plan?

– Possible Approach: Amend QDIA Rules • Permit annuity option to qualify as QDIA.

• Critics argue annuities not appropriate for all.

• Default annuity investments not easily reversed.

– Possible Approach: 2-Year Trial Period • Retirees receive annuity during trial period (unless they opt out).

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Education and Disclosures for Participants

– GAO Recommendations • Update DOL’s “investment education” guidance to cover decumulation.

• But DOL is concerned about conflicts.

• Guidance likely to restrict sales pitches.

– Lifetime Income Disclosure Act • Would require plan to show account balances as if converted into guaranteed monthly payments.

• Would also encourage participants to think about retirement paycheck for life.

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Summing Up

– Consensus emerging on lifetime income options.

• Proposal for longevity annuities to be finalized in near future.

• Recent IRS annuity rulings are plan-friendly.

• Guidance on decumulation education expected from DOL.

• But debate on use of annuities as QDIA likely to follow.

25 1.

Increasing Savings 2. Protecting Returns 3. Decumulation Planning 4. Tax Reform 5. Industry Groups

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Tax Reform

– Impact of Plan Contributions on Federal Deficit • $70.2 Billion Annually.

• $361 Billion 2011 – 2015.

– Plan Limitations That Can Be Reduced to Lessen Deficit • Annual Additions from All Sources - $50,000.

• Elective Deferrals - $17,000.

• Plan Sponsor Deduction – 25% Compensation of All Participants.

• Compensation Counted to Determine Benefits/Contributions - $250,000.

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Tax Reform

– National Commission on Fiscal Responsibility (20/20 Cap) – Lesser of $20,000 of 20% Compensation.

– Brookings Institution • Make All Employer and Employee Contributions Taxable.

• Refundable Tax Credit Deposited to Retirement Savings Acct.

– Obama Administration – 7% on Employer and Employee Tax Contributions for High Earners Only.

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State-Sponsored Plans for Private-Sector

– Secure Plan Proposal.

• Proposed by National Conference on Public Employee Retirement Systems.

• Provide coverage for employees of small employers.

• Seeks to benefit from economies of scale.

• Cash balance plan: 6% annual credits; minimum 3% interest credits.

• Funding shortfall would ultimately fall on states.

– Define Contribution Initiatives.

– Fiduciary Implications.

• Potential state liability for selection of investment alternatives.

• State must ensure that plan avoids prohibited transactions.

• Bonding.

• Administrative duties allocated between state and employer

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Harkin Universal Pension Proposal

– New retirement system proposed in “report” issued by U.S. Sen. Tom Harkin • Automatic and universal enrollment • Regular stream of income starting at retirement age • Financing through payroll system by employee contributions/government credits • Privately managed by new entities to be called “USA Retirement Funds” • Limited employer involvement and no fiduciary responsibility • Employees could increase/decrease contributions or opt out – Similarities to proposals for state-covered pensions of private-sector workers – Less likely to be enacted than Automatic IRAs

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Other Revenue Raisers

– Minimum Required Distributions to be Accelerated.

• Shrink Distribution Period for Inherited 401(k)s and IRAs.

• Administration want to waive MRD for small accounts.

– Limit or Eliminate Roth Conversions.

– Enactment of MAP-21 • PBGC premium increases for defined benefit pension plans under MAP-21 o Specific premium increases replace Administration’s proposal to allow PBGC Board to set o risk-adjusted rates Flat rate per participant premium increases from current $35 level to $42 in 2013 and $49 in o 2014, to be indexed for inflation in subsequent years Varriable rate premium per $1,000 of vested unfunded benefits increases from current $9 level to $13 (plus inflation) for 2014 and $18 (plus inflation) for 2015 • Defined Benefit Plan Funding Relief o Abnormally low interest rates increase funding requirements o MAP-21 adjusts rates upward if regular rate falls below 25-year average for interest rates, o resulting in lower required contributions If interest rates increase, larger plan contributions could be due

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Republican Reaction to Tax Proposals

– Republican budget does not directly address.

– Romney Campaign favors lower tax rates and broader base but no focus on retirement plans expenditure.

– Senator Hatch skeptical of changing current limits.

– Summing Up – Soak the rich schemes may defeat themselves.

– 20/20 Cap may be enacted.

– Consequences of lowered contributions • Private Retirement Plan System gets smaller • Reduced Role for Employers.

32 1.

Increasing Savings 2. Protecting Returns 3. Decumulation Planning 4. Tax Reform 5. Industry Groups

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Industry Groups

– Plan Services Industry • • ASPPA Spark Institute – Plan Sponsor Groups • • • ABC ERIC Chamber of Commerce – Investment Providers • • • ACLI ICI IAA – Social Policy Advocate • AARP • Pension Rights Center – Independent Research Organizations • EBRI

Thank you.

Marcia S. Wagner, Esq.

99 Summer Street, 13th Floor, Boston, MA 02110 Tel: (617) 357-5200 Fax: (617) 357-5250 Website: www.wagnerlawgroup.com

[email protected] 34 A0083724