Transcript ERISA Section 408(b)(2) Fee Disclosures: Impact on Broker

IMPORTANT PENSION CHANGES
–
WASHINGTON & REGULATORY
UPDATE
Marcia S. Wagner, Esq.
Transformation of Retirement System

DOL Interaction with White House

DOL rollouts in 2012 & 2013:
◦ Working with White House’s Middle Class Task Force
◦ Coordinated actions to improve retirement security
◦ Fee disclosures for plan sponsors
◦ Participant-level fee disclosures
 New 6-month reset of annual disclosure date
◦ Participant investment advice

2014 / 2015 DOL regulatory initiatives include:
◦ Tips on selection of target date funds
◦ Inclusion of lifetime income streams in benefit statements

Global Impact of ACA & Tax Reform Purposes.
◦
Unforeseen changes to retirement system
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Introduction
 1.
Target Date Funds
 2. Lifetime Income Initiative
 3. Tax and Healthcare Reform
3
Background on Target Date Funds

Popular default investment vehicle for 401(k) plans.
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Typically, formed as open-end investment
companies registered under Investment Co. Act.
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Defining characteristic – “glide path” which
determines overall asset mix of fund.
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Performance issues in 2008 raise concerns,
especially for near-term TDFs.
◦ Based on SEC analysis, average loss for TDFs
with 2010 target date: -25%.
◦ Individual TDF losses as high as: -41%.
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DOL Tips for Selecting a TDF
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Start process by examining TDF prospectus
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Identify Plan objectives
◦ Preservation of savings
◦ Maximizing income
◦ Stable retirement spending
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Relate TDF characteristics to plan objectives
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Investment performance
Fees & expenses
Glidepath
Landing point
Document decision-making process
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Understanding the Glidepath and
Landing Point
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Determine Fund’s relative allocation to equities and
fixed income investments
◦ Starting point
◦ Landing Point

Determine rate of conversion
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“To” or “Through” investment philosophy
◦ Significant equity allocation through death matches plan
with gradual withdrawal pattern
◦ Most conservative fixed income position at landing point
matches plan where most participants cash out at
retirement
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Consideration of Demographic Factors
in Selecting a TDF
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Consider alignment of TDF with the
following factors:
• Withdrawal patterns
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Participant ages and likely retirement dates
Participation in DB plan
Salary levels
Turnover rates
Contribution rates
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TDF Investment Strategy
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Identify TDF asset classes other than equity & fixed
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Real estate with capacity to address inflation risk
Commodities
Inflation-adjusted bonds (TIPS)
Cash
Know investment style
◦ Passively vs. actively managed
◦ Impact on fees
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Understand investment form
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Mutual funds
ETFs
Collective trust
Separately managed account
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Customized Target Date Funds
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Advantages of custom TDF
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Incorporation of plan’s core funds
Inclusion/exclusion of specialized asset classes
Broader asset diversification
Diversifying exposure to investment providers
Improved investment performance
Flexible glidepath design
Elimination of tiered mutual fund fees
Disadvantage
◦ Generally higher fees
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Monitoring TDF Modifications &
Performance

ERISA prudent process requires periodically
monitoring TDF characteristics
◦ Management team
◦ Investment strategy
◦ Effective implementation of strategy
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Periodically review whether TDF continues to meet
plan objectives and demographics

TDF changes or mismatch may require replacing
fund
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Check underlying funds/investments
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Employee Communications for TDFs
Participant-level disclosure requires annual comparative
chart and disclosure of plan-related fees
 DOL proposed enhancement to comparative chart requires
appendix for TDFs
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◦ Explanation & graphic illustration of TDF glidepath
◦ Relevance of date in TDF name (e.g., 2030)
◦ Statement that TDF may lose money near or after retirement
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DOL proposed change to QDIA notice
◦ Same as required on appendix to comparative chart
◦ TDF investment objectives and principal strategies
◦ Assets held by TDF/QDIA and historical investment performance
◦ Disclaimer as to performance
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No DOL model notice
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Target Date Fund – Role of Advisors
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Provide meaningful TDF disclosures to
participants as “best practice” right now
◦ Explain key information
 Glidepath
 Landing point
 Potential volatility
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Facilitate sponsor’s prudent review of TDF
◦ Assist in fiduciary review of glidepath, tiered
funds structure, underlying funds & risk
 Special review of TDFs with near-term (2015) target date
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 1.
Target Date Funds
 2. Lifetime Income Initiative
 3. Tax and Healthcare Reform
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Goals of Policymakers
 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
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Permit longevity annuities
Remove regulatory hurdles
Facilitate default annuities
Promote education and disclosures
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Lifetime Income Solutions for DC
Plans
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Three Basic Approaches
1) External Solution (Outside of Plan)
2) Distribution Option Within Plan
3) Investment Vehicle Within Plan
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External Solution
• Participants purchase IRA Annuities.
• Annuitization occurs outside of plan through
rollovers.
• Internet portals can improve participant access.
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“In Plan” Lifetime Income Solutions
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Distribution Option Within Plan
• Plan purchases Distribution Annuities
• Immediate annuity purchased at time of
distribution
• Annuity contract is distributed to participant
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Investment Vehicle Within Plan
◦ Plan invests in Group Annuity
◦ Offers various investment and distribution options
◦ Participant’s account converted to lifetime income
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Comparison of Retirement Income
Strategies
Guaranteed
Income?
Systematic Withdrawals
Managed Payout
Distribution Annuities
Group Annuity (Traditional)
Longevity Insurance
GLWB (Group Annuity)
No
No
Yes
Yes
Partial
Yes
Access to Cash
In Retirement?
Yes
Yes
No
No
Partial
Yes
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Guaranteed Living Withdrawal
Benefit (GLWB)
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Guaranteed Withdrawal
 Guaranteed percentage of “Benefit Base” may
be withdrawn annually during retirement years.
 Guarantee takes effect when account’s
investment value is insufficient to cover
guaranteed withdrawals.
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Benefit Base
 Initial value is based on contributions.
 Future value may “roll up” by fixed percentage
each year, or “step up” based on anniversary
value of account.
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Need for Additional Fiduciary
Guidance
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Selection of Annuity Provider and
Annuities
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Subject to ERISA fiduciary standards.
Must act in accordance with duty of prudence and
loyalty.
Existing DOL Guidance
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1995 guidance on Distribution Annuities for DB plans.
2008 safe harbor on Distribution Annuities for DC plans.
No clear guidance on other annuities for DC plans.
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Current Fiduciary Standard for
Annuities
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DC Plans and Lifetime Income
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Lack of clear guidance has not stopped DC plan
sponsors (e.g., United Technologies adds GLWB annuity
option)
Selection of Annuity Provider and Annuities
• Subject to ERISA fiduciary standards.
• Act in accordance with duties of prudence and loyalty
• 2008 DOL safe harbor on Distribution Annuities for DC
plans:
1. Procedural prudence
2. Cost
5. Seek expert advice
2. Insurer’s ability to pay
4. Draw appropriate conclusions
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First Step in Annuity Selection
(Procedural Prudence)
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Engaging in Objective, Analytical Process
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Prudence of fiduciary act is based on process
Must conduct appropriate investigation of annuity
investment
Documentation of Selection Process
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Maintain minutes of fiduciary reviews
Records for ongoing monitoring
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2nd Step for Annuity Selection
(Insurer’s Ability to Pay)
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Obtaining Sufficient Information
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Insurer’s experience and expertise
Level of capital
Ratings
Contract’s structure and benefit guarantees
Protection through state guaranty associations
DOL Proposal
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Proposed amendment to DOL safe harbor
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3rd & 4th Steps for Annuity Selection
(Cost and Appropriate Conclusions)
 Considering Annuity’s Cost
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Cost considered in relation to benefits and services.
Evaluate fees, commissions and other charges.
No requirement to select cheapest annuity.
Drawing Informed Conclusions
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Conclude insurer will be able to make future
payments.
Conclude annuity’s cost is reasonable.
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5th Step for Annuity Selection
(Seeking Expert Advice)
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Necessity of Hiring Expert
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Must hire expert if plan fiduciary cannot properly
evaluate annuity providers, contracts and costs.
Procedure for Hiring Insurance Advisor
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Investigate advisor’s qualifications.
Identify advisor’s compensation.
Provide complete information to advisor.
Ensure reliance on advisor’s advice is reasonable.
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Removing Regulatory Obstacles to
Annuity Distributions
 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
◦ Ruling confirms 401(k) plans with deferred
annuities can avoid onerous death benefit rules
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Promoting Longevity Annuities
 New
IRS regulation relaxes required minimum
distribution rules
◦ RMD rules mandate start at age 70 ½ but
longevity annuities provide income stream for
later in life
 Final
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Regulation provides:
RMD exception for investment in QLAC
Investment in QLAC capped at $125,000 or 25%
of account
QLAC payments to start no later than age 85
Applies to annuity purchases on/after July 2,
2014
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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 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
◦ Plan to show account balances converted into
guaranteed monthly amount
◦ Encourages participants to think about retirement
paycheck for life
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DOL Proposal for Lifetime Income
Disclosures
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Advance Notice of Proposed Rulemaking
 Lifetime income illustration in participant statements
 Must provide estimated income streams based on
(1) current account and (2) projected account at
NRA
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Safe Harbor for Projected Account
 Assume 7% investment return
 Assume current contribution level, with 3% increase
 Use 3% discount rate to convert to current dollars
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Lifetime Income Illustration
• Illustration for 50-Year Old Participant
Account Estimated Monthly
Balance Lifetime Payment
Current Account (2014)
$125,000.00
Projected Amount (2029)
$500,000.00
Projected Account (Current Dollars) $321,000.00
$ 700.00
$1,800.00
● Required Disclosures/Disclaimers
- Explanation of assumptions
- Estimates are not benefit guarantees
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 1.
Target Date Funds
 2. Lifetime Income Initiative
 3. Tax and Healthcare Reform
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Administration Initiatives to Increase
Retirement Savings Through IRAs
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Administration pushing automatic IRAs featuring:
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3% default contribution rate
Choice of traditional pre-tax IRA or after-tax Roth
Multiple alternatives for selecting IRA provider
Government designated default investments
MyRA Initiative
◦ Starter program does not require legislative
authorization
◦ Contributions to Roth accounts
◦ Permits small investments ($25 / $5)
◦ Low rate of return from Treasury bonds
◦ Maximum $15,000 balance
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Limiting Tax Cost of Retirement Plans
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Impact of retirement plans on federal deficit
◦ DC / 401(k)
• $61 billion (2015)
• $414 billion (2015 – 2019)
◦ DB
• $42 billion (2015)
• 235 billion (2015 – 2019)
Tax reform
Pension system reform
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Limiting Contributions & Benefits
•
2014 Plan limitations that can be reduced to limit deficit:
◦ Annual additions from all sources - $52,000
◦ Elective deferrals - $17,500
◦ Plan sponsor deduction - 25% participant compensation
◦ Compensation limit to determine benefits/contributions $260,000
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Proposed Tax Reform Act of 2014
− Freezes DC limits until 2024
‒ $63.4 billion revenue gain over 10 years
‒ Additional $144 billion from treating half of 401(k)
deferrals as Roth
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Administration Tax Proposals
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Obama FY 2015 proposed $3.2 million cap on
aggregate lifetime contributions
• Cap to vary based on age.
• Double tax if prohibited amount not
withdrawn
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Obama proposal limiting tax deductions for
plan contributions
• 11.6% tax on employer & employee plan
contributions
- High earners only
- Basis adjustment for extra tax
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Pension System Reform - Federal Level
USA Retirement Funds
• USA Retirement Funds proposed by Sen. Tom Harkin in 2014
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Harkin “report” in July 2012 proposes new retirement system
- Automatic/universal enrollment required by employers
with no plan
- Regular stream of income starting at retirement age
- No lump sum withdrawals
- Financed by employee payroll contributions &
government credits
- Privately managed investment by new entities:
USA Retirement Funds
- Limited employer involvement; no fiduciary responsibility
- Unspecified level of required employer contributions.
- Employees can increase/decrease contributions or opt
out.
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Pension System Reform –
State Proposals
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State-managed plans for private-sector workers
◦ Intended to expand access to retirement saving
◦ States would mange investments
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California Secure Choice
◦ Mandatory auto-IRA
◦ Pooled investments managed by state and
guaranteed returns
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NCPERS Proposal
◦ State managed investment and guaranteed returns
◦ Exposure to lifetime benefit obligation
 Backstopped by taxpayers
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Summing Up
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Significant Transformation of Private Retirement System
Possible.
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Tax Reform.
• Reducing tax incentives will shrink system.
° Lower contributions at all income levels result if tax
exclusions cut back.
• Obama proposal for general limit on benefit from tax
exclusions.
° Does not focus directly on 401(k) contributions.
° Provides political cover.
° Same effect on contributions as direct cutback on
excludible amount
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Summing Up (cont’d)
− Systemic Changes
• Intended to create access for low-wage employees
• Government will replace private employers in system
°Mandated benefits
°Guaranteed benefits and/or investment results
°Creation of new interest group to lobby for expansion of benefits
°Government influence in choosing investment managers or control of
investments could drive many out of the retirement industry.
• State-level programs may cause breakdown in uniformity of pension laws,
effective since enactment of ERISA
• Inflection Point regarding the types of Retirement Schemes Nation wants
and needs
• Interesting Times ……
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Effect of PPACA on Employees
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Earlier plan distributions, because employees will not be
tied to their jobs in order to maintain health insurance
◦ New investment and liquidity strategies needed
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Older generation of workers to be replaced more quickly by
younger less experienced employees
◦ Lower salaries will result in smaller plan contributions
◦ Some industries could experience higher pay and larger
contributions
◦ New generation will be less vested making plans less expensive
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Low-paid workers will choose health insurance over 401(k)
contributions
◦ ADP/ACP problems and issues with discrimination testing may
result
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Effect of PPACA on Employers
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PPACA-mandated healthcare benefits likely to reduce
level of employer support for 401(k) plans
◦ Knock on effect of smaller match; smaller employee contributions
◦ Shrinking employee contributions exacerbates discrimination
issues
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PPACA disincentive to maintain 401(k) plan
◦ $3000 per head penalty for unaffordable health insurance avoided if
cost of single-person coverage not in excess of 9.5% W-2 wages
◦ 401(k) reduction of wages makes avoiding penalty harder
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PPA 90-day rule for health plan availability can
compromise overall plan administration
◦ Delay greater than 90 days for entry into all benefit plans no
longer possible
◦ May necessitate enrollment at different times
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PPACA Effect on Retirement Industry
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Increased competition in healthcare marketplace
◦ Government-regulated exchanges
◦ Reduced brokers’ commissions
◦ Potential expansion of healthcare brokers into retirement
plan industry
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New legislatively-mandated retirement plan models
◦ Reduces/eliminates role of employer
◦ Marketing focus redirected to employees
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IMPORTANT PENSION CHANGES
−
WASHINGTON & REGULATORY
UPDATE
Marcia S. Wagner, Esq.
99 Summer Street, 13th Floor
Boston, Massachusetts 02110
Tel: (617) 357-5200 Fax: (617) 357-5250
Website: www.wagnerlawgroup.com
[email protected]
A0128703.PPTX