The Politics of Retirement A Washington Update Marcia S. Wagner, Esq.

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.

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

Increasing Savings Thru Automatic Features

• Pension Protection Act of 2006 • Auto-Enrollment • Auto-Escalation • Plan Sponsor and Advisor Initiatives • Re-Enrollment • Re-Allocation • Automatic IRA push by Administration • Key Features ◦ Default contribution rate set at 3% ◦ Employees to choose pre-tax traditional IRA or after-tax Roth ◦ Multiple alternatives available for selecting Auto IRA provider

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 .

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

Introduction

• Policymakers focusing on protection for investment returns.

• Regulatory Agenda – Improving fee transparency.

– Encouraging participant-level advice.

– Broadening “fiduciary” definition.

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 expected to drive down fees.

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.

• Tussey v. ABB, Inc. – Plan sponsor held liable for excessive fees.

• 408(b)(2) Fee Disclosures – Will force plan sponsors to monitor and benchmark all compensation – May support new theories of 401(k) litigation.

– Monetary settlements to date have been significant.

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.

• DOL expected to work with private sector in providing exemptions.

Proposal to Expand “Fiduciary” Definition

• ERISA’s Functional Definition.

– If fiduciary advice provided, fiduciary status arises. 5-factor test governs.

– Constitutes fiduciary advice only if it is a

primary basis

for plan decisions and given on

regular basis

.

– Ellis v. Rycenga Homes.

• DOL’s Initial Proposal.

– Constitutes fiduciary advice if it

may be considered

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

for plan decision.

– Re-proposed definition pending.

• Effect of Expanded Definition.

– Fiduciaries may not receive variable fees.

– Plan expense accounts – levelize fee arrangements .

◦ 2013 DOL Opinion holds that typical expense account does not violate ERISA prohibited transaction rules.

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.

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

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.

Removing Regulatory Obstacles to Plan 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.

– Investment capped at $100,000 or 25% of account.

– Must start no later than age 85.

• 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.

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).

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.

• DOL 2013 Proposed Rulemaking would require benefit statements to include: ˗ Participant’s current account balance and balance projected to retirement; and ˗ Lifetime income streams derived from account balance and projection.

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

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

Tax Cost of Retirement Plans

• Impact of Pan Contributions on Federal Deficit – $70.2 Billion Annually – $361 Billion 2011 – 2015 • Tax Reform • Pension System Reform

Tax Reform

• 2013 Plan Limitations that Can Be Reduced to Limit Deficit: – Annual Additions from All Sources - $51,000.

– Elective Deferrals - $17,500.

– Plan Sponsor Deduction - 25% Participant Compensation.

– Limit on Compensation Base to Determine Benefits/Contributions - $255,000.

• Obama FY 2014 proposed $3 million cap on aggregate lifetime contributions.

− Cap to vary based on age.

− Double tax if prohibited amount not withdrawn.

Tax Reform (cont’d)

• National Commission on Fiscal Responsibility.

• 20/20 Cap: Limits Contributions to Lesser of $20,000 or 20% Compensation.

• Brookings Institution.

• Tax All Employer and Employee Contributions.

• Refundable Tax Credit Deposited to Retirement Savings Account.

• Obama Administration proposals to raise revenue. • 11.6% tax on employer & employee plan contributions.

• High earners only.

• Basis adjustment for extra tax.

• • Repeal of dividends paid deduction for ESOP sponsors.

$25 billion in PBGC premium increases.

Pension System Reform: State-Sponsored Initiatives

• Secure Plan Proposal by National Conference on Public Employee Retirement Systems • State sponsored cash balance plans for private-sector ° 6% annual credits ° Minimum 3% interest credits • Participation voluntary but withdrawal liability assessed on terminating employers • Seeks to benefit from economies of scale • Funding shortfall would be state responsibility

•

Pension System Reform: State Sponsored Initiatives (cont’d)

California Secure Choice Retirement Savings Program − Mandatory payroll deduction auto-IRA program ° Auto enrollment at 3% unless employee opts out ° Required for enterprises with 5 or more workers if no current plan ° State chooses investment managers ° Guaranteed rate of return − Signed by governor but implementation subject to IRS and DOL approval • Other State Initiatives − Massachusetts enactment of defined contribution multiple employer plan for non-profits − At least 11 other states said to be considering plans for private-sector employees.

Pension System Reform: Proposals at Federal Level

• • USA Retirement Funds proposed by Sen. Tom Harkin Sen. Harkin issues “report” in July 2012 that proposes new retirement system: Automatic and universal enrollment required by employers with no plan.

Regular stream of income starting at retirement age.

No lump sum withdrawals.

Financed by employee contributions through payroll & government credits Privately managed investment by new entities called “USA Retirement Funds ”.

Limited employer involvement and no fiduciary responsibility.

Unspecified level of required employer contributions. Employees can increase/decrease contributions or opt out.

• • Similarities to proposals for state-covered pensions of private-sector workers.

• Would include enhancements to Social Security.

Text of bill expected in 2013.

Pension System Reform: Proposals at Federal Level

• SAFE Retirement Act proposed by Sen. Orrin Hatch – Starter 401(k) Plans • Up to $8,000 participant contributions annually • • Reduced administration and no discrimination testing Auto deferrals from 3% to 5% – Government sponsors may adopt SAFE Retirement Plan • Annual purchase of fixed annuities for participants • Insurers to be selected by bidding process • Improve funding and security but pays smaller benefits – Restores jurisdiction over prohibited transactions to IRS

Summing Up

• Significant Transformation of Private Retirement System Possible.

• 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

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 ……

Marcia S. Wagner, Esq.

A101432 99 Summer Street, 13 th Floor Boston, MA 02110 Tel: (617) 357-5200 Fax: (617) 357-5250 Website: www.wagnerlawgroup.com

[email protected]