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

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
The landscape for the pension industry is changing.  Unemployment, stagnant incomes, mountains of consumer debt and declining home equity have put the middle class under siege, and all sides in Washington acknowledge that action must be taken on a number of fronts to support this core group. 
One of the least understood threats to the middle class is an impending crisis in retirement for which so many are financially unprepared.  America’s retirement system is said to be a three legged stool consisting of Social Security, private savings and employer sponsored pension plans.  But each leg of the stool is wobbly, with the private pension system being particularly shaky. 
Under the current private pension system, half of all workers have no pension plan and, of those who do, only 20 percent have a plan that provides a guaranteed lifetime benefit.  401(k)-style plans have failed to deliver on their potential, not only because many workers lack access to them but also because savings rates are too low and management fees too high.  Further, volatile financial markets have reduced account balances which remain below their pre-recession levels.  Longer life spans stretch what savings there are even thinner.  The result is that less than half of American workers will have enough income to adequately maintain living standards in retirement.
Policymakers in Washington are aware of these problems and can be expected to focus on the need to increase retirement savings and ensure that those savings generate greater returns and are ultimately spent wisely.

3. Decumulation Planning Tax Reform Industry Groups
Increasing Savings
Protecting Returns
Decumulation Planning
Tax Reform
Industry Groups
Today’s discussion will focus on three areas where policymakers are likely to focus their attention:
increasing the savings rates,
protecting investment returns from hidden fees and conflicts of interests and encouraging participant-level advice, and
assisting participants with the decumulation phase of their retirement as they draw down their savings.
We will also address how tax reform and industry groups will influence the expected legislative and regulatory changes in these three areas.

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
Given the power of inertia, policymakers are betting big on retirement vehicles with automatic investment features. Under the authority of the Pension Protection Act of 2006, lawmakers have already blessed auto-enrollment for new participants, and even auto-escalation of contributions to 401(k)-style plans. As advisors and plan sponsors think of new ways to take advantage of these rules, we can expect regulators to weigh in on these matters and to provide new interpretive guidance. We can also expect them to tweak and modify the automatic enrollment rules, to motivate or otherwise encourage greater levels of automatic investments. And if there is a second Obama Administration, we can expect a real push for 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.
The IRS first approved the concept of using negative elections for 401(k) plan contributions in the late 1990s. The Pension Protection Act of 2006 then added a statutory basis for this tax feature, and it also created an ERISA safe harbor for the fiduciaries responsible for selecting the plan’s default investment. Although these rules created clear guidance to follow, many employer have decided to set their auto-contribution rates no higher than 3% of compensation, out of a concern that employees will opt out if contribution rates are set any higher. Fortunately, the PPA also created an incentive for businesses to increase these automatic contribution rates. In particular, the PPA created a 401(k) safe harbor design, giving plans a “free pass” from nondiscrimination testing, so long as the plan provides a qualifying matching contribution and set the plan’s automatic contribution level to 6% of compensation. A plan may also set its initial automatic contributions at 3%, and then increase it annually until it reaches the rate of 6%. The good news is that many plans have embraced auto-enrollment. But the bad news is that, despite the free pass from testing, many employers continue to set their default contribution rates at rates as low as 3% and have not embraced auto-escalation. This is especially unfortunate, in light of the studies showing that automatic escalation features are likely to significantly increase 401(k) balances, especially for low-income workers.  Moreover, surveys indicate that employees generally have a favorable view of these programs.

6. 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.
Typically, plans with auto-enrollment or auto-escalation features only cover new participants. In other words, incumbent employees are generally not subject to the plan’s negative election procedures. So that the plan’s automatic contribution features can help a broader group of employees, many advisors and plan sponsors are now beginning to consider “re-enrollment” features for their 401(k) plans. Under a typical re-enrollment program, all participants with low deferral rates are deemed to elect to defer a portion of their compensation, let’s say a 6% minimum, unless the participant opts out as of a particular date. Re-enrollments are a standard practice when changing recordkeepers, but a plan sponsor may decide to implement a re-enrollment on a one-time basis or even annually. In addition to a “re-enrollment”, advisors and plan sponsors are also talking about using negative elections for a “re-allocation,” where both new money and the existing account balance are transferred to the plan’s qualified default investment alternative or QDIA, unless the participant opts out. Re-allocations are typically performed with a re-enrollment, but a plan always has the option of implementing a re-allocation simply because its participants have allowed their investment elections to grow stale. In either case, re-enrollment and re-allocations are emerging features that can substantially increase plan contributions and optimize investment allocations and returns. We can expect the regulators, both the IRS and the DOL, to “bless” these practices and release appropriate guidance as they become more popular.

7. Automatic IRAs Legislative History Three Key Features
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.
The Obama Administration has included an Auto-IRA provision in its budget message for the last three years. This proposal has now become associated with the Democratic Party, obscuring the fact that, as recently as 2007, an earlier auto-IRA bill had been introduced in Congress by representatives of both political parties.  The Auto-IRA concept itself was jointly developed by conservative and liberal think-tanks and John McCain endorsed the idea during his Presidential campaign. Most people, it would seem, agree on the goal of increasing retirement plan coverage which is stuck at approximately 50 percent. In its fiscal year 2013 version, the Obama Administration’s automatic IRA proposal included three key features. First, the bill sets the default contribution at 3% of compensation.  Employees could raise or lower their contribution percentage, or they could choose to opt out entirely. Second, employees would have the choice of contributing to either a traditional pre-tax IRA or Roth IRA.  If no choice was made, post-tax Roth accounts would be the default vehicle, so that withdrawals would not be taxable.  This default rule addresses the likelihood that lower-income workers would be more likely to withdraw money before age 59½. Finally, the Auto IRA provider (a financial services firm) would be selected by the employer or the employer could allow each participating employee to designate the Auto IRA provider.  Another alternative would be to send all contributions to a savings vehicle specified by statute or regulation. The Treasury Department would prescribe a handful of standard, low-cost investment alternatives.

8. 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.
Despite consensus on the need for greater savings, the Auto-IRA proposal has elements that are problematic at either end of the political spectrum.  Republicans do not like the mandate, since it would require small businesses with more than ten employees, to offer Auto-IRAs. Even though no employer contributions would be required, Republicans believe that the mandated arrangements would be burdensome to employers.  Moreover, the prospect of a savings vehicle controlled by the Federal government (which has been featured in a number of versions of the Auto-IRA proposal) has also become a point of controversy.   On the other side of the aisle, some Democrats have given the various incarnations of the Auto-IRA proposal a lukewarm reception in light of the private sector’s potential role in managing Auto-IRA money.  At the moment, the prospect for legislative action on retirement initiatives, such as the Auto-IRA, is complicated by the high level of Congressional partisanship and policy gridlock.  This can be expected to continue in the short term until the balance of power is (hopefully) resolved by elections.  However, it should not be overlooked that Congress has traditionally dealt with retirement issues on a bipartisan basis.  This was true of the Pension Protection Act of 2006 in which the auto-enrollment concept for 401(k) plans was legislatively ratified. And it is possible that the mandate issue in the Auto-IRA proposal will be overcome by substituting a voluntary program coupled with larger employer incentives than are offered under the current proposal.

9. 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.
Summing Up.  Given the need to increase retirement savings, arrangements involving automatic enrollment, automatic escalation of deferrals and automatic investments are likely to be maintained and expanded.  The enactment of Auto-IRAs will be difficult in the short-term, but this may ultimately be an issue where pressure and concerns for the wellbeing of an aging middle class, force lawmakers to approve a measure on which they have reservations.  Auto-IRAs do not involve the expenditure of employer funds and, given the maximum annual contribution of $5,000 to such an arrangement, it will not detract form the desirability of establishing a qualified plan (which has far higher contribution limits)  by those employers that wish to do so.  Once funded, an auto-IRA will be owned and controlled by the employee, thereby eliminating the administrative responsibilities of the employer.  It may be too much to conclude that the Auto-IRA will have the same success as automatic 401(k) deferrals, but even if this is not the case, it would likely result in an appreciable increase in the number of Americans actively saving for retirement.

10. Decumulation Planning Tax Reform Industry Groups
Increasing Savings
Protecting Returns
Decumulation Planning
Tax Reform
Industry Groups
Now, let’s turn to policymakers’ efforts to protect and safeguard the investment returns of plan participants.

11. 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.
Introduction. In addition to increasing savings, policymakers are also working on a way to ensure that the amount employees are putting away in their retirement accounts, is generating an appropriate investment return. One of the areas of focus is the perceived problem of hidden fees in the 401(k) marketplace, which can significantly diminish investment returns over the long-term. There is also a concern that a lack of meaningful information is leading to poor investment choices by employees.  As articulated by the 2010 Report by the White House Task Force on the Middle Class, the Administration wants “to ensure that workers have good options to save for retirement, and to provide workers with all the information they need to make the best choices about their retirement savings.”  The comments of the Task Force reflect the fact that the Administration is already engaged in regulatory rulemaking in the following areas: (1) improving the transparency of 401(k) fees and investment options; (2) encouraging participant-level investment advice; and (3) broadening the scope of the ERISA “fiduciary” definition to cover more and more providers. Even if Congress does not pass major retirement legislation in this election year, a new regime is already underway as the Department of Labor’s proceeds with its rulemaking agenda.

12. 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.
Fee Transparency.  The Administration has stated that it wants to help plan sponsors and participants get a fair price for the services they purchase.  Consistent with this goal, the DOL has issued two sets of disclosure regulations. I’m sure you have all heard about the plan sponsor-level disclosures required under ERISA Section 408(b)(2), as well as the participant-level disclosures required under DOL Reg. 404a-5. The new 408(b)(2) rules are effective July 1, 2012, and all plan sponsors will need to receive comprehensive disclosures from their service providers concerning the hard-dollars and soft-dollars (such as 12b-1 fees) that they receive as compensation. These disclosures are designed to support the plan sponsor’s fiduciary duty to manage the plan’s fees, and to ensure that they understand the indirect or “hidden” compensation of providers. The new participant-level disclosures are designed to supplement the 408(b)(2) disclosures, and they go into effect on August 30, 2012 (for calendar-year plans). These rules require participants to receive charts with side-by-side comparisons of their investment options, as well as quarterly fee disclosures. The rationale for both sets of rules is that, if the 401(k) marketplace is to operate efficiently, both sponsors and participants must understand what they are buying and how much it costs.  The hope is that this will drive down fees, and recent press reports (in The Wall Street Journal) indicate this this is already happening. We can expect the DOL to fine-tune these rules in the year ahead.

13. 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.
Fee Litigation. The government’s efforts to mandate fee disclosures coincided with a wave of 401(k) fee litigation which began in In this wave, the plaintiffs in roughly 40 class action lawsuits claimed that plan fiduciaries had breached their duties by failing to monitor the indirect compensation paid to plan providers, resulting in the payment of excessive compensation in violation of ERISA. Trial courts were cautious in dismissing these cases before the plaintiffs had their day in court. The landmark case of Hecker v. Deere was a notable exception, where the court dismissed the case on the intellectual grounds that the marketplace efficiently regulated the price of plan services. The Hecker decision appears to have staunched the filing of new lawsuits. In the absence of this decision, the current 401(k) fee cases could have spawned thousands of copy-cat lawsuits on behalf of plans everywhere. Going forward, the new 408(b)(2) fee disclosures will force plan sponsors to monitor all compensation, both direct and indirect, which should eliminate 401(k) cases of this kind. But these new disclosures are likely to highlight conflicts of interest and compensation payments that were previously hidden, which may be used to support new theories of 401(k) litigation. In spite of the Hecker case, many parties have settled for significant amounts of cash. For example, General Dynamics settled their 401(k) case for $15 million, and the Hartford settled their case for over $13 million. Given the money involved and the ERISA expertise that the plaintiffs bar has developed, it is likely that the 401(k) fee litigation continue to evolve in the future.

14. 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.
Encouraging Participant Advice. The beauty of 401(k) plans is that participants get to make their own investment decisions, but many participants are unable or unwilling to make these decisions, and policy makers want to encourage providers to offer participant-level fiduciary advice. Unfortunately, ERISA prohibits many plan advisors from providing any fiduciary advice to participants. Given the nature of many 401(k) plan arrangements, the plan’s advisor often receives variable compensation from the plan’s investment options (such as variable 12b-1 fees). And variable compensation is effectively prohibited under ERISA, at least for fiduciary advisors. The DOL tried to provide some relief from this prohibition, when it finalized its new participant advice regulations on December 27, These regulations include a “computer model advice” rule, where an advisor can advise participants and receive variable compensation, so long as the advice is based on an objective computer model. They also include a “level fee for affiliate” rule, where the advisor continues to advise the plan sponsor for variable compensation, and the advisor’s affiliate advises the participants for a level fee. Despite the attention that the regulations have drawn, many plan advisors find them unhelpful, since they do not use computer models or rely on affiliates to service the same plan. However, given the principles outlined in the regulations, we can expect the DOL to work with the private sector on new ways to allow advisors to deliver fiduciary advice to participants, including class exemptions or even individual exemptions.

15. 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.
Broader Definition of Fiduciary Advice.   As part of its campaign to eliminate conflicts in the 401(k) industry, the DOL wants to expand its regulatory definition of who is an “investment advice fiduciary.”  The original proposal was withdrawn in September 2011 in response to heavy criticism but will be re-proposed shortly. Under ERISA’s functional fiduciary definition, your actions control your status. You are deemed a fiduciary if you provide any “investment advice.”  For this purpose, the current regulation imposes a five factor test, two of which have particular relevance for advisors.  The first factor requires that there be a mutual understanding that advice will serve as “a primary basis" for the plan’s investment decisions.  The second factor stipulates that the advice be provided on a "regular basis."  Thus, in the 2007 case, Ellis v. Rycenga Homes,  periodic meetings between a broker and a plan trustee over the course of a 20-year relationship, which resulted in the plan’s consistently following the broker’s suggestions, led to the court’s holding that the broker was a fiduciary. Under the DOL's proposed rulemaking, however, an advisor would be deemed a fiduciary if there were any understanding that the advice "may be considered" in connection with the plan’s investment decision, even if it is not provided on a regular basis.  Thus, even one-time casual advice could trigger fiduciary status.  If the re-proposed regulations are similar to the original in this regard, many non-fiduciary advisors could, for the first time, find themselves subject to ERISA’s fiduciary standards.

16. 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.
Emerging Practices. As we’ve discussed, ERISA fiduciaries must not receive any variable compensation. But advisors who are not fiduciaries may receive variable 12b-1 fees and other similar types of compensation. However, the DOL’s proposal to broaden its “fiduciary” definition would create a fundamental problem for these advisors, since they would most likely be viewed as fiduciaries in the new regime. Plan expense accounts (also called ERISA budget accounts) may provide a solution to this problem. A plan expense account is typically funded with all or a portion of a recordkeeper’s indirect compensation. The account is then used by the plan sponsor for the benefit of the plan’s participants, including the payment of reasonable fees. Typically, these accounts are used by plan recordkeepers with “gross to net pricing” for their services. For example, a recordkeeper might state that its gross fee is $4,000, but that this amount will be offset by the $1,000 of indirect compensation that it receives (in the form of shareholder service fees from the plan’s mutual funds), resulting in a net fee of $3,000. Many recordkeepers are now using ERISA budget accounts not only for their own fees, but as a tool to levelize the compensation of advisors. Thus, expense accounts could be used to levelize the varying 12b-1 fees the advisor would otherwise receive from the plan’s funds. We expect to see interest in expense accounts grow in the near future, especially as the DOL moves ahead with its “fiduciary” definition proposal.

17. Summing Up Administration has launched initiatives. Pressure on Fees
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 .
Summing Up.  The Obama Administration has launched a series of regulatory initiatives designed to assist plan sponsors as well as participants safeguard their investment returns. Plan sponsors and participants will now automatically be provided fee disclosures, to help them sort through opaque fee arrangements.  However, in light of the fact that many participants remain ill-equipped to manage their retirement assets, the Administration has attempted to develop ways for plan advisors to deliver useful investment advice to participants.  But at the same time, the Administration is trying to push out the boundaries of fiduciary status in ways that could disrupt large segments of the financial services industry.  We expect these developments to put pressure on providers to develop levelized fee arrangements and to offer more cost-efficient products and services. We have already started to see downward pressure on pricing in the 401(k) market space as a result of these developments.

18. Decumulation Planning Tax Reform Industry Groups
Increasing Savings
Protecting Returns
Decumulation Planning
Tax Reform
Industry Groups
The third area where we expect to see more focused attention is assisting participants with drawing down their retirement savings after they retire. As you know, this has been labeled “decumulation planning” in the retirement plan industry.

19. 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.
Administration’s Goal.  While increasing the savings rate is a vital goal for purposes of addressing retirement security, the Obama Administration also views how people draw down their savings to be an equally important matter.  For this reason, it is particularly concerned with the risk that retirees will outlive their assets.  To mitigate this risk, the Administration wishes to motivate plan participants to annuitize all or part of their plan accounts.  Some in the government have described these types of plan-related annuities as providing a “retirement paycheck for life.”   But rather than mandating annuity payment forms in retirement plans, policymakers are looking for incentives to encourage plan sponsors to offer lifetime income options voluntarily.  Specifically, they wish to promote the use of longevity annuities, give participants the ability to roll over their 401(k) balances to a pension plan, and remove certain regulatory barriers in other areas to the use of annuities. They are also looking at disclosure rules to persuade participants to think about their retirement accounts as lifetime income streams and examining techniques that enable plan sponsors to use annuities as default investments.

20. 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.
Longevity Annuities.  The Treasury Department and the IRS have taken the first of what will be a series of actions to allow longevity annuities in tax-qualified retirement plans. On February 2, 2012, proposed regulations were issued relaxing the required minimum distribution, or RMD, rules to accommodate the use of longevity annuities in defined contribution plans.  A longevity annuity is an annuity product with an income stream that begins at an age later than normal retirement, such as age 80.  The market for such annuities is currently very small, but the Administration would like to see an expansion of their use because they allow retirees to self-manage a significant portion of their retirement assets until a relatively advanced age.  However, the deferred annuity would commence regular monthly payments at the elected age (e.g., age 80) and provide protection against outliving your retirement assets. The RMD rules presented an obstacle to the use of longevity annuities, because they generally require plan distributions to commence at age 70 ½ (rather than a later date consistent with the annuity starting date under a longevity annuity).  Under the proposed regulation, a plan or IRA investment in a qualifying longevity annuity would be exempted from the RMD rules.  To qualify, the annuity premium would have to be limited to the lesser of $100,000 or 25% of a participant’s account balance, and the starting date of the annuity could be no later than age 85.

21. New Tax Rules Favoring Annuities
Rollovers to DB Plans
Rev. Rul
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
401(k) plans typically exempt from onerous death benefit rules.
Ruling confirms that 401(k) plans with deferred annuities can still avoid them.
New Tax Rules Favoring Annuities.  The IRS has also released a set of Revenue Rulings (RR and RR ) to further encourage the annuitization of plan benefits. Unlike the proposed rules on longevity annuities, these rulings are effective right now. Revenue Ruling encourages employers to use their defined benefit plans as a way to offer lifetime income options for their employees’ 401(k) account balances. Specifically, if an employer sponsors both defined benefit and a defined contribution plans, participants may be permitted to roll over their 401(k) balance to the defined benefit plan, and convert it into a plan annuity. The advantage of this arrangement for participants, is that they can easily annuitize their 401(k) benefit at favorable rates (rather than the rates otherwise available in the retail marketplace). Revenue Ruling confirmed that offering deferred annuities in your 401(k) plan will not accidentally trigger the IRS death benefit rules. Under these rules, defined benefit plans must pay death benefits to a participant’s surviving spouse in the form of special type of annuity, unless the spouse opts out. 401(k) plans are typically exempt from these rules, as long as they provide for payment of the participant’s account balance to the surviving spouse. Before the Revenue Ruling was released, there was a concern that the spousal death benefit rules might apply to a 401(k) participant who invests in deferred annuities. The good news is that the IRS has clarified that they will not, eliminating another obstacle for plan sponsors that want to use deferred annuities.

22. 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).
Default Annuities.   The debate triggered by the Obama Administration’s lifetime income initiatives has also extended to how annuities may be used as a default investment in 401(k) plans. Proponents believe that using the power of inertia to help participants who are afraid to take action will achieve better accumulation and decumulation outcomes. One way to implement this regulatory change would be for the DOL to amend its QDIA regulations, which currently limit the liability of 401(k) plan sponsors who default participants into a qualifying default investment alternative or QDIA. The tremendous increase in assets for target date funds illustrate how conferring QDIA status onto annuity products could result in a substantial flow of retirement assets into them. However, some observers have reservations about the appropriateness of using annuities as a default investment, given the fact that the needs of individuals tend to vary considerably during the decumulation phase of retirement. Some experts have been critical of default annuities, noting their inflexible nature and that default annuitization may not be easily reversed by participants (without significant economic cost). The Government Accountability Office, the watchdog or investigative arm of Congress, has also noted that, for some participants, default annuities may not be appropriate, given their health or other conditions. Proponents of default annuities have developed a proposal to offer default annuities over a two-year trial period, during which the retiree would receive monthly income unless the retiree opted and made an affirmative decision by the end of the trial period to take a lump sum.

23. 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.
Education and Disclosures for Participants.  The GAO has recommended that the DOL update its guidance on non-fiduciary “investment education”. The DOL’s guidance is designed to give employers and providers comfort, as well as relief from fiduciary liability, when providing investment assistance to participants. The GAO strongly believes that this guidance should be updated to give employers and providers the comfort they need to in order to provide participants assistance with the decumulation phase of their retirement. The DOL is likely to issue some related guidance in the near future. However, the DOL is also sensitive to the potential conflicts of interest that may result if providers are given the ability to highlight their annuity products.  Therefore, we can expect that any expansion of the current rules will come with restrictions on making sales pitches. In addition to regulatory action, we may also see the enactment of legislation, such as the Lifetime Income Disclosure Act, which would require 401(k) plan sponsors to inform participants annually of how their account balances would translate into guaranteed monthly payments. The goal of this legislation is to give participants an understanding of how much projected retirement income they can expect from their savings. It is also designed to encourage them to think about their accounts as potential lifetime income streams (or a retirement paycheck for life). 

24. 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.
Summary. Policymakers are starting to reach a consensus on how lifetime income options can be used to help participants manage the distributions they take from their plan accounts. The proposed rules on longevity annuities are likely to be finalized in the near future, and the IRS is already paving the way for annuities in 401(k) and other defined contribution plans, making them as plan-friendly as possible. We also expect to see guidance from the DOL in the near future, on how employers and providers can provide investment education on plan distribution options and we can expect some serious debate when the DOL finally proposes its standards for how annuities may be used as default investments in 401(k) plans.

25. Decumulation Planning Tax Reform Industry Groups
Increasing Savings
Protecting Returns
Decumulation Planning
Tax Reform
Industry Groups
We expect that tax reform will influence the impending changes in the three areas that we have discussed.

26. 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.
How Plans Affect the Deficit.  Legislators and policymakers know that the amount of tax revenue forgone on account of retirement plans is very large and this makes 401(k) plans an easy target for revenue raising initiatives. The Congressional Joint Committee on Taxation has estimated that annual tax expenditures for 401(k) plans, IRAs and Keogh plans amount to $70.2 billion, and the Office of Management and Budget has projected that foregone revenue attributable to 401(k) plan contributions for the period will be $361 billion.  Retirement saving through a 401(k) plan is tax-advantaged because the government generally taxes neither the original plan contributions nor the investment returns on those contributions until they are paid as benefits.  Since the budget process looks at revenues and expenditures within a ten-year window, and the payment of most retirement benefits occurs outside that window, the amount of taxes foregone because of 401(k) contributions tends to be viewed as a permanent expenditure.  As pressure builds to control the federal deficit, legislative proposals will be considered to reduce the tax cost of the retirement plan expenditure. 
 The tax code already contains various limitations on plan contributions that could be adjusted for the purpose of reducing tax expenditures (which, by the way, is another name for a tax increase).  For example, in the case of 401(k) plans, the maximum amount of annual contributions from all sources for any employee is currently $50,000, and the limit increases to $55,500 if the employee is at least 50 years old.  The limit on annual contributions includes elective deferrals by participants which themselves are capped at $17,000.  Another limitation subject to being reduced by legislation is the cap on the plan sponsor’s deduction for contributions to a 401(k) plan equal to 25% of the compensation otherwise paid during the taxable year to the plan’s participants. Further, compensation in excess of $250,000 cannot be considered in calculating contributions to a participant’s plan account. Over the years, Congress has raised or lowered these amounts depending on the needs of the time.

27. 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.
Competing Proposals to Reduce Deficit.  Reform proposals driven by fiscal concerns are illustrated by the December 2010 report of the National Commission on Fiscal Responsibility and Reform that recommended limiting the maximum excludable contribution to a defined contribution plan to the lesser of $20,000 or twenty percent of income.  This proposal, which covers the exclusion from taxable income of employee elective deferrals, as well as nontaxable employer contributions, is sometimes referred to as the “20/20 cap.”  Under this formula, if you earn $100,000 per year, the most that can be put into your 401(k) account is $20,000.  The 20/20 Cap is hard on high earners.
 Other proposals are motivated as much by policy concerns as by deficit reduction.  William Gale of the Brookings Institution has designed a much-discussed mechanism to shift the demographics of those receiving the benefits of the retirement plan tax expenditure from a perceived slant favoring highly compensated employees.  Advocates of this approach argue that all employer and employee contributions should be included in gross income and that existing deductions and exclusions should be replaced with a flat-rate refundable tax credit to be deposited directly into a plan participant’s retirement savings account.  Under this proposal, contribution limits would not change. However, the refundable tax credit would benefit low earners at the expense of the more highly compensated.  Critics have noted that this would seriously diminish the incentive many employers have to maintain qualified plans.
 The Obama Administration’s FY 2013 budget also takes a crack at the 401(k) tax expenditure, although it is cloaked in a more general tax increase.  The Administration’s proposal would limit the tax value of particular tax deductions and exclusions to 28 percent of the specified item’s amount that would otherwise reduce taxable income subject to the highest tax bracket of 35 percent.  This is not an entirely new proposal; what is new is the inclusion of 401(k) contributions (as well as health care contributions), regardless of who makes them, in the list of affected tax exclusions.  Thus, a taxpayer subject to the top statutory rate of 35 percent would pay a 7 percent tax (35% - 28%) on the value of any 401(k) contributions.  Under this regime, those receiving the highest contributions to their 401(k) accounts could be subject to an additional $3,885 in tax liability.  Critics of the Administration’s proposal were quick to point out that it contains an element of double taxation in that the same plan contributions would be taxed again when withdrawn from the plan. 

28. 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
The National Conference on Public Employee Retirement Systems (NCPERS) has proposed amendments to ERISA and state laws allowing the establishment of state-sponsored multiple employer cash balance plans that would cover private-sector workers. The NCPERS proposal or ones like it are being considered by several state legislatures.
The target group that this proposal seeks to benefit consists of employees of small employers that do not have access to pension plans. Several states have considered proposals to establish 401(k) or IRA-based arrangements for private-sector workers on the assumption that they would benefit from a state’s greater bargaining power, experience and expertise, but to date none of these proposals have been enacted, presumably because of the significant start-up costs and questions about how such arrangements would comply with the various reporting, disclosure and fiduciary rules of ERISA, although Massachusetts has passed such legislation and is in the process of implementing it.
The NCPERS initiative, which it calls a Secure Choice Pension (“SCP”), is a new and bolder variation of prior proposals for state-run plans in that it entails a cash balance plan design requiring employer contributions to fund an annual salary credit of 6% of compensation plus minimum interest credits of 3% per year with potentially higher interest credits up to the yield on 10 year Treasury Bills plus 2%. Amounts contributed plus earnings credited to the participant’s account would be guaranteed, although the allocation and interest crediting rates can be adjusted prospectively to better reflect benefit and financial needs.
There is uncertainty as to how SCP plans would deal with situations where assets are not sufficient to fund the promised lifetime benefit. One possibility that is mentioned in this regard is cutting back benefits, but this would not seem to be realistic if employees have been led on by promises of state-backed guaranteed benefits. Lengthening amortization periods for funding purposes is another technique that is mentioned. Ultimately, however, the states will be subject to the unfunded liabilities of SCP plans. The possibility that responsibility for private-sector pensions would be shifted to taxpayers at a time when states are struggling to meet the demands of public employee systems is the major political weakness of the SCP proposal.

29. 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.
Increase PBGC Premiums by $16 billion over 10 years.
Other Revenue Raisers. The blockbuster proposals already mentioned are likely to encounter significant resistance from stakeholders in the current system. Smaller changes that raise revenue from retirement plans are low-hanging fruit and are, therefore, more likely to be enacted. Among these is the acceleration of required minimum distributions which currently are payable over a participant’s life beginning after age 70½. The RMD rules are designed to prevent taxpayers from deferring tax-favored retirement benefits. Already under consideration by the Senate finance Committee is a proposal to shrink the period over which a beneficiary inheriting a 401(k) or IRA account may receive it to five years after the death of the plan participant or IRA owner. At the same time, the Administration’s budget contains a provision for waiving the RMD rules when the aggregate value of a participant’s accounts does not exceed $75,000.
Reimposition of the income limitations on conversions to a Roth IRA is also under consideration in order to raise revenue, as is the possibility of eliminating such conversions entirely. Even though Roth conversions increase tax collections in the short-run, this change is being considered because of its long term consequences that have a negative impact on the fisc.
And, finally, the perennial concern about PBGC deficits is likely to result in increased PBGC premiums for defined benefit plans. The National Commission on Fiscal Responsibility and Reform recommended increases in both the flat-rate and variable rate premium, and the Administration would like to raise an additional $16 billion from this source over the next ten years. The Republican-controlled House, which is concerned about taxpayer bailouts, has signaled that it is not necessarily opposed.

30. 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.
Republican Position. Neither the Republican Party as an organization nor its major presidential candidates have a formal position on whether the current level of employer deduction and employee exclusions for 401(k) and other retirement plan contributions are sustainable. The Path to Prosperity, the Republican alternative budget for Fiscal Year 2012 fails to address the issue, as does the campaign literature of Mitt Romney who, in general, favors a broader tax base and lower personal and corporate tax rates. However, certain senior Republican officeholders, such as Senator Orrin Hatch, have issued statements expressing skepticism with respect to proposals that would reduce the maximum level of contributions because the current system is seen as having produced beneficial results.
Summing Up. Given its soak the rich flavor and the stalemate in the current Congress, there is probably little chance that the Administration’s proposal to include 401(k) contributions in the tax base for high earners will be enacted, although it does provide an alarming insight into the priorities of an Administration that wants to be seen as supporting retirement savings.  The more neutral 20/20 Cap seems to stand a better chance because its ostensible goal is limited to deficit reduction. The Administration’s tax proposal and other major tax reform proposals represent a fundamental reduction of the incentives for maintaining a qualified plan.  Such cutbacks in the tax incentives for retirement plans seem to be the order of the day and have the potential to reduce the role of employers and to shrink the system.

31. Decumulation Planning Tax Reform Industry Groups
Increasing Savings
Protecting Returns
Decumulation Planning
Tax Reform
Industry Groups
Finally, we know that industry groups will be lobbying to influence changes that might affect their interests in the retirement plan industry.

32. Industry Groups Social Policy Advocate Plan Services Industry
AARP
Pension Rights Center
Independent Research Organizations
EBRI
Plan Services Industry
ASPPA
Spark Institute
Plan Sponsor Groups
ABC
ERIC
Chamber of Commerce
Investment Providers
ACLI
ICI
IAA
Advocacy Groups.
 Legislation relating to the level of contributions to the private retirement plan system affects many stakeholders. Accordingly, trade organizations and other interest groups align themselves on one side or the other of proposals that would reduce its size.
 Retirement Plan Services Industry. Possibly the strongest advocate for maintaining the system, as is, is the American Society of Pension Professionals & Actuaries which represents retirement plan professionals. ASPPA’s position is that the private retirement plan system must be maintained and that cutbacks in contributions would be detrimental for the nation’s retirement policy. The SPARK Institute also represents industry professionals, with a membership consisting of practitioners from its banking, insurance, mutual fund, investment advisor, TPA and benefit consulting arms. The SPARK Institute is oriented to developing and promoting practical solutions to industry problems.
 Plan Sponsor Groups. The American Benefits Council and the ERISA Industry Committee are the preeminent organizations representing the interests of large employer sponsors. Their interests lie in supporting and strengthening the current system and, therefore, they can generally be expected to oppose cutbacks in the level of contributions and employer deductions. The U.S. Chamber of Commerce also defends the interests of the plan sponsor community.
 Investment Providers. A number of groups represent the life insurance industry, but perhaps the most active is the American Council of Life Insurers which represents 300 U.S. insurers that offer products to 401(k) and other retirement plans. The Investment Company Institute advances the interests of the mutual fund industry, and the Investment Adviser Association advocates on behalf of investment advisor firms registered with the SEC. Each of these groups opposes proposals that would impose new taxes and regulatory burdens on members of their respective industries but also has an interest in maintaining the size and health of private retirement plans.
 Social Policy Advocates. Certain groups with social policy interests, such as the American Association of Retired Persons and the Pension Rights Center frequently comment on retirement savings issues and generally favor consumer protection regulation of financial products. Because of its membership of 37 million persons, the AARP wields significant influence that is somewhat offset by the fact that the interests of members and leadership are not always perfectly aligned, as shown by the leadership’s wavering commitment to opposing cutbacks to Social Security and Medicare benefits. The positions of the Pension Rights Center are less ambiguous in that the group’s mission statement includes a call for required employer and employee contributions to retirement plans. Given its strong interest, in expanding coverage, it is not likely that the group would oppose, and would probably support, a reduction of current contribution and benefit levels.
 Independent Policy Groups. The Employee Benefit Research Institute is a nonpartisan Washington based organization engaged in public policy research and education on employee benefits issues. EBRI’s research and Congressional testimony have indicated that cutbacks in deductible contributions and elimination of the tax exclusion for employer contributions would have the effect of reducing the formation of new plans, as well as interest at all compensation levels in plan participation and, therefore, would be likely to seriously weaken the entire private plan system.
Summing Up. These groups will attempt to persuade legislators that the current levels of tax deductions and exclusions should be maintained or reduced based on the needs of the retirement plan system and of the nation as a whole.

33. Thank you. Marcia S. Wagner, Esq.
99 Summer Street, 13th Floor, Boston, MA 02110
Tel: (617) Fax: (617)
Website:
Neither Eaton Vance or The Marcia Wagner Law Group, is providing legal or tax advice as to the matters discussed herein. The discussion herein is general in nature and is provided for informational purposes only. There is no guarantee as to its accuracy or completeness. It is not intended as legal or tax advice and individuals may not rely upon it (including for purposes of avoiding tax penalties imposed by the IRS or state and local tax authorities). Individuals should consult their own legal and tax counsel as to matters discussed herein.
This presentation is being distributed with permission from The Wagner Law Group by Eaton Vance Distributors, Inc. 2 International Place, Boston, MA
Eaton Vance does not provide tax or legal advice. Investors should consult a tax or legal professional before making investment decisions.
Copyright Marcia S. Wagner, Esq Reprinted by permission. All rights reserved.