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
Increasing Savings
Protecting Returns
Decumulation Planning
Tax Reform
Today’s discussion will focus on three areas where policymakers are likely to focus their attention:
increasing 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 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 blessed auto-enrollment for new participants, and even auto-escalation of contributions to 401(k) plans. 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. 
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. 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 regulators, both the IRS and DOL, to “bless” these practices and release appropriate guidance as they become more popular. The courts have already done so in the Bidwell case, where reallocation to the plan’s QDIA safe-harbor was upheld.
From the second Obama Administration, we can expect a real push for Automatic IRAs.

5. 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. Auto-IRA would be mandatory for all employers with at least 10 employees if they do not maintain a pension plan. Since eligibility is defined as employees who are at least 18 years old with 3 months of service, most employers will need to modify their plans or have an Auto-IRA plan in addition to a 401(k) plan. 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.

6. 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 and may not be Constitutional.  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 the President and the Congressional leadership. 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.

7. 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.

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

9. Introduction
Policymakers focusing on protection for investment returns.
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. 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 Middle Class 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 though Congress did not pass major retirement legislation in the past election year, a new regime is already underway as the Department of Labor proceeds with its rulemaking agenda.

10. 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 became effective July 1, 2012, and all plan sponsors must 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 plan fees, and to ensure that they understand the indirect or “hidden” compensation of providers. The new participant-level disclosures were designed to supplement the 408(b)(2) disclosures and went into effect 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.

11. 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.
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. However, the recent case of Tussey v. ABB, Inc. shows that a plan sponsor will be held liable if it does not use information from required disclosures to negotiate competitive fees. Going forward, the new 408(b)(2) fee disclosures will force plan sponsors to monitor and benchmark 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.

12. 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.
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 effective 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. 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.

13. Proposal to Broaden “Fiduciary” Definition
ERISA’s Functional Definition
If fiduciary advice provided, fiduciary status arises. A 5-factor test.
It is 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
It is fiduciary advice if it may be considered for plan decision.
One-time, casual advice may trigger fiduciary status.
Re-proposed definition pending.
Effect of Expanded Definition
Fiduciaries may not receive variable fees.
Plan expense accounts – levelize fee arrangements.
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.”  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.  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.
Emerging Practices. ERISA fiduciaries must not receive any variable compensation. The DOL’s proposal to broaden its “fiduciary” definition would create a fundamental problem for many financial 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. 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.

14. 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.

15. Decumulation Planning Tax Reform
Increasing Savings
Protecting Returns
Decumulation Planning
Tax Reform
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.

16. 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.

17. Removing Regulatory Obstacles to Annuities in Plans
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.
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.
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. 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 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.
New Tax Rules Favoring Annuities.  The IRS has released a set of Revenue Rulings to further encourage the annuitization of plan benefits; 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 a 401(k) plan will not accidentally trigger the IRS death benefit rules applicable to defined benefit plans.

18. 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.

19. 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). 

20. 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.

21. Decumulation Planning Tax Reform
Increasing Savings
Protecting Returns
Decumulation Planning
Tax Reform
We expect that tax reform and proposals for systemic transformation will influence the impending changes in the three areas that we have discussed.

22. 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
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. 
We will now review proposals that (i) focus on deficit reduction and tax reform or (ii) make larger systemic changes that will change how we all do business.

23. 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
Tax Code Contribution Limits. The tax code already contains various limitations on plan contributions that could be adjusted from their 2013 levels for the purpose of reducing tax expenditures and raising revenue.  For example, in the case of 401(k) plans, the maximum amount of annual contributions from all sources for any employee is $51,000, and the limit increases to $56,500 if the employee is at least 50 years old.  The limit on annual contributions includes elective deferrals by participants which themselves are capped at $17,500.  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 $255,000 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. For example, the last major tax reform effort in 1986 reduced elective deferrals from $30,000 to $7,000.

24. 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 - 7% Tax on Employer & Employee Contributions
• High Earners Only
20/20 Proposal.  Reform proposals driven by purely 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.
Brookings Proposal. 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.
Obama 7% Tax. The Obama Administration’s FY 2013 budget also took a crack at the 401(k) tax expenditure, although it is cloaked in a more general tax increase.  The Administration’s proposal limits 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 this 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.

25. 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
NCPERS Proposal. 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 covering 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. The assumption is that they would benefit from a state’s bargaining power, experience and expertise.
The NCPERS Secure Choice Pension (“SCP”) initiative is a bolder variation of prior proposals for state-run plans (involving voluntary contributions to DC 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. Although employer participation would be voluntary, withdrawal liability would be assessed on terminating employers as under a multiemployer plan.
There is uncertainty as to how SCP plans would operate 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 may not be realistic if employees have been promised state-backed benefits. Extending 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 a major political weakness of the SCP proposal.

26. 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
California Secure Choice. In September 2012, California enacted an auto-IRA program to be administered by the state in which employers with 5 or more employees and no other retirement plan will be required to participate. Employees are automatically enrolled and contribute 3% of pay unless they opt out. There is a state-guaranteed investment return. Contributions will be pooled and invested by investment managers selected by the state which may end up being CALPERS. Implementation of the program is conditioned on receiving an IRS ruling that contributions will be pre-tax and DOL approval that the program is not an ERISA plan.
Other States. In Massachusetts, 2012 legislation authorizes the state treasurer to create a multiple employer defined contribution plan that will receive contributions from non-profit employers employing fewer than 20 persons as well as from their employees. The plan will be managed by the treasurer separately from the state’s public-employee pension fund and will allow employees to direct the investment of their accounts from an investment menu selected by the treasurer. The Massachusetts legislation requires the treasurer to obtain IRS approval of the plan and to ensure that it complies with ERISA.
According to the National Conference of State Legislatures, Connecticut, Illinois, Maryland, Michigan, New York, Pennsylvania, Rhode Island Washington State, Vermont, Virginia, and West Virginia have also considered pension legislation for private-sector employees, although in some cases such proposals only authorize study of the matter and in others the proposals were defeated or tabled.

27. Pension System Reform: Federal Level
New retirement system proposed in “report” issued by U.S. Sen. Tom Harkin
Automatic and universal enrollment required by employers that do not offer a plan
Regular stream of income starting at retirement age
No lump sum withdrawals
• Financing through payroll system by employee contributions/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
Text of bill expected in 2013
To help prepare workers for paying basic retirement expenses, Senator Tom Harkin has proposed a new universal retirement system built around the following principles:
  (i) automatic and universal enrollment,
(ii) a regular stream of income starting at retirement age,
(iii) financing through the current payroll system by employee and employer
contributions and government credits, and
(iv) management by privately-run, licensed and regulated entities
established pursuant to the legislation.
Although expected shortly, there is, as yet, no specific legislative proposal implementing these principles, but it is understood that the pensions to be paid would be based on a participant’s total contributions supplemented by investment performance and government credits for low-wage earners. Participants would be allowed to increase or decrease contributions or to opt out of the system entirely. The proposal is intended to appeal to employers by relieving them of any fiduciary responsibility, although employer participation is mandatory if the employer does not already offer a plan with a minimum level of employer contributions and some level of employer matching contributions to the new plans will be required. The Harkin initiative bears a similarity to current proposals being considered by state legislatures under which state governments would sponsor hybrid defined benefit-type plans covering private-sector workers, except that the new managing entities, dubbed “USA Retirement Funds”, take on the role of the state government in managing investments.

28. Systemic Reform - Other Proposals
Unitary Defined Contribution System espoused by John Bogle, Vanguard founder
Consolidation of all retirement savings programs
Federal Retirement Board controls system
°Limit distributions and loans to prevent system leakage
°Limit number of investment options concentrating on low-cost funds
• ERISA fiduciary standards extended to service providers / money managers
Spark Institute Universal Small Employer Retirement Savings Program
• Eligibility limited to employers with fewer than 100 employees
• Pre-approved prototype
°Auto-enrollment and escalation of contribution levels
°No discrimination testing
°Contribution limits lower than 401(k) but higher than IRA
• Investment options to meet specific criteria
• Recordkeeping/5500 performed at service provider level
Bogle’s Unitary System. John Bogle, Vanguard’s retired founder, has for some years advocated a unitary defined contribution system whose twin goals would be to eliminate counter-productive speculation (in contrast to long-term investing) and to prevent premature leakage from the system by means of distributions and loans. To achieve these ends, the current array of retirement savings programs (including 401(k) and 403(b) plans and IRAs) would be consolidated and brought under the control of a Federal Retirement Board. The function of this board would be to limit investment choices to simple low-cost investments (e.g. index funds) and to severely limit loans and distributions prior to retirement. Retirement savings would continue to be tax-deferred, and low-cost annuities would be a mandatory offering into which some portion of a participant’s account balance would be deposited at retirement. Under this system, ERISA’s fiduciary standards would be extended to plan providers, including money managers. Bogle’s idea is to tame the influence of financial middle men and divert some of their profits to the retirement system, but it does not attempt to expand the retirement system to employees working for small employers who arguably lack access to retirement savings vehicles.
Spark Institute USERSP. Focusing on the under-served market of small employers, the Spark Institute has proposed a Universal Small Employer Retirement Savings Program (“USERSP”) for employers with fewer than 100 employees. USERSP features include automatic employee contributions and continued escalation with a participant opt-out. The simplified and pre-approved prototype plan receiving these contributions would not be subject to discrimination testing but would have lower contribution limits than regular 401(k) plans, although higher than IRAs so as to encourage small employers to establish new plans. However, unlike the NCPERS and Harkin proposals, the USERSP program entails no mandatory employer contributions.

29. Systemic Reform – Other Proposals (cont’d)
Proposals by Academics
• Teresa Ghilarducci (The New School)
- eliminate current tax breaks and use savings to make 5% contribution to all
employees
- mandatory contributions and guaranteed investment return equating to defined
benefit approach, supplementing Social Security
- participants in existing plans could continue in such plans if contributions are 5%,
no early withdrawals, mandatory conversion to annuity on retirement
- people not in employer plans would be mandated into Guaranteed Retirement
Accounts (“GRAs”) with mandatory 2.5% employer and employee contributions;
investments pooled and professionally managed to reduce fees.
• Meir Statman (Santa Clara University) – mandatory employer and employee
contributions but investment controlled by account owner equating to defined
contribution approach, like the current British and Australian retirement structures.
To preserve assets within the system, there are no plan loans and hardship distributions would have to meet strict standards. Investment options could be chosen by either the employer or service provider, but, in either case, would be required to meet specified minimum requirements for broad based investment choices. Recordkeeping and Form 5500 reporting would be performed at the service provider level, eliminating employer responsibility for these tasks.
Proposals from Academia. Professor Teresa Ghilarducci would eliminate existing tax breaks for retirement plans and use the savings to subsidize a 5% contribution on behalf of all employees to retirement accounts serving as a universal supplement to Social Security. Participants in existing employer-sponsored plans could continue such participation if the plan met more stringent standards, such as a contribution rate of at least 5%, a ban on early withdrawals, and conversion into an annuity at retirement. Anyone without an employer plan would automatically be enrolled in a Guaranteed Retirement Account to which employees and employers would each contribute 2.5% of pay. The government would then provide everyone a modest tax credit to offset the employee contributions. The return would be guaranteed by the government at a rate approximating the growth rate in gross domestic product. Individual accounts resulting from this system would be pooled and professionally managed for fees anticipated to be lower than on conventional retirement accounts.
Professor Meir Statman (in a yet to be published paper) is calling for a system that is similar to the current British or Australian retirement structure, with mandatory participation and contributions from both employers and employees. Unlike Professor Ghilarducci’s program, there is no guaranteed benefit level under Statman’s proposal and payout depends heavily on individual investment decisions.

30. 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
The private pension system is under pressure and may be significantly transformed either through tax reform seeking to reduce retirement savings incentives or through more direct efforts to transform the character of the system to a European statist model.
Reaction to Tax Reform Proposals. Current tax incentives encourage employers to offer retirement plans on a voluntary basis and encourage individuals to save for retirement. Analysis by the Employee Benefits Research Institute projects that if this support is cut back under the 20/20 proposal so that maximum deferrals cannot exceed $20,000 or 20% of income, reductions in 401(k) balances at retirement will result at all levels of the income spectrum. It turns out that tax incentives are important for low-wage earners as well as higher-paid employees which may be why there was broad support for last year’s Gerlach-Neal bipartisan House resolution recognizing the impact of tax-deferral status for retirement savings.
Accordingly, there is a sense that the Administration’s proposal to limit tax exclusions (including 401(k) contributions) as a general matter may be gaining traction, since it does not specifically identify which deductions are being curbed and politicians cannot be attacked for targeting the retirement system. However, the end-result of a general limitation on exclusions will also jeopardize retirement security by reducing the amount employees save each year and shrinking the system. Congressional Democrats are probably more amenable to such a cutback than their Republican peers because of the perception that high wage earners derive a proportionately greater share of the tax expenditure benefit, although the fiscal cliff negotiations indicate that positions can quickly change. Nevertheless, certain senior Republican officeholders, such as Sen. Orrin Hatch, have expressed skepticism regarding proposals that would reduce existing contribution levels, because the current system is seen as having produced beneficial results.

31. 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 ……
Reaction to Systemic Reform Proposals. Advocates of centralization who distrust financial markets recognize the deficit reduction debate as a once-in-a-generation opportunity to enlarge the role of government in the retirement benefits arena with the ultimate goal of eliminating the role of employers, except as a funding source. The issue is often framed as one of providing access to retirement savings vehicles by low-paid workers of small employers which may be seen as a laudable goal, although these employees have always had the ability to establish IRAs on their own. Generally speaking, the various state and federal proposals provide for auto-enrollment, mandate employer contributions and either create government responsibility for funding shortfalls or establish a guaranteed minimum return. Creating such entitlements will result in the formation of interest groups that will lobby for benefit enhancements and extending the scope of these programs. Government influence in choosing investment managers or its outright control of investments (e.g., by commingling private plan assets with state pension funds) has the potential to drive many investment providers out of the retirement industry.
The state-sponsored initiatives raise an additional problem in that a multitude of state-backed retirement programs covering the private-sector workforce, each with its own unique rules, has the potential to break down the nationwide uniformity in pension laws that was achieved by the 1974 enactment of ERISA. To the extent that they remain subject to ERISA’s fiduciary standards, state programs will need to be careful to avoid engaging in prohibited transactions and will also need to establish the appropriate balance of how much administration will be performed by the state and how much, if any, responsibility will be allocated to employers.

32. Thank you. Marcia S. Wagner, Esq.
99 Summer Street, 13th Floor, Boston, MA 02110
Tel: (617) Fax: (617)
Website:
A PPT