Thursday, September 11, 2014

IRS Verdict is in, But Buyer Jury is Out, on QLACs


The Internal Revenue Service took a needed step toward making delayed or longevity annuities a viable option for retirement savers, with its July issuance of qualifying longevity annuity contract (QLAC) final regulations.  This action will make it more attractive for savers to use retirement assets to purchase longevity annuities, which begin their payment stream at an advanced age, such as age 80 or 85.  The key to QLAC appeal will be the ability to exclude annuity contract costs from required minimum distribution (RMD) calculations, and the resulting taxation that generally begins at age 70 ½ .  Up to 25 percent of aggregate IRA and employer retirement plan accumulations – not to exceed $125,000 – can be used for QLAC purchase and still be excluded from the balances that will determine taxpayer RMDs.
The question no one is able to answer at this point is how attractive this investment option will be to those with assets accumulated in IRAs or employer plans.  It is a safe assumption that it will take time for interest to grow.  Longevity annuities are not actually a new product, but until now they did not offer the tax benefits provided by these final regulations. 

Another term some use for longevity annuities is “death insurance.”  If structured to begin payout at an advanced age and to last throughout the annuitant’s lifetime, he or she can be assured that they will not outlive these funds.  A valuable assurance to be sure.  Until now, longevity annuities have typically been purchased with nonqualified assets as part of a comprehensive financial plan intended to provide for an individual or a couple throughout their retirement years. 
At the risk of over-generalizing, it is likely that the buyer of a longevity annuity is a person of above-average wealth, able and willing to part with a substantial sum to purchase a contract whose promised return does not begin until at a date that may be 10, 15 or 20 years in the future.  The younger the buyer, the less expensive the longevity annuity, but the longer one will wait before seeing a return on the investment.  In some cases, depending on how a longevity annuity is structured, there could be no return if the annuitant dies and there is no residual payment stream guaranteed to a beneficiary.  Given these realities, the longevity annuity has understandably been a niche product to date.

The QLAC, after years of congressional and public policy advocacy for it, now offers the special tax incentive of excluding the purchase value from RMD calculations.  Will workers and younger retirees seriously consider this option?  How will it mesh with today’s qualified retirement plan environment?  Will QLACs be embraced, or remain a niche investment product that lacks the broad appeal its advocates have hoped for?
It’s no secret that there is a certain amount of hesitation on the part of plans participants and IRA owners today to annuitizing an IRA or retirement plan balance.  In an earlier time when defined benefit pension plans were common, a “promise to pay” was accepted with less hesitation.  But in today’s largely defined contribution world, in which I will include IRAs, there is greater reluctance to give up control of a large sum of money in exchange for a promise to pay.  Failures of insurance companies, the source of annuities, are not an everyday event.  But high-profile insurance company failures of the past, and the late financial meltdown that led us into the recent recession, have made many savers reluctant to give up control of their assets.  A longevity annuity that does not begin payments until well into the future may take some getting used to for a lot of savers.  Even in cases where this is an alternative that should be considered. 

In the employer-sponsored retirement plan realm, with the exception of defined benefit pension plans, most participants receive lump sum payouts.  The defined contribution plan world has to an increasing degree moved away from annuitized distributions.  If a QLAC is purchased under an employer plan the assets would essentially leave that plan when paid to an annuity provider, but continue to be accounted for as a plan investment in order to enforce the QLAC purchase limits.  It’s clear that shifts in both philosophy and logistics may be needed if QLACs are to make inroads in DC plans. 
For these reasons some feel that QLACs are most likely to gain initial acceptance as IRA investments.  This, in turn, has led to speculation as to whether there could be some “asset flight” from employer plans when a plan participant eligible for a distribution wants to purchase a QLAC when it is most affordable.  For many this will be while they are still in the work force. 
With QLACs, more so than many retirement issues today, the operative expression is “more to come.”

Friday, August 22, 2014

Happy Anniversary, ERISA!


Because summer is a popular time for weddings, it’s also a time of many anniversaries.  2014 marks an important anniversary that is unrelated to marriage but most certainly marks an important commitment to fidelity.  2014 is the 40 anniversary of the Employee Retirement Income Security Act of 1974, or ERISA as it has come to be known. ERISA is the statutory foundation for the regulation and rules that retirement plans must follow to qualify for the tax benefits employers receive when they offer qualified retirement plans to their employees. 

Given the amount of criticism that has been directed at the private sector retirement system recently, some might ask whether ERISA’s 40th anniversary is something to celebrate.  We can certainly find imperfections.  But when we judge something as complex as this body of law, we should view it not with the eye of a perfectionist, but the eye of a realist.  That’s not much different than having a reasonable perspective on interpersonal relationships.  If we’re looking for perfection we are likely to be disappointed.

Very few who are working in the retirement industry today were “in the business” in 1974, the year of ERISA’s enactment.  But an objective look at the state of retirement plans before that time leads to the inescapable conclusion that things have changed for the better.  There may be shortcomings in the implementation and operation of plans under the ERISA umbrella.  But these shortcomings generally have little to do with the intent of its provisions. 

Human weakness and error, intentional or inadvertent, can lead to such failings as unsatisfactory investment choices, inappropriate fees, conflicted investment advice, fiduciary abuses like diverting retirement assets for other business purposes; even such outright crimes as embezzlement.  But such miscarriages of ethics or justice should not unfairly taint the concept of ERISA retirement plans.  There will always be vultures, scavengers and scalawags looking for opportunities to enrich themselves at others’ expense.  That’s not the fault of ERISA. In fact, ERISA is the safeguard to prevent or address these failings.  And, at least in my opinion, ERISA has addressed these pretty well.

Some bemoan the fact that we do not have in place a national retirement program that ensures lifetime benefits to all American workers, benefits like those available to the fortunate minority with defined benefit plans.  As desirable as that might be, in the private sector there are competitive economic forces that play a huge role in determining what benefits an employer can provide to employees and still remain solvent.  And taxpayer funding of such a national program and the accompanying “mandate” is certainly not politically viable at this time.

ERISA has, without question, improved the retirement security prospects of American workers.  Prior to ERISA it was not unusual for profit sharing plans to require 10 or 15 years to reach full vesting, or for defined benefit plan vesting to be reached only at normal retirement age, or upon plan termination.  There were no controlled group rules to prevent abusive business structures that favored the delivery of retirement benefits to a limited group of owners or employees at the expense of others.

There also was no insurance program like today’s Pension Benefit Guarantee Corporation (PBGC) for defined benefit plan.  An example of the consequences of this was the 1963 closure of the Studebaker automobile plant in Indiana.  Its underfunded pension plan left thousands of workers with little, if any, retirement benefits.  There was also no EBSA to ensure that defined contribution plan fiduciaries met their responsibilities of fairness to rank and file employees. 

It was more than a decade – and numerous committees, commissions, surveys and reports later – when Congress finally acted.  Some believe that ERISA legislation only got the support needed for enactment when private businesses became fearful that the states would act individually, creating a patchwork of dissimilar rules that would have made compliance difficult.  Whether such support was motivated by generosity or self-interest, the result – ERISA – was a greater degree of predictability and equity than had existed before.

U.S. retirement plans are at a crossroads.  They are considered a federal budget luxury by some who are more concerned about their perceived impact on tax revenues than they are concerned about our citizens’ retirement security.  Conversely, they are considered by others to be not generous enough, and to provide insufficient guarantees of a dignified retirement. 

Those in the middle of this political and policymaking tug-of-war are most apt to appreciate today’s ERISA-governed retirement plans for the giant positive stride in employee benefits that they represent.   There is more work to be done to lead more Americans to a secure retirement.  But ERISA is the path that has taken us a long, long way toward a highly desirable destination.

Monday, August 4, 2014

Dudenhoeffer Dust Will Take Time to Settle


The U.S. Supreme Court has spoken.  In a June, 2014, decision the Court held in Fifth Third Bank v. Dudenhoeffer that fiduciaries of a retirement plan designed to offer employer securities – an ESOP – are not entitled to a special presumption of prudence in offering employer securities as plan investments.  Specifically at issue was whether such a plan’s fiduciaries are duty-bound to restrict or remove such an investment option when the employer’s financial health is in question, and the value of its securities may be in doubt.
In the background behind the ESOP specifics of this case was the broader issue of whether offering employer securities in any qualified plan should be presumed to be prudent.  Under such a presumption, referred to as the “Moench presumption” for the case after which it is named, the burden of proof that offering employer securities is inappropriate rests with the plaintiff alleging a fiduciary breach.  But, not only did the Court rule that plans designed to offer employer securities have no special presumption of prudence, it rejected the Moench presumption out of hand.  This finding is contrary to several Appeals Court rulings that supported in principle such a presumption of prudence.    

Some have seen the Supreme Court’s ruling as a blow to fiduciaries of plans offering employer securities, expecting a rash of new stock drop lawsuits.  We, as consultants and as retirement plan recordkeepers, have already been asked by some plan sponsors how they might gracefully and in a compliant, participant-friendly manner remove employer securities as plan investments.  Although the selection of prudent investments is clearly the province of a plan’s fiduciaries, we would caution plan sponsors not to react in knee-jerk fashion and blindly remove what might be a prudent option from its investment lineup.
A close look at the Court’s ruling may conclude that it actually raised the bar and made it more difficult for stock drop cases to be brought successfully.  The Court stated in its opinion that it would not be enough for a plaintiff to allege that a fiduciary armed with publicly available information should have recognized that the employer securities being held and offered to participants were over-valued.  To successfully bring a cause of action a plaintiff would also have to plausibly present that

 - a fiduciary could have acted on its knowledge of the business’s solvency and its securities’ value – for example ceasing to offer, or liquidating, plan investments in employer securities – without  violating insider trading laws, and

 - a prudent fiduciary in the same circumstances would not have viewed such actions as more likely to harm the investment fund than to help it; meaning, that market reaction to the fiduciary’s investment changes could actually cause the value of existing investments to drop, to the detriment of participants holding those investments.
Some ERISA litigation analysts are of the opinion that these will be formidable obstacles for a plaintiff, or a class of plaintiffs, to overcome in order to prevail in a stock drop lawsuit.  It will be no surprise if we initially see a spike in the number of lawsuits alleging impropriety in offering employer securities as plan investments.  But it may be that only when lower courts have applied the standards in the Supreme Court’s opinion that we can draw conclusions about the prospects for the success of such litigation in the future.  

Wednesday, July 2, 2014

Be Cautious of Offers to Pass the Fiduciary Buck


The term “fiduciary” is certainly one of the lightning-rods of these times in our industry.  In a period of intense scrutiny of the management and operation of retirement plans, and the arrangements between plans and those who provide services to them, to be a fiduciary is to be under a regulatory and legal microscope.  One need look no further than the dockets of our district and appeals courts, or the news releases published by the Department of Labor (DOL), to conclude that a great deal of time and energy go into policing retirement plans.  Unfortunately, even the most honest and well-intentioned plan administrators and service providers can be exposed to lawsuits or regulatory sanctions for outcomes seen as or alleged to be damaging the interests of benefit plan participants.  And, when the layers of the legal or regulatory onion are peeled away, “fiduciary” is as often as not at the core.
The most high-profile regulatory event of these times is the effort by the DOL’s Employee Benefits Security Administration (EBSA) to issue regulations defining who should be considered a fiduciary with respect to retirement plans, and the standards to which they will be held.  These regulations have several times been delayed, and it is unclear when, or if, they will ultimately be issued.  But, with or without such regulations, the mandates of the Internal Revenue Code and ERISA, and the eagerness with which lawsuits alleging fiduciary breaches are filed, already are enough to make potential plan fiduciaries uneasy. 

Given the demonstrated responsibility and related risk in being a fiduciary to a retirement plan, it’s not too surprising that some enterprising individuals and companies are offering themselves as solutions to this risk.  And, also not surprising, some employers, fearful of the risks accompanying fiduciary status, are listening.  They recognize that they don’t necessarily understand their obligations and responsibilities and the prospect of insulating themselves from risks involved in administering a retirement plan is appealing.  And in many cases, a course of action that results in the plan fiduciary hiring an expert is in the best interest of both the fiduciary and plan.  This said caution and understanding on the part of the plan fiduciary is still needed.
The most aggressive of these fiduciary service marketers propose to transfer all employer fiduciary risk to themselves by the delegation of certain functions that may include plan administration, investment management or a combination thereof.  With all fiduciary obligation for those functions lifted from the employer’s shoulders, they claim, the employer can focus on making their enterprise successful, rather than on the sometimes-indecipherable details of employee benefit administration. 

The marketing pitch is likely to contain official-sounding references to one of several classes of fiduciary, and tout the level of protection – even immunity – that the fiduciary service provider can give the employer.  But, whether the marketer presents itself as a 3(16) fiduciary, a 3(21) fiduciary, a 3(38) fiduciary, or what-have-you, there is one inescapable fact that often times you will not see prominently advertised.  While a service provider can take on fiduciary liability by the tasks it performs, the employer is always ultimately responsible for fiduciary decisions.  That’s because it is under the employer’s ultimate fiduciary authority that entities such as investment managers, third-party administrators, or those who only perform ministerial functions, and all who serve the plan, are chosen.   The employer is ultimately responsible for the providers they appoint to fulfill these roles and has an ongoing obligation to monitor the actions of each provider.  While use of experts to fulfill these roles is often a prudent course of action for the plan fiduciary, they must always remember that their fiduciary obligation doesn’t end with this appointment. 
When you dig deeper into the fine print of some of these fiduciary promotions you will typically find disclaimers.  These disclaimers, when interpreted with only a modicum of legal expertise, make it all too clear where the buck stops. It stops with the employer.  It is imperative that an employer understand exactly what is being provided and any limitations when choosing to use these types of fiduciary services.  All else being equal, an employer will be in better hands working with an administrator or service provider that acknowledges an employer’s fiduciary risk – and will help limit it through good services and administration and in some cases may even assume some of that risk – rather than someone who proposes to eliminate it all and doesn’t provide the entire fiduciary story.

Monday, June 23, 2014

Recordkeeper Consolidation Would Not Mean Falling Skies


A recent article appearing in the retirement industry press made a bold, but not necessarily accurate, statement about the consolidation of qualified plan recordkeepers and the services they provide.  First, the assertion that “rising technology costs, lower fees and increased intellectual capital needed to remain competitive” will lead to consolidation, and will reduce the total number of retirement plan recordkeeping service providers.  That much may very well prove to be true.  The bold statement came next, claiming that this consolidation “will result in higher fees and worse service.”
Beyond the obvious question of how the competitive need for lower fees and increased services will eventually result in higher fees for less services – those two contrary claims were made in consecutive sentences – there are other reasons to question the article’s pessimistic prediction.  Technology, and the costs associated with it, have certainly come to recordkeeping.  Investing retirement plan assets has become extremely sophisticated in a mostly daily-valuation environment, and the overall volume of transactions and plan-to-participant interactions has grown exponentially.  The idea that these things can be done efficiently and cost-effectively by manual means, or with simplistic technologies, is no more valid than believing that the evening news should be shot on film, rather than digitally.   Better technology has its price.

But in many, many cases where advancing technology has been applied, we can point to greater capability and lower prices, not less service and greater expense.  Smart phones, computers, robotic manufacturing, even the early assembly line process dating back to the time of Henry Ford, are examples of the quality and cost benefits of applying new technologies to a product or service. 
Another implication of the article is that the only way providing recordkeeping services can be profitable is if the provider has another product to sell, such as – for example – proprietary investments.  Believe it or not, there are recordkeepers in the marketplace who run profitable businesses without cross-selling anything, just as there are fee-for-service investment advisors who make a living without being compensated in other ways.  Neither model is wrong.  But I believe it’s inaccurate to state or imply that only by selling another product or service can recordkeepers serve the industry well, or remain in business.

From my observations, consolidation within the recordkeeping industry should not be seen as a sky-is-falling development.  Conscientious recordkeepers will continue their commitment to offering the best product they can, at a price that generates a reasonable profit, but is also fair to plans and their participants.  If they do less, someone will see the obvious opportunity and take their business. This dynamic will continue to govern the recordkeeping industry, as it has, whether the quality recordkeeper has many industry peers, or few.

Monday, June 9, 2014

EBSA May Be Listening After All … We Hope


Many seasoned industry professionals will remember an iconic TV commercial of some three decades ago, produced for the E.F. Hutton brokerage firm.  In this ad, when the broker shared his insights, the world around him came to a frozen-in-time standstill, in order to hear what he had to say.  The theme was: “When E.F. Hutton talks, people listen!” 
I don’t want to suggest that when representatives of the Department of Labor speak, the world comes to a complete halt and gives them undivided attention.  But when the subject is one which is as controversial as proposed regulations on a definition of “fiduciary” for retirement arrangements, the effect is similar.  Assistant Secretary of Labor Phyllis Borzi, of DOL’s Employee Benefits Security Administration (EBSA), had a captive audience when she spoke on this subject at the International Foundation of Employee Benefit Plans’ Washington Legislative Update in early May. 

In her comments, Ms. Borzi seemed to show a mixture of accommodation with a hint of impatience.  She acknowledged that her agency has slowed the pace of completing new proposed regulations to define “who” and “under what circumstances” an advisor or investment representative should be considered a fiduciary with respect to retirement assets.  Promised August issuance of these proposed regulations appears now to have been reset, in order to – we are told – obtain more input from the industry and interested parties.  In fact subsequent to this May presentation, the agency’s updated Semiannual Agenda of Regulations now lists a target date of January 1, 2015.  At the same time, however, Ms. Borzi was quoted as saying that “We’re not going to wait forever.”  It is apparent this is a high priority for Ms. Borzi and one she intends to see come to pass as quickly as possible. 
It is not entirely clear whose hand is actually on the throttle with respect to these new regulations.  Ms. Borzi has been EBSA’s “point man,” champion, and spokesperson for them since an earlier version was released in 2010, then withdrawn in 2011.  Yet she indicated in her recent comments that new DOL Secretary Thomas Perez would give the order on when to issue the new proposed regulations.  Adding more uncertainty is the fact that this is a mid-term election year, when control of the Senate and House of Representatives – really the national balance of political power – is up for grabs.  In a foretaste of the political season to come, already we see legislation being introduced in Congress that appears to be primarily intended to expose the opposing party to negative publicity, and provide campaign advertising fodder in the fall campaigns.  If the party now in the White House comes to view the proposed fiduciary definition regulations as a potential political liability, we can be almost certain that they will languish until after the November elections.  The  release of the regulatory agenda seems to indicate that is exactly what has happened.

Many in the industry fear that if EBSA overreaches in its new proposed regulations, advisors who are concerned about a level of responsibility out of proportion to their roles – and potential litigation – will be unwilling to advise and consult.  It is feared that if this happens, retirement savers – particularly IRA savers – may find themselves underserved or abandoned when it comes to badly needed investment guidance.  We do not doubt Ms. Borzi’s sincerity or good intentions.  Many simply disagree on the point where agency oversight and regulatory action and investor hand-holding could tip the balance from helpful to harmful, and leave retirement savers the losers in the bargain.  Taking the time to balance all the facts and to get this right seems to be the prudent course of action. 

Friday, May 23, 2014

Thoughts on “Decoration Day”


Given the pace at which we live our life these days, it’s pretty easy to let the distinctions between the different holidays become blurred.  We often find ourselves seeing holidays as just a break from time in the office, an extra-long weekend to spend on our favorite pastimes, an opportunity to focus on things other than work, or – less exciting, perhaps – to make progress on projects. 
If there is one holiday that we should not let that happen to, it is Memorial Day.  It’s a day to remember the sacrifices that others have made for us.  Ultimate sacrifices, to put a finer point on it.  As is often said of those who have served, “all gave some, some gave all”.  In honor of those who have paid that price, this blog will depart from its normal retirement plan focus and look at what this holiday means. 

There are probably few who are younger than the baby boom generation that will recognize the term “decoration day,” and even those of this generation that do recognize it, likely does so only because their parents or grandparents may have called it by that now-archaic name.  Memorial Day was, in fact, first known as Decoration Day when it was recognized as a national holiday following the American Civil War.  It was a day, traditionally the last Monday in May, when family members and others put flowers on the graves of soldiers, both Union and Confederate, who died in what many consider the event that most defined us as a people and a nation.  In other words, they "decorated" the graves in memory and recognition.  Since those early days the title changed and Memorial Day has officially become a day to honor and remember all who have made that ultimate sacrifice while in military service. 
Many Americans have no idea or have forgotten how close our country came to being two countries, rather than one, a century and a half ago.  There is no way to properly envision or comprehend what two divided Americas might not have accomplished in shaping the world as it now exists.  In particular, helping as we did to save our world from dark forces that rejected individual freedoms and sought political and military domination.  We are by no means a perfect nation.  We have made our mistakes and have our flaws.   But in our balance of imperfection and good intentions, our commitment to self-determination and individual liberties stands out and we can be proud of most of what we have come to stand for to the rest of the world.

The sacrifices a century and a half ago that affirmed us as a united people have been demonstrated more than once, in world wars and in other conflicts, but also in peaceful things, made possible by the common purpose that was a byproduct of our unity.  Creating an international forum in which nations can attempt to resolve their differences, striving and working for equal opportunity and personal dignity for our citizens, exploring the universe beyond the confines of our own sphere, and many other accomplishments, are a legacy of sacrifices both before and since the first Decoration Day. 
As a nation and a people we are not inclined to dwell on gloom and loss, the emotions that must have accompanied the first Decoration Day.   We’re inclined to look toward the future through the lenses of optimism and confidence.  Maybe that is why Memorial Day as we celebrate it in our era is a time for smiles and laughter, appreciating our families and friends, as well as for remembering the sacrifice and loss of those who have served and insured our freedom.

And after this welcome holiday is over, a time to get back to working toward a worthy and secure retirement for us all.