Monday, April 11, 2016

Final Fiduciary Regs Pack Less Than Hurricane-Force Punch

I’ve never directly experienced a hurricane.  But on Tuesday April 5th, the day before the Department of Labor (DOL) officially issued its final fiduciary regulations, I found myself imagining what it would be like to stand on a coastal beach and watch an approaching vortex of hurricane-force wind and surf about to make landfall; right where I stood.  Sometimes a fertile imagination can be too much of a good thing.

Fortunately, the final rule and accompanying prohibited transaction exemptions issued by DOL appear to be less disruptive and destructive than many thought they would be, compared to the 2015 proposed rule and exemptions.  Whether this came about through inherent reasonableness within the DOL (did I really say that?), or out of fear of lawsuit or possible congressional action, is unclear, and matters little.  DOL did move the “burden” needle considerably.  Some have gone so far as to say that DOL “caved” to the pressure of opponents, and modified their guidance to the point that it lacks sufficient teeth.  I think that’s an overstatement.  But the fact that both proponents and opponents of the guidance have quibbles with the final product may be an indication that DOL found a palatable – if not applause-worthy – middle ground. DOL appears to have listened to the many written comments and the public testimony given between the April 2015 release of the proposed rule and the close of the final comment period last September.  I’ll share some examples, most of them positive.

Apart from actual content, many worried about having adequate time to adapt to the guidance after it was issued as final.  As the saying goes: “timing is everything.”  Based on the 2015 proposed regulations, many expected that compliance would be required within eight months of issuance.  Happily, that is not the case.  Although EBSA has made the guidance technically “effective” 60 days after publishing in the Federal Register, or June 8, 2016, there is a much longer period before having to actually operate within the confines of the final rule and accompanying exemptions.  As of April 10, 2017, investment firms and advisors will be governed by the conduct and disclosure rules.  A transition period from that date to January 1, 2018, will apply to a central pillar of the guidance, the best interest contract, or BIC.

The BIC creates a contractual agreement between advisors and their firms and the recipients of investment guidance.  Without going into its fine points here, it is an agreement that contractually places the interests of the investor above those of the compensated advisor, chiefly when advisor compensation may vary based on investments chosen.  A signed contract was intended to enforce placing the investor’s interests first.  Under the proposed rule this applied to ERISA plans and to IRAs and non-ERISA plans, as well.  In any situation where compensation might vary depending on investments chosen, or in distribution, rollover or transfer advising situations, the purpose of a signed contract was to enforce impartiality and fiduciary behavior.  Happily, ERISA plans were excluded under the final guidance from the need for a signed contract, DOL recognizing that ERISA already provides statutory remedies for fiduciary misbehavior.  IRAs and non-ERISA plans do not have this legal recourse, so the signed contract approach of BIC was intended to provide just such an enforceable remedy.  But the principles of the BIC, including the disclosure of potential conflicts, and procedures to safeguard against investor harm, apply in all these cases.

There are several additional changes to BIC that will simplify compliance for those firms that will use it and must meet its requirements.  Essentially any investment can be offered if the principles of BIC are met, rather than the limited investment types identified in the proposed rule.  In those cases where a signed BIC document must be executed, such as in an IRA rollover situation, contract execution can be part of an account opening process, rather than before the very first syllable of an advising communication! Existing advisory clients for whom a BIC arrangement should be in place can be handled on a negative-consent basis, without the need for a new “please sign this” interaction. Also, the need for initial one, five and 10-year projections, and annual disclosures, were removed as BIC requirements, significantly reducing the administrative and record-retention burden of the BIC as initially proposed.

Another favorable step back from the proposed rule concerns advising situations where the recipient can be expected to have enough investing expertise to recognize the difference between a sales pitch and impartial, “best interest” advising.  In the proposed rule it was termed a “carve-out,” an activity that would not be considered investment advice.  If an advisor was making investment recommendations to an ERISA plan covering 100 or more eligible participants, or a plan with $100 million or more in assets, it would be presumed that the plan representative receiving the recommendations would take them at face value, as an informed fiduciary would.  Under the final rule the 100 participant element has been discarded, and the asset threshold reduced to $50 million, allowing this exclusion to apply to many more plans. 

Great concern with the proposed rule stemmed from the stance on investment education and educational materials.  While the proposal recognized the value and non-advice nature of information on general investment and asset allocation principles, it had prohibited the mention of actual investments available in a retirement plan.  The final rule reverses this and allows an asset allocation model to include actual plan investments, but these must be official designated investment alternatives (DIAs) within the plan.  Unfortunately, there may be other investments in a plan that would be advantageous for a participant or beneficiary, but these cannot be modeled.  Worse, asset allocation modeling for an IRA investor may not include actual investments, on the grounds that there is no independent fiduciary to review and select investment choices that could or should be included in such modeling.  This is a genuine missed opportunity, and a potential handicap for IRA investors

It is worthy of mention that Health Savings Accounts (HSAs) and Coverdell Education Savings Accounts (ESAs) are covered by this guidance to the same extent that IRAs are.  There has been little mention of this in either the media or in the guidance itself.  The statutory tracing rules take us there, and advisors should be aware of this, inasmuch as some investors who are maxing-out in other savings vehicles are also saving in HSAs, with little intention of spending down the accounts in the near-term.  These investors are availing themselves of more sophisticated investments when their balances warrant it. 

More could be said about specific provisions of the final fiduciary rule and its associated exemptions.  But the point to be made here is that proposed guidance that appeared potentially unworkable, may – when all is said and done – have been transformed into a final fiduciary framework the industry can possibly live with.  More to come on this industry changing topic. 

Monday, March 7, 2016

IRS “Future State” Could be Sad State of Affairs

“Nothing is more certain than death and taxes.”  Certainly you’ve heard that expression.  These days there is a great deal of uncertainty as to the future of taxpayer relationships with the IRS.  National Taxpayer Advocate Nina Olson recently delivered her Annual Report to Congress.  In her report she refers to an IRS vision for its future role vis-à-vis U.S. taxpayers, which has become known as the Future State plan. 

Unfortunately, some of her conclusions align with our observations that suggest a more remote and less approachable – rather than a kinder, gentler – IRS.  Olson calls out proposed increases in IRS user fees, and the agency’s plans to reduce person-to-person contact and refer some common tax law inquiries to outside, paid professionals.  She sees this as likely to segregate taxpayers into haves and have-nots, those who can afford to pay for tax compliance assistance, and those who may find it beyond their means.  Olson refers to it as a “pay-to-play” policy, and uses as just one example the fee charged by the IRS for a taxpayer who needs to satisfy a tax obligation on an installment basis.  Not only is there a fee, but the IRS has proposed to make this option even more expensive.

There are other fees that provide dramatic examples of disadvantaging less affluent taxpayers.  For 2016 the IRS is eliminating its tiered fee structure for requesting relief – via private letter ruling – from the 60-day limit for completing an IRA or employer plan indirect rollover.  A number of circumstances beyond a taxpayer’s control – such as financial organization error, or ill health – can be, and often are, grounds for needing an extension of time to complete the rollover.  Some can be considered automatic, but others require IRS approval.

Last year a taxpayer with a rollover amount less than $50,000 could request such a ruling for $500.  This year it will cost $10,000; yes, that’s four zeros!  Those who can’t afford to obtain such IRS ruling relief could suffer serious tax consequences, in addition to diminishing their retirement nest egg, the accumulation of which is ostensibly an elevated public policy goal.  In its guidance outlining conditions under which such a rollover extension can be granted, the IRS cites as a guiding principle the concern that to do otherwise might be “against equity and good conscience.”  Hopefully, few of us will ever be at the mercy of the conscience that came up with this fee increase!

Lest I be accused of selectively citing only data critical of the IRS, the agency has reduced several of its fees for 2016, including those for retirement plans to correct certain failures through its Voluntary Correction Program, or VCP.  For those unfamiliar, under VCP a retirement plan sponsoring employer pays a fee, essentially owns up to the failures, and proposes to the IRS a remedy or remedies for its transgressions.  In this way the IRS both gathers fee revenue from participating employers, and in theory promotes greater plan compliance; all without expending time and expense in identifying and auditing those plans.  In virtually every case these fees decreased for 2016.  This, of course, could be interpreted as a carrot to promote even greater participation, and perhaps greater fee revenue overall.

One root of the problem seems to lie in the politics and funding war that is being waged between the IRS and Congress.  Apart from a long-term, deeply-rooted dislike some lawmakers have for the agency, there recently has been serious concern over IRS misuse of the tax-exempt organization rules to favor one end of the political spectrum over the other.  This unfavorable climate has led recent Congresses to punish the IRS with funding cuts.  In inflation-adjusted terms, the IRS has lost almost 20 percent of its budget since 2010.  This has led the agency to look for ways not only to cut expenses, but to raise revenues – apparently through raising user fees – on its own.

Not surprisingly, service levels have fallen, as well.  Although more than 80 percent of individual income tax returns are now filed electronically, compared to less than 55 percent a decade ago, a very complex tax code has led to increases – not decreases – in taxpayer requests for help on IRS Customer Service phone lines.  Such calls have increased 59 percent over this 10-year period.  And from 2014 to 2015 alone, calls to IRS Customer Service lines increased 15 percent.  Sadly, the number of callers who actually got through for help declined from 64 percent to 38 percent from 2014 to 2015.  The average time of answering, for those who got one, increased from 19 minutes to 30 minutes.  Hardly a service rate that would keep a private sector company in business for long.

Returning for a moment to the issue of increased fees, the cost for retirement plan document drafters to obtain IRS approval is proposed to go up steeply.  This includes the approval of a drafter’s basic plan document and adoption agreements.  Without resorting to a tedious breakdown, one major industry provider’s total fees for document approvals under the current Pension Protection Act restatement cost roughly $50,000, but would have cost in the neighborhood of $270,000 under the IRS’s 2016 fee schedule.  Under what authority is the IRS permitted to raise fees so egregiously?

Then there is the IRS’s unilateral decision to gut the determination letter program, basically delivering it to the industry as a fait accompli, rather than allowing input regarding its potential consequences for plan sponsors. 


Some might call this “piling on” an already beleaguered agency.  Others might say it is compelling evidence that the path we are on is not one that enhances, or even maintains, a healthy relationship between taxpayers and the agency with which they must regularly deal.  Congress and the IRS must come to an understanding that both provides adequate funding, and defines the relationship the IRS must maintain with taxpayers, both individual and business. 

Monday, February 29, 2016

Ends Seem to Justify Means for Partisan DOL

For starters, we can dispense with the notion that federal agencies are always impartial and unfailingly neutral.   We know better.  We know that the heads of federal agencies often dance to the tune played by the administration in power at the time.  To the degree they do this, they are partisan, something that in a perfect world these agencies would not be.  Of course, this phenomenon is not new.  It has been this way in previous administrations, too. 

Some will argue that it is a matter of degree, and contend that there has been more partisan teamwork during the present administration than has been the norm.  I’m not a historian, so I’ll leave that judgment to those who are.  I do believe, however, that in the process of drafting and presenting proposed regulations on conflicted advice in the retirement plan space, the Department of Labor (DOL) and Obama administration are setting a high partisanship bar for future bureaucrats to shoot for. 

The latest after-shock in the seismic upheaval these regulations represent for the industry is a report by the Senate Committee on Homeland Security and Government Affairs, chaired by Sen. Ron Johnson (R-Wisc).  Though the connection of these regulations to “homeland security” may seem tenuous, the original purpose of the agency – as the “government affairs” element in the title suggests – has historically been to oversee the efficiency, economy, and effectiveness of agencies and departments of the federal government; in particular, relationships between federal agencies in the regulatory process.  This side of its responsibilities comes a lot closer to explaining the objections found in the Committee’s report.

The report was published on February 24, 2016, several weeks after legislation was introduced in the Senate to block these regulations.  The regulations are currently in the hands of the federal Office of Management and Budget (OMB), awaiting clearance to be released as “final.”

Contention over these regulations, which would establish fiduciary standards and rewrite rules for interactions between advisers and brokers and their retirement saver clients, is nothing new. The process of proposing, collecting comments and (we hope) revising the regulations for presentation as final has been as fraught with disagreement and bitterness as any in our collective industry memory. What is new are some of the revelations in Sen. Johnson’s report, which shine light on behind-the-scenes procedures of DOL’s Employee Benefits Security Administration (EBSA), the sub-agency that owns – and would enforce – the conflicted advice regulations.

A second comment on partisanship could be made here.  The Committee chaired by Sen. Johnson is controlled by his party, the Republicans.  The report released last week is the “majority report,” which means it was not presented as the unanimous conclusions of Republicans and Democrats on this committee.  It should be said, however, that substantial criticism of these regulations has also come from the Democratic side of the aisle in both Senate and House.  How these Democrats would vote if it came down to an effort to override a veto of regulations-killing legislation is unclear.  But there is easily more bipartisan opposition to these proposed regulations than there is bipartisan support.

In fairness to EBSA and the Obama administration, this Committee report does some dot-connecting and conjecturing that could be questioned.  For example, the fact that EBSA has not demonstrated a willingness to accept some of the suggestions offered by other federal agencies, and by public and private critics, may not be convincing grounds for denunciation.  None of us takes every suggestion given to us, in either our personal or our professional lives.

But some of the report’s findings are very troubling, findings based on e-mails and other communications which – in many cases – were obtained without DOL cooperation.  In fact, in some instances these communications were obtained over opposition – even obstruction – by the DOL.    
One of the key concerns of lawmakers and the retirement industry was whether the DOL had effectively communicated with the Securities and Exchange Commission (SEC) as the conflicted advice regulations were being drafted.  This should have been important because a major share of the investments in IRAs and retirement plans are securities, and because the compensation formulas associated with securities investing have significant variability, and – frankly – the most potential for abuse.  Any attempt to regulate the process of securities investing should have closely involved the agency with the greatest securities expertise.

The DOL not only refused to provide copies of what might have been its key communications with the SEC, but evidence obtained by the Committee from the SEC paints a picture of the DOL attempting to influence SEC not to fully cooperate with the DOL; not to provide these requested communication records.  SEC staff had also pointed out numerous flaws in the regulations.  The upshot is that the DOL’s claim to have actively and substantively worked hand-in-hand with the SEC in creating these regulations turns out to be a fiction.

Another key concern has been the actual origin of the regulatory initiative.  Did it originate within the DOL, based on credible evidence that retirement investors were being harmed?  Or, did the impetus come from the White House, based on a belief that investor abuse is inevitable considering current structures for compensating advisors and brokers who give saving and investment advice?

The report highlights substantial evidence that administration staff were involved in ratcheting-up the perception that the conflicted advice regulations were needed.  A White House memo written months before DOL issued its proposed regulations, and cited in the Committee report, had argued that “aggressive regulatory action [is] necessary to remedy inadequate consumer protections on investment advice.”  As a further indication of who was likely in the driver’s seat, an e-mail from a dutiful DOL policy advisor to a White House senior political advisor declared that “we need to determine whether the available literature … and any other data we have not identified, can be woven together to demonstrate that there is a market failure, and to monetize the potential benefits of fixing it.” 


If that doesn’t sound like a solution in search of a problem, I’m not sure what would.  There are other examples in this Committee’s report on these proposed regulations that would raise still more hackles on our collective necks.  But, in the interest of not raising readers’ blood pressures unduly, I will leave it at that.

Friday, January 8, 2016

2015 a Year of Mixed Blessings

When we were youngsters, one of the lessons our parents tried to teach us was that we were unlikely to get everything we wanted.  We were to be appreciative when things went our way, but not be whiners when they didn’t.  The 2015 year now ending was just that kind of year for those who serve the retirement industry.  We have some things to be grateful for, and some things we might have preferred to have turned out differently.  Our glass may not be full, but neither is it empty, so we won’t whine unreasonably.

For much of the year the dominant story was the DOL’s fiduciary regulations, renamed – some think – for public relations purposes as the “conflicted advice” regulations.  In my nearly three decades in the retirement industry I doubt there has been another set of regulations that has generated so much public comment, whether live in public hearings or in written comments submitted to the Department. 

The polarization between opponents and supporters has been profound.  Some within the certified financial planner (CFP) community have voiced support for the proposed regulations; these advisers already consider themselves fiduciaries.  There has also been support from some retiree, consumer advocacy and public policy groups.  Many financial industry firms, affiliated industry groups, and individual investment professionals on the other hand, have been extremely critical of a fiduciary standard they fear will ultimately deprive less affluent savers of badly needed assistance.  There was also an unprecedented level of bipartisan effort in Congress to delay or thwart implementation of these proposed rules.  Many do not think they will ultimately be in savers’ best interest.

Some opponents hoped the Consolidated Appropriations Act – the must-pass federal budget legislation enacted during the week before Christmas – would provide a vehicle by which Congress could intervene via amendment, but efforts to do so were unrewarded.  Advocates of this strategy reportedly may attempt to introduce stand-alone legislation aimed directly at delaying DOL’s issuance of the final regulations.  But overcoming an almost certain presidential veto is thought to have a less-than-an-even chance of succeeding.

Such preoccupation with the proposed fiduciary regulations left the industry open to a virtual blind-side when the DOL in November issued guidance on states establishing or coordinating retirement plans for private sector workers.  Many had expected that the guidance would begin and end with automatic payroll withholding IRA contribution programs, with some states mandating them for most employers that do not establish a recognized retirement plan – however sophisticated or simple.  Instead, DOL went well beyond this, handing states a playbook for assisting businesses in establishing qualified plans. 

Under either the IRA or qualified plan regimen sketched out by DOL’s proposed regulations and interpretive bulletin, states could readily find themselves involved in functions that put them in competition with financial organizations and service providers in the public sector.  DOL, by the way, in its interpretive bulletin created what many feel is an unprecedented and inexplicable exception to its past guidance limiting the creation of multiple employer plans (MEPs).
We understand the numerous states’ clamor for guidance so that they might confidently proceed in encouraging retirement saving by private sector workers within their borders.  This, in the face of inaction by Congress to legislate options or parameters.  But it’s hard not to view this DOL state-coordinated plan guidance as anything but legislation by regulation.

One area in which reason did prevail in 2015 retirement developments is in the requirements for annual plan reporting to the IRS and DOL, via the 5500-series forms.  Proposed for 2015 plan years was a new reporting regimen for filers of Form 5500, 5500-SF, and 5500-EZ, to provide detailed information not only on plan characteristics, but on operations, testing, amending and other elements of compliance.  Apart from an unprecedented level of intrusiveness and “audit mining” in the questions on draft 2015 forms and schedules, also to be required was disclosure of preparer/client relationships.  

Just as most audacious was the matter of timing, and the lack of lead time for plan sponsors and service providers to prepare for the capture, retrieval, and outputting of the information sought in the 2015 plan year reporting cycle.  Fortunately, IRS and DOL were ultimately convinced that plans and service providers needed more time to comply, and this compliance-related information will be optional on Forms 5500-, 5500-SF and 5500-EZ for 2015 plan years.   

Exactly one week before Christmas day, Congress and the President found themselves for once pulling in the same direction and enacted the Consolidated Appropriations Act of 2016.  Within this extremely full and complicated package were some provisions affecting qualified savings programs, including IRAs, SIMPLE IRA, church retirement and 529 college savings plans, and the new ABLE accounts for special needs individuals.

Worthy of special mention is the qualified charitable distribution, or QCD, option for those age 70 ½ or older with IRAs.  This option, which has been with us under numerous legislative extensions since 2006, allows a taxpayer to donate up to $100,000 of IRA assets annually to a qualifying charity, tax-free.  It was made permanent by CAA 2016.  Instead of such taxpayers generally being limited to a charitable tax deduction up to 50 percent of annual income, the amount contributed under QCD can be as much as 100 percent of income, but no more than $100,000.

One might guess that this option would be availed by only a limited number of taxpayers.  But based on evidence from our retirement consulting practice, it was the most-asked-about provision in this legislation.  Also based on our informal data, it’s certainly not the case that every taxpayer using this option gives the maximum amount.  Far from it.  Donating under the QCD program is not “a wash” tax-wise for the giver, either.  Keeping, rather than donating the amount, would still be a net cash benefit to the taxpayer.  While the tax break may be generous, so is the charitable giving! 

One can argue that this tax provision has a cost in tax revenue that must be borne by other taxpayers.  But that can be said of just about any of the several dozen tax benefits in the Act.  Very few of these have at their core the creation of an incentive to be generous.  Among these many so-called “tax extender” provisions, this is one that a taxpayer can be proud to have taken advantage of.

Have a happy and prosperous New Year!   

Friday, December 18, 2015

DOL Stretches Credibility and Precedent in New State Plans Guidance

Several months ago, when the retirement industry was chiefly absorbed in the Department of Labor’s proposed conflicted advice regulations, a colleague commented that many would be surprised by soon-to-be-released guidance on state-based retirement savings programs.  True to this prediction, the guidance issued on November 18th by the DOL’s Employee Benefits Security Administration (EBSA) has given us all something more to ponder, and – at the risk of being called alarmist – perhaps to be quite concerned about. 

As hinted at by Labor Secretary Thomas Perez shortly before the November guidance was released, the agency issued both proposed regulations on state-mandated payroll withholding IRA programs, and also sub-regulatory guidance – Interpretive Bulletin 2015-02 – on state-coordinated ERISA-type plans.  FAQs accompanied the release, as well.  

The more than two dozen states that have taken steps toward implementing state-coordinated retirement solutions have been overwhelmingly interested in payroll withholding IRA programs.  If they proceed, most are expected to mandate that all but the smallest employers must offer such a program if they have no conventional retirement plan.  But given the political divisions that exist all the way from Washington down to local levels, whether this will happen in any given state is anything but certain. 

A small minority of states, at least until now, have shown interest in becoming involved in ERISA-style retirement plans for private sector employers and their workers.  This may change as the new EBSA guidance is digested, especially given the DOL’s very accommodating stance in Interpretive Bulletin 2015-02, offering several options for state involvement in ERISA plans for private sector employers.  This prospect should be of major concern to practitioners and providers in the employer-sponsored retirement plan space. 

It’s hard to fault state legislators and policymakers for taking the initiative on behalf of “plan-less” private sector workers within their borders.  They’ve watched the senators and congressmen they sent to Washington unable to make progress in broadening or enhancing options for their citizens to have greater retirement security.  If something is going to happen, the states’ seem to be concluding that they will have to act on their own instead of waiting for Congress.

I have to remind myself that those in the Department of Labor who drafted this guidance no doubt have good intentions and defensible motives.  They want to see more Americans better prepared to enter their retirement years with adequate financial resources.  But intentions and motives do not by themselves make good guidance or policy. 

Reasonable minds may differ regarding the things government should manage in a free market economy like ours.  But – such philosophical differences notwithstanding – is there any reason to expect that a state will do a better job of managing a retirement program than the private sector?  A number of states’ and other governmental units’ pension systems are in woeful shape.  There also is no shortage of examples of unprincipled use of political power and influence at the state level.  Can we be assured that this will not spill over into the administration of a state-sponsored retirement plan encouraged by this guidance?  One of the reasons ERISA was enacted was to provide both fairness and uniformity in the administration of retirement plans, and there is little reason to expect that every state will do an equally good job of it.

But, even if we accept the premise that state government-coordinated retirement programs for private sector workers are a reasonable way to broaden coverage and participation, there are parts of this DOL guidance that don’t pass muster.  The industry is justifiably asking how the agency could have reached some of its conclusions about acceptable state plan structures.

For instance, DOL takes the position that a state government could set up what would be called an “open MEP,” a multiple employer plan for employers that have no common interest, purpose, or ownership.  This is something that DOL has expressly and aggressively forbade in such recent guidance as Advisory Opinion 2012-04A.  In that 2012 guidance DOL maintained that in order to establish a MEP, the participating employers must have “substantial common control, ownership or organizational connections,” or “substantial economic, business or representational purpose” in common.  

Advisory Opinion 2012-04A further asserted that an unrelated coordinator of a MEP – such as a third-party administration (TPA) firm – would lack legitimacy if the only interest it held in the arrangement was for the purpose of providing benefits to the participating employers.  In that guidance DOL did, in fact, deny just such a firm’s request for approval of a proposed open MEP, citing the fact that there was “no employment-based common nexus or other genuine organizational relationship between the employers.”  This sounds like the very role that a state might be playing under a MEP option blessed by DOL in Interpretive Bulletin 2015-02. 

In legitimizing its new state-coordinated MEP option, DOL relied on a different argument in Advisory Opinion 2012-04A, one which stated that those sponsoring or maintaining the plan had to be tied to the participating employers “by genuine economic or representational interests.”   DOL now declares in Interpretive Bulletin 2015-02 that “a state has a unique representational interest in the health and welfare of its citizens that connects it to the in-state employers that choose to participate in the state MEP.”  Done and done!

There are also legitimate questions to be asked about the alternative DOL-approved options for state-coordinated ERISA plans.  Such as, do we want state governments deciding which service providers they will favor by including then in a state-approved retirement plan “marketplace?”  Do we want a state to sponsor a prototype plan document and offer it directly to employers, essentially competing with private sector firms that offer prototype documents and the services that go with them?

Right now, there are more troubling questions than there are reassuring answers.

Thursday, November 19, 2015

Whose Responsibility is Socially Responsible Investing?

We sometimes complain when the federal agencies that oversee retirement plans drag their feet and fail to issue badly needed guidance.  Occasionally, however, the reverse is true, and we get an answer to a question that few – if anyone – has asked, or perhaps even anticipated.  Sometimes it’s an answer that makes things more complicated, rather than easier.  This may be the case with the Department of Labor’s recent issuance of Interpretive Bulletin 2015-01, released by its Employee Benefits Security Administration (EBSA).   It addresses the issue of retirement plans and investment options that might be considered “socially responsible” or “economically targeted.”  IB 2015-01 became effective on October 26th, the date of its publication in the Federal Register.

Socially responsible or economically targeted investments are loosely defined as those which, in addition to meeting the primary objective of generating sound returns for a participant or beneficiary, may have the potential to positively influence the growth of a community, or have a positive social impact.  EBSA’s clearly stated intention is that IB-2015-01 should make plan administrators more comfortable choosing plan investments that fall into this category. 

IB 2015-01 withdraws a prior interpretive bulletin on this issue, IB-2008-01, which EBSA now feels may have “unduly discouraged fiduciaries from considering so-called economically targeted or socially responsible investments.”  Notice 2015-01 notes that “Fiduciaries need not treat commercially reasonable investments as inherently suspect or in need of special scrutiny merely because they take into consideration environmental, social, or other such factors.”   

What kinds of things could be considered socially responsible or economically targeted investing?  The range is probably wide, but it’s not hard to come up with several examples that many would find meet that definition.  Because mutual funds are such meat-and-potatoes investing options for retirement plans, particularly participant-directed individual account investing, I’ll focus on those.
The characteristics that define a mutual fund as socially responsible or economically targeted can be measured both in terms of what they include, and what they exclude.  Some funds may invest in alternative or renewable energy companies, such as wind generation, geothermal, biodiesel, or ethanol production.  These funds might, due to this focus, exclude holdings in fossil fuels, such as coal mining or offshore oil drilling.  Some exclude holdings in companies associated with the nuclear power industry.

Some such funds exclude defense contractor stock.  Others exclude the stock of such high-performing companies as Apple, because factory working conditions in some of the countries where certain Apple products are made are considered substandard.  Some of these funds are actually titled in a manner that touts their emphasis on social consciousness, including such terms as “social choice” or “social equity,” as part of their formal naming.

A little bit of EBSA interpretive bulletin history is called for here.  In 1994, EBSA’s IB-94-01 stated that socially responsible or economically targeted investments were not incompatible with retirement plan investment selections, as long as such investments have “an expected rate of return that is commensurate to rates of return of alternative investments with similar risk characteristics.”  As a follow-up in 2008, a brief clause in IB-2008-01 seemed to be a vote of no-confidence for socially responsible or economically targeted investing.  It stated that “consideration of collateral, non-economic factors in selecting plan investments should be rare, and when considered, should be documented in a manner that demonstrates compliance with ERISA’s rigorous fiduciary standards.”

EBSA now believes that its 2008 guidance may have put a chill on retirement plan fiduciaries selecting and offering such investments.  Actually, IB-2015-01 and an accompanying news release seem to have turned the 2008 guidance more or less on its head.  The news release states that while socially responsible or economically targeted investment considerations “may not accept lower returns or take on greater risks,” they are “more than just tiebreakers, but rather are proper components of the fiduciary’s analysis of the economic and financial merits of competing investment choices.” 

Furthermore, an accompanying EBSA fact sheet addressing the documentation issue seems to directly counter IB-2008-01, stating that “no special documentation is presumptively required for such investments…” and that “the appropriate level of documentation would depend on the facts and circumstances.” 

Two things, at least, are troublesome here.  One is EBSA’s inconsistency over time in the emphasis it places on fiduciary caution, and the embrace of investment considerations that have little if anything to do with generating returns for participants and beneficiaries.   Second is the unmentioned, but no less real, matter of just what is “socially responsible.”  One need look no farther than America’s democratic political system to know that there is no fool-proof consensus on what is moral, ethical, or socially responsible. 

One citizen may think nuclear power is a destructive genie that should be kept corked in a bottle, and would shun any related investment.  Another, however, may believe that nuclear power should be made safer and promoted to help the nation move away from fossil fuels.  One investor may believe that only by maintaining a world-leading defense capability can the U.S. remain free and defend the interests of democratic peoples; therefore, invest in defense companies.  Another may believe that the military industrial complex bears responsibility for our involvement in conflicts around the globe, and owning an interest in them should be avoided.  I could certainly come up with more examples of such conflicting views.

Should a plan administrator or investment committee be encouraged to make such thumbs-up or thumbs-down decisions on investment availability?  Is it possible to be even-handed and take into consideration very divergent views on social issues when selecting an investment lineup?  Is it even fair to put plan fiduciaries in a position of feeling pressure to weigh issues of social responsibility in the selection of investment options? 


There are readily understood standards for selecting and continuing to monitor an investment for its financial suitability.  Picking investments that are compatible with a participant’s conscience is another matter altogether.  IB-2015-01’s suggestion that social responsibility considerations “are proper components of the fiduciary’s analysis … of investment choices” is quite likely to raise more questions than it answers.

Friday, September 25, 2015

Some Retirement Savings Numbers of Note

If ever there was an enterprise inextricably tied to numbers and statistics, it is our retirement industry.  Numbers are the bedrock of retirement plan operations and recordkeeping.  We continually analyze rates of worker access to retirement savings options.  We compare the U.S. savings rate with our counterparts around the world (sometimes unfavorably, at least by recent history).  We try to quantify such subjective things as worker confidence in a secure retirement.  Some federal agency number crunchers even think they can calculate how much retirement savers lose as a result of investment advisor conflicts of interest.  Stats and numbers: they are part and parcel of our business.

I recently came across a thought-provoking study compiled by the Transamerica Center for Retirement Studies, entitled Retirement Readiness Survey 2015.  The Center is a division of Transamerica Institute, a nonprofit private foundation funded by Transamerica Life Insurance Company and other third party funders.  This 15th annual survey is one of the longest-running of its kind, and polls American workers and their employers to explore attitudes and behaviors on retirement benefits and security.  Many of its queries were measured by level of interviewee education, which – like it or not – is often a predictor of both income and financial literacy.

One of the questions commonly asked in such studies concerns having a retirement strategy, generally meaning whether an effort has been made to calculate how much will be needed in order to have a reasonably comfortable retirement.  There are lots of variables affecting retirement security that can’t be fully known.  They include the ups and downs of securities markets, the general state of our U.S. economy, inflation rates, our health, or the age when we choose or are forced to leave the workforce.  But, in order to set savings goals, it’s imperative to have some idea of what the target is.

The Transamerica study may be overly generous in measuring the share of the U.S. population that has a retirement strategy.  It counts both written and unwritten strategies.   An “unwritten” strategy seems almost a contradiction in terms, and I’m inclined to discount its value in any serious effort to measure Americans’ self-assessment of their retirement preparedness. 

Only a small minority have made an attempt to create a tangible, written retirement plan.  Among those who have, a notable predictor is the education level of the survey subject.  Generally speaking, the higher the level of educational attainment, the more likely that the individual has made a serious attempt to develop a savings strategy.    

This may be the result of several factors that often intertwine.   Higher education levels commonly translate to higher lifetime earnings.  Higher earnings may not only lead to more disposable income that can be saved, but may also mean being employed where there is a retirement plan in place.  Access to a retirement plan generally brings with it at least basic information on investing, as well as encouragement to save through that employer’s plan.  Such individuals are the most likely to think about their future retirement security, and take action.

Among workers with a high school education, or less, only seven (7) percent had a written retirement strategy or plan.  In sharp contrast, 24 percent of those with post-graduate college attendance or a post-graduate degree had a written plan.  College graduates with a basic bachelor’s degree were found to have a written plan in 18 percent of interviews.  Among those with trade school or non-degreed college attendance, 13 percent could point to a written plan they had created.  Assuming similar numbers of interviewees in the four groups, an average of just 15 percent had a written plan or strategy.

There are other statistics in the Transamerica study that are worth sharing.  The use of a professional financial advisor to help with investment decisions and planning for future retirement security also showed a great disparity when measured against the education of the interviewee.  Forty seven percent of those with advanced degrees or graduate school exposure had used a financial advisor, while 25 percent of those whose education was limited to high school level did so.  In between were college graduates at 49 percent and “trade school/some college” interviewees at 33 percent. 

Asset allocation on the spectrum from conservative to aggressive also varied markedly by education.  Seventy-nine percent of those with a post-graduate degree were invested either in stocks or in a balanced mix of stocks, bonds and other investments.  Only 49 percent of those with high school level education were invested this aggressively.  College grads and trade school/some college folks were positioned in between; the higher the education level, the more aggressive the investing.  Rather alarming, Transamerica interviewers found that 35 percent of those with high school level education were unsure of what they were invested in.  One need look no farther than this to support the contention that Investment education is critically important, apparently more so for those with less formal education.
Participation rates for those who are actually offered such an opportunity varied similarly across educational lines.  Eighty-seven (87) percent of those with graduate school exposure – and those with bachelor’s degrees as well – participated when they were given the opportunity, while only 67 percent of those educated through high school or less education took advantage of the opportunity.  Those with trade school or less-than-degreed college exposure accepted a participation offer 79 percent of the time.

It should not be a great surprise that contribution rates of those more highly educated would be greater, given the generally reliable likelihood that higher education leads to higher lifetime income.  Obviously there are exceptions, but they mostly prove the rule.  The average plan participant with a post-graduate degree – and those with a bachelor’s degree, as well – contributed 10 percent of income to retirement saving.  Both those high school-level-educated and having trade school or non-degreed college exposure contributed six percent of income, on average. 


There are many other statistics of interest in Transamerica’s Retirement Readiness Survey 2015; these are among those that stand out.  Certainly there are facts and circumstances that make saving more difficult for some workers than for others.  Balancing basic financial needs against income is an obvious one; these needs differ at different stages of life.  But basic investment education and savings habit formation, with access to some kind of formal retirement savings, can have a positive impact on saving outcomes, even if the first steps are small ones.  For that reason it is critical that we preserve and expand access to retirement savings options, as well as to meaningful investment education and advice.