Thursday, June 27, 2013

Auto-Enrollment Critics Miss a Major Point

These days it’s pretty common to hear or read a financial writer, academic, or policy wonk, criticize defined contribution retirement plans.  Service provider revenue sharing arrangements, investment fees and performance, participant inexpertise, tax cost, or what-have-you, have all become grist for the critic’s mill.  One of the more suspect criticisms is the charge that automatic enrollment 401(k)-type plans—also known as automatic contribution arrangements, or ACAs—are lowering contribution rates in employer-sponsored retirement plans.  This is the premise of an article in the Wall Street Journal in May of this year, repeating a charge that appeared in the same publication in 2011.  That 2011 article was the most brazen, and was entitled “401(k) Law Suppresses Saving for Retirement,” claiming that the Pension Protection Act (PPA) “is actually reducing savings for some people.”
To take a script page from the late radio personality Paul Harvey, there is a “rest of the story” that deserves equal time.  The most important objective of those who have been supporters of automatic enrollment is to bring more employees into retirement plans, even if only in a modest way.  The logic is that once they have become participants, and see their retirement account balances growing, they will remain in the plan, hopefully becoming more informed, perhaps even more aggressive savers. 
Automatic enrollment detractors cite the fact that average deferral percentages for U.S. retirement plan participants have in some cases declined from pre-auto-enrollment days.  Many plans that have implemented automatic enrollment have set the initial deferral rate at 3% of compensation.  Because many existing participants in 401(k)-type plans defer at levels higher than 3%, an influx of many new participants deferring at this lower rate must—by the nature of statistics and the law of averages—reduce the overall average.   
This does not mean that everyone is deferring at the lower rate.  What it really means is that more are deferring, and those deferring at a lower rate are dragging the average down somewhat.  Another criticism is that some participants take the path of least resistance and enter the plan via automatic enrollment—at a low deferral rate—when they might otherwise have deferred at higher rates if they had entered the plan by making an affirmative election.  And, inertia being what it is, some may not revisit the issue and take advantage of the opportunity to increase their deferral rates.    The “cure” for this, if a cure is needed, may be for plans to consider setting their initial automatic enrollment rates higher than 3% or to implement automatic deferral increases that occur after the initial deferral period. 
Critics need to realize that new concepts take time to reach their potential, to work out initial kinks, and eventually reach the optimum.  Thomas Edison is reported to have said about his inventive endeavors: “I haven’t failed.  I’ve found 10,000 ways that don’t work.”  PPA, it must be remembered, was enacted in 2006, its provisions mostly taking effect for 2007 and later years.  It will take time to reach the optimum.
Some members of Congress seem to see this, and have proposed tweaks to the Internal Revenue Code to help automatic enrollment reach its potential.  For example, Rep. Richard Neal’s Retirement Plan Simplification and Enhancement Act of 2013 (H.R. 2117) has provisions that would encourage setting initial automatic enrollment rates at higher levels.  New plan testing exemptions, and a special tax credit, would be available for plans that set initial automatic enrollment deferral rates at 6%, and raise them—subject to employee opt-out, of course—in following years.
Without bashing the media, it sometimes seems like publications and their reporters are looking for the sensational headline, the calamity, the failure, or the threatening, as a means to capture reader or viewer attention.  With something as important as Americans’ retirement security, thoughtful reporting rather than sensationalism needs to rule the printed page and the broadcasting airwaves.

Friday, June 21, 2013

President’s Budget Includes More Than at First Met the Eye

No matter whom the occupant of the White House happens to be, that person seems bound to please some, while displeasing others.  This is the case with just about any decision or proposal made by the Chief Executive.  It was certainly the case when President Obama’s 2014 fiscal year budget proposal was released, and it became evident that it would break some new ground with respect to retirement savings provisions.
The president’s proposal of a dollar cap on tax-advantaged retirement accumulations, and also a limit of 28 percent on any taxpayer’s benefit for income tax deductions and exemptions, were immediately criticized as hostile to the goal of saving for retirement.  Like many others, we were not especially pleased with these proposals, as they seemed to be a changing of the rules while the game is in progress.  However, the president’s 2014 budget contained a number of other provisions that could affect retirement saving, provisions that merit comment, too.  Here are our thoughts on some of them.
§  An automatic-enrollment workplace IRA program would be required of most employers that sponsor no retirement plan, that have been in business for two or more years, and have 10 or more employees.  The proposal includes a start-up credit for employers with 100 or fewer employees.   Traditional or Roth IRAs could be used, with a Roth IRA proposed as the default.  Some may see this as potentially siphoning off true “qualified plan” business, but to the extent that more workers at least begin saving in preparation for retirement, the industry and the nation as a whole benefit.  And, such a program could eventually lead an employer to establish a more traditional retirement plan.
§  Required minimum distributions would be waived for persons with aggregate IRA and employer plan balances that do not exceed $75,000.  This could be beneficial to many retirees who have other assets to help support them in retirement, and who want to preserve tax-deferred amounts until they are actually needed.  
§  Nonspouse beneficiaries would be allowed indirect rollovers between retirement plans and IRAs, and between IRAs.  “Inherited IRA” status would remain a requirement.  In the past, the inability of nonspouse beneficiaries to execute an indirect rollover has been a trap that has caught—and cost—many.  An indirect rollover option would also allow nonspouse beneficiaries to “split” pre-tax and after-tax portions of inherited employer plan accounts when rolling them to inherited IRAs, something they now cannot do because of the present nonspouse beneficiary direct rollover requirement.
§  The maximum small employer retirement plan start-up credit would double from $500 to $1000 per year, and would be available for four years instead of three.  Anything that encourages employers to establish new plans, including tax credit incentives, is worthy of consideration.
§  Electronic capture of employer plan data could be expanded.  A provision of the president’s budget proposal would authorize the IRS to require that nondiscrimination testing data be included on electronically-filed Form 5500 plan returns.  The IRS seems intent on identifying retirement plans that have potential noncompliance issues, and requiring the annual submission of testing data would seem to be a step in that direction.  It would, at minimum, seem to necessitate revising some recordkeeping procedures and Form 5500 generating systems, which would be costs that participants would ultimately bear.  “Is this really necessary?” is the question we ask. 
§  E-filing of information returns could broaden.  The IRS would be given authority to set a threshold below the current 250 for mandatory electronic filing of information returns, including the 1099 and 5498 form series.  A maximum $5,000 penalty could be assessed for failure to e-file when required.  Yes, we live in an increasingly “wired” world, and electronic submission is increasingly more the rule than the exception for trustees and custodians that submit such forms.  But for those with limited filing numbers, the option to submit in paper format rather than deal with programming and software issues may still be valuable.
§  Five-year depletion of IRA and employer plan accounts by nonspouse beneficiaries would be required under the president’s proposed budget.  There would be certain exceptions, including beneficiaries with a disability, a chronic illness, minor status (reverting to five-year payout upon reaching the age of majority), and those whose age is within 10 years of the decedent.  While we recognize that IRAs and employer retirement plans are not primarily for the purpose of inter-generational wealth transfer, it seems that this provision takes away one of the few simple means of providing financially for family members after one’s death.  The concept is intended by lawmakers to raise revenues to finance other tax provisions, and should be recognized as such, rather than as some kind of noble tax policy.
It is highly unlikely that President Obama’s proposed budget will find its way into legislation and become law in its current form.  Given the split in control of the Senate and House, and the meager evidence of across-the-aisle cooperation, expectations for meaningful legislation in the 113th Congress are low.  Nevertheless, all laws begin as proposals, and elements from different sources can become assembled into legislative packages that find their way into law.  Therefore, serious scrutiny should be given to any proposals that could have an impact on retirement saving.