“March Madness” an Apt Name for Fiduciary Regulations Battle

Perhaps it’s fitting that the country is in the period we’ve come to know as “March Madness.”  As even casual sports fans know, the term refers to the NCAA men’s and women’s college basketball tournaments.  It’s a time when basketball junkies are filling in the brackets for their friendly “it’s not really gambling” office pools, scratching their heads over the prospects of teams they’ve never heard of, and getting caught up in a fever that is the college sports equivalent of the Super Bowl. 

In the retirement industry we are generating a little March madness of our own.  I’m not aware that any Las Vegas bookmakers are establishing odds, but the players in this contest are definitely serious about the outcome.  No one will be cutting down basketball nets, or pulling a “Champions” T-shirt over their uniform when it’s over.  But without a doubt, one side or the other will see itself as the winner if it prevails. 

The contest in our industry is the battle over the Department of Labor’s proposal for defining “fiduciary” in the context of retirement plan accounts and IRAs.  In question is: under what circumstances will a financial advisor, investment advisor, or broker, be considered a fiduciary, with all of the responsibilities and the duty of care that entails?  

We have seen these same opposing forces arrayed against one another on this stage before.  In October of 2010, DOL’s Employee Benefits Security Administration (EBSA) issued proposed fiduciary definition regulations.  This guidance expanded the fiduciary definition beyond the so-called “five-part test” that has been in effect for some 40 years.  Certain advising relationships that might not have been considered “fiduciary” under the old regulations, now would be. 

The regulations applied to advising IRA owners as well as qualified plan participants, and to situations where participants might be rolling over assets from employer plans to IRAs.  Under much criticism for this expanded application, EBSA withdrew the proposed regulations in September of 2011, promising to perform a more robust economic study of the impact of these rules and to review the issues raised by public comments on the original proposed regulations.  Some cynically suggested that the decision to withdraw the controversial proposal and to re-propose it a later date was motivated by presidential and general election year politics, a time when regulatory red tape is always in the crosshairs of one party or another.

Fast-forward to today, and the oft-promised (threatened?) and several-times-postponed reincarnation of EBSA’s fiduciary regulations has now left that office.  The regulations now reside with the federal Office of Management and Budget (OMB), where such guidance typically resides for up to 90 days for “fly-specking” before eventual release. 

It seems almost as if we’re still in the midst of an election campaign, so visible, caustic and politically-charged are the energies and commentary being poured into support – or opposition – to the anticipated regulations.  The match-to-the-tinder seems to have been the Obama administration’s release in late February of a report entitled The Effects of Conflicted Investment Advice on Retirement Savings.  As is now widely known, the report contends that many retirement savers suffer substantial financial losses due to advisor conflicts of interest.  It is significant that these anticipated regulations are now widely being referred to as the “conflicted advice” regulations, a name that unquestionably is more charged than “fiduciary definition” regulations.  “Politically charged” would not be putting it too strongly. 

There have been numerous salvos fired by members of Congress in the direction of Labor Secretary Thomas Perez, including letters from the House Committee on Education and the Workforce, and the Senate Health, Education, Labor and Pensions (HELP) Committee, expressing concern that the anticipated regulations will lead to advisors abandoning many investors with small accounts, and that the EBSA regulations may conflict with fiduciary regulations that the Dodd-Frank Wall Street Reform and Investor Protection Act charged the Securities and Exchange Commission (SEC) with drafting.  These committee letters pointedly ask for proof that EBSA has attempted to coordinate its regulations with the SEC.    A bill, the Retail Investors Protection Act, has been introduced in the House that would require EBSA to defer issuing fiduciary regulations until the SEC acts first.  Meanwhile, Secretary Perez has said emphatically that these regulations will be issued.

Not all lawmakers are challenging the administration and EBSA on the advisability of EBSA going forward with release of its fiduciary definition regulations.  Elizabeth Warren, widely expected to be in the running for a nomination to the Democratic Party presidential ticket in 2016, recently used the forum of a Senate Special Committee on Aging hearing to reinforce the administration’s message that advisor conflicts of interest are hurting Americans’ retirement preparedness. 

Apart from the vigorous sparring among administration policymakers and Washington lawmakers, there are numerous pro and con analyses and opinion pieces appearing almost daily in industry and general media.  It appears that the all-too-brief calm between election cycle storms that we’ve come to expect may not be a reality this time.  Instead it’s “game on” for what could be one of the defining regulatory actions of the Obama administration – or not!

Does Retirement Saving Cost, or Pay?

February will likely be remembered in our industry for a seismic response to the Obama administration’s launch of a campaign to generate support for regulations governing fiduciary behavior in the advising of retirement savers.  We certainly have our own thoughts on the matter, as we have expressed in the past and most likely will again. 

For that reason, some may have overlooked the release by the Congressional Research Service (CRS) of a report on the largest individual income tax breaks for fiscal year 2015, which CRS has historically described as “tax costs.”  This is something the CRS has been doing for many, many years, but it is especially relevant at a time when those in Congress and in commerce have their eyes on possible major tax reform.  There is virtually no way to substantially lower individual and corporate tax rates without cutting into some of these tax provisions that now save citizens billions in federal taxes each year.  “Cutting into,” in plain terms, could potentially mean reducing the benefits of some – or all – of these and other individual tax breaks.

The lineup in this top-five roster of so-called tax costs is projected to be as follows for the 2015 fiscal year:  1) home mortgage interest deduction, $74.8 billion; 2) state and local tax deduction, $59.2 billion; 3) charitable giving deduction, $45.6 billion; 4) state and local real estate tax deduction, $34 billion; and 5) retirement savings deduction, $18.3 billion. 

It is a bit like stepping through a mine field to make comparative judgments about the value or importance of federally-delivered benefits, whether it is an entitlement like a social welfare program, or a tax break like a deduction for a Traditional IRA contribution.  Each has its advocates, and credible arguments can be made for many of these benefits.  Favoring one while questioning another exposes a person to accusations of partisanship.  But it’s part of our responsibility as citizens to make value judgments, and grapple with issues where there may not be answers written in black or white, or answers that will be universally popular. 

It is not my intention to step on any toes, but I do happen to feel that there are differences in the relative importance to our society of some of these tax benefits.  Differences, too, in which actually result in a loss of tax revenue.  One of the true “sacred cows” in American tax law is the home mortgage interest deduction for one’s principal residence.  We are generally allowed to reduce our taxable income by this amount of interest paid when we file our individual income tax returns.  This is especially beneficial in the early years of home mortgage payments, when a high proportion of that payment represents interest, and a much lesser proportion represents principal. 

Many, if not most, Americans grow up with the admirable goal and expectation of owning a home.  For some, the tax benefit of a mortgage interest deduction might be a deal-breaker when it comes to when – or whether – they will become home owners.  To date though, I haven't seen anything that would show that this would be the case for a majority of citizens.  Certainly the housing industry, and the associated professions of real estate broker, mortgage banker, contractor, insurance provider and numerous others, benefit from robust activity in home buying. 

But are tax incentives that make home ownership easier for an increment of Americans more important than preparing us for security in retirement?    A value judgment to be sure but one that at some point will likely have to be made.  The annual “tax cost” estimated by CRS for home mortgage interest deductions is four times the estimated cost in lost revenue as a result of IRA deductions and contributions to employers’ retirement plans.  Furthermore, citizens who reduce their taxable income via the home mortgage interest deduction do not pay this tax benefit back to the U.S. Treasury at some future time.  Contrast this with deductible IRA contributions and pre-tax amounts deferred into 401(k) plans which are eventually taxed when a retiree withdraws them for financial support in retirement.  Contrary to the way these retirement benefits are often characterized, they are not a permanent “cost” to the federal tax revenue stream.  Again, I do not mean to imply this tax benefit does not serve a valuable benefit but rather want to point out that comparing this to retirement benefits, is not an apples to apples comparison.

Next after the home mortgage interest deduction as a tax cost are deductions for state and local non-business taxes paid.  This amount is three times the so-called annual tax cost for retirement contributions, and is never recovered.  Charitable giving comes next on CRS’s list, and is almost two-and-one-half times the retirement number.  I have no quarrel with the importance to our society of tax incentives for charitable giving and in fact strongly believe they serve an important purpose.  But perhaps we should not impede the average American’s ability to provide for their own security in retirement – helping to insulate them from the need to rely on social programs – by reducing their tax incentives for saving, in order to deliver maximum tax benefits for charitable giving.

The same can be said for CRS’s #4 cost, from deductions for state and local real estate taxes paid.  This is twice as large as the price tag for retirement saving incentives.  Like the others, it too is a permanent tax loss, whereas most retirement saving pours back its tax “cost” when amounts are taken from these savings arrangements and included in income.

The administration’s fiduciary campaign cited at the start of this blog has been criticized for a lack of perspective.  Perspective is also needed when lawmakers consider the relationship between an imagined cost of retirement tax benefits, and the real and painful costs of having a retiree population unprepared for that stage of life.

Where Are We Bound in 2015-16?

The turn of the New Year can be a time to start fresh, which is why so many people make New Year’s resolutions, vowing to change some behavior, or in some way live differently than in the past.  On a less personal level, for workers and most businesses, it’s the start of a new tax year, and of course a time to begin reckoning with the tax year just ended. 

For those we’ve sent to Washington, D.C., to govern us, it’s an opportunity to regroup and take a fresh look at priorities for the coming session.  This year, 2015, is a pivotal one, with the seating of new senators and congressmen and the start of the final Congress with President Obama at the helm.  The dynamics have changed, of course, with both the House of Representatives and Senate controlled by the Republican Party, mirroring the potentially adversarial scenario faced by Mr. Obama’s two immediate predecessors, President Bush and President Clinton. 

Because of this shift in the balance of power on Capitol Hill, there has been lot of uncertainty over how the 114^th Congress and the President will interact, and how they will be able – or not – to govern in the roughly 22 months until the 2016 presidential and congressional elections.  The Republicans now hold 247 seats in the House and 54 in the Senate, an advantage that party has not enjoyed since the 71^st Congress of 1929-1931.  To start this year, the early indications are an ongoing inability to interact seems to be continuing.

One thing that did not change with the 2014 elections is the leadership of the federal agencies with oversight over tax-favored savings arrangements, such as employer-sponsored retirement plans, IRAs, Health Savings Accounts, Coverdell Education Savings Accounts, and the like.  This means that the power within these agencies has not shifted as a result of the elections, and the philosophies that might be reflected in their guidance are unlikely to be different during the next biennium. 

Having said that, however, there’s no denying that the ultimate leaders of such agencies as the Department of Labor and the Treasury Department – both cabinet functions – are political appointees.  Whether desirable or not, pressure sometimes finds its way down from the very top, through the cabinet members, and ultimately to the ranks where guidance is written and issued.  Many believe, for example, that the Department of Labor’s highly unpopular fiduciary definition guidance was first withdrawn – and then subsequently kept on hold – for political reasons in the presidential election year of 2012, and through 2014.  It now appears that at the end of this administration, a strong push to issue this guidance is at hand.

But the intersection of presidential power and regulatory action can work both ways.  Prior to the 2012 and 2014 election the White House had reason to temper aggressive regulatory actions, for fear of election losses.  That is less a concern, at least at the presidential level, since our president cannot run again for reelection.  Perhaps because of this, we have already seen bold – some would say excessively bold – moves taken by executive action.  The last two years of a president’s term are sometimes the period in which the country’s top leader seeks to leave his stamp on the nation, and it could be so with regulatory actions that are favored by the current administration.  The proposed fiduciary regulation may be a good example of this. 

One consideration that could temper aggressive executive and regulatory activism in the next two years is a weighing of the odds for the 2016 election, with the obvious concern that unresponsive or uncompromising regulatory action could weigh against Democratic candidates in both congressional and presidential elections.

Despite the difficulty of governing with a divided, polarized government, one bright spot for the coming Congress is the elevation of Senator Orrin Hatch (R-UT) to chairmanship of the Senate Finance Committee.  Sen. Hatch has substantial credentials when it comes to retirement issues, and his committee plays a key role where retirement savings-related legislation is concerned.  In the last session of Congress Sen. Hatch introduced the Safe Annuity for Employee Retirement (SAFE) Act, and it will be one of his priorities in the 114^th Congress.

But don’t let that title fool you; the bill is not only, or primarily, about annuities.  Yes, the legislation advocates that retirees have access to investment options that can provide lifetime income.  In that respect it reflects the philosophy of the current qualifying longevity annuity contract (QLAC) regulations.  For example, dating back to 2013, Sen. Hatch’s bill mirrored these regulations in limiting to 25% the use of retirement assets to purchase qualifying deferred annuities.  The objective of both Sen. Hatch’s legislation and the current QLAC regulations is to enable what policy makers and lawmakers have long advocated – investment planning that takes into account guaranteed lifetime income options.  Such options are not the entire answer, but can be part of the formula in the retirement security equation.

But Sen. Hatch’s bill goes way beyond the annuity dimension.  It encourages greater use of automatic enrollment and automatic escalation of contributions in deferral-type plans.  It simplifies plan testing, reporting and disclosure.  It enhances the popular and successful 401(k) safe harbor plan, enhances the portability of lifetime income options from employer plans to IRAs, and offers numerous other positive – some might say overdue – retirement savings enhancements.

Whether these exact provisions are embraced, or refined, or in some form eventually become law, is of course uncertain.  In the current political environment an odds-maker would probably not give ANY legislation a high probability of success.  But if legislation such as this fails it won’t be for lack of vision and effort.  Sen. Hatch seems to have “the right stuff” to lead on the retirement savings front.  Whether others will have the good sense to follow is, of course, another question.