Is It “Buyer Beware” with New Rollover Self-Certification?

Barb Van Zomeren, Vice President, ERISA

Federal agency retirement plan guidance has taken some interesting and surprising turns in recent months. But if there is a prevailing direction to these developments, it is toward minimizing the expenditure of personnel resources, and relying less on Congress to get things done.

We’ve certainly seen this with the Department of Labor (DOL) conflict-of-interest regulations, as well as their guidance for state coordination of retirement plans for private sector workers. The Internal Revenue Service (IRS) has made radical changes in its determination letter program, clearly with the goal of reducing manpower devoted to that process. Most recently, the IRS has taken major steps to liberalize the process of granting waivers for IRA rollovers that fail to be executed within the normal 60-day window allowed for such transactions.

“Once upon a time,” as the fairy tale goes, the IRS maintained that it had no authority to extend the statutory 60-day period for completing an indirect rollover between IRAs, or between an employer-sponsored retirement plan and an IRA. EGTRRA, the Economic Growth and Tax Relief Reconciliation Act of 2001, changed that, giving the IRS the authority to waive the 60-day deadline if failure to do so “would be against equity and good conscience.”

IRS guidance in 2003 set out the conditions for obtaining a waiver, identifying multiple conditions – such as financial organization error, disaster, illness, incarceration, and others – that might justify an extension in order to complete a rollover and avoid unwanted tax consequences. In some cases, such as financial organization error, the waiver could be automatic. In others, the taxpayer had to apply to the IRS for a private letter ruling, or PLR.

PLRs have never been free, but the fee for these rollover waiver PLRs began at less than $100; a real bargain as IRS fees go, and many, many taxpayers took advantage of it. Rollover waiver PLRs became by far the most numerous to be issued. Over several years the fee was increased to a range between $500 and $3,000, depending on the volume of assets involved. Finally, in 2016, the IRS eliminated the special reduced fee, and the cost rose to a daunting $10,000. Clearly, the only taxpayers who would apply for a rollover waiver were likely to be those with a great deal at stake if the 60-day limitation could not be waived.

Little IRS or DOL guidance is issued without either being identified on their priority guidance plans, or via leaks of insider information revealing what these agencies are about to issue. Guidance that does not rise to the level of regulations is not reported as pending with the federal office of Management and Budget (OMB), so for any guidance below regulations-level there is no tip-off from that source.

Against this backdrop, IRS release of Revenue Procedure 2016-47 on August 24 came without hint or advance fanfare, and apparently little, if any, advance industry awareness. The latest update to the IRS priority guidance plan had made no mention of sub-regulatory IRA guidance on rollovers.

  

The IRS has provided what at first glance seems like a very generous option for taxpayers to claim eligibility for an extension of the 60-day limitation on executing rollovers. Now, many of the justifications that might have earned a waiver in the PLR process are available in what seems an almost automatic fashion. Illness, damage to one’s residence, postal errors, serious injury or death of a family member – even misplacing a check – are among 11 reasons for self-certifying one’s eligibility for a waiver, requiring no blessing from the IRS.

Is there a dark lining to this apparent silver cloud? Obtaining a waiver from a rule that could otherwise yield unpleasant tax consequences is obviously of great benefit to a taxpayer moving assets from one savings arrangement to another, and missing the deadline. But this guidance is not without some “maybes.” The most sure and certain of its positive effects is to grant protection to IRA custodians and trustees, and plan administrators, who receive rollovers under the self-certification process. They may rely on the representations of the taxpayer providing the certification, unless they have actual knowledge that the reason is invalid.

The real ambiguity is faced by the taxpayer himself. For example, what constitutes severe damage to a taxpayer’s principal residence, one of the exemptions cited in the latest guidance? What does “seriously ill” mean? What is “a postal error” that would prevent completion of a rollover? How could a taxpayer substantiate that he believed a non-retirement account was a retirement account when he mistakenly made the deposit? These are but a few examples among the 11 for self-certification.

  

Missing are details to help a taxpayer be certain that he or she meets some of these less-than-straightforward conditions for self-certification. That could be a bad thing or a good thing, depending on your viewpoint. Certainty will not be easy in some situations. That will bother some taxpayers, and may lead them – if the stakes are high enough – to seek an actual PLR. Others may feel just the opposite. If the door has been opened for them to give themselves “wiggle room” in an ambiguous self-certification situation, they may go for it and take comfort in the low probability of their ever being audited.

That certainly will not make every potentially eligible taxpayer comfortable. Nor should it.

Why Are Fees Our Only Focus?

If I were to name one ongoing issue that has absorbed more time and energy for retirement industry regulators, and has been the paramount compliance concern for plan administrators, it would have to be plan fees.  Investment fees, administrative fees, transaction fees, there has been a concerted effort by regulatory agencies and policymakers to limit the negative effects that fees can have on the account balances of retirement plan participants.  Disclosure regulations, best interest regulations, benefit statement requirements, all in some manner reflect fees and their perceived importance.

This fee-focused thinking has also influenced the growth of a cottage industry for law firms that have seen an opportunity to litigate.  Their presumptive stance seems to be that lower fees are always desirable.  The Department of Labor has been highly visible as an amicus curiae supporter of plaintiffs in fiduciary breach cases, and law firms have no reason to expect the DOL to be anything but an ally in such litigation. 

Yet there are other important factors besides fees alone that influence the account balances that workers will take with them into retirement.  Some are partly or entirely within the control of the worker, yet they are not talked about as they should be; if they’re discussed at all.  Tunnel-visioned preoccupation with minimizing fees, rather than promoting more aggressive saving and improving investing behavior or reducing “leakage”, can lead to retirement accounts that under-perform in the long run. 

A presentation by Tom Kmak, from the firm Fiduciary Benchmarks,  at a recent conference really caught my attention.  It was entitled Stopping the Race to the Bottom and caught my attention with thought-provoking points about the numerous factors that can influence retirement savings accumulations.  It’s their conclusion that fees are well down the list of most important factors.  This is somewhat ironic since Tom Kmak’s firm is the leading fee benchmarking service in the industry.  Tom’s presentation basically lays out the argument that the DOL in many ways, including their own booklet on 401(k) Fees, notes that fees should not be considered in a vacuum.  Tom then uses mathematical examples to show why the DOL stance is in fact the moral high ground.  Or as Tom would say: “Fees without Value is like knowing ½ the score of a football game.”

In any event, I believe the suggestions they make for boosting retirement accumulations are worth pointing out.  This kind of information should be in every employee enrollment meeting, in participant investment education, and stressed at every reasonable opportunity when a plan and a participant interact.

Some may not be enthusiastic about the recommendations found in Stopping the Race to the Bottom.  Some require decision making and resolve on the part of a worker saving for retirement.  Admittedly, not all of the recommendations may be within reach of everyone attempting to save for retirement.  But many participants can implement at least some of the suggested steps, rather than relying on regulators to deliver a secure retirement.     

The first suggestion was to retire at the Social Security full retirement age, which for many is age 67, rather than claiming a reduced Social Security benefit when first eligible at 62.  Health problems may prevent some from doing this.  But those able to wait to retire can put away a portion of full-employment earnings for four or five more years, and will also have a higher monthly Social Security check when these benefits begin.

Second, starting to save specifically for retirement at an earlier age, and not depleting those accumulations for other purposes, will take greater advantage of the power of compounding and the time value of money.  Increasing one’s deferral rate is similarly advised.  Both of these suggestions may be met with laments of “I have other important priorities” or “I won’t have enough disposable income.”  For some it may be true.  For others such objections favor short-term gratification, and are an excuse for ignoring retirement’s inevitability because it seems far away. 

Increasing the rate of return on investments may seem an unlikely thing to propose.  How can a retirement saver do that?  He or she probably can’t do so on a short-term, basis.  But a retirement saver may never gain control over investment performance if they don’t educate themselves in investing principles, and – being so equipped – begin to make sound investment decisions.  This is where investment fees should be considered, but they must be judiciously weighed against investment growth potential.  Sometimes the latter is more important than the former.  And this is where the importance of working with a good investment advisor proves itself.

One factor that is clearly beyond participant control is an increase in employer matching contributions.  This factor was a “wish list” item that Fiduciary Benchmarks included among those factors which – over time – would contribute to greater retirement readiness. 

Having identified these factors that could boost retirement saving accumulations, Fiduciary Benchmarks ranked them top to bottom according to what it believes is their potential to influence assets at retirement.  An assumption was made that each measure could be improved by 20%.  For example, increase deferrals by 20%, lower fees by 20%, and so on.  Based on these assumptions, Fiduciary Benchmarks ranked the factors in importance as follows: 

    

    1.    Retire later

    2.   Begin contributing sooner 

    3.  Increase investment rate-of-return

    4.   Increase rate of deferrals

    5.   Increase employer matching contributions

    6.   Decrease investment fees

Like any proposal to enhance retirement readiness, the ideas offered in Stopping the Race to the Bottom are not a magic bullet.  Variables can differ greatly from participant to participant and plan to plan.  Conditions change over time, and with stages of life.  But the big take-away here is that most of us have choices we can make to enhance that readiness.  No regulatory action by itself is going to make it happen.

Will Fiduciary Rule Survive Rising Tide of Lawsuits?

The first week of June saw the filing of two lawsuits challenging the Department of Labor’s final fiduciary rule and its accompanying exemptions.  Those in a position to know were confident that it was only a matter of time before additional lawsuits were filed, and they were right.  At the time of drafting this blog, the number of suits had increased to five.  Just how many will ultimately be filed is still an open question.  The common aim of these legal actions is an injunction to prevent the collective guidance from being implemented, despite the official June 7th effective date and start of transition period having already been reached.  It is the hope of some opponents that an injunction could buy time, and that a new administration in the White House might choose to nullify the guidance.

Regardless of the probability of success of these legal challenges, it seems this result was inevitable, if for no other reason than that this guidance has been accompanied by more controversy than the industry has seen in a very long time. 

The plaintiffs in the first lawsuit filed included a group of chambers of commerce and financial services industry groups, filing in a jurisdiction – the U.S. District Court for the Northern District of Texas – that is not particularly cozy with Washington, D.C., interests.  Whether this venue – a venue also chosen for at least one of the subsequent lawsuits – will translate to an injunction remains to be seen.  Even if this happens, it is certain that the DOL would file an appeal in an attempt to vacate the injunction.  Some speculate that the legal process could ultimately lead to the U.S. Supreme Court. 

The plaintiffs’ arguments for an injunction are numerous, and while similar in nature,  are not completely uniform from one lawsuit to another.  Collectively, they include – among other charges – DOL infringing on the authority of other federal and state agencies, doing financial harm to investors, violating the Federal Arbitration Act, violating the First Amendments freedom of speech, exposing financial advisors and their employers to litigation risk, and issuing a final rule with new conditions that allowed no opportunity for public review and comment. 

This last accusation is one that is thought to have a greater chance of swaying a court in favor of the plaintiffs.  There were, in fact, some important new provisions in the final rule that were not open to comment, if for no better reason than that no one knew of them before April’s release.  One of these was a sweeping definition of the “management” of securities.  Another was the loss of the prohibited transaction exemption for Indexed annuities.

 Another charge that might have some possibility of “sticking” is that DOL, despite their claims to the contrary, does not appear to have coordinated in a serious way with the Securities and Exchange Commission (SEC), an agency empowered by the Dodd-Frank Wall Street Reform Act to undertake such a regulations project as this.  DOL has released e-mails as evidence of some communication with SEC, but many feel these do not come close to the level of cooperation or coordination hoped for and expected.

More than one of the lawsuits charged that DOL was “arbitrary and capricious” in formulating its final regulation.  This may have merit from the standpoint that DOL could reject at will any of suggestions in the more than 3,500 comments it received on the regulations.  But the long history of these regulations – dating back to 2010 – and the multiple comment periods and public hearings, suggest a deliberate process rather than caprice.

To obtain an injunction, plaintiffs must generally demonstrate certain things.  For instance, convincing a court that the plaintiff’s case has merit and could potentially be won at trial.  Or, that failure to issue the injunction will result in injury to another party, such as retirement investors.  These may not be so easy to prove to a court’s satisfaction.

There is a history of federal agencies being given the benefit of the doubt in interpreting statutes and issuing regulations.  We have, however, seen cases in which the courts have overruled federal regulatory agencies, such as a U.S. Tax Court ruling that overrode a 30-year IRS interpretation of how many IRA rollovers a taxpayer is entitled to.  But the courts are inclined to defer to the interpretive judgment of federal agencies unless there is a compelling reason to do otherwise. 

Perhaps this is one of those compelling situations.

Legal actions like these motions for injunction end in a formal request for remedies.  Perhaps surprising in our generally secular society, the official name for this request for remedy is called a “prayer for relief.”  Perhaps that’s fitting, since both supporters and opponents are hoping for a little divine intervention for their side.  Whether, or how, that happens will ultimately be up to the courts.

Let’s Hope the Regulation is Worth It

I’m sure that “the regulation” needs little, if any, further definition. Just as “the drive” in Super Bowl annals will always be associated with John Elway and the Denver Broncos, “the regulation” is a good candidate to forever be associated with the Department of Labor and its fiduciary definition package of final regulations and exemptions.  This guidance has been that big.

Big, of course, can mean a couple of things.  In terms of length in its Federal Register-published version – or any version, for that matter – the guidance is certainly big.  It fills more printed pages than any other in my 31 years in the retirement industry.  In terms of its potential impact on the way advisors do business with retirement investors, it is certainly big.  While notably improved over the proposed regulations, the final regulations are likely to be just as demanding in terms of the analysis required to comprehend what it all means, and configure operations and administration in order to comply. 

These DOL regulations contain a Regulatory Impact Analysis that attempts to quantify in dollars-and-cents terms the effort – translated into cost – that will be required to comply.  Notably, the costs being accounted for – whether or not they are reasonably accurate – measure chiefly those costs incurred by individuals and organizations involved in the advising relationship.  The brokerage, the mutual fund company, insurance company, street corner bank or credit union, and their employees or affiliates, are theoretically taken into account in this assessment of effort and cost.

One expense we can find no evidence of being taken into account by DOL is the effort being expended by organizations that consult with, and counsel, financial organizations and advisors who must comply with the new rules.  Benefits consulting firms, including law firms whose practice specializes in retirement benefits, are included in this group. 

DOL might argue that their final regulations and exemptions are a boon to such businesses, and a revenue stream for the analysis and guidance that must be given to their clients.  If only that were true.  Certainly there are firms that work strictly on a billable-hours basis, and for them the changes may trickle down to a better bottom line.  But that is far from universally true.   My firm is a typical for-instance.  We serve qualified retirement plan recordkeeping clients, IRA, HSA and ESA custodians, trustees and issuers, and have many partners and clients that use a wide variety of our services and products that are tied to tax-favored savings.

Almost without exception, our service agreements include interpreting and sharing findings related to our clients’ compliance responsibilities.  Whether we inform them in web site postings, in articles written for industry media, create special webinars, or assist in strategizing changes to product offerings, we are “at their service.”  We don’t shrink from such responsibilities; such relationships are a privilege.  But such relationships do not yield windfalls, as some might believe.

Even a very superficial tallying of the “man hours” that have gone into analyzing this fiduciary guidance reveals that it has been a huge expenditure of time and talent for our staff to understand and share their meaning and impact.  We take pride in our ability to dissect and interpret, and to be an important compliance resource to our clients.  But when all is said and done, the cost of adapting to these regulations will be far greater than four pages of the April 8, 2016, Federal Register suggest.  We truly hope the benefits delivered to retirement investors will prove to be worth it.

Final Fiduciary Regs Pack Less Than Hurricane-Force Punch

I’ve never directly experienced a hurricane.  But on Tuesday April 5^th, 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. 

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. 

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.

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!   

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 18^th 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.

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 26^th, 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.

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 15^th 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.

Is it Manpower Shortage, Intrusiveness – or Both – Behind New Form 5500-SUP?

Beyond the divisiveness and unwillingness to compromise that seem to have infected many of our lawmakers in Washington, D.C., there is also a growing distrust of some government agencies.  Actually, this distrust is encountered from Pennsylvania Avenue to Main Street, USA, and includes agencies and personnel responsible for implementing our laws and the regulations that spring from them. 

While the U.S. Department of Labor has recently been targeted for its proposed fiduciary regulations, the most consistently criticized and attacked government agency has undoubtedly been the Internal Revenue Service.  Some of the animosity comes from lawmakers’ dislike for the complex Internal Revenue Code, which – they may be forgetting – is a creature of the Congress itself. 

Being the police force tasked with enforcing this Code has made the IRS an available and visible target, including for grandstanding politicians wanting to score points with their constituents.  It seems that in every Congressional biennium some lawmaker proposes legislation to eliminate the IRS altogether.  While such proposals are rarely taken seriously, and there are functions performed by the IRS that are vital, the proposals are an indication of how disliked the IRS is.

The IRS didn’t do itself any public relations favors when some of its staffers allegedly targeted for special scrutiny a number of conservative groups seeking nonprofit status, a controversy that is still being played out.  However limited, or extensive, such practices might actually have been, given the hostility some politicians have for the IRS it was like pouring gasoline on a fire. 

Realistically, politicians’ attitudes do matter, because one way they can attack the IRS is by cutting the agency’s funding.  One can argue endlessly over whether the IRS or other federal agencies spend their taxpayer-funded annual budgets wisely.  But stagnating IRS funding has led to the loss of about 8,000 of its employees since 2010, this at a time when responding to landmark court decisions and complicated legislation – like the Affordable Care Act – is placing even greater demands on the agency.

Cuts in IRS funding have left fewer field staff available to perform audits of individual taxpayers, businesses, and retirement plans.  It has been estimated that there is now less than a 1% probability that an employer-sponsored retirement plan will be examined.  Another indication of IRS staff resource scarcity is the elimination of most plan determination letter reviews, except in the year of plan establishing and year of termination. 

To make its auditing resources more efficient, the IRS is focusing on plans it believes have the greatest probability of compliance problems.  Such information has come to the IRS in surveys it has conducted, the most high-profile occurring with some 1,200 401(k) plans in 2010.  The IRS sought information on plan design, contributions, nondiscrimination testing, employer demographics, loans, and more.  With a gun to employers’ heads warning of potential audits for non-response, the IRS got the data it wanted.

There is also information contained in Form 5500 filings that identifies plans with 401(k) features, plans with automatic enrollment, with participant-directed accounts, that use a default investment option, etc.  While most Form 5500 filings go to the Department of Labor, it is generally understood that some information is shared between the two enforcement agencies.

The IRS has proposed a way to collect detailed plan-specific compliance data on a regular basis, via new Form 5500-SUP, Annual Return of Employee Benefit Plan Supplemental Information.  A draft of the form was released in March, and the IRS envisions its use for 2015 plan years.   

Many, if not most, feel that the process of plans and service providers gearing up to report this information for the first time could take significantly longer than the 2015 plan year Form 5500 filing deadline, which – for calendar year plans – would be July 31, 2016.  In many cases the information sought is not maintained in a place or format that is readily obtained, especially not capturable or transferable by electronic means.  Given the fact that many plans are presently in the throes of restatement for the Pension Protection Act of 2006 (PPA), the timing for a 2015 Form 5500-SUP is very problematic, at best. 

Some feel that a plan that provides data on its methodology for conducting coverage and nondiscrimination testing, its amending history, opinion or advisory letter information, etc., is making itself an all too convenient target for an IRS audit.  The flip side of the argument  is that the IRS is attempting to do its compliance oversight job with diminishing personnel and budget resources, and that in its design of Form 5500-SUP the Service has taken a logical step in trying to take a more “rifle” – rather than shotgun – approach to monitoring plan compliance.  Reasonable minds may differ!

Ambiguity, however, is not reasonable.  For example, a plan is asked to declare whether it passed 410(b) coverage testing by the ratio percentage test or by the average benefits test.  Eligibility need not be determined by just one or the other across the board; some plans use both.  Another question asks for the date of the most recent “plan amendment/restatement for the required tax law changes.”  Is this question limited to full restatement events only?  Is it intended to capture dates associated with interim amendments?  If interim amendments, the IRS should be providing plans with a list of interim amendments appropriate to the particular year’s Form 5500 filing. 

There are questions on Form 5500-SUP the answers to which will come from other providers, which the preparer may be in no position to authenticate or verify.  Is the preparer potentially on the hook for the work of others over whom it truly had no control?  Mandating that the preparer of the Form 5500-SUP be identified will result in a public record disclosure of the client/preparer relationship; something not required of preparers of Form 5500 itself.   Is this really necessary?  As a matter of public record, I don't believe it is. 

We should probably expect that some level of compliance self-reporting is in all retirement plans’ future.  We are also aware that new procedures have growing pains.  But this initial attempt could and should be improved greatly, both in terms of content and in terms of timing.  

Battle Lines Are Drawn in Fiduciary Regulations Fight

Long ago, in distant elementary and junior high school days, some of the most galvanizing words on the playground or in the neighborhood were heard in the battle cry “Fight…fight..”  Brawls major or minor have always had the power to stir the blood and draw a crowd.  Back then, the motivation was likely to be nothing more serious than someone’s wounded pride, pecking order conflicts, or the mistaken belief that the opposite sex was impressed by such macho behavior. 

Times change, and we hopefully outgrow the need for those juvenile tests of strength and will.  But that doesn’t mean that the appetite for combativeness goes completely away.  It’s a part of everyday life, from the competitiveness of business to the sparring of politics and policy making.  We’ve been treated to a classic demonstration of this combativeness in the aftermath of the Department of Labor’s April release of proposed regulations on – how apropos – “conflicted investment advice,” much better-known as fiduciary definition regulations. 

The avowed intent of these regulations is to assure that those saving for retirement receive investment advice that is in their best interest, not advice biased in some manner that favors the advisor over the saver.  Proponents believe some version of these regulations will do this.  Opponents believe the rules as proposed will result in such advisor anxiety over possible fiduciary liability that smaller investors – particularly IRA investors – will be left without the investment advice they need.

Most of the shots in the minor war that has ensued have been fired from a distance, in newsletters, speeches, editorials and the like.  Some also in Congress, including legislation to halt or defund the regulations, and lawmaker pleas to Secretary of Labor Thomas Perez.  A dramatic exception, perhaps worthy of comparison to a Las Vegas fight card, occurred in a hearing held June 17^th by the Health, Education, Labor and Pensions (HELP) subcommittee of the House Committee on Education and the Workforce. 

That hearing bore the unambiguous title “Restricting Access to Financial Advice: Evaluating the Costs and Consequences for Working Families and Retirees.”  Unambiguous, in that it clearly expressed the organizers’ judgment that unless the proposed regulations are significantly modified, their effect will be to deny many retirement savers the guidance they critically need to prepare for life after their careers.

It might be overstatement to call the hearing and the testimony of lead witness Perez and private sector witnesses a “pitched battle.”  But some who witnessed it have characterized the testimony as intense and spirited.  As one put it, “Secretary Perez vigorously defended the proposal and the need for its adoption.” 

Secretary Perez repeated a previously-presented example of a couple that invested IRA rollover assets in an annuity investment whose fees he characterized as excessive.  He stressed that this was not illegal, because advisors in such circumstances operate under an investment “suitability” standard, rather than a best-interest fiduciary standard.  This the Secretary characterized as “flawed,” expressing his belief that the compensation interests of the advisor are almost inevitably in conflict with the best interests of the investor.

There seemed to be little disagreement on whether the best interest of the retirement saver is the appropriate standard of conduct for those who provide investment advice.  But there was little agreement that the regulatory formula proposed by the DOL can be successfully adapted to the actual investment marketplace, particularly where IRAs are concerned. 

While the proposed regulations allow variable forms of advisor compensation, they do so at the price of a binding contractual relationship – a “best interest contract” – between advisor and client.  That contract was described by Secretary Perez as necessary to enforce a best interest standard.

But a number of witnesses believe that the proposed regulations are unclear in defining just when in the advisor-client relationship this contract would be necessary, and fear that those who do not want to become fiduciaries will stop short of giving savers even basic investment education, to avoid being ensnared in a fiduciary net.    

Secretary Perez expressed his belief that these proposed regulations do a much better job than the long-since-withdrawn 2010 regulations in carving out and allowing advisors to provide investment education without giving themselves fiduciary liability.  But there was significant disagreement from other witnesses, to which Secretary Perez sharply asked for “chapter and verse” language on how they would improve it. 

Witnesses also expressed the belief that the best-interest contract, now commonly referred to as “BIC,” and the education-versus-advice conundrum, together will lead to more litigation in the form of breach-of-contract lawsuits.  To which the Secretary responded that binding arbitration language in the proposed regulations was intended to resolve such conflicts.  Many advisors, however, are unlikely to be cheered by the prospect of arbitration any more than they would welcome litigation.  Both have costs in time, expense, and uncertain outcomes.

As summers always seem to do, this one is flying by.  The deadline for submitting written comments on these proposed regulations, July 21^st, is already upon us.  It’s now less than a month to the public hearing scheduled for August 10^th through 12^th, with an additional day in case it is needed.  Based on the combativeness we have seen so far, it would surprise no one if this bout goes that extra round.

Many Ifs, Ands & Buts in EBSA’s Fiduciary Solution

When we were young, we may have been told that beginning a sentence with the word “but” was inappropriate.  We believed it because the people who said so were adults, and were supposed to know such things.  Later, we learned that “but” is a “coordinating conjunction,” and many good writers properly begin sentences with it.  Perhaps we had been intentionally misled because “but” is a word of protest often used by children.  “But I don’t want to eat my broccoli!” “But I’m not sorry!” 

Appropriate or not, “But” was the first word that came to mind when I had digested the Department of Labor’s “conflicted advice” – formerly fiduciary definition – proposed regulations, issued in April.  (Some other words that came to mind are less charitable.)  “But how can you propose,” I wondered, “a solution that seems generous to the present advising environment, but sets a snare that can spring future litigation and fiduciary liability even on principled and conscientious advisers?” 

I’m certainly not unsympathetic to the need for retirement savers to receive principled advice when making critical investing decisions.  They deserve no less.  But the most prominent solution being prescribed by the Department’s Employee Benefits Security Administration (EBSA) – the proposed Best Interest Contract – has some ingredients that beg the question of whether the remedy is worse than the malady.

To the genuine relief of many, EBSA’s proposed regulations did not narrowly limit the types of compensation that can be received by advisers or brokers serving retirement savers.  Some had feared that a fee-only approach might be required to avoid prohibited transactions and their inherent liability, which many believe might have caused advisers to flee the small investor market.   On the contrary, EBSA’s proposed regulations make clear that compensation that may vary depending on the investments chosen – like commissions, 12-b1 fees, revenue sharing, etc. – can continue to be a part of the adviser or advising firm’s compensation structure.

But – and it’s an important “but” – the price for this freedom in compensation arrangements is the Best Interest Contract, or BIC, as it is becoming known in industry shorthand.  If variable compensation structures are used to compensate for investment advice, something normally prohibited, an adviser or advisory firm must agree to enter into this arrangement.  It is a contractual one, make no mistake.  In EBSA’s own words, “It would require retirement investment advisers and their firms to formally acknowledge fiduciary status and enter into a contract with their customers in which they commit to fundamental standards of impartial conduct.  These include giving advice that is in the customer’s best interest and making truthful statements about investments and their compensation.”  Fail to meet either general or specific conditions of the BIC, and an advisor could be exposed to potential EBSA prohibited transaction enforcement, IRS excise taxes, and client litigation. 

There are a number of things that stand out as problematic with EBSA’s proposal, but for now we’ll focus on just two.  One is subjectivity.   “Best interest” may be in the eye of the beholder.  How much emphasis should be given to the lowest possible fees?  Are higher fees justified by facts and circumstances, such as a more expensive fund whose manager has a track record for outperforming others?  Would advice that looks questionable today be considered acceptable in the historical context of the time and options available when it was given?  Will those with enforcement and judicial authority have the expertise and the impartiality to make these and other judgment calls?

Another problematic issue is the potential for litigation if a client does not feel that an advisor has lived up to expectations.  An advisor or advisory firm must warrant that it has not only identified possible conflicts of interest, but has adopted measures to take them into account and prevent financial harm to the investor.  Based on such warranties, clients will have a contract law basis for seeking legal remedies, including class actions, and – specific to IRAs – bringing a case under state law without the benefit of ERISA preemption.   

There is nothing new about risk and return; it’s fundamental to investing.  In the case of EBSA’s BIC it now applies to the advisor, as well.  The potential for legal exposure may prove to be an unacceptable risk for some advisors and advisory firms.  Some might say it is appropriate that risk of a fiduciary nature find its way to the doorstep of folks who dispense investment advice to retirement plan participants and IRA owners.   But how much is “too much?”

A major concern of some who question EBSA’s approach is that instead of conflicted advice, some retirement savers will get little or no advice.