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Fiduciary Enforcement: A Camel’s Nose Under the Tent?

By W. Andrew Larson, CPC

Retirement Learning Center

We closed our eyes. We held our breath. June 9, 2017, came and passed, and the new Department of Labor (DOL) fiduciary rules for financial advisors became applicable, albeit subject to a relaxed transition period that runs through July 1, 2019. Gee, it didn’t seem so bad after all. Perhaps the new regulations aren’t the media event many of us made them out to be. Or is there more to the regulations than we realize that will lead to more serious and less desirable consequences down the line. Is there a camel putting its nose under the tent?

Clearly, the new regulations have resulted in broker-dealers implementing significant changes to their platforms, pricing, processes and products. These changes will have long-term effects for consumers, advisors and broker dealers. Originally, the concern over the regulations focused on the application of certain Employee Retirement Income Security Act (ERISA) rules to IRAs and rollover transactions. Under the new rules, previously commonplace transactions, such as recommending a rollover to an IRA, become a prohibited transaction and, potentially, subject to penalty unless an advisor follows an exclusion (e.g., providing education not advice) or the Best Interest Contract exemption (BICE) from the regulations. One immediate impact of these changes for advisors is increased oversight and the need for intensified documentation of IRA-related transactions—in particular—rollovers. One immediate impact on consumers seems to be reduced choice with their IRA accounts.

What about enforcement of the new rules? Well, according to DOL Field Assistance Bulletin No. 2017-02 and the DOL’s extension to the special transition period, until July 1, 2019, under a temporary enforcement policy, the DOL will not take any enforcement action against, “… fiduciaries who are working diligently and in good faith to comply with the fiduciary exemptions.” Likewise the IRS will not IRS will not apply § 4975 and related reporting obligations with respect to any transaction or agreement to which the DOL’s temporary enforcement policy applies. But, I am less concerned about the DOL and IRS, and their enforcement and reporting initiatives. The good news regarding federal-level initiatives, whatever they may be, is that they create a level playing field applicable to all players in essentially the same manner.

No, my concern with the new regulations is not at the federal level but rather at the state level. Under the regulations “state camels” may be placing their noses under the retirement tent. What could possibly go wrong? Before we explore the new state level issues let’s review the traditional ERISA and the Internal Revenue Code (IRC) enforcement environment.

The governance and control of retirement plans sits with the Federal government and courts. The DOL writes the rules for both retirement plans and IRAs. The DOL has enforcement authority over retirement plans under ERISA, and the IRS has enforcement authority over IRAs through the IRC. While there is no private right of action for IRAs, the IRC’s prohibited transaction provisions generally prohibit IRA fiduciaries from self-dealing, enforced through an excise tax.

The Federal venue offers several significant advantages. Federal law is uniformly applicable in all 50 states: One set of rules; one level playing field. In general, Federal rulings result in consistent interpretation (usually!) of the applicable laws. Next, Federal litigation is expensive. This means the issues brought forth are usually legitimate and not frivolous. Litigation occurs with significant issues when the plaintiffs believe they have a winnable case.

How are states able to become involved in retirement enforcement and litigation? Let’s examine how the regulations bring state courts into the retirement arena. Recall many IRA providers and advisors will utilize the BICE to avoid prohibited transactions. The BICE is a contract between the client (e.g., an IRA owner) and the advisor or other service provider. Contract law is based at the state level. Thus, if a plaintiff believes the advisor, provider, etc., has violated one or more elements of the BICE contract he or she can seek relief in state court. As the rule stands today, a BICE contract is enforceable under state law, and must provide for the right to sue in a class action.

And it gets worse. Each state’s contract law is unique. Much contract law is similar but not completely so. Thus, a BICE contract violation in one state may not be a BICE contract violation in another state. Theoretically, large retirement vendors will need to concern themselves with 50 sets of state ERISA BICE contract rules.

I would argue the States are not well versed in, nor facile with, the complexities of the Federal retirement regulatory environment. At a recent conference, one of the speakers was the official responsible for launching a state-run retirement program for small businesses. This state program requires most small businesses to offer a Roth IRA retirement program to employees. Again, this was an IRA-based program. I was, honestly, appalled at the official’s lack of insight and understanding of IRA programs, retirement plans and retirement regulations. Perhaps this is unfair of me, but I don’t see why states should commit resources to an area where the federal government and its agencies have done a credible job with enforcement and the protection of workers and their retirement benefits and rights. Another level of enforcement will simply increase costs that ultimately are paid by investors. I fail to see the benefit or the need for this new level of enforcement.

© Copyright 2017 Retirement Learning Center, all rights reserved
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401(k)s−The Magnificent $4.8 Trillion Dollar Failure

By W. Andrew Larson, CPC

Retirement Learning Center

 

Independent thought leadership—it’s not just a lame tagline to us. At the Retirement Learning Center, we believe thought leadership must go beyond simply parroting the common media narrative. That’s why in this and future blog posts, as well as elsewhere, we strive to rise above the inane chatter to explore and challenge the real retirement-related issues and trends facing consumers and the industry in general.

In a previous blog we alluded to what some have called the supposed failure of the 401(k) experiment to provide retirement income security to U.S. workers. Let us now honestly explore the purported shortcomings of the 401(k) plan, and discuss possible enhancements to help the plan better meet the needs of the current workforce.

Have 401(k) plans failed? Hardly! According to the Investment Company Institute (ICI), 401(k) plans hold $4.8T.[1]  That amount represents a doubling of 401(k) plan assets in the last 10 years. I contend $4.8T is a magnificent failure, and is a lot of money earmarked to support millions in their retirement. In addition to supporting retirees and their families, 401(k) plan distributions will provide significant tax revenue to the Federal and many state governments.

Let’s take a look at how much money is accumulating in participant accounts. According to EBRI/ICI Participant-Directed Retirement Plan Data Collection Project[2] the average balance by age group is as follows:

Age                        Balance

20s                         $26,428

30s                         $61,757

40s                         $117,863

50s                         $176,922

60s                         $171,641

Perfect? No, but 401(k) plans seem to be working for the traditional, full-time employee segment. But there is always room for improvement.

Imagine for a moment a counter reality where 401(k) plans did not exist. Assume further that Congress never contemplated any other type of self-contributing, tax-favored retirement savings arrangements [e.g.,  IRAs, Roth IRAs, 403(b)s, 457s, Savings Incentive Match Plans for Employees (SIMPLEs), etc.]. You get the idea. In this counter reality where would the $4.8T of 401(k) assets be today? I suspect most of the money would not have been saved for retirement. It probably would have been spent on the myriad of earthly consumer delights tugging at our wallets.

401(k) plan participation rates among full-time employees are good. Eighty-two percent of workers are making employee pre-tax contributions to 401(k)-like plans.[3]  This is a good start. Can we do better? Certainly; for example, part-time workers were not on Congress’ mind when it enacted the Revenue Act of 1978, which created 401(k) plans. And, if a plan is available, the average percentage of income contributed to 401(k) plans—6.8%[4]−could be higher.

But notice it’s not the plan’s fault. 401(k) plans do not succeed or fail. Claiming 401(k) plans have failed is, frankly, foolish. As my esteemed colleague Nevin Adams succinctly opined, “Blaming the 401(k) for the retirement crisis is like blaming the well for the drought.” 401(k) plans don’t fail – we fail. Success is a choice.

Saving for retirement is a personal choice. Not saving enough or at all for retirement, ultimately, is a reflection of personal priorities. Recently, my spouse and I had dinner with friends of many years. The couple related their newly married daughter and her new husband just got back from a trip to Ireland, are busy decorating a new home and looking to purchase motorcycles. Both work for large corporations with good retirement programs. However, neither is participating in his/her respective company’s 401(k) plan. Plan participation is not a priority for them at this time.

But better retirement outcomes through increased plan participation is in the best interest of our society overall. Several policy changes come to mind that could address the mindset of this young couple and make the 401(k), no to make us, more effect in building retirement readiness.

First, let’s take a page from many state and local governmental plans that mandate employee contributions as a condition of employment. Many governmental plans mandate employees contribute 5 , 6, 8 or even 10% or more of compensation to their plans as a condition of employment. These contributions are irrevocable, and the money remains in the plan until retirement or separation from service.

Perhaps a national mandate requiring all employees (and independent contractors) to contribute a certain percent of compensation to a retirement plan would be a sensible step to improving retirement outcomes. Every time I mention this strategy I get the, “What if they can’t afford it,” objection? My response: They (and ultimately all of us) can’t afford not to have more people save for retirement.

It’s not about affordability; it’s about priorities. When retirement readiness is a priority people save for retirement. Let’s not overthink this. To illustrate the shift of priorities over time, let’s take a look at housing. According the June 2, 2016, edition of the Wall Street Journal, the median square footage of a family home is 61% larger than the median size of a family home 40 years ago, and is 11% larger than a decade ago. The larger home decision is based on priorities.

In addition to contribution mandates, a coordinated public policy initiative focused on savings and retirement readiness is essential. Let’s quit bashing 401(k) plans and push public policy initiatives to change investor behaviors and priorities.

We as a society are effective at changing mores and behaviors through public policy initiatives. A great example is smoking. The effective messaging of smoking’s ills created an all but smoke-free public environment; and we did it rapidly. Those of us over 40 remember when smoking was ubiquitous. Our younger colleagues may find it shocking to discover that people once smoked in airplanes, restaurants, theatres, hotels and cars. Smoking was cool and sexy. Anyone remember when the airline industry began to offer “No Smoking” sections on planes?

Let’s move the retirement readiness needle through the same type of public policy messaging. The campaign’s focus is one of encouraging saving and retirement readiness. It’s doable. It’s not political. Congress tends to listen to those who speak up.  You can contact your senators and representatives directly and, to make your voice even louder, join with trade groups like the National Association of Plan Advisors (NAPA). It’s in everyone best interest.

[1] 2017 ICI Fact Book, Figure 7.9

[2] ICI Research Perspective, September 2016, Vol. 22, No. 5

[3] Bureau of Labor Statistics, National Compensation Survey-Benefits, 2016 https://data.bls.gov/cgi-bin/dsrv

[4] Plan Sponsor Council of America, 59th Annual Survey, 2016

© Copyright 2017 Retirement Learning Center, all rights reserved
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The Golden Age of Pensions: Another Fairy Tale

By W. Andrew Larson, CPC

Retirement Learning Center

 

Independent thought leadership—it’s not just a lame tagline to us.  At the Retirement Learning Center, we believe thought leadership must go beyond simply parroting the common media narrative. That’s why in this and future blog posts, as well as elsewhere, we strive to rise above the inane chatter to explore and challenge the real retirement-related issues and trends facing consumers and the industry in general.

“We are in a retirement crisis!” “401(k) plans have failed!” Media outlets frequently chant both of these mantras. Often underlying these assertions is the subtext that we need to return to the good old, defined benefit pension plan days when retirees lived happily ever after, supported by their generous pension checks.  Images of contented pensioners enjoying their golden years with golf, gardening, shuffleboard and an occasional game of bingo may warm the heart—but are not accurate.

Sadly, this vision of a blissful, pension-supported retirement world is—for the most part—a fantasy. Very few, lucky individuals actually experienced the good old pension days. It’s time to face reality and dispel some long-held myths associated with defined benefit plans so that we can get on to real-world solutions.  

Myth #1. Once upon a time most people retired with a pension.

  • Reality check: As with many myths, this one contains a grain of truth. Until the late 1970s, a larger percentage of the workforce was, in fact, participating in defined benefit plans over other types of retirement savings arrangements. According to the Employee Benefits Research Institute, the high-water mark of defined benefit plan coverage in the private sector probably occurred in 1980 when nearly 35 million workers were covered by defined benefit pension plans. This represented 46 percent of the private sector workforce. Since that time the overall pension coverage rate has declined. The Bureau of Labor Statistics reports fewer than 18 percent of private sector workers are currently covered by pension plans.
  • The important take away is the misleading nature of the pension coverage statistic. Pension coverage does not necessarily equate to ultimately receiving a pension benefit. Many workers may have been covered by pensions in the past, but few ever received a benefit.

Why?

One simple answer is the pension rules were different back in the 70s and 80s than they are today.  Let me illustrate with a personal example.

In the 1970s, I worked at a grocery store stocking shelves and carrying out groceries. Despite the part-time status of the job I participated in the Amalgamated Meat Cutters Pension Plan. I was one of the 46 percent of workers covered by a pension plan. However, after I left employment at the store I received no pension benefit. I didn’t work there long enough and had to leave my benefit behind. My former employer used this “left behind” amount to help pay for benefits of participants with 30 years of service. These amounts became what are now called forfeitures.

Under the old defined benefit plan rules, in some cases, eligibility to receive a benefit required 30 years of service and employment with the plan sponsor through the retirement age of 65. Workers leaving before retirement usually got nothing, and their accruals were used to fund benefits for those who retired and earned a benefit. In fact, only about 10 percent of the covered workers ever stayed long enough to receive a benefit. If you made it to age 65, and had enough service—congratulations—you got a monthly check!

The forfeitures helped control plan costs by reducing the size of employer contributions. So, while fewer people received benefits in the old days, the dollars left behind helped keep plans more affordable for employers. As a result of modern-day vesting and accrual rules, many more employees who separate early—even before retirement age—still receive at least some benefit.  Consequently, with fewer forfeitures today plan sponsors need to increase their contributions. Do you see the trade off? Under the modern rules, because less money is left behind, the plan is more expensive for the plan sponsor (and less appealing). There is no such thing as a free lunch.

Myth #2. Pension benefits were generous back in the good old days.

Actually, benefits were quite modest. According to study by Walter Kolodrubetz, published in the Social Security Journal, the average pension benefit was about $137 a month up until 1970. The Pension Rights Center’s research indicates the current monthly benefit today is approximately $781 a month.

Adding insult to injury, most pre-1970s retirees lost half their purchasing power during the inflationary surge of the 70s and early 80s. As an example, a retiree with a $1,000 monthly pension check in 1970, by the early 80s had about $160 of inflation-adjusted buying power. In other words, during this period, inflation eroded about 86 percent of retirees’ buying power.

This brings us back to reality. There never really was a golden age for pension plans.  And, today, defined benefit plans are becoming too expensive for employers to continue. Pensions are not coming back. So, what should be done?

First of all, we need to challenge proponents of the “let’s bring back pensions” notion. Demographics and economics make that idea a nonstarter.

Next, we should propose and advocate modern 401(k)/IRA enticements, designs and products to enhance retirement readiness, such as

  • Automatic enrollment,
  • Automatic escalation,
  • Automatic investment,
  • Lifetime income options,
  • Availability of saver’s credits,
  • Expansion of multiple employer plans (MEPs), and
  • Incorporating HSAs into retirement planning.

So let’s focus on developing strategies and policies that fit in the real world.

© Copyright 2017 Retirement Learning Center, all rights reserved