Senator Harkin’s USA Retirement Funds proposal

On January 30, 2014 Senator Harkin (D-IA) introduced the USA Retirement Funds Act. The bill includes Senator Harkin’s USA Retirement Funds proposal and a variety of other proposals. To avoid confusion, in this article we are going to call the entire bill the “Act” and the USA Retirement Funds proposal the USARF. In this article we focus on two of the major parts of the Act: the USARF itself and provisions on hybrid plans; we summarize briefly other provisions of the Act.

The USARF proposal

The centerpiece of the Act is Senator Harkin’s USA Retirement Funds proposal itself. That proposal would, generally, provide for automatic participation (default in/option out) of employees not covered under a current defined benefit plan or defined contribution plan (with automatic enrollment at minimum levels) in a new USA Retirement Funds system — a system of collective trusts providing (generally) a DC-type benefit payable as an annuity at retirement.

Here are the details:

1. Coverage. The program would generally cover all employees of employers that do not maintain a “qualifying plan.” A qualifying plan (one that gets you out of the requirement to provide a USARF arrangement) is (1) a DB plan under which there are ongoing accruals or (2) a DC plan that provides for automatic enrollment at USARF automatic contribution rates (3% in 2014 increasing to 6% for 2018 and after) or for an employer contribution at those rates. Subject to certain exclusions (e.g., for age and service or coverage by a collective bargaining agreement), employees of a subsidiary, division, or other business unit not eligible to participate in a qualifying plan would have to be covered by a USARF arrangement. Thus, while the USARF proposal generally targets employers that don’t already have a plan, employers that do have a plan but don’t cover certain groups may also have to set up a USARF for those un-covered employees.

2. Automatic enrollment. Under a USARF arrangement, employees are defaulted in to a contribution rate (3% in 2014 increasing to 6% for 2018 and after). Covered employees would at any time have the right to decrease or opt out of contributions.

3. Tax treatment. A formal tax proposal was not included in the Act, but the accompanying fact sheet states that “[i]ndividuals could contribute up to $10,000 per year pre-tax, and employers would also be able to contribute up to $5,000 per year for each employee, provided the contributions are made uniformly.” (We understand that related tax legislation will at some point be introduced.)

4. Investment. Contributions would be paid into a USA Retirement Fund specified by the employee, or if none is chosen, the USA Retirement Fund designated by the employer.

The USA Retirement Fund is one of the key concepts of the proposal. Quoting from the fact sheet:

USA Retirement Funds would be privately run retirement plans approved and overseen by the Department of Labor. Each USA Retirement Fund would be managed and administered by a board of qualified trustees able to represent the interests of employees, retirees, and Employers. The trustees would be fiduciaries required to act prudently and in the best interests of plan participants and beneficiaries. They would also have to avoid conflicts of interest, remain independent of service providers to the fund, be bonded, and have fiduciary liability insurance.

From the sponsor’s point of view, the key feature of a USARF arrangement is that generally the sponsor would have no fiduciary responsibility with respect to the USARF. The sponsor’s responsibility would generally be limited to “meeting the enrollment requirements and transmitting contributions.” It also appears that the USARF would handle most required reporting and disclosure.

Some believe that these features of the USARF – relieving employers of much of the headache that comes with sponsoring a qualified ERISA retirement plan – are so appealing that some sponsors may terminate their DB or DC plans and set up a USARF arrangement.

4. Benefit. As early as age 60 and as late as age 72, a USARF participant may begin benefit payments. Payments are made generally in the form of a joint and survivor annuity with the spouse (if there is one) as the joint beneficiary; the USARF would also provide a pre-retirement surviving spouse benefit.

The calculation (and the amount) of the benefit is, under the bill, somewhat flexible:

The amount of such benefits [the annuity benefit paid by the USARF] shall be dependent on the amount of contributions made by the participant, the experience of the Fund, and the form of distribution elected by the participant. The amount of an annuity may be adjusted to reflect the experience of the Fund as necessary to protect the financial integrity of the Fund, except that annuity payments for those in pay status shall not be reduced more than 5 percent per year unless the Fund is faced with a significant financial hardship and the Secretary has approved the reduction.

USARF participants would have very limited access to their benefit. Before age 60 a participant could withdraw up to $5,500 and roll it over to certain retirement savings vehicles including a qualified plan or SEP. After age 60 a participant could take a one time payment of the greater of $10,000 or 50 percent of her benefit if the participant demonstrates that either she has sufficient retirement income apart from the USARF or is facing a substantial hardship.

These features – annuity payment form and extremely limited participant access – are appealing to the retirement policy community. Whether employees – particularly the lower-paid ‘under-covered’ employees that are a principal target of the USARF proposal – will accept these limits remains to be seen.

5. Politics. Senator Harkin is retiring. This year is an election year, and we have a deeply divided government. In this context, passage of comprehensive retirement policy legislation, like the USARF proposal, is extremely unlikely.

Nevertheless, USARF represents a serious proposal – perhaps the most serious proposal so far – of a ‘third way’ in our current two-way DB/DC system. It addresses, in a practical way (that is, in a way that might conceivably work) two of the key obstacles to extending retirement savings coverage to employees who, currently, have no employer-provided plan: (1) How do you avoid imposing insupportable administrative and fiduciary burdens on the employer? And (2) where do you put the money? It takes a position on other issues, e.g., mandatory coverage, automatic enrollment and (more or less) compulsory annuitization that, for some, may be controversial.

It is very possible, in a less divided Congress, that progress can be made on improving our current retirement savings system. There is some bipartisan support for that effort. If and when we get to that point, the USARF proposal may well be the place to start. Some features are likely to change. But the end product (if there is one) may be recognizably like what Senator Harkin has proposed.

Hybrid plan proposals

The Act contains several provisions addressing issues with respect to hybrid (generally, cash balance and pension equity) plans that are also currently subject to an IRS rulemaking process.

Background

Congress, in the Pension Protection Act (PPA), authorized the use of a ‘market-based’ interest crediting rate in cash balance plans, and IRS proposed regulations (on which sponsors may generally currently rely) in 2010 authorizing interest crediting rates based on the returns on trust assets or on an investment company. Two rules in the PPA affect the implementation of a market-based interest crediting rate: (1) a ‘capital preservation’ rule requiring that the participant’s benefit be at least equal to the sum of her principal credits (pay credits) (we are currently doing a series on the capital preservation rule); and (2) a requirement that the interest crediting rate not exceed a “market rate of return.”

An issue is raised with respect to the market rate of return rule by the fact that many cash balance plans provide for a fixed or minimum interest crediting rate. The PPA included a provision that the market rate rule was not violated “merely because the plan provides for a reasonable minimum guaranteed rate of return or for a rate of return that is equal to the greater of a fixed or variable rate of return.” The IRS and some in the sponsor community have differing views as to what fixed or minimum rates satisfy the PPA rules. The PPA language in this regard is not as straightforward as it might be, and IRS has taken a long time settling the issue. It has been over seven years since the PPA was adopted, and we are still operating under proposed regulations.

The Act includes a set of proposals that would, for the most part, resolve these issues:

With respect to a cash balance plan that provides interest credits based on actual investments (or an index with a similar effect), the Act would (apparently) allow a guaranteed cumulative rate of 3 percent (or a lower rate not less than zero). This is consistent with the current IRS proposal.

For plans with other interest crediting rates (e.g., plans that use an interest crediting rate based on a fixed income index), the Act would allow a guaranteed minimum rate equal to the lowest interest rate permitted under Tax Code section 415(b)(2)(E)(i) (currently, 5%). 5% is 1% higher than the current IRS proposal.

Finally, for plans that use a fixed interest crediting rate, the Act would allow a rate equal to the one permitted under Tax Code section 415(b)(2)(E)(i) plus 1%, or 6% in total. This is also 1% higher than the current IRS proposal.

Permitted interest crediting rates

In a departure from the IRS proposed regulation, which only allows specified interest crediting rates, the Act would, with certain narrow exceptions (e.g., company stock), allow “any rate of return available in the market.” In addition, the Act identifies several “safe harbor” interest crediting rates. The following safe harbor rates more or less track the IRS proposed regulation:

The first, second, or third segment rate (without regard to MAP-21 interest rate stabilization).

The discount rate on 3-month, 6-month, and 12-month Treasury bills with appropriate margins.

The yield on 1-year, 2-year, 3-year, 5-year, 7-year, 10-year, and 30-year Treasury Constant Maturities with appropriate margins.

A cost of living index with appropriate margin.

The rate of return on a broad-based regulated investment company.

The rate of return on an annuity contract for a participant issued by an insurance company licensed under the laws of a State.

The following safe harbors are added by the Act — that is, they aren’t in the proposed regulation:

The actual return on all or a diversified portion of the assets of the plan. (The proposed regulation only allows a rate based on plan assets in the aggregate.)

Any total return index or price index commonly used as an investment benchmark, as determined under regulations prescribed by the Secretary of the Treasury.

Any investment in which participants may elect to invest under a defined contribution plan maintained by the sponsor of the plan other than a stable value fund, or an investment available only through a brokerage account (or similar arrangement).

The foregoing proposals would significantly increase the design flexibility of cash balance plans.

Other hybrid plan proposals

The Act also (1) includes rules designed to accommodate (at least until final regulations are issued) interest crediting rates that were reasonable in relation to market rates when established and (2) allows pension equity plans to function under a good faith interpretation of the statute until regulations are issued.

Other provisions

The Act contains a number of other provisions addressing a range of retirement plan-related issues, including:

Authorization of “pooled employer plans” – DC plans for a group of unrelated employers – if certain requirements are met.

Provision for simplified administration and fiduciary rules (and, in effect, outsourcing of those responsibilities) for small employers (generally, 50 or fewer employees).

A “sense of the Congress” “that a person may be providing investment advice when such person advises a plan participant to take a permissible plan distribution and such distribution advice is combined with a recommendation as to how the distribution should be invested.” The Act instructs DOL to issue guidance consistent with this “sense” within 90 days of enactment. This provision obviously reflects Senator Harkin’s view of this issue. There are those in his own party who want to take jurisdiction over this issue away from DOL. In this regard, see the discussion of the “definition of fiduciary” issue in our article on retirement policy issues for 2014.

Requirement that DC plan benefit statements include “an illustration of the participant’s benefit as an estimated lifetime income stream,” together with relief from sponsor fiduciary liability based solely on such an illustration.

A limited fiduciary safe harbor for the purchase of annuities in a DC plan where certain requirements with respect to state insurance regulation are met.

Clarification that the availability of certain annuity provisions, death benefit guarantees, investment guarantees, or other features in insurance contracts will not affect the status of a fund as a default investment.

Provision for the outsourcing of annuity contract administration.

Imposition of a moratorium on Pension Benefit Guaranty Corporation enforcement of ERISA section 4062(e). We discuss the issue of PBGC’s 4062(e) enforcement policy in our article PBGC proposes new test for waiver in re-proposed reportable events regulation.

Provision for the determination of funding for purposes of PPA benefit restrictions and quarterly contributions without reducing assets by the amount of any credit balance.

Modifications of PBGC’s plan termination authority (the modifications generally appear to favor PBGC).

A segregation/preservation of assets rule for qualified domestic relations orders.

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As noted above, in the context of a divided government and an election year, passage of this legislation is unlikely this year. It appears that changes in retirement policy in 2014 will mainly involve proposals that can raise revenues for other, more urgent purposes – e.g., the increase in PBGC premiums to solve the 2013 year-end deficit challenge. Senator Harkin’s bill, however, addresses a number of issues that are, for the retirement policy community, important and, in some cases, urgent.