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On September 21, 2016, the Senate Finance Committee unanimously approved the Retirement Enhancement and Savings Act of 2016. The bill includes a number of provisions affecting both defined contribution and defined benefit plans.
In this article, we begin with some background on the bill’s genesis and prospects and then focus on four of the more significant proposals in it: providing a path forward for open MEPs; fixing the DC annuity fiduciary safe harbor; addressing the nondiscrimination issues presented by closed groups; and requiring lifetime income disclosure in DC plans.
As noted, the Retirement Enhancement and Savings Act was approved unanimously. Generally, the proposals in it are regarded as non-controversial. It had been held up in the Senate Finance Committee by committee Democrats, who conditioned their support of it on committee approval of some sort of relief for the UMW multiemployer health and pension funds. That legislation (the Miners Protection Act of 2016) was also approved by the committee on September 21, 2016, by an 18-8 vote, with all opposing votes cast by Republican committee members.
It’s unclear, at this point, whether this bill (that is, the Retirement Enhancement and Savings Act) will move forward. Its fate will depend, in part, on the results of the coming election. But it will also depend on whether the bill’s sponsors can either move it as a standalone bill (that is, get it on the Congressional legislative agenda) or attach it to a “moving legislative vehicle.” And, critically, passage will depend on whether Senate Democrats will condition their support (in the full Senate) on either UMW health and pension fund relief or (conceivably) broader multiemployer plan relief.
As we have discussed (see our article The multiemployer plan crisis), several large multiemployer plans are experiencing significant financial difficulty, and the PBGC does not have sufficient assets in the multiemployer insurance fund to pay off anticipated shortfalls. These are union plans. And, while the lines on the issue of federal relief for these plans haven’t been explicitly drawn, it’s generally believed that most Democrats support relief and most Republicans adamantly oppose it (although there are some exceptions, e.g., Republicans in coal states). It’s unclear how this conflict may be resolved or whether it will be an obstacle to the passage of any significant retirement savings legislation in the Senate.
Finally, note that all we have at this stage in the process is a Joint Committee on Taxation description of the proposed legislation. As we discuss below, the specifics of certain proposals may become clearer when we have actual legislative language.
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In what follows we discuss some of the more significant provisions of the bill.
Multiple employer plans (MEPs) are, generally, non-union plans for participants of unrelated employers. They are viewed by many as a way to make the qualified plan system generally and DC plans in particular “more accessible” (cheaper and easier to administer) for smaller employers. There are (at least) two major regulatory obstacles to using MEPs this way. First, current Department of Labor rules provide that MEPs may only be established where there is a “nexus” between employers (e.g., all the employers in the MEP are in the same industry). And second, current Tax Code regulations apply a “one bad apple” rule to MEPs – a qualification violation that applies only to one employer may disqualify the entire plan.
Open MEPs would (as we said) theoretically be targeted at smaller employers. Many view them as a possible solution to the main problem that is preventing smaller employers from establishing plans: the cost of plan administration and sponsor fiduciary liability. As a “lighter” and cheaper way of providing retirement a retirement savings vehicle, however, open MEPs may also be of interest to larger employers for whom reduced plan cost/liability exposure is a higher priority than, e.g., the ability to design a unique retirement plan investment program.
The Retirement Enhancement and Savings Act would allow certain “pooled employer plans” to operate as open MEPs (that is, as multiple employer plans of unrelated employers without any “nexus” of interest). To qualify, the pooled employer plan must:
Designate a “pooled plan provider” who is a named fiduciary and is the plan administrator.
Designate a trustee, who cannot be a participating employer, and who will be responsible for collecting contributions and holding plan assets. The trustee must also implement written contribution collection procedures. (This requirement addresses a major DOL concern: that some employers may collect contributions but not transmit them to the trustee, diverting them to improper, “non-plan” uses.)
Provide that each participating employer retain fiduciary responsibility for the selection and monitoring of the pooled plan provider and any other named fiduciary, and (unless delegated) the investment and management of plan assets. (Presumably the default for most open MEPs will be a delegation of investment management to a professional manager.)
Provide that participating employers and plan participants are not subject to unreasonable restrictions, fees, or penalties for ceasing participation, taking distributions, or otherwise transferring plan assets.
Require that the pooled plan provider provide to participating employers any disclosures or other information DOL may require.
A “pooled plan provider” must (i) register with the Secretary of Treasury and provide any required information, (ii) acknowledge in writing its status as a named fiduciary and as plan administrator, and (iii) ensure that all persons who handle plan assets or are plan fiduciaries are bonded in accordance with ERISA requirements.
With respect to plan qualification issues, generally, assets attributable to a noncompliant employer would be transferred to a plan maintained only by that employer or to a tax-favored retirement plan for each employee.
Thus, the bill would address both the nexus and “one bad apple” issues. The practicality of this proposal will very much depend on (i) ultimate legislative language and (ii) DOL and IRS implementing regulations.
As a general matter, many DC plan sponsors have been reluctant to add an annuity option because of possible fiduciary liability – perhaps years after the selection of the annuity carrier – based on a claim that the fiduciary should have known that the carrier was not “financially capable of satisfying its obligations.”
In 2008 DOL finalized a regulation providing a safe harbor for the purchase of annuities in a DC plan. While that rule improved on DOL’s “safest available annuity” standard, it still imposed significant duties on plan fiduciaries, including that the fiduciary appropriately conclude that “at the time of the selection, the annuity provider is financially able to make all future payments under the annuity contract and the cost of the annuity contract is reasonable in relation to the benefits and services to be provided under the contract.” (Emphasis added.)
In the view of many sponsors, this regulation did not solve the problem of fiduciary risk, and most 401(k) plans still do not offer in-plan annuities.
The Retirement Enhancement and Savings Act would address this issue by, generally, deferring to state insurance regulation on the issue of the financial condition of the annuity carrier. Under the bill, a fiduciary would be deemed to satisfy the “financially capable” requirement if:
[T]he fiduciary obtains written representations from the insurer that it is licensed to offer guaranteed retirement income contracts; that the insurer, at the time of selection and for each of the immediately preceding seven years operates under a certificate of authority from the Insurance Commissioner of its domiciliary State that has not been revoked or suspended, has filed audited financial statements in accordance with the laws of its domiciliary State under applicable statutory accounting principles, maintains (and has maintained) reserves that satisfy all the statutory requirements of all States where the insurer does business, and is not operating under an order of supervision, rehabilitation, or liquidation; and that the insurer undergoes, at least every five years, a financial examination (within the meaning of the law of its domiciliary State) by the Insurance Commissioner of the domiciliary State (or representative, designee, or other party approved thereby).
The insurer must notify the fiduciary of any relevant change in circumstance, and the fiduciary cannot be aware of other facts that would cause it to question the insurer representations.
One issue that has been raised: given that, after it is selected by the plan fiduciary, an annuity carrier will be issuing, on an ongoing basis, annuity contracts under the plan: when does the safe harbor apply? When the carrier is selected (which would be preferred by many fiduciaries)? Or when the annuity is issued to a participant? The bill would allow the safe harbor to apply as of the time of carrier selection, “provided that the selecting fiduciary periodically reviews the continuing appropriateness of its conclusions with respect to the insurer’s financial capability and cost.”
“Closed groups” – e.g., a limited group of participants who get grandfathered benefits under a DB plan or make-up benefits under a DC plan – present several problems under the Tax Code nondiscrimination rules. Very briefly (and oversimplifying a lot): while a closed group may be nondiscriminatory when it is “closed,” as some participants remaining in the group are promoted and get pay increases, and younger, lower-paid, non-closed group members join the plan, the closed group may over time become discriminatory. (We discuss these issues in detail in our article Frozen plan update.)
IRS has provided temporary relief with respect to this issue, which it recently extended through 2017. As discussed in our article, many regard the permanent solution IRS has proposed as inadequate.
The Retirement Enhancement and Savings Act would provide an improved solution (vs. IRS’s proposal). Under the bill, DB plans could be aggregated with DC plans and tested on a benefit accruals basis, without having to satisfy (burdensome) threshold conditions if:
For the year the class closed and the two preceding years the plan satisfied the nondiscrimination requirements.
Either the class was closed before September 21, 2016, or the plan … has been in effect for at least five years before the class is closed and, during that five-year period, there has not been a substantial increase … in the coverage or the benefits or other rights or features under the plan, other than in connection with certain transactions.
After the class was closed, either no discriminatory amendment is adopted to modify the class or the benefit accruals or benefits, rights, and features for the closed class, or the nondiscrimination requirements are otherwise met.
Similar relief is provided for closed groups receiving make-up benefits in DC plans.
In addition, a plan that meets these requirements would be deemed to satisfy the minimum participation requirements – another problem closed groups present which IRS has not addressed.
While the bill is an improvement over IRS’s proposal, its utility will to some extent depend on how, for instance, such terms as “substantial increase” are defined in final legislative language (and interpreted by IRS).
Under the proposed legislation, DC plan administrators would have to annually provide participants a description of the monthly income stream a participant would receive if her account balance were paid in the form of a single life annuity and joint and surviving spouse annuity, based on assumptions specified in DOL guidance. The bill instructs DOL to issue model disclosures. Finally, the proposal would provide protection against sponsor and plan-fiduciary liability.
Other provisions of the Retirement Enhancement and Savings Act as approved by the Finance Committee would:
Allow participants to withdraw earnings on 401(k) contributions on account of hardship and eliminate the requirement that participants taking a hardship withdrawal first take any available plan loan.
Increase certain filing penalties.
Restrict 401(k) “credit card” loans.
Modify procedures for the election of the 401(k) design-based safe harbors.
Eliminate (after the first year) the 10% limitation on the safe harbor default contribution rate.
Significantly increase the small employer plan start-up and auto-enrollment tax credits.
Extend the period for rollover of unpaid loan distributions (e.g., on termination of employment) to the due date (with extensions) for filing the Federal income tax return for the taxable year of distribution.
Eliminate the requirement that prohibits an employee who is taking a hardship withdrawal from making 401(k) contributions for 6 months after the withdrawal.
Allow the distribution of certain annuity contracts, generally when the annuity is “no longer authorized to be held as an investment option” under the plan.
Allow combined annual reporting in certain circumstances.
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The Retirement Enhancement and Savings Act includes a number of provisions that might improve the current DC retirement savings system and address issues that have arisen under the DB system. The biggest question about it, however, is not about substance but about process: will Congress, either the current Congress in a lame duck session at the end of this year, or a new Congress in 2017, be able to act on (generally) bipartisan retirement initiatives? Or will the partisan differences that have frustrated legislative action for the last several years continue?
We will continue to follow this issue.