In this article we review key retirement benefits issues that policymakers will focus on in 2014.
Legislation — budget and tax battles
2013 began with the “fiscal cliff” legislation (the American Taxpayer Relief Act of 2012), generally raising tax rates for higher paid individuals. As we discussed in our article on this legislation, increases in the taxation of higher-earner investment earnings (increased capital gains and dividend taxes and the new 3.8% Medicare tax on net investment income) had the effect of making ‘in-plan’ savings more attractive.
There were two more budget battles – in March over the sequester and in October the ‘government shutdown’ over the Continuing Resolution and the debt ceiling. At year end there was a budget deal that involved a significant increase in Pension Benefit Guaranty Corporation premiums.
Probably the most significant policy fact for retirement plan sponsors is that retirement plans will remain a revenue target in ongoing budget deliberations. The current reality in Congress is that every legislative project that costs money – transportation, education, farm policy or the military – must somehow be paid for. And retirement policy is coming to be viewed (as it has in the past) as low hanging fruit for those seeking new revenues. On the current short list we would identify: PBGC premiums (although given the end-of-2013 increase, another increase seems unlikely); elimination of stretch IRAs; and additional defined benefit plan funding relief. The elimination of the deduction for dividends on employer stock and expansion of Roth IRAs, 401(k)s and conversions have also been proposed as a revenue raisers by some.
More fundamental changes are likely to be made only in the context of a ‘grand bargain’ or as part of fundamental tax reform. All of the comprehensive reform proposals we discussed in 2013 (see, e.g., our article on the Administration’s 2014 budget) remain on the table. Both the House Ways and Means Committee and the Senate Finance Committee have been reviewing fundamental tax reform proposals. But proposals for fundamental reform are likely to involve eliminating politically popular tax benefits, and the 2014 election makes consideration of such proposals problematic.
An expanded Saver’s Credit.
A comprehensive rule for the electronic delivery of notices required under ERISA and the Tax Code.
A proposal limiting the fiduciary exposure of DC fiduciaries selecting an annuity provider for a plan where annuity payments are guaranteed by a State guaranty association.
Relief from Tax Code required minimum distribution rules for deferred annuities (annuities that commence at a date after retirement, e.g., age 85).
2014 is, of course, an election year, and Congress remains deeply divided. In this context it would seem unlikely that any serious work would be done on retirement policy. It is, however, very possible that some piece of retirement-policy-as-revenue-raiser (the ‘low hanging fruit’ discussed above) may move as a pay-for for, e.g., an extension of unemployment benefits.
The term ‘retirement income’ has become shorthand for the issue: how do you turn an account-based benefit (e.g., a 401(k) plan lump sum) into income in retirement (e.g., an annuity)?
Last year DOL published its ”Advance notice of proposed rulemaking” describing changes to rules for defined contribution plan benefit statements that would require plan administrators to provide an estimate of a lifetime stream of payments based on (1) the participant’s current account balance and (2) the participant’s account balance projected to retirement. We expect further progress on this initiative in 2014. Because, generally, enhanced retirement income disclosure does not ‘cost’ revenues, there may also be efforts in Congress to move on this issue.
A critical outstanding retirement income issue is the extent to which it is practical to offer annuity options in a 401(k) plan (see our article Payout options from the sponsor’s perspective). DOL is aware that current fiduciary rules applicable to the selection of an annuity carrier are preventing some sponsors from adopting in-plan annuity alternatives. As we understand it, however, DOL is giving priority to its disclosure project – thus it’s unclear whether there will be action on this issue in 2014.
Finally we note that there are aspects of the fiduciary definition initiative (discussed below) that focus on distributions and payout options – particularly issues being raised by participant advocates concerning rollover practice.
Definition of fiduciary
Probably the highest profile policy issue affecting sponsors (particularly, but not exclusively, 401(k) plan sponsors) is the long-anticipated re-proposal of a re-definition of ‘fiduciary’ for purposes of ERISA. This project was very controversial. The original proposed re-definition was very broad; it raised significant issues for sponsors and for a number of different provider communities; and it had to be withdrawn (in 2011) after considerable pressure from industry groups and Congress. DOL has consistently indicated that it intends to re-propose.
Since the original proposal was withdrawn, the issue of rollover practice and procedure has emerged, and it is clear that the participant advocate community and DOL would like to see a re-definition of fiduciary that (somehow) addresses perceived abuses in that area.
Significant opposition to this initiative remains. In 2013, legislation was introduced in the Senate to take exclusive jurisdiction over the issue away from DOL; and legislation has passed the House that would delay re-proposal until after the Securities and Exchange Commission (SEC) has finalized its rules on the standards of conduct for broker-dealers under Dodd-Frank.
Litigation — fees and fund menus, Windsor, stock-drop cases
Fee/fund menu litigation continues following on the decision (in 2012) in Tussey v. ABB. In 2013 this sort of litigation generally focused on providers and on the issues of float and the use of in-house funds (in plans for employees of financial services institutions).
In June of 2013, in United States v. Windsor, the Supreme Court struck down section 3 of the federal Defense of Marriage Act (DOMA), which had defined ‘marriage’ as “a legal union between one man and one woman.” That decision cleared the way for federal recognition of same-sex marriages. After Windsor, for tax-qualified and ERISA-covered retirement plans, both IRS and DOL adopted a ‘state of celebration’ rule that effectively did just that. A number of very difficult questions, however, remain. Most critically, whether the Supreme Court will allow state laws prohibiting same-sex marriage to remain. For retirement plans, there are significant issues about the retroactive application of Windsor, e.g., what is the status of pre-Windsor non-spouse beneficiary designations and payments made without regard to a (now-federally recognized) marriage. One possible ‘wild card’: will the courts, in considering disputes between parties (e.g., rival claimants to benefits), defer to IRS and DOL guidance (e.g., the state of celebration guidance) or adopt their own rules (e.g., a ‘state of domicile’ rule).
The other significant retirement plan litigation development is the Supreme Court’s decision to review the Sixth Circuit’s decision in a stock-drop case – Fifth Third Bancorp v. Dudenhoeffer. There were some important employer stock decisions in 2013 (see, e.g., Taveras v. UBS AG et al.), and this area continues to be a target for litigation.
Valuation interest rate ‘stabilization’ under 2012’s “Moving Ahead for Progress in the 21st Century Act” (MAP-21) continues to provide significant funding relief for DB plan sponsors. In 2013 a proposal to make MAP-21 relief permanent was floated, mainly as a revenue-raiser, and the possibility of funding relief as a pay-for for other revenue-costing initiatives remains in 2014.
The trend in increasing interest rates, if it continues, may make permanent MAP-21-style relief less significant (right now at least) but also may make it more ‘do-able.’ The funded status of DB plans generally improved dramatically in 2013, and (if interest rates continue to increase) that trend is likely to continue in 2014. Thus, making relief permanent is not likely, in the short run, to encourage significant underfunding. In this regard we would note that the end-of-2013 dramatic increase in the PBGC variable-rate premium – when fully phased in, a 3% per year tax on underfunding – also discourages underfunding.
In 2013, despite very low interest rates, defined benefit plan sponsors continued to pursue de-risking strategies.
Two factors (at least) make a de-risking strategy more compelling in 2014: (1) significantly higher interest rates have reduced the cost of de-risking; (2) increased PBGC flat-rate premiums have made not de-risking significantly more expensive. These two factors have, in effect, reduced the cost of de-risking in 2014 (relative to 2013) by as much as 25% for younger participants.
At the same time, participant advocate groups have begun raising questions about current de-risking policy generally and the appropriateness of offering lump sums to retirees in particular. If (as we expect) de-risking activity accelerates in 2014, opposition to at least some de-risking strategies is likely to sharpen, and it is conceivable that we will see pressure in Congress or at DOL to ‘do something’ about these transactions.
In this regard, we note that the issues raised by participant advocate groups with respect to current rollover practice in connection with DOL’s definition of ‘fiduciary’ project become more acute as de-risking activity accelerates.
PBGC – financially risky sponsors
In 2013 PBGC continued its campaign for discretion to set its own premiums and to increase premiums, particularly on ‘financially risky’ sponsors. The Administration’s 2014 budget and PBGC’s 2013 annual report repeated the case for these changes. In the year-end budget deal PBGC was not given the discretion it wanted, but premiums were increased significantly, and the increase in the variable-rate premium can be thought of as targeting financially risky sponsors. As we discuss in our article PBGC variable premium vs. borrow-and-fund: impact of higher premiums, sponsors with reasonable borrowing costs may do better borrowing and funding rather than continuing to maintain unfunded liabilities.
PBGC has two other projects targeting financially risky sponsors: proposed reportable event rules and enforcement policy of ERISA section 4062(e). We expect further work – and negotiations with the sponsor community – on these issues in 2014.
Frozen DB plans
A problem has been developing for some time with respect to frozen DB plans that maintain ongoing benefits for a ‘closed group.’ We discuss the problem in detail in our article Treasury/IRS highlight ‘closed plan’ DB issues in Priority Guidance Plan. At the end of 2013 IRS provided limited, 2-year relief for plans meeting certain conditions. It also indicated that it intends to work on regulations providing a permanent, comprehensive ‘solution’ (in quotes because it is not clear whether IRS is prepared to provide much relief).
Other active 2014 initiatives
In addition to the foregoing the following initiatives remain on the agenda in 2014: