Business of Benefits

Business of Benefits

Myth-Busting the Ratings Allure: Fiduciary Risk From Use of Ratings In Purchase of Lifetime Income Products

Posted in Fiduciary Issues, Lifetime Income

 Guaranteed lifetime income from a DC plan requires a contract with a life insurance company. Period. Even if the program is provided by a mutual fund company, a bank, or any other non-governmental entity, insurance companies are the only businesses which can issue to DC plans a contract guaranteeing lifetime income.

Choosing the right insurer is an important task. It is a fiduciary act, and it is incumbent upon the fiduciary to be able to make a prudent choice of insurance companies.


Advisors and attorneys often struggle with this, though we don’t believe it is difficult as it seems.  We have suggested that there are some sound ways to do this, particularly since trustees have been buying annuity contacts for centuries (yes, centuries. The material we have found in “Open Library” and “Mendely” are fascinating).

What is NOT sound, however, is a mere reliance on an insurer’s ratings in deciding what insurer to choose-or even the improper use of a rating in the decision making process.  It does seem like such a simple task doesn’t it? When choosing between a AAA rated insurer, and an A rated insurer, you are better serving the fiduciary function to always choose the “AAA” rating, right?

No so. There are, in fact, circumstances under which relying solely on the current level of an insurer’s ratings may actually cause the fiduciary to engage in a breach.

This became apparent in Moshe Milevsky’s (an economist, and one of the world’s leading authorities in lifetime income) presentation on Tontines (more on that in another blog, but tontines were, effectively the first annuities) at the Stanford Center on Longevity’s roundtable on Best Practices in Retirement Income in May (which was well put together by Steve Vernon). Moshe discussed in some detail as to when an annuity is worth the price you pay for it. His answer was that it depends on the “load” an insurer builds into its annuity contracts.


How does “load” relate to an insurer’s rating, and to a potential fiduciary breach in relying upon that rating?  Simply put, an insurance company can effectively “buy” a high rating by making sure its RBC Ratio-which is fundamentally determined by its level of reserves-is high.  However, in order to have the funds to increase its reserves necessary to obtain or maintain a higher rating, an insurer typically needs to charge more for its annuities, placing a heavier “load” on them. The insurer, in effect, passes on its cost for a higher rating to its annuity policyholders.

The problem for a fiduciary is that a higher RBC ratio (and higher ratings) above a certain level does not necessarily provide greater assurance of insurer solvency.  It may just mean that the fiduciary is paying too much for an annuity, without getting a commensurate return in the form of lessened risk of insolvency. I do invite you to read, as an example, Consumer Reports’ discussion of insurer ratings.  It makes the point that, above a certain level of financial strength, ratings may have limited usefulness.

The question a fiduciary needs to ask if making a decision based upon ratings is whether, given the relative rating of two insurers, is it worth paying potentially higher premiums for the higher rated company. This is particularly true for ratings in the same class (for example, S&P has seven different levels within its “A” class of ratings). Paying too much for an annuity contract can be a fiduciary breach, which means the fiduciary needs to exercise caution under these circumstances.

Ratings do have their usefulness in a fiduciary review. Any changes in an insurer’s ratings, for example (either higher over lower), within recent years should provide fertile grounds for the fiduciary to ask a number of important questions.  But merely using upon an insurer’s static rating in making a fiduciary decision may actually be the basis of a breach.

New QLACs Establish Foundation for DC Annuitization

Posted in Lifetime Income

Lifetime Income for 401(k) plans has been been getting a lot of press, driven in large part by efforts by the DOL and Treasury to find ways to promote retirement security.

The IRS took a substantial step in making these DC lifetime income efforts become a reality with its publication of the final regulations establishing the “Qualified Plan Longevity Annuity Contract,” or “QLAC “. In order to even publish this regulation, however, the IRS had to “clear the underbrush” and resolve an number of technical issues relating to the manner in which defined contribution plans could even provide lifetime income.

Treasury and IRS staff did just this, and quite practically. The final regs even addressed some key market concerns, removing a couple of roadblocks which would have made the QLACs difficult to provide. So, for example, the QLAC can have a return of premium feature; can pay certain gains (which is important for certain, popular, annuity products); removed potentially duplicative disclosure requirements; and permits insurance companies to use off the shelf annuity products without amending them (if the contract otherwise meets the QLAC annuity requirements) until 2016. Staff also kept the QLAC simple (for example, no variable annuity contracts will qualify), thus keeping it very affordable.

Even though the establishment of the QLAC provides a good planning tool, for sure, and it does provide a modest tax benefit, that is not the real story here. The true impact of the QLAC reg, and what makes it so very important, is that it establishes the foundation under tax law by which DC plans can simply annuitize.

So, before you dive into the close details of the QLAC (and we will do that, as will many others, I’m sure, over the coming months), lets first turn to the tax rules that actually make lifetime income work in a defined contribution plan. You will need to understand what it takes to put an annuity into a plan, as well as what it takes to distribute an annuity from the plan.  I invite you to read the preamble to the originally proposed QLAC reg, as well as Rev Rul 2012-03. Between these two pieces of guidance, you find some very basic instructions on how DC annuitzation-even beyond QLACs- will work. Here’s a brief list of key elements: Continue Reading

ERISA and Mom

Posted in General Comment

I have tried to publish this as my “Annual Mother’s Day” posting. It puts a very personal twist to the things we do, and hopefully puts a larger and hopeful light on many of the mundane tasks that make up much of our business: 

ERISA wonks such as ourselves tend to get lost in the press of details which seem to flow non-stop from our regulators and legislators in D.C.  It is sometimes helpful to step back and see the personal impact of the things we do.

A few years back, a good friend of mine who ran the retirement plan operations of a large insurance company asked me to speak about ERISA to a meeting of his administrative processing staff. At the time, they were still struggling with some of the more difficult administrative processes related to the QJSA and QPSA rules. Here’s what I told them:

My father died at Ford’s Rouge Plant in 1970, after 20 years with the company. Back then, the normal form of benefit under a defined benefit plan was a single life annuity, covering the life of only the employee.  There was no such thing yet as a qualified joint and survivor annuity or a qualified pre-retirement survivor’s annuity.  This meant that my father’s pension died with him. My mother was the typical stay-at-home mother of the period who was depending on that pension benefit for the future, but was left with nothing. With my father’s wages topping at $13,000 annually and five kids at home, there was also little chance to accumulate savings.

The Retirement Equity Act of 1984 (a copy of which I still keep in my office) was designed to change all of that. By implementing the requirement of a spousal survivor annuity, a whole class of non-working spouses received protection which was desperately needed.  So in that speech to my friend’s administrative staff, I asked them to take a broader view-if just for a moment- of the important task they were being asked to implement. It was valuable social policy with real, human effect which they were responsible for pulling off, and they should take a measure of pride in the work they were doing.

Things have evolved much over the years, and some of those same rules which provided such valuable protection have become the matter of great policy discussions centering on whether they are appropriately designed, and whether they can be modified in a way to accommodate new benefits like guaranteed lifetime income from defined contribution plans. But the point is that Congress sometimes gets it right, and there is very valuable social benefit often hidden in the day to day  ”grunge” of administering what often seems to be silly rules.


In years past, I had reported on Mom’s well being. She has recovered from a series of strokes and, though suffering from advancing dementia, she has now moved from Memory Care to Assisted Living.  ”Doing well” takes on a whole different set of meanings. She is still healthy,  does know all of us, and remembers well many important things from a very precious past. We come more fully to the understanding that blessings truly  come in many different forms.

Happy Mother’s Day

Bob and Conni



The Wharton Loan Default Study: Documenting Unemployment’s Unrecognized Penalties

Posted in General Comment

The Wharton School Pension Research Council’s new Working Paper on” Borrowing from the Future 401k Plan Loans and Loan Defaults”  finally validated what some of us knew to be true for quite awhile. Using actual participant and plan data from a very large database (not just a statistical sampling), the study found that 90% of 401(k) plans force a default on loans outstanding at the time a participant leaves employment and that, indeed, such loans actually do default at an extraordinary rate. This had never been apparent in the past because of the manner in which loan defaults are reported on the Form 5500, which then led to a great deal of cynicism by a number of commentators that this was a serious problem.

It is now clear. Defaulting loans at the time of unemployment is a significant source of retirement “leakage.”

Perhaps even more importantly is the human cost that the study’s numbers reveal. It shows that this traditional plan design imposes a severe financial hardship upon those who loan defaultinvoluntarily lose their jobs, at a time when they can least afford it. The taxation on the forced deemed distribution and 10% penalty on loan defaults is especially cruel. Not only may it artificially inflate the marginal tax rate and impose taxes without a distribution to pay them; but then the penalty is paid regardless of the application of the marginal rate or deductions. So, even if income was so small so that one would otherwise owe little or no tax, the 10% penalty is still applied.

No big deal, you may say? Well, think again. In January 2009, 779,000 jobs were lost; the total being 4.7 million that year. Given the level of 401(k) participation rates and given the loan rates referenced in the Wharton study, a large number of those unemployed would have been penalized while losing their retirement accounts. The heaviest impacted are low and middle-income workers, which also results in a goodly amount of tax revenue to the Treasury from their misfortune.

I wrote about this in my blog of December of 2011, about the Great Recession, that

“At a time when it was necessary to provide substantial assistance to large financial institutions in many-and now we find out, often hidden-ways, those who were unemployed continued to pay a 10% penalty tax on their defaulted loans and DC distributions which were taken to keep them afloat. In effect, the unemployed were funding, even if in the smallest part, the assistance to large financial orgs which received substantial government support (and, apparently, paid large bonuses from those funds to many of their still employed executives and traders). Regardless of political persuasion, most should have difficulty with this proposition.”

The problem persists even after the recession, as participants taking plan loans often aren’t even aware of their exposure.

Limiting the availability of loans is not the solution to this problem which some suggest. Reducing the liquidity of a plan only reduces plan participation by those who we are trying to encourage to save. The Wharton study shows, instead, that plan participants resist taking loans until they really need to do so. Taking away loans takes from the participant the ability to rebuild their retirement account after they need to tap into it. Compare this to taking a hardship distribution, which can never be rebuilt.

This is just not an employee concern, either. I have worked on a number of layoff efforts, where employers really do understand this type of human toll- but business exigencies force them to move forward anyway.

Given the lack of policy action dealing with these issues, what’s left are marketplace solutions. As is so often the case, innovative financial products (designed properly, with proper transparency) can provide some of the answers which support both the employee and the employer under such circumstances. Our practice focuses on this sort of innovation (think about the likes of DC lifetime Income, MEPS, aggregation models, affiliation arrangements, and other unique programs which we cannot yet discuss openly). So it is with the loan default problem. We are working at designing and implementing credible, affordable and non-disruptive loan protection programs in the same manner as we have always promoted marketplace solutions when Congress and the regulators aren’t providing the answers needed to make the system work just a little bit better.

The Wharton study confirms the depth of the problem and the importance of addressing it. Just being cynical doesn’t cut it. There’s meaningful work to be done.


Trouble Ahead for the Non-ERISA 403(b) Plan*

Posted in 403(b)

* Except,of course for governmental 403(b) plans and non electing churches……

It is difficult to maintain the non-ERISA status of a 403(b) arrangement. Those who wish to do so really have to work at it, with the irony being that “working at it” just may be what triggers ERISA status for those plans. In essence, one must “work at” “not working at it.” Don’t worry, this makes sense to those who engage in these efforts.

The ability to maintain the non-ERISA status of a 501(c)3 – 403(b) plan seems to have dimmed considerably late last year when the DOL took an interesting position in a lawsuit it filed last year against a 403(b) plan administrator.  The administrator regularly delayed depositing elective deferrals into a non-ERISA 403(b) plan for 3 or 4 months- a time period for which we would all agree is pretty egregious. What makes the case so striking (besides the fact that it is an enforcement effort by the DOL against a 403(b) plan, of which we have seen few) is that the DOL appears to condition the plan’s ERISA status on the “discretion” exercised by the plan administrator in failing to make timely deposits.

roughroadFor some background,  the non-ERISA status of a 403(b) plan is premised on employer “noninvolvement” in the plan. The challenge for these plans is that the IRS expanded employer responsibility for 403(b) arrangements in its 2007 regulations, making it tougher for an employer to exercise the authority needed to otherwise keep a 403(b) plan in tax compliance without also stepping over the line which would trigger ERISA status of a plan.  The DOL issued a “safe harbor” regulation in 1974, 2510.3-2(f), under which it granted 403(b) “elective deferral only” plans an exemption from ERISA as long as certain conditions were met. These conditions were based on the principal of non-employer involvement in the arrangement.  With the 2007 IRS regs causing more employer involvement, the DOL issued guidance in FABs 2007-2 and 2010-1 under which it further clarified how the safe harbor would now apply.

The DOL  generally takes a jaded view of claimed non-ERISA status for these plans, asserting that most any discretionary control over a plan’s assets or administration would nullify the exemption. So, for example, discrete acts such as authorizing plan-to-plan transfers; approving the processing of distributions; approving hardship distributions, QDROs, and eligibility for or enforcement of loans are all seen as discretionary acts which are “inconsistent” with the use of the safe harbor. An employer taking on any of these responsibilities will generally be triggering ERISA status for the plan.

The lawsuit seems to be adding a new twist to the determination of ERISA status. What the lawsuit looks to be asserting is that a non-ERISA plan which otherwise complies with the DOL “safe harbor” guidance may become an ERISA plan if the employer mishandles employee contributions. This is because an employer which does not deposit elective deferrals into the plan “within a period that is not longer than is reasonable for the proper administration of the plan” (as required by the tax regulations), or within the period required by the plan document, can be viewed as excercising discretion that triggers ERISA status.

There are substantial implications to this. It is the rare tax-exempt employer which always deposits, without fail, employee contributions in the 3-4 day window now being required by the DOL. Though I have little doubt that the occasional failure is unlikely to provide a sound basis for claiming that the employer is exercising discretion over plan assets, and trigger ERISA status, there is some tipping point at which this will occur. So, for example, a pattern of late deposits (even not of the 3-4 month variety described in the lawsuit) might do it.  Should the DOL continue with this approach, it may well incredibly limit the use of the ERISA “safe harbor” for a significant percentage of  plans.

We described the lawsuit (including its name and citation) in an article for our latest quarterly newsletter we wrote for our “403(b)/457(b) Technical Requirements Handbook.” The Handbook is really an unusual and useful tool. Its written and organized as a “how to” book, instead of the typical technical manual which merely defines terms. Its focus is on the practical application of the 403(b) and 457 rules; a guide designed to be used by those who want hands on guidance to compliance with both the tax and ERISA rules. Most unusual of all, it comes with a both a quarterly newsletter discussing timely compliance issues and a quarterly update to the manual itself, making sure your resource is current.

We encourage you to try a free 14-day trial of the Handbook. We think you’ll like it.



A Useful Compendium of Lifetime Income Guidance for Defined Contribution Plans

Posted in Fiduciary Issues, Lifetime Income
bookshelves sized

We have been extensively researching, writing on and developing the concept of providing lifetime income from defined contribution plans for some 15 years. The work has resulted in a patent; several major independantly published research papers; the  outlining of some of the important concepts which underline the proposed QLAC regs and its key revenue ruling; and the development of more than one retirement product. If you look closely, you’ll see that that many of the major whitepapers  published on lifetime income are well based on this extensive work we have published. Some of the work really is groundbreaking; for example, we propose  a useful fiduciary process which can be used by fiduciaries in the purchase of annuities, in our NYU paper.

This blog has carried much of that material for the past 5 years, since February, 2009. We’ve now compiled those pieces here for use by  employers, vendors, actuaries, advisers and attorneys who may be struggling to support lifetime income in defined contribution plans.

Continue Reading

Rome was not built in a day… build internal controls one step at a time

Posted in 403(b)

After many years of wading through a variety of retirement plan platforms and services, I can honestly say “I will never stop being fascinated”.  I do believe, with 100% certainty, that I will never be able to anticipate every possible compliance issue.    However, with as much certainty, I can say “processes, procedures and effective internal controls are vital to avoiding possible compliance gaps and hiccups and maintain a successful retirement plan.”

The IRS recognizes that gaps and hiccups will arise when comparing FORM, the plan document & design, to the plan’s operations, administrative processes and procedural activities.  The IRS provides guidance for plan sponsors to self-correct with the understanding that it isn’t as simple as just finding the gap or hiccup.  The IRS expects the plan sponsor to take three steps when gaps or hiccups arise… Continue Reading

“When All Else Fails, Read the Regulations….”

Posted in EPCRS

EPCRS, or some version of it, is now 23 years old. It really dates back to the first Audit Closing Agreement Program in 1990 and the Administrative Policy Regarding Sanctions (the “APRS”) in 1991. Prior to that time, as many of you will recall, plan disqualification was the sole sanction against which we needed to negotiate with the IRS-negotiations which were often wrapped up in negotiations of the plan sponsor’s own tax liability. I remember one classic deal where we received a pass on the plan penalty for acquiescing on a botched foreign tax credit.

This means that the IRS corrections rules are now based on long experience, and have quite a measure of sophistication and nuance (built of experience) baked into them. It has been continually updated, and the IRS regularly seeks to refresh the program and keep it relevant based upon taxpayer and practitioner input. In short, it’s an IRS program that works (warts and all).

It really shows up in the practical application of the rules. Consider EPCRS’ “Under Examination” rules. If a plan is “Under Examination” it generally cannot take advantage of the more favorable VCP; and SCP is limited- meaning the plan sponsor would need to rely upon the more expensive Audit Cap to fix the problems.

Applying the “Under Examination rules really are interesting, and demonstrates the nuance. For example:

-If the plan sponsor of a 401(a) plan has been notified of an IRS audit of its business tax return (such as the Form 1120), this NOT “Under Examination” for purposes of using VCP or SCP. “Under Examination” is an audit of the Form 5500, not the other business related tax returns of the plan sponsor. It is, however, a heads up that you should probably move fast and fix problems if you want to take advantage of the more favorable VCP and SCP. The agent may open a Form 5500 review as part of the business audit.

-If the plan sponsor of a 403(b) plan is notified of a Form 990 audit (effectively, the information return for a 501(c)(3) org), that IS “Under Examination” for purposes of EPCRS, and VCP cannot be initiated for plan problems at that time. It appears that the source of the rule is that a large number of 403(b) plans are not required to file Form 5500′s, and this is meant to accommodate that issue.

-Notice of a DOL audit, or even an actual DOL audit, does NOT constitute “Under Examination” for EPCRS purposes. As a matter of fact, receiving a DOL notice and then proceeding to use EPCRS to fix a plan problem may be to the employer’s advantage when dealing with the DOL (as you have found a problem and fixed it) if that problem may also constitute a potential fiduciary breach.

A V.P. of Tax for a large company once advised me as a young lawyer many years ago, that “when all else fails, read the regulations.” Even now, when I think I know the answer off the top of my head, or when trying to cobble together a solution, a quick look at the close detail and the nuance of a reg is helpful. EPCRS is no exception…..


Any discussion on any tax issue addressed in this blog (including any attachments or links) is not intended to be used, and cannot be used, for purposes of avoiding penalties imposed under the United States Internal Revenue Code or promoting, marketing or recommending to another person any transaction or tax-related position addressed therein. Further, nothing contained herein is intended to provide legal advice, nor to create an attorney client relationship with any party.

A Regulatory and Fiduciary Framework for Providing Lifetime Income from Defined Contribution Plans

Posted in Lifetime Income, Lifetime Income Published Papers

In July 2008, Bob Kistler, Nick Curabba and I put together what may have been the first published effort at compiling the fundamental rules which govern the distribution of lifetime income from defined contribution plans.

Quite a bit has happened since then. There’s been two new GAO studies on lifetime income; a joint DOL and Treasury Request for Information Regarding Lifetime Income Options (the “RFI”) and the related hearings; the issuance by the IRS of two contradictory revenue rulings on key lifetime income issues, and a clarification on those issues by a subsequent Revenue Ruling; a Revenue Ruling on DC transfers to purchase benefits under a DB plan; two new sets of proposed IRS regulations, including the Qualified Lifetime Annuity Contract regs; The ERISA Advisory Council issued a report on the “spend-down” of retirement assets; and the DOL’s Advanced Proposed Rule Making on lifetime income disclosure.

A number of new lifetime income products have been introduced into the market by both insurers and mutual fund companies to build upon all of this interest.

On the liability side, NOLHGA (the National Organization of Life and Health Insurance Guaranty Associations) issued a report on the “Life and Health Insurance Guaranty System, and the Financial Crisis of 2008–2009″ which helps explain how state guaranty associations cone into play in protecting lifetime income; and there have been several key court decisions addressing fiduciary status under group annuity contracts.

A more complete and up to date description of how lifetime income can work in a DC plan is in order. Evan Giller (newly Of Counsel with Boutwell and Faye) and I put together the attached piece entitled “Regulatory and Fiduciary Framework for Providing Lifetime Income from Defined Contribution Plans.“ It is originally appearing in the New York University Review of Employee Benefits and Executive Compensation – 2013, published by LexisNexis Matthew Bender, Copyright 2013 New York University. In the paper, we’ve drawn upon our long experience with retirement plan annuities, mixing it well with all of these new developments.

One of the paper’s key features is that it lays out a framework by which fiduciaries may be able to make fiduciary determinations on products and insurers without requiring further guidance from the DOL; relying instead on traditional concepts.

We found that each of the sections in this paper could have easily been significantly expanded, now that we have a broader experience in the workings of this idea.

Please let us know what you think!

The “Balancing Problem” in Reporting “403(b) Policy Loans” on the Form 5500 Schedule H

Posted in 403(b)

If you are wringing your hands trying to figure out how you report those 403(b) “policy loans” on the Form 5500 Schedule H, understand that you are not alone-and that there is no easy answer to your dilemma. This problem arises from a continuing flaw in the Form 5500, which the DOL never fixed after requiring 403(b) plans to fully report financials for plan years 2009.

A “policy loan” is an instrument unique in the retirement market to the 403(b) plans. With just a few exceptions, it is the manner in which loans are made by vendors under 403(b) annuity contracts. They are fundamentally based on policy loans from insurance contracts issued in the non-retiremnt market.

Here’s the source of the problem: Typically, for the “plan loan” (of the sort under a 401(k) plan and the 403(b) plan with Custodial Accounts (ether group or individual)) the funds for a loan are actually removed from the participant’s account, and investments are liquidated. What is left in the plan is an account receivable backed by the promissory note, and there are no investments in the plan to report. This matches up well with Line 1(c)8, which requires that the outstanding value of the be included as part of the plan’s financial statement as an asset.

But the 403(b) annuity “policy loan” is much different. The cash from the loan is obtained from the insurer’s general account, and no investment funds are ever liquidated from the participant’s annuity contract. An amount equal to the value of the outstanding value of the loan are transferred to a “restricted” investment held within one of the annuity contract’s investment funds, or in a separate account specially designed to pay a special rate of interest on that investment. The participant has no access to those funds, and the funds are released over time as the loan (with interest) is repaid to the insurer.

The asset statement from the insurer then shows that there is an investment still in the contract, as an asset equal to the value of the outstanding loan. It is earning interest which is reportable on the 5500, and is reportable as an asset of the plan as part of the value of Line 1(c)10 or 1(c)14 of Schedule H. If you then also report the outstanding value of the loan on Line 1(c)8, as you seemingly are required to do, you have double counted the value of the asset, and have an unbalanced financial statement.

Auditors hate this, and they try to address it in a number of creative ways. The problem is that it can’t be ignored: the loan balances, and in particular the defaulted loans, still need to be reported. I find it useful to be reported on the auditor’s report, either as a footnote or separate paragraph. But don’t ignore the issue.

This is not so much a problem for Schedule I filers, for small plans, because the participant loans are reportable on line 3 just as a description of assets in the plan, where it does not need to balance back to Line 2.



Any discussion on any tax issue addressed in this blog (including any attachments or links) is not intended to be used, and cannot be used, for purposes of avoiding penalties imposed under the United States Internal Revenue Code or promoting, marketing or recommending to another person any transaction or tax-related position addressed therein. Further, nothing contained herein is intended to provide legal advice, nor to create an attorney client relationship with any party.