Business of Benefits

Business of Benefits

Lifetime Income: Using the Statute Of Limitations to Minimize Insurer Insolvency Risk

Posted in Fiduciary Issues, Lifetime Income, Uncategorized

Tim Hauser, EBSA’s Deputy Assistant Secretary for Program Operations, mentioned something very striking regarding lifetime income at the annual meeting of the 5 regional TE/GE Councils this past February, something I’ve taken some time to consider. His thoughts, as it turns out, can have a significant impact on the eventual success of the ability of DC plans to provide lifetime income .

We were talking about the DOL’s effort to provide further guidance for DC plan fiduciaries who purchase annuities to provide lifetime income-including QLACs.  What is proving to be the most difficult issue to resolve as we work through the regulatory landscape is the insurer insolvency issue: how do we protect the fiduciary from a participant’s breach of duty claim should an insurer become insolvent years hence, and be unable to the pay the retirement benefit otherwise promised under the annuity?

The insurance industry has repeatedly sought relief and guidance, even to the point of having legislation passed which directed the DOL to provide safe harbor guidance.  The DOL has tried. It has issued a non-exclusive safe harbor on fiduciary standards for the purchase of DC annuities, but even that guidance provides little comfort for sponsors on the long-term risk of insurer insolvency.

Then Tim, being a long-time litigator, suggested the simplest of things. Why, he asked wouldn’t the fiduciary be protected by ERISA’s 6-year statue of limitations under ERISA section 413.

I was actually stunned, mostly by the simplicity and sensibility of his point. A lot of folks, much smarter than myself, have spent serious time in trying to crack this nut. It struck me that this might actually be the answer. Think about it: insurance companies do not become insolvent overnight. There is usually much hand wringing, review, public scrutiny and regulatory action which precedes an insurer’s failure. The public, at least those which follow the financial services world, have long notice of something currently being amiss in an insurer’s balance sheet.  And even when it does go wrong, the other insurers typically cover policyholder losses  through the (admittedly very imperfect) state guaranty associations.

This suggests that a workable fiduciary standard can be reasonably constructed which would not require a crystal ball, or one which relies upon the state bearing that sort of risk as a matter of public policy. I become even more interested when I thought about the non-ERISA cases, where the statute of limitations would be based on contract or fraud, which are often even less than the ERISA six year statute.

Given a six-year risk window, I think we have the tools now to construct a workable standard which addresses the insurer insolvency risk.


For those of you who may be interested, I am putting on a webinar with Thompson Publishing on the technicals of QLACs and lifetime income on Tuesday, April 14, 2015. Here’s the link to register.


State Auto-IRAs and Federal Law: “We’ve already stepped on that rake…..”

Posted in 403(b), Auto-IRA, Automatic Workplace Pension, B/D-IA Issues, Lifetime Income, Retirement Plan Securities Issues, Uncategorized

Chuck Thulin, a fine ERISA attorney from Seattle, WA, chaired the DOL practitioner panel at the latest (and very successful) annual meeting of the 5 regional TE/GE Councils, in Baltimore.  When I commented that we’d  “been there, done that” when discussing some obscure rule,  he told me of reading of the Russian language version of that well worn phrase: Na eti rabli my uzhe nastupali, or  “we’ve already stepped on that rake.” What immediately came to mind was one of my favorite Robert Frost poems, which I share at the end of this blog.

More importantly, however, was that phrase came to mind when I was reviewing some technicalities implementing state-auto-IRAs. Auto-IRAs will be very real, with at least some 17 states at some level of development of a program. This “rake” we are stepping on is  one that which we have stepped on before: that being the same combination of ERISA and federal securities laws which continues to “str(ike) me a blow in the seat of my sense” (as Robert Frost put it so well below) in our dealings with 403(b) plans.

The ERISA issues related to state-auto-IRAs are well recognized, which are similar to the issues related to 403(b) plans: how do you established a payroll based auto-IRA without causing the arrangement to be governed by ERISA?  Like 403(b)s, there is a regulatory safe harbor to prevent the application of ERISA.  Like 403(b)s,  the safe harbor was not exactly  designed with the current state of affairs in mind.

I suggested what I think is the most supportable ERISA analysis on on this point on the AARP Auto-IRA website; and it is helpful that the President’s 2016 Budget would set aside nearly $6.5 million to help implement “State-based automatic enrollment IRAs or 401(k)-type programs.”  This is likely to include the EBSA exploring sound ways to address this issue. Until then, however, we need to work with the existing rules.

A close working of the details also reveals critical issues related to securities laws which, again, are similar to the securities law issues we deal with on the 403(b) side of things-an example being well described in the recent SEC letter to the American Retirement Association (formerly ASPPA) which granted certain disclosure relief from securities law related to non-ERISA 403(b) participant disclosures.  Unlike participant investments in 401(k) plans which enjoy extensive securities law exemptions, providing investments and investment advice to individuals related to their IRA investments enjoy no such exemptions.  Attention needs to be paid to such matters within the SEC’s and FINRAs purview, such as suitability, pooling of assets, the natiure of asset allocation models, and other like- regulated matters. This host of securities law issues is one which IRA providers will need to work around until legislators and securities regulators pay the attention necessary in order to make state-based auto-IRAs work simply. Unfortunately, these issues are not currently getting the attention they need.


In the meantime, here’s the Robert Frost poem:

The Objection To Being Stepped On
By: Robert Frost

At the end of the row
I stepped on the toe
Of an unemployed hoe.
It rose in offense
And struck me a blow
In the seat of my sense.
It wasn’t to blame
But I called it a name.
And I must say it dealt
Me a blow that I felt
Like a malice prepense.
You may call me a fool,
But was there a rule
The weapon should be
Turned into a tool?
And what do we see?
The first tool I step on
Turned into a weapon.

Dealing with “Small Amount” 403(b) Annuities of Former Participants, and Other Matters

Posted in 403(b)

It is going on 8 years now since since the IRS fundamentally changed the 403(b) world with the issuance of regs which were designed to make 403(b) plans more like 401(k) plans, and to formally impose more employer accountability on the operations of those plans.  Though those regs brought very valuable change in many ways, and the attempt to hold employers more accountable is really crucial to the success of the retirement system, they were also overreaching in many other ways.  We continue to see the negative impact from some of the more myopic and unfortunate portions of those  rules, often showing up in the most mundane but important ways. Or, as Doonesbury once well put it in one of my favorite strips, “Even in Utopia there’s Myopia, Sir.”

Doonesbury, April 19,1976

Doonesbury, April 19,1976

Perhaps the most persistent of the regs’ shortcomings is the failure to adequately recognize, and deal with, the fact that individuals- and not plan sponsors-control vast aspects of plan operations under individually owned annuity contracts and custodial accounts. This results in circumstances  (often in the otherwise most simple matters) which offer no easy solutions,  compelling us to seek unique procedures addressing some of this regulatory myopia’s most difficult effects. We often must look to “dusty” and unfamiliar sections of the Code and ERISA for solutions.

One of the more useful tools we have found is one to deal with “small amounts” in former employees 403(b) annuity contracts. It really is indicative of the sort of thinking in which one must engage to adequately to deal with some of the more intractable 403(b) problems we face almost daily.

This particular problem arises for plans with  contracts of former participants which cannot be excluded from plans under DOL FAB 2009-2 and Rev Proc 2007-71 which also have balances less than $5,000.  401(k) plans can easily distribute these small amounts, under 401(a)(31).  But 403(b) plans have a challenge. Though the “small amount” rules of 401(a)(31) do apply to 403(b) plans, how do you distribute small amounts out of an individually owned contract over which the plan has no ability to force a cash rollover?  These contracts typically need the participants consent to distribute even the “small amount.” This has a two very real impacst for many plans:

  • That former participant’s “small amount” contract is  counted toward the participant counts in determining determining eligibility for the small plan exception to the annual audit.
  • It also can cause a serious “form and operation” problem with the plan document: just about every 403(b) plan document I’ve looked at blindly incorporates 401(k)’s “small amount”  distribution terms into the plan. This term virtually always mandates the distribution and rollover of those amounts, as 401(a)(31) requires that the employer have no discretion in making the distribution if the term is in the document.  However, the inability to force the distribution causes an operational failure, which can only be fixed by plan amendment-meaning a submission to EPCRS.

This really means is that you need look to an entirely different method other than 401(a)(31) to manage these small amounts, to the extent that there is no employer ability to force a cash distribution from a contract.  That method would be to “distribute” those small annuity contracts from the plan as an “in-kind” distribution, not as a mandatory roll-over under 401(a)(31)(B). Because the distribution of an annuity contract is NOT (and really cannot be) a rollover, 401(a)(31)(B) can’t work.

The analysis is an interesting one.  You start with the basic premise: forcing the small distribution from a plan before retirement age is generally not permitted without a statutory exception. For ERISA purposes, ERISA Section 203(e) covers this. It specifically permits the mandatory distribution of an accrued benefit of less than $5,000. ERISA does not require the distribution to be in cash, nor that it  be accomplished through a rollover. This means that it is permissible to force an in-kind distribution of a “small” annuity contract from the plan under ERISA.

For Code purposes,  we rely upon one of the basic differences between 401(a) and 403(b): though  411(a)(11)(A) prohibits a forced distribution (except, as a practical matter, as provided under 401(a)(31)), 411 does not apply to 403(b) plans. 403(b)(1)(C), on the other hand,  only requires that “the employees rights under the contract are nonforfeitable.”  Any individual 403(b) annuity contract (or custodial account, for that matter) must be, by its terms, nonforfeitable in order to qualify as an 403(b) annuity contract.

Therefore, making a distribution of a small annuity contract is a viable alternative to 401(a)(31).  Note that ERISA 203(e) will not apply to governmental and church 403(b)plans-which also raises the possibility of forcing out larger amounts. You do not save on the Form 5500 and audit fees (there are none), but it offers some interesting planning opportunities for plan sponsors.

There are a few details to make this all work, of course, (for example, a plan document would want both 401(a)(31) and the above machination) and the IRS is still resisting treating custodial accounts as annuity contracts for distribution purposes. But at least the rules are forcing us to take a fresh look at rules for which we have otherwise fallen into “conventional wisdom” in our dealings.

A few other notes:

  • Our thanks to Chris Carosa and Fiduciary News for listing us as one of the 10 Insider Blogs Every 401k Plan Sponsor & Fiduciary Must Read.”  Thank you Chris for the high compliment.
  • Chris noted in his review that I do have an opinion on matters. There is a fascinating piece on Legal Blogging and self-censorship by Kevin O’Keefe in the aftermath of the Paris killings I do invite you to read. I do write much- my favorite Christmas gift from Conni was a beautiful fountain pen with a nib which absolutely dances on the page-and do so cherish and value the opportunity to express my opinions.
  • Finally, for the curious among you, the following is the full Doonesbury strip from which I have quoted, above:

Myopia Strip


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.

MEP Reform: Is it Necessary? A Rebuke

Posted in Multiple Employer Plans, Uncategorized

There is a serious, and important, debate occurring whether, and to what extent, should there be MEP reform following the DOL’s restrictive advisory opinion on the matter in 2012.  There appears to be bi-partisan support for the changes proposed in Senator Hatch’s SAFE Act, which makes wholesale changes to  the current MEP rules, and will make them much more widely available.

My own position on the matter has really transformed with time and experience since the Advisory Opinion. The real question now is whether the benefit from re-opening MEPS outweighs the potential regulatory difficulties which will accompany it.  Though I believe MEPs can be valuable tools under the right circumstances, the Holy Grail is NOT the MEP. The MEP is only a tool; the goal is to cost effectively bring the advantages of scale to the small case marketplace.  What we have discovered over time in developing MEP alternatives since the Advisory Opinion is that there can be better ways to bring scale to the market, one that involves traditional methods of fiduciary allocation and pooling of investments.

I have long been an advocate of making the simplest regulatory change to achieve the necessary goal (see, for example, my blog on annuity regs). To my mind, then, the only “MEP” Reform really needed is a modest change to the Form 5500 rules which would permit employers which aggregate their investments and fiduciary allocations to also pool their Form 5500s. The TAG Statement of Troy Tisue to the ERISA Advisory Council lays out this position nicely.

Now the Rebuke.  What is NOT helpful, however, to this discussion is the misinformation of the sort contained in an article entitled “Multiple Employer Plans (MEPs) are a marketing play, not a way to cut costs. We don’t need them” on something called the Employee Fiduciary blog, linked on Benefitslink on December 10.  The article took direct aim at “Open Meps”®, (note that the term Open Mep® is actually a registered trademark of TAG Resources) claiming their promotion is a conspiracy of Wall Street to hoist unnecessary and expensive financial products on small plans, as a way to further promote mutual fund interests.

Quite frankly, I could choose to either be flattered or flabbergasted by the article, given my deep involvement in the development of Open Meps® with TAG Resources, and Advisory Opinion, 2012-04.

To a long-time corporate attorney like myself, with a pedigree in the financial services industry, being accused of being a Wall Street shill could be, in a very real way, considered a sign of significant success in our fine profession. It surely demonstrates my skills as a rainmaker of the highest order with the kind of clients of which most attorneys could only dream of having.

I choose, however, to be flabbergasted by the misinformed view expressed in that article that small employers are fine, thank you, and that they need no assistance in dealing with large financial service companies with what amount to contracts of adhesion. Those who are familiar with the small end of the 401(k) market know of the pressure to adopt proprietary funds with the highest expense loads; the limited access to competing fund families; the lack of affordable expertise; and the often-lousy level of services which accompany the lack of scale. Its not that this is part of a diabolical plot; its just a matter of economics. This has not gotten better over the past 25 years, as the article states. It has, actually, gotten much worse.

In spite of the absurd assertion to the contrary, small employers do need to be able access the buying power which is only available with scale, for which it is still far too hard for them to obtain. The question is how it will most effectively be done.

“Hidden” New MEP 5500 Legislation Requires Substantial New Reporting for 2014 Plan Year

Posted in Multiple Employer Plans

Buried deep within “The Cooperative and Small Employer Charity Pension Flexibility Act of 2014 (CSEC Act),” enacted on April 7, 2014 is a new MEP Form 5500 reporting requirement. It is one which, frankly, most of us missed. It came to light as the DOL issued its Interim Final Rule (to be published November 10 in the Federal Register) implementing the reg for the 2014 plan year (yes, this plan year). MEPs will now have to report all of their participating employers, their EIN and a good faith estimate of the “percentage of the contributions made by all participating employers made by each employer relative to the total contributions made by each employer.”

Here’s the language from the new reg:

The instructions to the Form 5500 and Form 5500-SF will now provide that the Annual Return/Report filed for a multiple-employer plan must include an attachment that identifies the participating employers in the plan by name and employer identification number (EIN) and includes for each participating employer an estimate of the percentage of the contributions made by each employer (including employer and participant contributions) relative to the total contributions made by all participating employers during the plan year. This attachment, entitled “Multiple-Employer Plan Participating Employer Information,” supplements and does not replace other Form 5500 filing requirements that apply to multiple-employer plans.

The CSEC Act effectively created a new sort of multiple employer defined benefit plan for certain charities. The new reporting rules, however, did not apply just to these new types of plans. It applies to all MEPs, including those 401(k) MEPs run by PEOs and payroll companies.

This will have a significant impact on these types of arrangements:  now that the each participating employer name and EIN will be listed in the Form 5500, I would expect these plans to see substantially increased audit activity from both the DOL and the IRS.  This is because of the simple math. Prior to this rule, only the Lead Employer in a MEP would (as a practical matter) be audited. Now each participating employer will individually show up on the agencies’ audit protocols (think IRS’s EPCU (creators of the infamous 401(k) Questionnaire)). We do know, for a fact, that this will be demanding on a MEP’s resources.

This will also increase the scrutiny of MEPs and the applicability of the DOL’s MEP Advisory Opinion AO2012-04A. However, even should legislation pass permitting “Open MEPS”®, the landscape for these arrangements will be permanently changed.



Notice 2014-66 Addresses Lifetime Income’s “Relevancy” Problem

Posted in Lifetime Income

SquareCircleOne of the biggest challenges facing the task of wider implementation of retirement security through use of DC lifetime income has been the question of relevance. Quite frankly, plan sponsors and their advisors really have not seen the whole idea of lifetime income as relevant to their own plans and practices. It really hasn’t been clear to them how “DC annuities” could actually fit into the everyday realities of operating the typical 401(k) plan. There seems to be a prevailing view that we are somehow trying to fit a square peg into a round hole (note the “suits” in the accompanying picture).  That is very far from accurate, for many reasons, but perceptions often mean much.

IRS Notice 2014-66  and the related DOL Information Letter look to have had the effect of addressing that problem. In a surprising way, they may have made lifetime income relevant to large parts of the market virtually overnight. This was done by making it a necessary component of any serious future discussion of target date funds. Its almost like Treasury has turned on a light for many to see what really has been there for a while: lifetime income is a valuable tool in any platform, whether it be based on mutual funds, advisory services, equities or insurance.  Now, throw on top of that the reminder from the DOL letter which accompanied the notice that, yes, certain annuity contracts can be actually be part of a QDIA and Voilà! NOW it makes some sense, being attached to something advisers can wrap their arms around.

The legal issues in the Notice are really not groundbreaking, and I really admit to have being a bit stumped by why the stakeholders even needed to go in for the advice contained in the Notice.  The “deferred annuity” referred to in the Notice is merely the garden variety type of fixed account in a group annuity contract, and restricting participation in the TDF to a particular age group actually has no impact on the operation of the TDF itself. Those restrictions, upon which the IRS granted helpful relief, are really about the deal cut between the insurer issuing annuities at the dissolution of the TDF and the TDF manager.  For those contemplating using annuities as part of target date funds, and other arrangements, there are a number of more effective ways to do it than the manner chosen by those stakeholders.  The business design issues raised in the Notice could have handily been dealt with by contractual provisions between the interested parties.

But my hats off, again, to IRS, DOL and Treasury staff in their smart choices of incremental changes which really have an impact. This is one of those rare choices which seem to substantially broadened the “conversation” about lifetime income.


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.