Business of Benefits : Employee Benefits Lawyer & Attorney : Law Office of Robert J. Toth, Jr. : 403(b) Plans, Annuity & Insurance Law : Business of Benefits Blog

The Green Book, published May 11 by the Treasury Department, contains further details on Obama's workplace pensions first described in his budget proposals (on which we blogged  in March). See pages 7-9 of the Treasury report for details.

It really does create a new scheme of individual pensions, much akin to the 403(b) arrangements of the past. I strongly suspect that there will be many similarities to the manner in which private industry approaches these to the way industry had approached "non-ERISA" 403(b)s.

It will cover employers who had been in business for  two or more years and who have 10 or more employees. Eligibility will be a lot like the "universal eligibility" rules under 403(b), in that those employees who are eligible (or who are excluded under a statutory exclusion) under a plan of the employer (even if not participating) can be excluded from this automatic program. If an employer excludes a class of employees for reasons other than the statutory exclusions, they must be covered by the IRA program.

The default rate of deferral is proposed to be 3%, which the employee could lower or raise (but who cannot "opt out"). 

It would be by payroll deduction, mostly with direct deposit to the IRA. There would be default IRA investments set by statute, for employers who did not wish to be involved in vendor selection. Employers would have the option of designating a private sector custodian, or permit employees to choose their private vendor.

Like the 403(b) plans of old, employers would have no responsibility for compliance with "qualified plan-like" requirements, nor have any responsibility for monitoring IRA eligibility or contribution limitations. The individuals, not the employers, would bear ultimate responsibility for compliance. A national website would be maintained with information and investment educational material.

Like 403(b) plans of old, the variable investments among these products these will be registered  which need to be sold by registered reps. They will be individual arrangements, typically with higher costs and fees, and in different asset classes than employer products. Inevitably, group arrangements will be offered by vendors to attempt to garner more assets from larger employers or groups of employers in order to offer more competitively priced products. Eventually, there will be RFPs and competition at the employer level for access to payroll slots. This all can create some ERISA tensions.

This proposal really means something for 403(b)plans down the road. But even now, given the Administration's position that it is OK to rely upon participant representations under circumstances such as these, perhaps the IRS should take a closer look at allowing such representations under its current 403(b) regulatory attempts as a way in which to resolve many of the tough transition rules which we are now facing.

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We recently blogged on the similarities between the Automatic Workplace Pension being proposed in President Obama’s budget proposal and the original concept of the retirement programs under IRC section 403(b). We noted that while 403(b) programs were initially set up as individual pension plans, it has been the policy of the IRS for over 15 years to treat 403(b) programs as employer plans. The IRS’ approach to 403(b) plans, most recently manifested in the new regulations under 403(b), is particularly problematic for the continued viability of the so-called non-ERISA 403(b) arrangements. These are 403(b) programs that are intended to fit under a safe harbor from ERISA coverage ( DOL regulations §2510-3.2) that exempts a 403(b) program from Title I of ERISA if the employer is minimally involved in its administration and does not exercise any discretionary authority over the program. The increased compliance responsibility imposed by the new IRS regulations can easily cause an employer to run afoul of the DOL rules, and have caused practitioners to question the continued viability of non-ERISA 403(b) arrangements.

Despite some helpful efforts by the DOL to provide guidance (e.g., Field Assistance Bulletin 2007-02), there are still significant obstacles for the employer that wants to maintain a non-ERISA 403(b) arrangement. Under the 403(b) regulations, the employer is responsible to make certain that the program remains in compliance with the tax rules, but its efforts to meet this responsibility can then cause it to fall out of the DOL safe harbor.   For example, a program that allows loans or hardship withdrawals will fail to meet the IRS’ rules unless someone, other that the employee, determines that a request for a loan or hardship withdrawal complies with the applicable tax rules. If the employer makes that determination, it has gone beyond what is permitted under the DOL rules. While the determination can be made by the investment provider, many are unwilling to take on that responsibility. And the employer apparently cannot simply hire a TPA to fulfill this function; the decisions of the TPA will be attributed to the employer. This problem is exacerbated when the plan is funded by multiple investment providers and the records of each provider need to be coordinated to ensure compliance with the tax rules.   As the DOL has said that in order to fall within the safe harbor a 403(b) plan must (at least in most cases) have more than one investment provider, most non-ERISA 403(b) arrangements will need to coordinate between providers.

The similarities of the Automatic Workplace Pension proposal to 403(b) plans and its apparent (early) support from both sides of the political spectrum demonstrate that there is still a continuing need for the non-ERISA 403(b). This is a simple and relatively inexpensive retirement savings arrangement that works much like the new proposal: the employer’s major responsibility is to send salary reduction contributions to investment providers. It avoids some of the costly obligations that apply to ERISA covered plans, such as the need to have an independent audit if the plan has over 100 employees.   Moreover, the non-discrimination rules that apply to the salary reduction provisions of 403(b) plans – universal availability – are easy to apply and consistent with the policy goals of encouraging widespread participation. Arrangements under section 403(b) have a long and successful track record of promoting retirement savings among employees in the tax-exempt community, and should continue to be encouraged.

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There has been a discussion circulating around Washington for a number of years about the value of establishing a simplified Defined Contribution retirement system commonly referred to as "401(x)".  This program would create a single defined contribution program with a single set of rules to replace the "alphabet soup" of DC plans currently in existence.

Many product vendors have championed this cause, particularly through organizations like the Investment Company Institute, the mutual fund companies' trade group. Even the U.S. Chamber of Commerce's chimed in with support in a policy report in 2007. It is an attractive notion. The claim is that the system is far too complex for employers, and that going to a single, simplified program would work to everyone's benefit.

I have always viewed this as a dubious claim.  "401(x)" seems to be a program that is more centered on the self-interests of a handful of vendors for which such a program would save much expense; it is not one which is designed to benefit employers. While it is true that  ASPPA and Metlife count no less than 17 types of DC plans (see the Metlife's excellent chart , which was also published by ASPPA in its latest Journal), and I could probably add a few more, it is also true that these programs did not arise in a vacuum. We have a complex, sophisticated employer base in the United States.  It stands to reason that an effective retirement program cannot be based on a "one size fits all" concept. Does it make sense that a small, 5 employee charity has the same design as a publicly traded company with 150,000 employees? I think not. Does it make sense that a start-up sole proprietorship has the same program as a large international company that is over 100 years old? I think not.

These 17 plans are there for a reason: both the marketplace and valid policy concerns have insisted that they be there. Each of the plans have a particular purpose, a particular market whose purposes they serve. Trying to force it otherwise will be disruptive to those same forces which enabled those program in the first place. I do not doubt that these programs may need a bit of tweaking, but the fundamental concept remains: they were each created in response to a (at least perceived) specific policy concern  and need of the marketplace.

The classic example of the potential disruption which can be caused by a "401(x)" approach is found in the implementation of the new set of 403(b) regs. 403(b) plans were designed as individual pensions for employers that could ill-afford highly complex retirement plans. They have worked well for over 50 years. But since the IRS has taken upon itself the view that these should be treated like 401(k) plans, it wrote a set of regs which actually acts as a sort of "backdoor 401(x)."  While I understand and support the notion that the serious non-compliance the IRS found needed to be addressed,  the chosen approach to enforcing compliance is creating awful results. The transition costs have been unexpectedly high for the retirement industry (including many vendors which had originally supported 401(x)) and has created a growing anger and frustration in the bar and in the 403(b) plan sponsor community.  The new rules attempt to force a well designed individual pension program into an employer program that large parts of the market are ill-equipped to handle.  We will likely see, as the year progresses, a regulatory and enforcement nightmare.

It is this nightmare, I believe, that exposes the serious shortcomings of the concept of "401(x)." It doesn't serve marketplace needs; there is no significant  policy it serves; and it has large, hidden transition costs.  The New York Times noted the lack of political will to do a single simplified program in its recent  article discussing  Workplace Pensions.  The Workplace Pension program sits on top of the current system, addresses a serious policy need and marketplace need, and does not attempt to replace the current system with thoughtless uniformity. It is a lesson which I hope policymakers remember as they discuss the revamping of the current system, one which should dissipate any notion of a "401(x)."

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I was intending to leave this issue alone for a few weeks, and wait until the Workplace Pension proposal (upon which we blogged a few days ago) had a chance to percolate within the retirement industry. But I had the chance to spend a few minutes with David John (David is a senior scholar at the Heritage Foundation and is one of the Principals of the Retirement Security Project) in DC this week, and he spoke of this program-one on which he and Mark Iwry have spent years developing. The conversation set me to thinking.

Those of us who have spent serious time within a large organization, whether it be a financial services company, a manufacturing company or a governmental agency,  all have many war stories on these organizations'  capacity to ignore lessons from their own pasts-even their recent pasts. I would argue (digressing for a moment) that many of our current economic problems arise from us ignoring our history-not remembering that the anti-trust rules were there in part to prevent a handful of companies and individuals from amassing so much economic strength as to be able to wrack havoc on the entire economy.

So what does this have to do with the President's proposals for Workplace Pensions? The retirement markets have a long and rich experience in dealing with salary deferral programs which can well inform the structure of this new program. We know what things work, and what things have been a disaster. 

This proposal is  unique in that it DOES recognize our experience. It has the support of both ends of the political policy spectrum (scholars from both Brookings and Heritage have lent their weight), which is likely because it uses well learned lessons of our past.

Some thoughts of what this thing may look like:

• Yes, the proposal really does look a lot like the simple, old 403(b) programs. Though the legislative proposal is not yet written, the idea is designed to rely upon marketplace products. The twist is that vendors will be listed in a program designed on the successful parts of Medicare Part D. And simplicity is a key.
• It will recognize the need for safe, "stable value" like investments for a while, until the employee can weigh in on where the money will be invested.
• There will be "COBRA -like" rules for small employers, and there will "403(b) like" rules for part-time and short term employees.

Fee transparency will be important, and there is even some discussion of the making available the purchase of lifetime income guarantees.

There will be a number of technical issues that will come up as this thing progresses. Some may have been addressed, but they are worth noting:

• We need to avoid the 403(b) disaster, which has arisen from trying to force an individual pension program into an employer program mold.
• The tensions with Title 1 of ERISA will need to be addressed. A way needs to be found to balance employee protection (for example, on the deposit of the funds) with limits on employer responsibility.
• There are a number of technical security law rules which need to be addressed, as most of these products will be registered investment products. Touchy issues such as suitability, prospectus delivery, and whether, practically,  an employer can force the purchase of a registered product.
• Data, we have learned over time, is ugly. Privacy of data is critical. So the lesser the data requirements, likely the better.

I expect that there is much discussion and negotiation yet to be had. Of course, there is likely to be a grand policy debate on whether this sort of program will ultimately lessen the use of traditional 401(k)  and profit sharing plans, undermining incentives for employers to contribute to their employees' retirement.

But the thoughtfulness and bipartisan manner in which the proposal has been developed leads me to believe that these sorts of issues (and others) will be well addressed. It is  a welcome breather from the often frantic approach to policy we have seen emerge in the past few years.

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President Obama's new budget proposes the establishment of a new "Automatic Workplace Pension" (see pages 84 and 85 of the OMB's budget description and David John's description at the Heritage Foundation's site). It is based upon proposals from the Retirement Security Project run by Mark Iwry, David John and William Gale.

There is little doubt that the proposal will catch a lot of heat, as the logistics of establishing this type of program seems, at first glance, to be almost overwhelming. A number of trade groups are already discussing the issue of what kind of financial products and services can and should be used to implement this proposal, and there doesn't seem to be an easy answer at first glance.

But there really may be an answer. The good Mr. Iwry and I have been talking about his proposal for a few years now, and it strikes me how similar this proposal is to the original 403(b) programs of the past.  Nearly 50 years ago, 403(b) programs were designed as individual pensions.  The employer's sole responsibility was to make sure the employee's deferrals were sent to the company of the employee's choosing. The design was very similar (and actually still is today) to the IRAs which were adopted some 20 years or so later, more so than the qualified plans that the IRS is now trying to make them out to be.

Think about the delivery system which was successfully established by the marketplace for those early 403(b) programs. The tax-exempt employers agreed to which vendors they would permit deferrals, and the vendors came in and did the rest. They were (and still are) registered products (to the extent they provide equity based investment accounts) which are required to be sold by registered representatives. The employees owned the products, or had individual certificates under group annuities, which were completely portable. Revenue Ruling 90-24 gave employees the right to transfer their money tax free to another 403(b) investment product, making them REALLY portable.

In short: the marketplace has proven its ability to make this kind of program work, using the old 403(b) model.  Is there any reason why this shouldn't serve as the basis for this new proposal?

There is a curious side bar to all of this, though. The IRS has spent the last 15 years trying to force the individually based 403(b) program into an "employer" based model. The IRS may face a new challenge, as the Automatic Workplace Pension proposal may well be 403(b) on steroids. It would seem to offer an alternative to all those non-ERISA 403(b) plans who find themselves being "ERISAfied" by the new 403(b) regulations.

THIS is going to be interesting.....

For a blog discussion thread on the Automatic Workplace Pension, check out the Bogleheads blog.

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