Now with EPCRS, we are told, being on the verge of release, and with 403(b) audits beginning to enter a new, what I would call “normalized,” stage, the 2007 regs will truly be put to the test. I have long been critical of those regs as being far more complex than necessary, and as being based-in part-on a basic misconception that 401(a) plans and 403(b) plans are similar in too many respects.  This second point has been implicitly recognized by the good work of  both the DOL and the IRS in their efforts subsequent to the issuance of the regs to address some of the more glaring problems which the regs brought into play.
 
At the heart of the problem is the statute itself: Code Section 403(b) is still more like an IRA in many ways than a qualified plan. The tax impact and benefits are fully directed at the individual not the employer. 
 
Where this will have its impact is when you have to drill down and attempt to apply the regs in detail to any particular fact circumstance, as we are now attempting to do. Take, for example, any attempted application of the plan document “form and operation” rule (which is, at is heart, a 401(a) rule). Assume  a case where either the employer or the IRS discovers that elective  deferrals to an individual contract violated the manner in which the 15 year catch-up and the age 50 catch should have been coordinated for the past 3 years, and that $9,000 needs to be disgorged from the plan. If the individual contract gives the employer no right to order a corrective distribution from the contract, and the participant refuses to take a distribution, the plan has clearly violated the plan document “form and operation” rule  (and VCP has failed because  a corrective distribution was not made), and the plan would not qualify for 403(b) treatment.  What is the sanction then, where, legally, the employer has no tax liability for a failed 403(b) plan? Is the employer assessed for the tax on the $9,000;  or is the base for the sanction the tax on all amounts in the 403(b) plan-but what is the legal basis for either of these actions?  At least under the VCP portion of EPCRS, it could be imposed as a condition for the favorable treatment under the program, but what happens under audit/audit CAP? 
 
There is actually a whole host of issues like this. As a practical matter, IRS 403(b) audits have been,  well, practical, up to now. But as “institutionalization” seeps in, with more 403(b) agents, with EPCRS finalizing, formality will begin to impose itself. And I would expect technical application of the questionable portions of the regs to begin to run into rough sailing.
 

 

 The GAO issued its long awaited study on Multiple Employer Plans. It is nicely written, and for those who with an interest in such matters, it’s a good read. 

It pretty well summarizes the current state of affairs related to MEPs. The report, along with our own recent review of MEPs, really demonstrates a few key points:
 
1.  MEPS, under current rules, operate best in a controlled environment.  The report makes it clear that there remains a great deal of uncertainty, ambiguity and risk in a MEP unless it is a controlled environment. For example, the problems associated with recognizing service of a participant with all participating employers can be a serious challenge (particularly in those PEOs with thousands of employers); the “one bad apple” rule can be expensive for the sponsor of a MEP to fix, especially when spinning off the plan doesn’t work as a cure; there is a potential co-fiduciary liability issue no one discusses; and there is that insistence by the DOL that both commonality and control be met. What this all adds up to is that, unless you are working with a small, identifiable group-such as franchisees or other closely related firms; with a group of companies with close working relationships (such as in a “non-controlled” group with common ownership); or in a traditional association, its going to be tough to adequately address these sort of risks under the current MEP rules. 
 
2. There are better arrangements.  When you look closely at it all, the alternatives to MEP arrangements can be pretty favorable, with a lot less risk for both the participating employers and the MEP sponsor. There are legitimate ways to create fiduciary and investing relationships which accomplish the similar end result of a MEP (the good Mr. Pozek coined the term “APA”, or ”Aggregated Plan Arrangement”) which uses existing DOL and IRS rules to accomplish virtually the same thing as a MEP-the exception being dealing with the audit costs. However, there are even suitable ways to deal with that under certain circumstances.
 
3.  A MEP fix is a way off.  The GAO encouraged the IRS and the DOL to move “sooner than later” in resolving what it found to be the lack of coordination between the regulatory agencies, and the agencies all agreed. Given their current workload and the delays in, for example, one of the agencies issuing something as relatively straightforward as the new EPCRS program, one can only imagine the priority an interagency coordinated regulatory effort would receive-and how soon it would come to be.  And even then, the simplest coordination is to declare that the DOL current rules on MEPs are a precondition to application of 413(c).  I suspect legislative changes would occur much before we see the agencies acting. 
 
And legislation? The priority for the retirement industry this coming year will be preserving the 401(k) system, and I would expect MEP solutions to be given low priority.
 
In short, risk, particularly in non-traditional MEP markets, is likely to be a regular companion. 
 
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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.   

 

 
Both Treasury and Labor continue to engage in efforts to accommodate the availability of defined contribution plans to provide participants the ability to choose to use a portion of their account balances to choose some level of guarantee lifetime income.  The Treasury’s efforts have been especially notable, as Rev Ruling 2012-3 (which defined the spousal consent rules for plan annuities) and the proposed Qualified Longevity Annuity Contract regulation (which grants RMD relief for certain annuities) have established some very basic groundwork to enable DC annuitization to be broadly made available. 
 
Both of these agencies continue to attempt to support this process, using their existing regulatory authority. Though there are a number of things which probably need legislative action in order to really make guaranteed lifetime income readily available, there are still a few things regulators may want to consider doing to help it all along:
 
1.  Clarify the QPDA.  Both the QLAC at 2012-3 rely on a fundamental premise, that the annuity contract, or “qualified plan distributed annuity” (the “QPDA”) can be distributed from the plan. Distributing annuities from plans has been around for generations, and the concept is well imbedded in various parts of the Code. However, it would be helpful to consolidate those rules into a single piece of guidance discussing the rules which will apply to these distributed annuities.
 
2. Title 1 Clarification. While the DOL is focusing on important issues such as education and disclosure of lifetime income amounts, there is actually an important structural issue it can also address. We all assume that a distribution of a QPDA is also considered a distribution for Title 1 purposes as well, mostly because of the "ordinary notions" of property law upon which ERISA’s plan asset rules are based. It s a fiduciary decision to purchase the right kind of an annuity, and any sort of post distribution protections which are needed can be built into such an annuity (such as not being used as an end-around the spousal consent rules). But there appears to be little reason not to treat annuities, even if they have a cash surrender value, or otherwise have an account balance, as a distribution from the plan under ERISA Title 1. This is particularly so where the participant has the right, instead, to take that same amount in cash rather than purchasing an annuity.
 
3.  Rollover Guidance. 1.401(a)31 Q&A 17 makes it clear that you can roll money over from a distributed annuity. The language is quite striking:
 
“Q-17. Must a direct rollover option be provided for an eligible rollover distribution from a qualified plan distributed annuity contract?
 
A-17. Yes. If any amount to be distributed under a qualified plan distributed annuity contract is an eligible rollover distribution (in accordance with Section 1.402(c)-2), Q & A-10 the annuity contract must satisfy section 401(a)(31) in the same manner as a qualified plan under section 401(a). Section 1.402(c)-2, Q & A-10 defines a qualified plan distributed annuity contract as an annuity contract purchased for a participant, and distributed to the participant, by a qualified plan. In the case of a qualified plan distributed annuity contract, the payor under the contract is treated as the plan administrator. See Section 31.3405(c)-1, Q & A-13 of this chapter concerning the application of mandatory 20-percent withholding requirements to distributions from a qualified plan distributed annuity contract.”
 
However, it is has never been entirely clear that you can roll funds into a QPDA.  Making this clear would increase the ability to consolidate and “port” these benefits, and to switch out of a contract that becomes unfavorable or from an insurer that becomes financially weak.  The complications for this, however, lie in the securities laws, and whether or not this annuity would need to be a registered product.  
 
In any event, there are a number of interesting steps the agencies can take within existing authority-even though I probably shouldn’t be thinking about this stuff while we’re surrounded by peak color season up in mountains….  

Designing a product or platform for the retirement plan market is an incredibly complex task, involving a large number of integrated relationships and coordinated protocols between unrelated parties which all must work seamlessly. “Looking under the hood” (its that Detroit thing, y’know. I do wear my “Imported From Detroit” shirt with pride) of even the simplest of 401(k) arrangements will reveal surprisingly sophisticated sets of arrangements.  

It is almost mind boggling to think of what is behind, for example,  executing even the simplest 401(k) transaction: an electronic trade between two unrelated mutual funds on a trust platform.  With my apologies to James Joyce and my English teachers from the Sisters of the Holy Family of Nazareth, the let me provide the following run-on sentence, listing a number of the logistical tasks involved in pulling off of this “simple” transaction:

Protocols and software to make sure the website or smartphone data is handled and stored securely; testing the parties to the transaction under the OFAC regulations (yes, even some of your 40(k) trades are subject to testing for terrorist transactions); the matching of the trade to the right plan to the right participant; the testing under SEC Rule 22(c)2 at both the omnibus and plan level for market timing and restrictions on the trade if it is in violation; testing the trade against plan document terms and, ultimately, the Investment Policy; imposing equity wash restrictions on trades, if applicable; documenting the processes to meet the accounting and auditing standards under SSAE16 (formerly SAS70); the balancing of the plan and participant accounts both before and after the trade, and the accurate timely execution of this balancing in a very tight time frame; transmitting the information between fund companies or platforms using NSCC protocols; obtaining and applying the correct NAV, and dealing with breakdowns related to the untimely setting of a funds’ NAV; the actual execution of a trade, often in a block trade, which may include the use of certain offsetting of trades; the generation and monitoring of soft dollars from the trade; the recording of the trade for the generation of 12b-1 and subtransfer fee purposes; the T-1 settlement of the trade, and the process related to its failure; the management of cash and cash flow arising from high volumes of liquidating trades; handling the mismatching of data and dollars; and the proper posting and balancing of the trade to the plans after it is done.
 
This is only a partial listing of all of the discrete tasks required to perform this simple 401(k) transaction.  It does not even take into account the plethora of agreements and regulations which apply at every stage of this arrangement to legally enable them;  the procedures related to the marketing and distribution of these products and the design of the compensation related to them; or the massive amount of tax and ERISA compliance services integrated at every stage.  These pieces are governed by a fascinating combination of state and federal law, including securities laws, banking laws, tax, insurance and others.
 
These steps become geometrically more complicated when you have other services or platforms involved. Think about what happens when an annuity contract or a self-directed brokerage account is added to the equation. Take a look at the flow charts at at the beginning  of that link, which outlines a process than Dan Herr and I put together on annuitizing from a mutual fund based 401(k). There are a lot of moving pieces. 
 
In short, a retirement plan product is really a package of financial and administrative services.  This knowledge is especially important when one is tasked with understanding the reasonableness of fees related to retirement products and services.  Purchasing investments through a defined contribution plan is so different than an individual making purchases for their own personal account, and it is horribly misleading to suggest otherwise.
 
Layering on top of all of this the 408(b) 2 and 404a-5 disclosure regulations, and you can begin to understand the challenge that the new ERISA disclosure requirements can create. 408b-2 is especially crucial, as it is a prohibited transaction rule which can through a monkey wrench into the entire Rube Goldberg-type structures which are necessary to make these programs look simple.
 
I am not an apologist for those who will use this complexity to hide unreasonable fees, something I will discuss in a future post, and this is something upon which advisors must be diligent. Transparency is critical to the fair operation of the retirement plans. But one of the benefits of transparency will be a better understanding on just how complex the system is, and just what it is that these fees support.
 
The marketplace has worked hard to make the 401(k) plan look deceivingly simple. But it is anything but.
 
 

 

A number of friends, and other commentators, had suggested to me that I was perhaps “overstating” the position I had discussed on my last blog regarding the delivery of 404a-5 notices to non-electing participants in an elective deferral plan. It was a very kind way of saying that I was wrong. After looking at the way I wrote the blog, I’d have to agree. I have retracted the posting. This is the first time I have had to do this in nearly five years of postings, but I strongly suspect it will not be the last. As one of my early mentors once exclaimed to me: “Toth, this stuff’s hard!” -though he did NOT use the word “stuff….” 

And I do apologize for not getting this “errata” piece out sooner than this.
 
In that blog, I stated that “the mere eligibility to make a deferral into an individual account plan doesn’t trigger the right to the 404a-5 disclosures.” That is the error. The “mere eligibility” does trigger the right to the 404(a)-5 disclosure, without question. The real question I was badly attempting to get at is “when.” Or, more precisely, a question that a number of professionals are asking: did the August 30 deadline for initial disclosure apply to those participants in an elective deferral plan who had not elected to participate? 
 
This is a real question.  We know that someone need not be given the notice immediately upon  becoming eligible for the plan (though, as a practical matter, I would recommend giving participants that disclosure when required to be given the SPD).  The regs in § 2550.404a–5(c)(2)(i)(A) state that the administrative expenses must be given to participants “on or before the date on which a participant or beneficiary can first direct his or her investments and at least annually thereafter.”  (c)3(i)(A) states the same for the individual expenses; while (d)(1) contains the exact same language for investment related information. 
 
So, we know there is time, beyond the date first being hired (or otherwise first becoming eligible) to provide the relevant information to any eligible employee, which is to be no later than the date that that person enrolls in the plan.  (A related question is how far can you push this out before you actually undermine the rule that all participants are required to be given a notice?  It appears that it DOL suggests that this be no later than the annual notice you would otherwise provide to all participants, as the preamble, again, gives a clue, when the DOL states that “The Department believes that, with regard to employees that have not enrolled in their plan, the annual notice will serve as an important reminder of their eligibility to participate in the plan.”).
 
But what about that initial August 30 notice requirement? The reg at 2550.404-a5(j)(3) states that “the initial disclosures required on or before the date on which a participant or beneficiary can first direct his or her investment must be furnished no later than 60 days after such applicability date to participants or beneficiaries who had the right to direct the investment of assets held in, or contributed to, their individual account on the applicability date.”
 
Does this suggest that the term “participants and beneficiaries” may be conditioned on whether there is an account under which assets could be directed?  Indeed, the Department has made it clear that beneficiaries do not have the right to such a notice unless they can exercise investment control over an account.
 
This position would be consistent with the well established concept that a claim for a fiduciary breach requires the showing of actual harm (see, for example, CIGNA v. Amara, 131 S.Ct. 1866, 1878-80 (2011). In a regulation which is geared to fee and expense activity (as opposed to general, non-monetary ERISA rights), if there is no account against which to assess fees and expenses, can non-disclosure be a fiduciary breach? If the breach is the lack of knowledge that the deferrals can be made, isn’t this is well covered-at least in the 403(b) space-where the responsibility (which is actually under the Tax Code, not Title 1) to notify participants of the availability to make elective deferrals is covered by the annual notification of universal eligibility; and by the rule of current availability for 401(k) plans?
  
 A conversation worth having…..
 
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 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.   

The DOL has long treated the revenues sharing programs (such as 12b-1 and sub-transfer agent fees) related to investment funds in the same manner as the SEC:  as an integral part of the funds’ operating expenses. This choice, however, has the side effect of the actual amount of the revenue sharing not ever having to be disclosed under ERISA’s various disclosure schemes. So, for example, the actual amount of revenue sharing generated by the vast majority of plan investments is exempt from disclosure under Schedule C as long as the prospectus describing the revenue sharing formula is delivered to the trustee; 404a-5 exempts disclosure of these amounts from the other disclosures required on participant statements as long as the revenue sharing is part of the fund operating expenses under the model disclosure chart; and the 408b-2 regulations and PTE 84-24 only require disclosure of the formula used upon which the compensation will be based.

One court’s decision, however, may throw a monkey wrench into this disclosure scheme. 
 
The case in point is the Tussey vs ABB. Tussey, in case you are not familiar with it, is a U.S. District Court matter in which the employer used the revenue sharing generated by the employer’s 401(k) plan investments to help subsidize the administration of other employee benefit programs. The plan’s Investment Policy Statement actually required that the fiduciary track the revenue sharing generated by the plan’s investments, something the fiduciaries never did. The court held the fiduciaries liable for a fiduciary breach with regard to, in part, their failure to monitor revenue sharing and assessed approximately $35 million in penalties.
 
The first commentary coming from practitioners was relatively narrow, that the holding really stood for the proposition that the plan had better follow what is in the plan’s governing documents like the IPS. But a growing number of respected practitioners and advisors have been taking the position that the Tussey case stands for something much broader than that: that it stands for the notion that-beyond just following the plan documents-fiduciaries should affirmatively seek information regarding how much revenue sharing will actually be be generated by their plan.  After all, this approach is consistent with the manner in which the DOL treats other sorts of sales related compensation. Schedule A to the Form 5500 has always required insurance companies to disclose the actual amount of sales related payments generated by assets paid for the past year, related to an annuity contract, and Schedule C also requires the disclosure of such payments, if made from something other an insurance contract, as long as those payments are not generated as part of the funds operating expenses.
 
In practice, many investment vendors are moving in this direction, and an estimate of the revenue generated by the investments is becoming more and more part of the sales process. It is an especially critical number where ERISA Accounts (upon which I commented a few times) are involved.
 
Yet, should this position evolve and develop into a basic fiduciary obligation, it will not be without a bit of difficulty in application. Small employers, in particular those with little or no bargaining power, would be put in a pretty unfair spot: having an obligation to review a number that no one is required to report to them. 
 
 

Pension funds and insurance companies share a little discussed attribute, one which I have mentioned from time to time on this blog: they are both great drivers of capital formation.  One of the unique aspects of capital formation through these entities is the function of time: it takes time, to quote the bankers from the movie Mary Poppins in the infamous "Fidleity Fiduciary Bank"  scene, to “build railways through Africa” (or even California, for that matter). Pension funds and insurance general accounts are of a nature uniquely suited to such investment, the commitment to which often may span decades.

Annuity contracts purchased by 401(k) plans, and other retirement plans, often offer the ability for the plan or the participant to invest in these insurer’s “general accounts” as an investment fund. They are now often marketed as “stable value funds” which, in return for time, provide guarantees of principal, some measure of guaranteed returns, and enhanced crediting rates. Though they are called "stable value funds," they are really nothing like the stable value mutual funds. They are backed (in part) by real "things" like investments in bridges, roads, equipment, factories, apartments and shopping malls.
 
Many of these general account investments offered under annuity contracts, however, have the hated “contingent deferred sales charges” (otherwise known as surrender charges), or “market value adjustments (MVA) ” to the stable fund investments, should these contracts be terminated or substantial amounts withdrawn before a stated time. Surrender charges are generally related to sales costs, but the MVA, as unpopular as they may be, are often necessary because of the long term capital investments backing the guarantees which may be provided. Many products today, by the way, are offered without surrender charges or MVAs, but also generally offer reduced crediting rates in return.

Which really brings us to an obscure problem the DOL has struggled with in the past under ERISA’s plan asset rules (in attempting to define a “transition guaranteed benefit policy”), and now is an issue which may well come to the forefront because of the termination rules under Reg. 1.408b-2(c)(3). 1.408b-2(c)(3)  states that a contract will not be considered reasonable if it does not permit termination “on reasonably short notice under the circumstances“ of the contract by the plan without penalty to the plan. Fortunately, the DOL noted that this should not be read to prevent long term contracts, nor contracts which “reasonably compensates the service provider” for their loss upon early termination of the contract. This exception will not apply if that recoupment is “in excess of actual loss or if it fails to require mitigation of damages.”

So the question becomes what does “without penalty” mean, under 408b-2, when you are terminating an annuity contract.  As noted, the DOL had addressed this issue in the past in an odd, and very specialized, regulation under ERISA 401(c)(1) – which may now have renewed meaning under 408b-2. Under 2550.401c–1, the DOL outlined what it meant to terminate an annuity contract "without penalty" for purposes of that reg.  It established a standard to be applied to both the surrender charge and the MVA:   ”the term penalty does not include a market value adjustment (as defined in paragraph (h)(7) of this section) or the recovery of costs actually incurred which would have been recovered by the insurer but for the termination or discontinuance of the policy, including any unliquidated acquisition expenses, to the extent not previously recovered by the insurer."
 
This seems consistent with the language used in 408b-2.
 
The challenge for regulators, insurers and the responsible plan fiduciary will be figuring out when annuity contract termination charges cross this line.  Though annuities designed for the retirement market typically are designed to meet these rules, there may be some questions related to retail annuities placed into plans.
 

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Continue Reading Annuity Termination Charges under 408b-2: What is “Without Penalty?”

I have a statue of an elephant on my office credenza. It is actually an exotic little contraption, a bank, where a coin placed on its spring-loaded trunk will be deposited in the elephant.  It was a gift to me from a consultant friend of mine, after I told him about my experience with a number of major financial software conversions. Dealing with the fallout from system conversions, I explained, is like cleaning up after elephants (after recalling an incident I had witnessed involving some poor photographer at the Brookfield Zoo…). Next time, I promised, I was going to get in FRONT of the elephant. 

The Wall Street Journal today reports the slogan “One Line Of Code” in its description of the massive software failure at Knight Capital Group, which resulted in nearly a half billion dollars worth of losses and the collapse of a central player in the equities market.  This could well be the mantra, however, for any major system change involving retirement plan systems as well.  
 
Think about it. Retirement plans, and all of their moving pieces (from CRM, to compliance, to trading, to financial transactions and everything in between) likely create some of the most complex of transactional requirements that exist in the financial marketplace. Hedge fund and other trading platforms have complex formulas, for sure. But if you take a retirement plan from soup to nuts, with all of its different iterations, you’ll likely not find a set of processes in the financial marketplace that has more massive and demanding systems requirements.
 
The problem Knight had is really one that has (usually quietly) been encountered by most major financial service firms in the retirement market, and has been outrageously expensive for those firms. The challenge is what I call the “overpromise of technology.” The IT executive or consultant of an organization makes grand promises to the business side of the house based upon grand conceptual notions, all of which-by the way-make great sense on paper. These notions can be made to sound so very enticing. But the problem is that the executives generally underplay one very basic tenant of software development painfully driven into to me by some very talented developers: software and computers are dumb.   They will only do what you tell them to do, and at a very granular level. 
 
The “grand notion” may be great on paper, but-particularly in the retirement world-the very close details, the minutiae of which I have often spoken of in this blog, is what will make or break any such effort.  The “80%” rule won’t work; you have to worry the details.  It is the smallest of choices which will trip up the viability of any system development effort. What makes this so counterintuitive to the executive is that properly managing this risk means putting some very high level and valuable corporate assets into the “grunge pit,” grinding through the thousands of small decisions that must be made in the development of software which are really reflective of corporate decisions about how you will run the business. It is painful. It is time consuming. It is ugly. It is exhausting. But it is the ONLY way a system can be properly developed in a way that serves the business, and delivers on the promise. But this is a lesson far too often lost in the C-Suite.
 
 

Well I have to admit I was wrong. About 15 months ago in this Business of Benefits blog I predicted that "Time Had Come Today" for in-plan retirement income solutions to gain traction in DC plans. After all, it seemed like all the stars had aligned for the big turn around in the way retirement plans were perceived.  DOL and IRS had tag-teamed on a RFI designed to find ways to facilitate the offering and selection of guaranteed lifetime income (both in-plan and out-of-plan), DOL’s ERISA Advisory Council had issued a report containing recommendations for viable regulatory changes to enhance the environment for plan sponsors to offer GLI, the first baby boomers were reaching retirement age and approaching the decumulation phase of their retirement planning, new and innovative guaranteed lifetime income products were now available that addressed the challenges and shortcomings associated with traditional GLI products and more and more recognition and appreciation had emerged for the need to address the risks associated with outliving one’s assets. 

Unfortunately, it turns out that the status quo persists as plan sponsors continue to be leery/reluctant to offer GLI as an investment alternative or distribution option.  My prophetic blunder was aided and abetted by an ever-expanding and burdensome regulatory environment, a continuing weak economy making plan sponsors less inclined to consider enhancements and low interest rates which increases the cost to purchase GLI products. Couple the foregoing with costly compliance concerns and the dreaded "F" word that plan sponsors can avoid by steering clear, it’s not at all surprising that what seemed to me like a reasonable time horizon prognostication for widespread acceptance and use of in-plan guaranteed lifetime income strategies. now doesn’t seem anywhere in sight. 
 
That said, the critical need for the certainty and security that guaranteed lifetime provides cannot be overstated. That is something that everyone – short of those who have a contra interest in keeping control of funds – can agree on. See for example.  The NY Times  “Wealth Matters” (July 27 2012) article written by Paul Sullivan in which he discusses research conducted by the noted behavioral economist Shlomo Benzarti  Sullivan says “Shlomo Benartzi, a business professor at the University of California, Los Angeles and the chief behavioral economist at Allianz Global Investors’ Center for Behavioral Finance, said research had shown that most people were incapable of managing a lump sum of money well and that at least half of them got worse at it by the time they turned 80 and their mental faculties declined.”  The article provides a well balanced discussion of the pros and cons relating to GLI choices and if you haven’t read it I recommend it highly.  Of course the article was written in the context of a defined benefit plan but for the vast majority who need GLI the conclusions are the same (if not even more dire) in the case of most defined contribution plans where GLI isn’t even a choice.  
 
 So, let’s consider another way to address this issue. Like the overall basis for DC plans in the first place, let’s put the responsibility for selecting GLI on participants who bear the risks and ask plan sponsors to merely help participants recognize the need. How? Comprehensive financial education made available to employees by plan sponsors. Retirement planning represents only one of the many critical components that comprise individuals’ overall financial plans. And, in this area as we all know, people need help with a lot more than saving for retirement. This includes,  but is not limited to, matters as basic as strategies for coping with everyday financial pressures, debt management, buying a home, saving for college, estate planning and, of course retirement savings and investment issues and the important role protection products can offer to address longevity risks, retiree health and long term care needs. 
 
So, after 15 months of pondering, I’ve now reached the conclusion that the focus must shift from trying to engage plan sponsors about the need for GLI to the need to help participants understand and manage their finances in an increasingly complex investment and financial world. If we take care of providing quality financial education to American workers, thereby helping people make better financial decisions, then it stands to reason that the obvious need for GLI will take care of itself.  
 

A couple of decades ago, I attended an ERISA litigation conference where one of the topics of discussion was the potential for lawsuits from participants who were placed in stable value (then known as "fixed funds") investment funds in a 401(k) plan, who would claim somehow that it was a fiduciary obligation to optimize gains in such plans. I scoffed at those comments then, as I do now.

I bought my first shares of stock when I was 16, using $300 of savings from my Detroit News paper route collections to buy into Continental Telephone, American Airlines and Georgia Pacific.  I had studied these (and other) companies under the tutelage of my stepfather, a civil servant in Wayne County, whose passion was the stock market. At that time, Merrill Lynch had a broker in its Downtown Detroit office which specialized in small, odd lot sales. And yes, I ordered delivery of the stock certificates, and enrolled in those companies’ dividend reinvestment programs.  Ahh, the days of Lou Rukeyser and Wall Street Week.

It is this long familiarity with the equity market which had caused me to challenge the wisdom of the QDIA regs when they were first proposed. Though I very much understand those who are concerned about the importance of smart investing in retirement plans, I remember more than one conversation with Ann Combs about the concerns I had about a default fund being equity based. Markets do go down, and employees tend to trade investments in defined contribution plans at inopportune moments. As I’ve noted in a past blog, ERISA Section 404 demands that the funds be invested in such a way to minimize the risk of large losses, not to optimize gains for adequate retirement. Optimization may be a laudable public policy position, but a fiduciary standard it is not.

Even today, I advise clients about the downside of choosing an equity based investment as a default.  I actually don’t  think the QDIA, as currently designed, is necessarily prudent.   But for the QDIA reg granting relief, choosing a default investment fund based on equities could cause fiduciaries some exposure. And even though an employer may have a legal defense to the participant losing money on a default fund because of the QDIA rules, it is the employer, not the regulators, who have to deal with the bitter employee who has lost funds under such an election. It may be legally defensible, but it isn’t necessarily right-or the right thing for participants.

So finally we have the Bidwell case, involving a platform I helped design.  An employer changed its default fund from a insurance guaranteed account type of fund to an equity based QDIA just as the market was entering into the Great Recession’s downturn.  Those participants who’s funds were moved lost substantial value. They sued, but the employer prevailed. In that the employer had complied with all of the particulars of the QDIA rules, there was no fiduciary breach, and the employer was not held liable for those losses.

Though we legally applaud the ruling, and the affirming status it gives to the QDIA regs, there really are a couple of "darker side" takeaways from this case: if you are doing a QDIA, make sure you are doing it right. Otherwise, there may be exposure, as there is nothing inherently prudent about target date or lifecycle funds as a default investment fund. The second is to not discount the thought that  "prudence" as a standard still applies to other default investments, and that the QDIA may actually be putting participants at a disadvantage.

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