I had posted in an earlier blog some of the technical  differences between 401(k) plans and 403(b) plans. One of the more striking differences I did NOT mention was that of the Prohibited Transaction.

Assume a successful insurance agent sits on the Board of a mid-sized tax exempt organization with 250 employees, a Board which also serves as the Plan Administrator of its ERISA 403(b) plan. The Board has just conducted a review and chosen a new vendor to handle all of the new tax rules while also complying with its fiduciary obligations. The Board selected a 403(b) vendor which is an insurance company that the agent/board member has been appointed to do business with. That agent/board member took all the (often excruciating) steps necessary to make sure that no commissions are paid to her on the purchase of those annuities by the charity’s plan.

The agent opens her quarterly bonus statement from the insurance company and finds, to her great dismay, that the insurance company has paid a retention bonus on the charity’s 403(b) plan annuities. She immediately calls a fellow Board member, who also happens to be the CPA which will be auditing the charity’s plan. She wants to know whether this is a problem, and how should she fix this. The CPA is now concerned, because the audit may need to address this circumstance.

Assuming that the payment of the retention bonus is a prohibited transaction  (there are circumstances in which it may not be), and setting aside the issue of how to correct something like this (that’s why people hire lawyers like me), how does the CPA approach this?

The first, and most important, point is a 403(b) plan is NOT a plan defined under IRC Section 4975(e)-which means that 4975 and its related excise taxes does NOT apply to 403(b) plans. There is no "disqualified person;" there is no "non-exempt transaction" that is reportable under Schedule G, Part III of the Form 5500; and no Form 5330 needs to be filed.

This also means that, by virtue of not being covered by 4975, that it is subject to ERISA’s Civil Penalties under ERISA Section 502(i), which relate to the Title 1 Prohibited Transactions under ERISA Section 406. The 403(b) plan is NOT exempt from this section. But there is currently no way to report this transaction to the DOL, which "may" asses the civil penalties thereunder.

This may put the CPA in a bit of a quandary, particularly if the potential prohibited transaction penalty is substantial because of the size of the transaction or because of the number of years it went uncorrected. Until the matter is resolved with the DOL, and a decision made whether to asses the penalty, this may be carried as a sort of open liability on the audit report. … yet another 403(b) regulatory issue to be resolved.

Preview

For a heads up, I thought I’d preview with you a few of the matters I expect to address in the early part of the new year:

  • Part 3 of the Annuity "Fiduciary Concerns." Yes, there is a "Part 3" on the boards. This will cover "Invisibility", which is really a discussion of sales charges, and "Immobility,"which is a discussion on Portability.
  • Annuity Transparency.  How to make disclosures relevant.
  • Complex Prohibited Transactions. There will be a few blogs on how the prohibited transaction rules apply in large, complex financial organizations.
  • A Schedule H and C "walkthrough" for the 403(b) plan. 
  • ERISA Section 502(a)(9), the Plan Distributed Annuity and 403(b).

And a few other interesting tidbits.  Keep watching…..

A Final Reflection

The year’s end always brings the opportunity to reflect again on important matters. I would like to share with you a quote from Learned Hand, eminent jurist of the federal bench in the early 20th century. I came across this quote some 30 years ago, as I was deciding to go to law school, and have carried it with me since. In a corporate world where the staff "common denominator" often seems to be fear, where ideas are much at risk, this takes on particular relevance:

 Our dangers, it seems to me, are not from the outrageous but from the conforming; not from those who rarely and under the lurid glare of obloquy upset our moral complaisance, or shock us with unaccustomed conduct, but from those, the mass of us, who take their virtues and their tastes, like their shirts and their furniture, from the limited patterns which the market offers.

Learned Hand June  2, 1927, commencement address at Brym Mawr College. Bryn Mawr Alumnae Bulletin, Oct, 1927.

To all, wishing a healthy and fulfilling new year.

 

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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.  

 

403(b) devotees often speak of the continuing, and significant, number of technical differences between 403(b) and 401(k) plans. The following lists a few of the differences not given a lot of attention, a sort of holiday stocking stuffer:

Handling 403(b) cash.   Handling cash is much more challenging under a 403(b) plan than under the 401(k) plan as pointed out to me a little while back by David Walters of Bodman LLP. A 401(k) deposit can sit in some sort of cash account (sometimes for lengthy periods of time) in the trust while a variety of administrative issues related to the handling of that cash can be resolved. Not so with 403(b) plans. First,  403(b) cash needs to put in a "custodian account  held"  registered investment company share or into an annuity contract to maintain its 403(b) status. It can’t just sit around in some sort of custodian owned cash account for more than a very short time.  Secondly, 403(b) investments are registered products which are subject to strict SEC rules on timing of deposits and the return of funds received "Not In Good Order." 403(b) custodians beware!

Notice of restrictions on distributions.  In an example of the quirkiness of the 403(b) rules, the SEC issued a No-Act letter in 1988 to the ACLI regarding the distribution restrictions on 403(b) annuity contracts. It appears that the 403(b)(11) distribution restrictions could have run afoul of the distribution requirements under the Investment Company Act of 1940 (403(b) investments being registered securities subject to these rules) but for this issuance of this No Act. 

The 403(b) SAR.  ERISA 403(b) plans have always had to file an SAR. They were very silly, not looking at all like a 401(k) SAR, with very little information on them because of the minimal 5500 reporting requirements. Now, those 403(b) SARs will be substantial. Those who have "standard" 403(b) forms will need to modify them to look like the 401(k) standard.

Non-merger.  It was conventional wisdom in the past, as Kurt Lawson of Hogan and Hartson notes, that 403(b) plans and 401(a) plans could not be merged, though this surely would be a handy planning tool to have today to manage all of these 403(b) issues. The 403(b) regs confirmed this "conventional wisdom" in 1.403(b)-10(b)(1)(i).

Employer Approval.  I find it fascinating that, with all the back and forth going on between employers and vendors on "approving" hardships and loans and the like that, unlike 401(k) plans, the 403(b) regs do not actually require employers to approve such things. The 403(b) "Plan Administrator" is really a much different animal than the 401 (k) Plan Administrator. It really is more like a compliance coordinator.  

A Personal Thought

My friends and colleagues likely do not think of me of being particularly religious or spiritual, even given my 12 years of Catholic schooling and reading more than my fair share of the likes of Lao Tzu, William Stringfellow (lawyer and theologian),  Kahil Gibran,  Eckhart Tolle and others. But this holiday season causes us all to reflect, regardless of one’s religious tradition, on the magnitude of personal tragedy we are witnessing today. NPR reported the other day that 1 in 7 U.S. families are struggling putting food on their tables. 

So let us be thankful for what we do have and for those incredible folks who give their hearts-mostly without thanks or recognition- to righting the indignities and inequities of this time. And let us  humbly remember those who are much less fortunate than us, as all of the traditions teach us that-yes-we are all our brother’s keeper.

 

 

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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.  

 

 

I blogged a couple of weeks ago on the DB demise because of what I was seeing my current work on DC annuities, triggered by an interesting e-mail discussion string between fellows of the American College of Employee Benefits Counsel. 

But then the PBGC held a 35th anniversary forum shortly thereafter, extolling the idea of revitalizing the current DB system.  I thought this made it an opportune time to further the discussion.

The December 7 Forum on DB plans seem to hit it mostly right  in its calling the attention to the fundamental value of employers providing "guaranteed income for life" to employees. The National Institute on Retirement Security also reported on the meeting, noting the  critical role of Defined Benefit Plans, calling them the "Real Deal." The NIRS has also published its vision with which one can hardly argue. Under a high quality retirement system retirement system: 

  • employers can offer affordable, high quality retirement benefits that help them achieve their human resources goals;
  • employees can count on a secure source of retirement income that enables them to maintain a decent living standard after a lifetime of work;
  • the public interest is well-served by retirement systems that are managed in ways that promote fiscal responsibility, economic growth, and responsible stewardship of retirement assets

But here’s where the problem lies. Juxtapose those statements with the following quote from "The Black Swan," by Nassim Nicholas Taleb, Random House, 2007:

"Consider the following sobering statistic.Of the five hundred largest U.S, Companies in 1957, only 74 were still part of that select group, the Standard and Poors 500, forty years later. Only a few had disappeared in merger; the rest either shrank or went bust." p.22

This where the PBGC, the NIRS and Pension Rights Center (which also presented at the conference) have it all wrong: the traditional DB plan does not, and will not, meet these laudable goals if you rely upon the private employer for the financial wherewithal to insure that the funding and fund management will be adequate. Plan sponsors can be terribly conflicted, with their own corporate financial needs creating economic pressure to engage in some sort  dangerous "creative accounting" in the management of these plans- which we have all too often seen in the past.  I am tempted to argue that public plans do not have this problem, and that they should get a "bye" on this concern. But think again. Many state and local governments are in serous trouble because of a disturbing lack of financial discipline, as they have not really had to "pay as you go" when promising very expensive benefits. Are not these promises really of the most cruel kind, when we find the money to pay for them really is not, nor ever can be, there?

The current DB system is premised on the notion that a private employer can more cost effectively provide this benefit. Logically, this cannot be true because of the lack of sensible pooling even in the largest employers. Some employers will be able to do so today because of their current demographics, but many cannot-and even those who can may find themselves in a bind in a decade or two. The only potential cost savings is in the profit charge on this guarantee issued by an insurer.

In effect, the system believes that it can do a better job at longevity risk management than regulated insurance companies, and to get that insurance for, in effect, free. When all is said and done, it is likely far from free. We are seeing the effect of the fallacy today, with only 19,000 DB plans now being covered by the PBGC.

So if the system REALLY needs a guaranteed lifetime benefit based upon employer sponsorship, one under which employers have the ability to choose the benefits (and thereby control the cost),  but one under which the employees should not be exposed to the vagaries of foolish business decisions of their  employers’ senior management, what IS the answer?

I truly believe the answer lies in a private insurance system which provides Annuity Transparency, in annuities purchased through the employer sponsored system.  I’ll talk about this on my next blog. For now, though, its back to the ski slopes of Quebec…. 

A footnote, added 12/21: Gretchen Morgenson reports in the Sunday NY Times  on a multi-billion dollar failure in the Alaska pension system, caused in large part by the alleged error of Mercer.  Again, my point: non-regulated institutions are ill-equipped to manage DB plans, particularly large ones. Had Alaska purchased insurance, the risk of error would have be borne by a well capitalized, highly regulated expert organization.

 

 

 

 

 

The DOL issued FAB 2009-2 back in July, in response to the concerns of employers and investment providers that in many cases they would not be able to obtain the information necessary related  to a number of "old" 403(b) contracts and accounts for the expanded Form 5500 required for 403(b) plans beginning with the 2009 plan year. Moreover, even in cases where some annual reporting with respect to the contracts would be possible, the DOL recognized that compliance efforts involved in including these contracts in the financial statements would be substantial and expensive.

The FAB  was not uniformly well received initially, many expressing the thought that the relief was illusory at best.  Now that we have had some time for the FAB to settle in, and now that parts of the market are beginning to try to identify past contracts and "classify" what to do with them, the usefulness of the FAB becomes more clear. 

The FAB allowed contracts to be excluded from an audit if they met the following 4 conditions:

  1. were issued prior to 1/1/09,
  2. all contributions ceased prior to 1/1/09,
  3. all rights under the contract are"legally enforceable" against the insurer or custodian by the individual owner "without any involvement of the employer," and
  4. the mounts in the contract were fully vested and non-forfeitable.

The real key to making the FAB work for the employer in keeping auditing costs down is in the sensible application of the FAB’s 3rd condition.  I would suggest that applying it consists of two parts. First, use a reasonable effort to determine and find contracts that were related to the plan at some time in the past and, secondly, making a reasonable effort to determine whether or not the rights under those contracts are "legally enforceable" by the individual.

Finding contracts

Establish a reasonable (meaning not "perfect") method to use to find what contracts might possibly be part of your plan. Review the employer records to determine (to the best of your ability) which employees made contributions to which vendors over a reasonable period of time (perhaps the ERISA 6 year recordkeping requirement?).  Do the best you can, document it, and convince your CPA that a reasonable effort should do. 

Legally Enforceable 

From a purely legal viewpoint, this should be "easy." Heck, just get a copy of all those contracts issued over the past (6 years?) and read them. Right? Two problems, of course:

  • Go ahead. Try finding them. You won’t find them. This is in part because insurance companies don’t typically keep actual copies of contracts. Instead, they keep records of the application, plus the "form number" they issued to the individual. Which means when you try to ask for a copy, you’ll just get an assembled form-assuming the company would give the employer (who doesn’t own the contract) a copy anyway.
  • Then try reading it. I dare you.  Have you ever tried to read an annuity contract?Trying to determine whether or not rights are solely enforceable by the individual will be a difficult task, and one which an answer to this question may never be readily findable.

There may be a way a reasonable method or two to try to divine this answer.  For current vendors, for example, the task is a simple one (of course, nothing is turning out to be simple nowadays in this world): have your vendors give you a list of all the contracts to which they seek your approval for something like loans or distributions.

For past vendors, this is where the gold mine should be. See if you have heard from any of those past vendors for which you have compiled a list (see "Finding Vendors"). It may well be reasonable to assume that, had you not heard from them on your former or current employees, that those employees rights are being enforced without your involvement.

Tougher questions arise when, under 2007-71, you have excluded contracts from your plan.  Can these contracts be excluded for Title 1 reporting purposes? Vendors have taken a hard line on these contracts, and are submitting all sorts of decisions to employers for approval, even where the employer has advised them those contracts are not part of the plan-and many times these approvals are demanded in spite of contract language NOT requiring employer approval.  

A number of employers have decided that they were subject to ERISA just this year, because of the press of the tax regulations. One needs to consider (after consulting a lawyer or accountant) whether any of the old, past contracts under such circumstances would need to be counted.

Finally, this business really is only the tip of one of those melting Antarctica icebergs. Ultimately, the lawyer, accountant and employer need to sit down and review the employer’s situation, and make a case amongst themselves for the most reasonable approach. Remember, the DOL’s approach right now is accommodative. It is not trying to bankrupt charities through the crushing cost of unreasonable audit requirements.

 

 

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 continues what is actually a pretty extraordinary effort with regard to 403(b) plans.  It had struggled early with the new 403(b) changes brought on by the IRS rule changes. It had not really taken a good look at these plans since 1978 when it issued its "safe harbor" which exempted many 403(b) plans from  Title 1 coverage, and I do not recall ever actually dealing with a DOL investigation of a 403(b) plan prior to this year.

DOL staff has kept talking to the accounting, legal and consulting professions, as well as employers and vendors, as they try to sort out  some of the unusual difficulties presented by 403(b) plans. Indeed, the biggest challenge in this market is not related to the tax code, it is in addressing  the mystery of how to define and manage fiduciary issues arising from 403(b) plans funded with individually owned annuity contracts.

The DOL is about to take the next step, and is considering issuing a 403(b) "Frequently Asked Questions" as they have done twice for the Schedule C. The FAQ is to address critical year end 403(b) issues related to reporting and Title 1 status.

While applauding the DOL in its continuing efforts, there is a danger related to one particular issue it may be addressing: the question of how few vendors can be offered by a 403(b) plan (which otherwise qualifies under the safe harbor) without triggering Title 1 coverage.

Putting aside the the very real practical problem of whether a 403(b) plan of a non-church, non-public educational organization can even qualify under the safe harbor because of problems created by the new tax regs, there is a significant issue related to "open architecture" platforms and certain annuity contracts which offer a large number of unrelated investment managers and mutual funds under the programs.

DOL Reg 2510.3-2 (click for a download of the reg) permits the employer to limit the number of vendors which are offered under the plan as long as employees are offered a "reasonable choice." The reg does not specify whether the choice of  "vendor" or "investment" needs to be reasonable.  

The regulations were written 25 years before the first "open architecture" 403(b) programs began showing up, where these large number of mutual funds are made available, and before the advent of a significant number of variable investment alternatives were available under certain annuity contracts. It would not be unreasonable for an employer to take the position that limiting the investments  to a single platform with a large ("reasonable choice") of investment options available would not jeopardize a plan’s "non-Title 1" status.

DOL staff has been discussing publicly for the past year or so the position that any less than 3 vendors would not be considered offering a "reasonable choice," even if the one platform offered a large number of mutual funds unrelated to the "platform vendor."  Should this position be published now, at year’s end, in the FAQ , without any hint of relief for all those plans which had interpreted the "reasonable choice" rule in a good faith manner, the effect can be severely disruptive. There are a significant number of (some very significant) plans which have taken the position that a single platform offering many choices kept them from Title 1 status.

Taking this position now in a FAQ has the same practical effect of issuing a final regulation: employers would take it as THE RULE, immediately effective. There would be no room for a comment period, or proposed corrections or transition periods. In short, this could cause a great deal of problems for a large number of employers.

One other thing. We have seen estimated that there may be some 35,000 or so 403(b) plans, and perhaps less than 20,000 that will be filing Form 5500s.  This number is likely to be sorely underestimated: There are a million or so private charities in this country and at least 14,550 public, k-12 school districts as well. If only 10% of the charities have 403(b) plans, and if almost all school districts have them, we are at least triple the government estimates. As mentioned, the impact of any of these rules will be significant, so their effect needs to be well considered.

 

 

 

 

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 private employer-sponsored defined benefit plan has had a good run of it, supporting two generations well in its goal of providing economic security  for retirees.  But the last 10 years have seen gradual though substantial decline in the number of employers sponsoring these plans, and in the percentage of employees being covered by these plans-now somewhere well south of 19% of the workforce is covered.The economic collapse has exacerbated the problem even further by exposing the weaknesses of the system, as the remaining DB plans are seeking funding relief from Congress.

You can find many sound opinions which attempt to explain this demise, from over-regulation, to difficult statutory schemes,  to the allure of defined contribution plans. If you step back, though, you can see that all of the reasons for the demise have a central theme: private employers are structurally ill-suited to bear the lifetime risk associated with providing this kind of benefit.

Think about it. Private business can, and indeed some must, fail. These companies  grow, expand and, ultimately either fail or need to be exposed to the risk of failure. There is a lot of conversation at the policy level about the evils inherent in having companies that are "too big to fail."  So what is the sense, then, to rely upon companies that we structurally need to fail from time to time to be responsible for funding a lifetime risk of their employees? One may claim that this is the function of the PBGC, but the PBGC doesn’t specifically reserve for risks undertaken by plans. Its reserving system is ad hoc, at best.

Taking a close look at the current DB funding rules, you can see that they really require employers to have, or buy, sophisticated actuarial and investment expertise that you will only normally find in a regulated financial institution. We are, in effect, demanding our manufacturing base to become experts at insurance.

These employers are also seeing the changing nature of their workforce and retiree population, and they find that the DB Plan is unable to meet employee and retiree demands. DB Plans are, for the most part, proverbial “one trick ponies,” whose inflexibility has limited their usefulness in the current marketplace.

I have blogged on popular new annuity products in the marketplace, many of which are reliant upon sophisticated hedging strategies.  These innovative annuity products include features well beyond anything that could be offered in a traditional DB plan. These includes features like (but not limited to) the elective, periodic purchase of a pension guarantee with each payroll; the ability to access cash balances with minimum penalties; equity participation which will raise or lower the lifetime income guarantees; guaranteed minimum withdrawal benefits; guaranteed minimum income benefits with equity participation; and variable annuitization.  Employers who sponsor DB Plans are not in the business of developing and providing these sophisticated guarantees to meet changing employee and market needs. Additionally, plan sponsors generally have limited skills in even maintaining traditional DB benefits, much less having the resources to provide a wide variety of lifetime payout benefits which can adapt to change. They are also severely restricted by a regulatory scheme which discourages innovation. 

What is the answer? Most will agree that the former insurance schemes are sorely inadequate: inflexibility in pricing, little transparency, little portability, and irresponsible acting in some quarters has fueled the current economic mess. What the insurance industry DOES have is the necessary skills and regulatory scheme to guarantee and manage the solvency risks inherent  in guaranteeing life time income.  

Mark Iwry and Phylis Borzi both have recently noted noted their commitment (and cooperation) to providing a sensible regulatory scheme for providing annuitization from defined contribution plans, which will rely upon transparency, simplicity, relevancy and portability. To make this really work, we will need legislative relief as well, in such things as providing a "double 415" limit in such plans in order to provide the same sort of tax benefit which is available for sponsors of DB plans.

Should the insurance industry be able to answer this call, we may be able to finally have a sensible approach to providing retirement income from employer sponsored retirement plans.

 

For further discussion on this matter, see this link. 

 

 

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.  

 

 

 

 

 

There are still a number of critical tax issues related to the 2007 403(b) regulations that need to be resolved.  For example, the IRS needs to clean up the horrible mess created by the ambiguities of Revenue Procedure 2007-71, and it needs to come to terms with the fact that mutual fund custodial accounts should be able to be distributed upon plan termination. For the most part, however, answers to the remaining tax  issues are  being wrought through a transition processs -albeit sometimes painfully.

What is really turning out to be the gravaman of the 403(b) marketplace, the one laden with the most liability for plan sponsors and the one with the most intractable problems are those related to the application of ERISA Title I.

For many years, a large number of 403(b) plans assumed that they fell well within the ERISA safe harbor,  which permits such plans to operate without regard to ERISA.  Others, because of the individual nature of the annuity selections, never considered that they were covered by Tile I, but would have realized that they have always been covered if they took a serious look.

The new regs have complicated the ERISA matters by forcing more accountability upon 403b plan sponsors, which has resulted in some serious catfights between employers and vendors about who has responsibility for what. This has ultimately resulted in a large number of even safe harbor plans finding themselves in the throes of Title 1.

Title 1 ‘s most obvious problem is the 5500, because, concurrent with the rest of this mess, is the new requirement that 403(b) plans are now subject to the full 5500 rules which have always covered 401(a) plans.

But the story does not end with 5500. Here are some thoughts (by no means exhaustive, by the way) of the true difficulty of what a non-ERISA plan has to go through when it bites the bullet and accepts  ERISA responsibilities:

-Corporate Action. Recognize, by formal corporate action, the “establishment of a plan” under ERISA Title 1.

–Vendor cooperation.  The vendor needs to transition its relationship with its vendors, and resolve compliance responsibilities

–Spousal consent/beneficiary designations. Perhaps the most significant issue, is working through and now applying these rules properly.

–ERISA-ify the Document and Summary Plan Description.

–Investment classes. Many investment classes under non-ERISA custodial accounts aren’t available under ERISA.

–ERISA Compliance Co-ordination.

–Establishing Plan Governance Structure including:

–ERISA Committee

-Claims and Appeals process.

–Investment Policy, geared toward the unique aspects of 403(b).

–Insurance.  ERISA bondng and fiduciary insurance.

–Audit and Annual Report.

-Participant Notifications, statements and disclosures.

Its going to be a difficult and time consuming process.

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.  

 

 

We have posted a number of blogs and otherwise written over the past year discussing the growing role of the SEC in the retirement plan market. See, especially, the article on the SEC’ sand DOL’s "Cross Agency Waltz." The ERISA sessions at the National Society of Compliance Professionals, at which I spoke, were particularly well attended.

The fact that the DOL and the SEC held their first ever joint hearings in June, reviewing target date funds, is further evidence of the SEC’s continued interest in a field which has been traditionally dominated by the Treasury and Department of Labor.

The SEC’s rules have always had particular applicability to the 403(b) marketplace. But the SEC also has leverage into the 401(k) market, a market which often pays scant attention to the agency. in addition to the SEC’s  authority to regulate registered investment products,  a participant’s interest in a 401(k) plan is still, legally, a "security" under its jurisdiction. 401(k) plan interests  may be exempted from the registration and filing requirements of the ’33 and ’34 Acts, but they ARE NOT exempted from those laws’ anti-fraud provisions. So, the agency has every right to investigate fraudulent activities related to the provision of 401(k) plans to plan participants. This is particularly why last year’s  Memorandum of Understanding between the SEC and the DOL-promising cooperation at the investigation and enforcement level- becomes so critically important to retirement plan consultants and practitioners. It will be interesting to see what level of SEC/DOL cooperation we see coming out of the DOL’s Consultant and Adviser Program, which is investigating abusive practices of pension advisers.

This is all reinforced by an October 22, 2009 speech to the AARP by Mary Schapiro (Chair of the SEC), reported in BNA Pension and Benefits Daily. Here is an excerpt from that speech which really puts the retirement plan community on notice:

 

"In my view, financial service firms should engage in responsible product development in the retirement market. Barraging investors with retirement products that feature the latest financial gimmick or marketable fad will not ultimately serve investors’ interests.

America’s future retirees deserve products that they can understand and evaluate. This means that complex fee arrangements or product descriptions should be discarded in favor of simple, clear disclosure.

Our future retirees should have access to products that will help them meet their retirement goals without imposing inappropriate risks. Products offering enhanced leverage and avant-garde investment techniques may be appealing to those investors that want to speculate. But they are not the type of investment products that belong in the retirement portfolio of the average American seeking to provide for security in retirement.

In addition, extolling the eye-popping results of the short-term performance of certain investment products, without focusing on the long-term implications or risks, can result in disappointed investors and potentially angry plaintiffs — not to mention an SEC prepared to be aggressive in enforcing the investor protection rules.

These types of disclosure, product development and marketing issues surrounding retirement products will be areas of focus in the coming year for those of us at the SEC. The burden imposed on those investing for retirement is significant, especially after the market events of last year and we must be committed to assisting those investing for retirement."

 

 

 If you didn’t believe it before, you probably really need to take notice now. The SEC is very interested in your world.

 

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

 

A couple of months ago, I began writing about the fiduciary concerns related to the purchase of annuities as distributions from  individual account DC plans. In that Part 1, I noted that there are five elements, so called "I’s", which need to be addressed by any plan annuity. In that blog I focused on  "irrevocably", the fiduciary risk of what I called the "30 year risk"-on how one gets comfortable with the inherent risk of an insurance company failing over an annuitant’s lifetime.

Inflexibility and Inaccessibility

 These two "I’s" are closely related, as they really point out the nature of annuity products which are purchased for annuitztion from DC plans: they are plan investments. Treating them otherwise risks turning the DC plan into a DB plan, the ultimate disaster for this kind of program. So the fiduciary focus should be on how to address these elements in choosing annuities as investments under the plan.

Lets talk about what the fiduciaries need to deal with, and about what I mean when I say say irrevocable and inflexible. Traditional annuities are inflexible. Period. You get the monthly benefit you pay for. They provide a very valuable benefit which should be part of anyone’s retirement planning, but this inflexibility can be scary, as it takes away from the participant the ability to address unexpected contingencies. This fear comes from the second point: the funds used to buy the traditional annuity are gone for good. Other than payments made under a survivor annuity, the traditional annuity doesn’t give the participant any access to funds to pay for contingencies, nor does it typically pay a death benefit. So what’s a fiduciary to do?

It’s a plan investment. Unlike a DB plan, Including the annuity in a DC plan is a fiduciary decision-not a settlor function. So plug something like this into the normal fiduciary process:

  1.  Decide whether you really want this sort of traditional annuity within the plan, and whether you want to limit the purchase to a portion of the participant’s account balance. Check with the annuity company. There are number companies that have a variety of features which address these issues: some have death benefits; some are "cashable," having some sort of surrender benefit; some have a guaranteed payment over time.
  2. Check for annuity purchase rates. Though "fees" are the typical focus of fiduciaries, that’s not not the proper inquiry for these sorts of annuities-it really is all about seeing how much benefit can be purchased for what price. Check commissions.
  3. Make sure the annuity is designed for a retirement plan: make sure there are unisex mortality; that it can do the proper Schedule A reporting; that there can be appropriate valuation; and if there’s a death benefit, the incidental benefit rules are met. Depending on the type of contract and features, there may be a couple of more things to check out.
  4. Decide whether to hold the annuity in the plan and pay the benefit out from the plan; or issue the annuity from the plan as a plan distributed annuity. If distributing, make sure the plan document permits in-kind distributions.
  5. Review the range of variable and living benefits that may be available, where, inflexibility and inaccessibility are not a problem.
  6. If allowing participants a choice of annuities, if an advisor is used, and any of products are registered products, make sure the advisor follows FINRA’s suitability rules.

Of course, check out the insurance company (see Part 1).

Next up: Invisibilty: the sale/advising side of annuities

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The Swagger

I had the privilege to speak on a 403(b) panel at the recent DOL/ASPPA "DOL Speaks" seminar,   with Lisa Alexander and Susan Reese of the DOL.  Our own panel went very well, with Susan and Lisa both speaking directly to and recognizing the transition problems related to this new 403(b) world. As Lisa repeatedly pointed out, many of the rules causing the challenges have always been there, but not given much attention by 403(b) employers or their advisors. The audience showed some frustration, but that arises from there not being answers to a lot of the tough questions we now face.  But our take away is that the DOL is spending time and smart effort in recognizing the difficult issues now being raised, and is considering ways to approach them.  You will from time to time see in this blog me disagreeing with their chosen approach, but it will never be a criticism of the seriousness of their choices nor of the professional manner in which they are being handled.

This conference was my first serious view of the direction of the EBSA under Phylis Borzi, and it is already showing some swagger under her leadership. My first clue came from the EBSA’s staff’s position with regard to the material being presented. We are all very used to the typical government staff comment during most such seminars that any comments of staff in their presentations reflect their own personal opinions, not that of their employing agency.

Well, at this seminar, the DOL took accountability. None of their speakers issued this disclaimer. My own presentation material was reviewed with the view that in a seminar labeled "DOL Speaks", it couldn’t very well disclaim what its staff members were saying. So the staff statements took on an import we have little seen at other such conferences. This was a rare act of bureaucratic courage.

Phylis’s comments about the EBSA’s priorities sounded a more hardened approach to enforcing the public policy underlying ERISA.  It reminded me some of my favorite line from one of the all time great movies, "Mr. Smith Goes to Washington". A "little bit more of looking out for the other guy" is what I recall Jimmy Stewart saying.  Plan participants have always had this kind of advocate in the EBSA, but those efforts look to clearly become more focused.

Annuities to be addressed

At long last, both the DOL and the IRS will be taking a look at the technical rules related to the offering of annuities in 40(k) plans. The DOL announced that they will be soon be publishing an RFI on annuity issues, while the IRS  announced that they will be considering auto-annuitization. This will be both challenging and fun, particularly as it comes to making annuities sensibly transparent, able to be effectively compared, and in designing programs that make sense for those with modest accumulations. 

And for those of you still looking for Part 2 of my fiduciary analysis of annuities, its on the boards and will be out shortly.