The DOL released to Field Assistance Bulletin 2009-2 on July 20th, which provides much needed Title 1 reporting relief for 403(b) plans. 

So, first of all, our hats off to Ass’t Sec’y Borzi, for what looks to be one of her first public acts, and to the Good Bob Doyle, for showing true leadership in assisting a critical sector of our society which has been unduly burdened at a time their scarce resources are most needed elsewhere.   

Here’s what the relief does:

 The 2009 Plan Year for 403(b) Plans has been recognized as a "Transitional Year."  This means that if an annuity contract or custodial account  to EITHER a former employee or current employee:

  1. was issued before January 1, 2009;
  2. had all contributions, or rights to contributions,  to it cease prior to 1/1/09;
  3. has all of the rights enforceable against the insurer without involvement by the employer; and
  4. holds only fully vested amounts,

assets in that contract will be excludible from the 2009 Form 5500 and 5500-SF.  Even better, those former employees owning those contracts will not need to be counted as participants toward that 100 participant threshold for large plans. (As an aside, there is a technical question about current employees: though they may be excludable by virtue of a pre-2009 contract, they may then be includable because of operation of the universal coverage rule, even if not owning a post 2008 contract).

Pretty incredible. Simple, clear and adminsterable.  Just for kicks, you may want to try to re-read Rev. Proc. 2007-71 again, just to appreciate how valuable the DOL’s guidance really is.

It is not Nirvana by any stretch of the imagination. First of all it is all only transitional, but granted when it is needed the most and in a very timely fashion. We now have time to discuss the nature of permanent relief. Secondly, it is only for reporting purposes, not other Title 1 purposes such as spousal consent and others.

Next, though is a practical problem.  The third requirement mandates that all rights are enforceable without involvement of the employer. In the current environment, with vendors demanding employers’ approval of all distributions from all contracts- even of those deselected vendors with no contributions after 12/31/2008 which employers have otherwise excluded from their plans- employer approval may make those contracts ineligible for exclusion from the 5500 and participant counts.

This is a bit sad, as often employers will sign these vendor imposed forms as a matter of convenience just as a way to help employees who need the money- lending truth to the axiom that no good deed will go unpunished.

Who knows. Perhaps Andy Zuckerman’s fine staff (and they truly are a good bunch) is penning tax relief right now which would mirror that granted by the DOL……

I have updated this with a further blog with the following:

 

 The DOL’s release of FAB 2009-2 may well more significant than I took at first glance. Soon after blogging on the release of the FAB and how it sets us up to develop a more permanent solution, Ellie Lowder and my colleagues Evan and Monica let me know of a different view: they believe that the relief only make sense if it applies to all years-as the data collection requirements in future years for those old contracts will only get worse, not better. The NTSAA has taken this position in a notice to their members.

The FAB itself is silent on the specifics of its application to future years, and it is clear that the DOL was focusing on the immediate problems posed by the 2009 Form 5500. But I’m now convinced after to talking to a number of colleagues that there is little reason to believe that this same reasoning will not apply to future years.  Should this position hold sway, and I believe it will, this is a pretty incredible move on the part of the DOL . It  addresses the most troubling of the new generation of 403(b) Title 1 issues.

The DOL’s Lisa Alexander and I will be talking about those other pressing 403(b) Title 1 issues at ASPPA’s  "DOL Speaks" in Washington on September 14 and 15. Come join us!

 

 

 Annuity companies have been innovative in addressing marketplace concerns in the sale of guaranteed income annuities to individuals outside of 401(k) and 403(b) plans. The recession has spurred even more interest in these products, with insurers  telling us they are seeing an increased interest in both annuitization and in other  guaranteed insurance products. A number of these annuity products for the "non-pension" markets are beginning to show up in some defined contribution plans, though awkwardly so. Those product  designs don’t typically fit well with ERISA’s rules, and are often administered on computer platforms which don’t support ERISA compliance.

The nut that is proving the hardest to crack is finding a way make these products available to 401(k) participants in a simple, compliant and seamless way, either as a form of distribution or as a way for participants to otherwise protect their investments within the plan-and many vendors have designed products attempting to meet these criteria.

Plan Sponsor co-hosted a webinar a few weeks ago with MetLife, in which the use of annuities as distributions from defined contributions were discussed. Kent Mason, an old friend and a fine lawyer with Davis and Harman, commented that he believed that one of the key reasons annuities and other longevity products were not being used by DC plans is because of the way the RMD rules apply to them. Though I hold Kent’s opinions in the highest regard, I have to disagree with him on this point. I think instead the fiduciaries’ concerns lie with the fear of locking up funds for a lifetime with a single company. I would go with the view of another longtime friend, Dan Herr of Lincoln Financial Group.  Dan’s experience tells him that the key obstacle to the purchase of annuities for individuals  is something he calls the "4 I’s": Irrevocability, Inflexibility, Inaccessibility and Invisibility. 

In applying Dan’s theory to the 401(k) marketplace, it seems to me that addressing those "4 I’s" would also serve to address the concerns of fiduciaries, to which I would add a fifth "I": Immobility (or, to be more precise, portability).

Lets take a look at each one of those "I’s" separately, from a fiduciary’s view. In this Part 1, I’ll discuss Irrevocability. The other "I’s" will be covered in blogs soon to come.

 Irrevocability

The traditional annuity, one in which a set price is paid for a set amount of lifetime income, is typically irrevocable. I call this "your grandpa’s annuity."  Once a participant commits a substantial payment to the insurance company, it is gone for good.  This gives both fiduciaries and participants a great deal of heart burn. It locks a participant up for a lifetime, raising some very difficult fiduciary concerns about the predictability of an insurers’ solvency. It is not a new concern, as  Individuals live with that same fear when they buy any life or annuity product-a concern about what I call the "30 year risk" (my apologies to the actuaries). 

It sees to me that the first element in an adequate fiduciary review is to get at least a layman’s  grasp on the nature of insurance and insurance regulation. Pooling risks with others is an uncomfortable concept that is foreign to a fiduciary with a defined contribution mindset. The pooling of risk and the undertaking of this "30 year risk" are critical societal functions, but they pose significant risks to a state’s citizens whose policyholders are unable to address individually. Because of this, states have uniformly stepped in to protect their citizenry by regulating insurance in ways of no other industry:

  1. Reserves are required for the risks taken (one of the big AIG failures was that large levels of risk were taken on without any reserving by a non-insurance subsidiary which was not governed by an insurance regulatory authority);
  2. The manner in which the reserves are  invested are heavily regulated for investment risk and type;
  3. Insurance companies are regularly and comprehensively examined by state insurance authorities and must do substantial regular reporting on their assets and the nature of them.
  4. Insurance companies are required to participate in their state guarantee associations to protect the policyholders of all companies within the state. (See the NOLHGA site for further information). This is an imperfect system, and insurance companies are severally restricted by law from discussing this guarantee with their policyholders. The best solution for the future is the proposal for a sort of FDIC program for plan annuities, as described by the David John,  Bill Gale of the Retirement Security Project and Mark Iwry, Ass’t Treasury Sec’y.
  5. Review of marketing material of all insurance products is required.

I would think that an adequate fiduciary review would have the fiduciaries acknowledging that the task they undertake is different from the mere investment of account balances; the standard against which they will be judged has necessarily a stronger insolvency risk; and that they have addressed that risk adequately-in part-by understanding and relying upon the state’s regulatory role in managing the risk.

Fiduciaries can then further manage the risks by looking closely to the terms of the annuities being purchased. They can look for products that offer terms which address their concerns. For example, they can look  well-priced "outs" in the form of cash surrender options;  for products which are funded in part with separate accounts which are protected from the insurer’s creditors; or for funds and guarantees which are partially re-insured by an unrelated insurance company-thus spreading the risk.

This should then be balanced and integrated into looking at how the other 4 "I’s" are addressed- a topic of soon to be published blogs.

NOTE: I have moved offices (though still with Evan and Monica), moving back downtown (yes, Fort Wayne has a very nice downtown!).  I needed to change telephone numbers in the process.

My new contact information is:

Bob Toth
110 W. Berry 
Ste. 1809
Fort Wayne, IN 46802
Office: (260) 387-6827
Cell: (260) 312-3204
rtoth@gillercalhoun.com 

 

 

 

 

 

 

Some of the dust is settling, in an odd sort of way, on the IRS issues related to 403(b) plans. For sure, there are many unresolved and contentious issues that remain open or poorly addressed (such as terminations and dealing with historical contracts) which will continue to to cause vendors, employers and employees all shared amounts of anguish.  There is enough of a framework in place however, to now get down to the nitty gritty of running 403(b) plans.

So what are we finding as we get down to this nitty gritty of things? Most striking is the unique ways in which ERISA’s fiduciary rules will need to be used in their application to ERISA 403(b) plans.  It is not that the rules were never there in the past, it is just that the new rules have forced the industry and employers to more closely define their relationships and the duties for which vendors and employers will each be responsible. This process of defining roles has caused us all to look more closely at how the rules apply, in ways we have never done in the past.

All 403(b) practitioners are painfully aware of the controversies surrounding the threshold question of whether any particular plan is governed by ERISA Title 1. Once you get past that point and attempt to, for example, draft a proper investment policy, you will see that we will not be able to apply many of the ERISA rules in the same manner in which we are used to applying them in the 401(k) context. This is particularly true where individual annuity contracts or individual custodial contracts are involved. We are all likely to find some challenging surprises as we work through the details.

Let me give you an example. Individually owned variable annuity contracts are a "staple" in the 403(b) industry. They continue to be regularly offered in 403(b) plans, even with the advent of "401(k)-like" group custodial arrangements.  These variable annuity contracts offer investment accounts, called "separate accounts" or sub accounts which are treated by security laws as a type of mutual fund.  Annuity contracts (for technical tax reasons) cannot offer publicly available mutual funds in their separate accounts, so these funds are often designed as "clones" to those publicly available mutual funds offered to 401(k) plans.

These separate accounts often offer large numbers of different investment sub-accounts managed by a wide variety of managers with varying styles.  The management of these investment accounts are all monitored and benchmarked by the annuity companies.  Occasionally, the annuity company will find it necessary to completely replace a fund (a "fund substitution") because of either performance or investment style considerations.

The fund substitution process is a lengthy one,  governed by the Investment Company Act of 1940, requiring notice and proxies going to the individual participant in a 403(b) plan-not, typically, the plan sponsor.

What are the ERISA implications of a fund substitution under individual annuities for the 403(b) plan fiduciary? It is clear that the choice of an annuity carrier for an ERISA 403(b) plan is a fiduciary act, which also carries with it the ongoing obligation to periodically review the appropriateness of that choice.  In a 401(k) plan, changing the investment fund made available to the participant is a fiduciary choice. Likewise, some duty will also apply to changing the investment choice by way of a substitution of an investment fund in an ERISA  403(b) annuity. 

So the question becomes what is the fiduciary obligation of a 403(b) plan sponsor who has no right to vote on such a substitution, or otherwise have any authority with regard to the contract? I think its pretty clear that the plan fiduciary has an obligation to review the fund substitution, and make an independent determination as to whether the new fund is  appropriate for its plan. The review is going to be quite different than the typical 401(k) review as the fiduciary really will have no control over whether or not the substitution will occur.

If the fund substitution is appropriate, the fiduciary need to take no further action other than to document its review. If the substitution is not appropriate, some very real fiduciary issues arise.  It seems that the fiduciary would need to approach the carrier and ask that their employees be blocked from being able to make new deposits to the inappropriate fund. If the annuity company does not have that ability, there may be a fiduciary obligation to cease making contributions to that entire contract. With regard to the existing funds which will be substituted, where the fiduciary has no authority over the contract, little can be done. But it seems that the fiduciary is unlikely to be found in breach where it has no authority, but may have some sort of duty to inform participants of its finding.  

This problem is by no means limited to annuity contracts. If an ERISA 403(b) plan funded with individual custodial accounts permits the participant to invest in any of that mutual fund family’s funds, the availability of all of those funds would be subject to fiduciary review, as well as any material changes made to the management of any of those funds.

This is all so different than the process to which we have become accustomed in the 401(a) world. What does all this mean? It means that 403(b) plan sponsors of plans funded with individual contracts  will need to pay close attention to matters to which they have likely paid little attention in the past, and monitor changes in their annuity contract and custodial account offerings over which they have little control.

In a broader context,  it really seems to me that a whole new line of ERISA will develop, much as it had to when 401(k) plans became popular, and how it will need to further develop as annuitization grows. The circumstances of 403(b) administration will demand unique approaches to the law.

 

 

 

 

One of the natural byproducts of doing a lot of 403(b) work is a necessary familiarity with many of the security law rules which apply to retirement  plans. This familiarity is recently becoming handy on the 401(a) side of our business as well, with the SEC showing an increasing interest in all retirement plans. The DOL, FINRA and the SEC have a growing "commonality of interests" in things like disclosure and advice.

It is striking, though, how separate the securities compliance world is from the ERISA compliance world-though it is a "separation" which will eventually die a natural death. Security practitioners and ERISA practitioners will be getting to know each other well, and probably sooner than later.

So this is my contribution to that effort. The link below brings you an article which describes ERISA compliance for the security law compliance officer. To many of you, this will be very basic, and pretty boring stuff. The securities folks, however, have expressed amazement of some of the basic things I have written about, things which we take for granted.

My article is entitled "SEC’s and DOL’s Cross Agency Waltz: The ERISA Connection to Disclosure, Advice, Compensation and Conflict of Interest ", in the May-June 2009 Issue of the Practical Compliance & Risk Management For the Securities Industry."  It really is impressive how closely correlated these rules of the various "compliance" industries really are.

POST NOTE:

I’ve been told by a number of readers that the above link is not working well, coming up "garbage." If so, try this link for another PDF version , or write me at rtoth@gillercalhoun.com and I’ll get you a copy.

Our blog of May 26 on "Distributed Custodial Accounts" generated a number of comments, which require a bit of a "follow-on."  Ellie Lowder, one of the grand dames  of the 403(b) world, agreed with my assessment.  She mentioned  that she had discussions with the IRS on this point. Staff  just couldn’t see how distributions of custodial accounts from a terminated 403(b) plan could work under Section 72 (dealing with the taxability of distributions from plans and annuities). The IRS mentioned that Section 72 is clear on the distribution of annuities, but there is nothing about the distribution of custodial accounts.

Though I can empathize with the IRS’s concerns, it actually points out the difficulty with the path it has chosen to foster greater 403(b) compliance: for over 50 years, these arrangements have been treated as individual pensions. Trying  to force them into an employer plan scheme gives rise to these kinds of  difficulties.

For the past 20 years,  custodial accounts have existed outside of a plan, with Section 72 being applied well-and being administered properly under the Code, to boot. There are a few examples  which are telling:

  • Example 1:  A tax-exempt employer goes out of business in 1998, after having  sponsored an ERISA 403(b) plan funded with individual custodial accounts from a single mutual fund complex.  The plan would have terminated (for ERISA purposes) upon the employer going out of business and ceasing contributions. A former employee, age 71,  begins withdrawing his RMDs.  There is no employer to approve the distributions, or to certify to the participants age, and the investment company relies upon the employee representations.  The employee has to take distributions, or suffer penalties. What happens? The mutual fund begins the payments, and continues even today, should he still be living. The custodial account exists without a plan, and is effectively distributed. Though the plan termination was not a distributable event, the severance from employment was. But the tax effect is the same.
  • Example 2:  A similarly situated employer employer goes out of business in 2010. Now what? Will the investment company ever approve payments out, bcause there is no employer? Does the IRS now view the custodial accounts of the plan participants as being immediately taxable because it is no longer associated with an employer? And why should the tax treatment be any different between the 1998 bankrupt employer and the 2010 bankrupt employer? Will the participant be penalized by a 50% tax on the failure to take an RMD when he was required to, but there was no way to do it?
  • Example 3:  The plan of the employer in Example 2 was funded solely by annuity contracts of a single vendor. Two months prior to going out of business, the employer terminates its plan and distributes the annuity contracts.  We know the IRS permits this, so the contract maintains its 403(b) status. But we don’t know what rules apply to the contract when an employer no longer exists. Will the annuity company permit the RMDs without employer approval? When the IRS eventually promulgates rules on how such contracts such be administered, is there any legal reason those rules should not apply to the custodial account in Example 2?

This really all points out to the unworkability of the IRS’s position. The impact of forcing individual pensions into an employer mode is tough enough without having to make it more difficult on vendors, employers and employees than need be. 

 

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.

 

ERISA really did create some fundamental changes that has broad personal affect. This reposting of a blog I wrote last year provides a good Mother’s Day reminder of the importance of the work we do:

 

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

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

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

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

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

Mom, by the way, is still alive and doing well.

  

 

 Mark Iwry, one of the principals of of the Retirement Security Project, has been appointed as  Senior Advisor to Treasury Secretary Geithner and Deputy Assistant Secretary for Retirement and Health Policy.

First and foremost, our heartfelt congratulations to Mark. This is a post well suited to him, and an appointment which will serve the nation’s retirement needs well.

Mark’s policy pedigree will be known to many readers of this blog: he was one of the early advocates behind the Automatic Enrollment rules under the PPA; he was instrumental (with David John) in the development of the Administration’s retirement policy of mandatory employer based IRAs; and has done much work with the RSP (through writings and many presentations) on the value of annuities and lifetime guarantees in defined contribution plans.  We have mentioned his work a few times in our blog.

We have no crystal ball or any inside information, but the presence of a senior administration official who passionately believes in protecting workers’ retirement income, and who sees annuities as one of the critical tools in that effort, is likely to manifest itself in the policies developed by this administration.

This appointment clearly gives a boost to an imorrtant financial tool. The challenge is for vendors  to develop a series of appropiate products and policymakers appropriate rules that address the concerns that advisors continue to raise, most particularly the transparency of an annuity’s financials and addressing the fear of insurance company meltdowns.

 

The mantra of Congress, investment advisors and the DOL over the past decade has been consistent: retirement plan assets must be invested in such a way to provide American workers with sufficient assets upon which to actually retire comfortably. This is as basic as apple pie, and a concept with which one can hardly disagree. It has even been the driving force behind regulatory efforts like the QDIA regs, where stable value or insurance investment options were openly scorned as appropriate default investment options.

As laudable as these efforts have been in the past, and as sound as they still may be, encouraging investment gain for the purpose of providing adequate retirement gain is NOT and has NEVER been the standard by which fiduciaries are judged.

ERISA Section 404(a)(1)(b) is written pretty clearly:

…a fiduciary shall discharge his duties…. by diversifying the investments of the plan so as to minimize the risk of large losses, unless under the circumstances it is clearly imprudent to do so."

There is no talk of maximizing gain. There is no language about providing any particular level of income. There is nothing about testing to see what level of return is needed to maintain a lifestyle. There is no discussion of age based target funds. It is truly based upon the concept of preserving the assets of the trust. 

It is important to re-find this lost concept, particularly as fiduciaries review their investment policies to test whether they are adequate under the current market conditions. This is not an argument against the use of equities, merely that the manner in which one fulfills the duty to minimize large loss necessarily includes investments designed to preserve capital.