Publication: Journal of Pension Benefits
Date/Volume/Issue: Summer 2018/Volume 25/Number 4
Is the Swan Going to Live?
Ilene H. Ferenczy, Esq.
Will Congress pass the Retirement Enhancement and Savings Act (RESA), introduced by retiring Senator Orrin Hatch, which would be a boon to plan sponsors and participants alike?
Throughout the past several years, Senator Orrin Hatch (R-Utah) has led a charge to make certain modifications to the law relating to qualified retirement plans. This has endeared this man, who is on the opposite political spectrum, to the author in a manner that is quite unexpected. Senator Hatch recently announced that he is leaving the Senate when his term expires this year. And, he again introduced a 2018 version of the Retirement Enhancement and Savings Act (RESA) for consideration by Congress. Will this last chance to get this bill passed be the Senator’s wonderful swan song and offer retirement plan sponsors the relief they so richly deserve? Or, will it die on the vine, as have its predecessors?
One Big Reason RESA Rocks: MEPs
First and foremost, RESA contains provisions to untangle the ridiculous web of difficulties that surround retirement plans that are multiple employer plans (MEPs). Both the Labor sections of ERISA and the Tax Code provisions stumble around multiple employer plans in a particularly inept way and for very little reason. RESA provisions address those concerns. For those who have not been part of the MEP dance, here is where we currently stand:
- The Department of Labor (DOL) considers most MEPs to be … not MEPs. In particular, unless the plan sponsor can show that it fits within a labyrinthine set of requirements (including a relationship between adopting employers that is almost Shakespearean in complexity), the DOL treats the structure as if each adopting employer sponsored its own plan. This means that each employer must separately file a Form 5500 for its part of the plan and that the DOL’s audit requirement (i.e., that a plan with 100 or more participants must obtain an independent certified public accountant (CPA) audit) is applied based on each employer separately. The net result: more Forms 5500 and less CPA audit oversight. (Someone needs to explain the value of these rules, which appear to most practitioners to be a lot of additional effort with very little payoff in terms of retirement security or other benefit.)
- The Internal Revenue Service (IRS) considers MEPs to be one plan, notwithstanding the DOL’s viewpoint. Nonetheless, certain provisions of the Tax Code are applied on an aggregated basis for the plan, and some are applied on an employer-by-employer basis. Strange as this may sound, this structure works wonderfully, because the employers do not have to worry about how the other adopters of the plan are meeting nondiscrimination or coverage rules. The rub, however, is that the IRS believes that a failure of a plan to meet the qualification rules—which are requirements that must be met for the employer and the employees to benefit from the tax deferral that retirement plans offer—affects the accounts of all participants in the plan. As a result, a participant of Employer A located in Maine can lose his or her tax benefits in a MEP if there is a failure to comply with the rules by Employer Z in Hawaii. This result, commonly referred to as the “One Bad Apple Rule” (as in “one bad apple spoils the whole bunch”), can be resolved, but the manner of such resolution is not well outlined in IRS guidance and is expensive.
- Congress, the DOL, the IRS, and the public are all concerned about the accountability of sponsors and administrators of MEPs. In 2012, soon before the DOL issued its ruling denying MEP status to many MEPs, there was a major defalcation by a MEP sponsor. This fellow allegedly used plan funds to remodel his house and was intending to purchase a ski resort in his home state of Idaho. He is currently an involuntary guest of federal housing, but the fear of such a result remains in the industry, calling out for legal reassurances.
RESA attempts to resolve all three of these issues. First, it essentially tells the DOL to sit down and shut up about MEPs that are not MEPs, ensuring that multiple employer plans meeting much more reasonable and clear requirements will be treated as such for DOL purposes. RESA defines a new type of MEP, called a Pooled Employer Plan or PEP, which complies with additional requirements directed at identifying responsible fiduciaries (called Pooled Plan Providers or PPPs) who affirmatively take on the laboring oar for ensuring that the plan meets qualification rules. The PPPs must register with the IRS, so that the government, adopting employers, and participants all know “where the buck stops” in relation to the plan.
Second, RESA provides a means by which a PEP may toss a nonconforming part of the plan and its employer out on their respective ears, providing ongoing protection for the assets of participants in the “bruised” part of the plan apple, while also protecting the balance of the PEP employers and participants. The preferred way for a plan to protect itself from a noncompliant adopting employer is to spin off the part of the plan for that employer’s employees to a separate plan, leaving the rest of the PEP unscathed. Under the One Bad Apple Rule, this would not purge the problem, which must be corrected by the MEP to protect the MEP’s tax-qualified status. Under RESA, the proper steps for this process are outlined, and the PEP is protected.
One of the biggest concerns of the DOL, as well as the public, is ensuring the safety of plan benefits in a MEP, particularly considering the 2012 debacle discussed above. By constructing the PEP concept and requiring that there be a PPP with fiduciary responsibility, RESA ensures that someone is responsible for the plan’s security. In addition, RESA confirms that the adopting employer retains responsibility for overseeing the PPP to ensure that it is doing what the law requires. This section ensures that neither employers nor PEP promoters will have any misconceptions (or misrepresentations) that this structure completely eliminates any employer responsibility or liability.
Finally, filing requirements for the MEP will enhance the ability of the regulators and the participants to hold bad actors financially responsible for losses their actions cause.
Not everyone is convinced that PEPs are the answers to the myriad retirement plan issues that they claim to solve, but RESA would go a long way to assuaging at least some of those concerns.
RESA would allocate significant responsibility to the Department of the Treasury to provide regulations that give PPPs and adopting employers a structure for taking advantage of these rules, including model plan language. Therefore, the PEP rules would not go into effect until 2022. Perhaps not coincidentally, this delay will also provide MEP sponsors and other service providers with time to modify their business models and to permit retirement plan sponsors to properly assess whether PEPs are for them.
Enhancing Automatic Enrollment
Many in Congress, in the retirement plan industry, and in the economic press have embraced automatic enrollment of participants in 401(k) plans as a solution to the low savings rate in the United States. Under automatic enrollment, rather than requiring a participant to affirmatively elect to make salary deferral contributions to the plan, the “default” is for a participant to defer compensation into the plan at an assumed rate. A participant must take action to change that rate, including to reduce the deferrals to zero. Because most people fail to act unless highly motivated to do so, the result is that more participants save in an automatic enrollment situation than when left to their own devices … which leads to better retirement savings. Another automatic feature of some plans is an “automatic increase,” under which the default rate of savings increases over time, so that the participant saves more of his or her salary each year.
Under current rules, particularly for automatic enrollment 401(k) plans that are deemed to be nondiscriminatory (i.e., qualified automatic contribution arrangements or QACAs), the rate of automatic enrollment cannot exceed 10 percent. Although this might seem like a high rate of savings for many employees, statistics show that this level—or even a higher rate—is needed for most employees to have a comfortable retirement. As a result, RESA would remove that 10 percent cap, permitting the ratcheting of deferral rates upward until the participant cries “uncle.” The hope is that, at that point, the participant will have caught onto the benefits of saving and will continue at the rate of deferral with which he or she is comfortable, rather than reverting to zero. And, the hope is that such rate will be higher than the insufficient 3 or 4 percent that is so common in 401(k) plans nowadays.
Other Retirement Security Efforts
RESA would encourage participants to save and plan for a more secure retirement. First, RESA would outlaw the practice of plans permitting participants to borrow out their accounts via a credit card. Under this type of structure, the participant agrees up front to the terms of loans against his or her account. Thereafter, when the participant needs to borrow money for a purchase, the participant activates the loan using a credit card. The funds are taken from the participant’s account, and the participant repays the borrowed funds each month, usually through payroll deduction, based on the plan’s repayment terms. This easing of procedures for participant loans is thought to encourage use of funds intended for retirement for other purposes, which commonly leads to loan defaults (particularly if a participant terminates employment with the company that sponsors the plan). When a loan defaults, the loan balance becomes taxable income, and the funds will, by definition, not be in the plan when retirement comes. As a result, this practice is commonly considered to be detrimental to retirement savings.
RESA also contains a provision under which plans would be required to estimate on participant statements the amount of retirement income that would be purchased by the participant’s account balance. This requirement recognizes that the vast majority of plan participants have no idea how much money they need to save to have a comfortable retirement, nor how to discern that information. Although these estimates would be exactly that—that is, guesses about retirement income, rather than guarantees—they would at least give participants some sense of what their accounts will buy in retirement security. Furthermore, the law would require that these reports use certain interest and mortality assumptions, with protection for the employer from liability if the participant’s account fails to achieve the estimated value at retirement.
Finally, in an attempt to encourage participants to use their retirement plan to provide periodic income rather than a fat lump sum, RESA contains provisions to inspire plans to offer—and participants to elect—annuitization at retirement.
Practitioners and plan sponsors have cried out for compliance simplification for almost as long as ERISA has been around. Although RESA does not provide simplification to the degree found in earlier versions of the bill, it does contain two important provisions that would be welcomed by many. First, RESA would change the rules so that a sponsor of a safe harbor 401(k) plan with a 3 percent “profit sharing”-type contribution (rather than a matching contribution) would not have to provide annual notice of the plan to its participants. This recognizes that a participant’s deferral rate is normally not affected by the amount the employer contributes, unless that contribution is tied to how much the participant defers. Participants already receive a summary plan description that lets them know that they are eligible to participate and that the employer will contribute to the plan on their behalf, so this annual notice is unnecessary additional paperwork.
The second proposed compliance change recognizes how common it is for employers—particularly small companies—to need to understand how successful their company was for a given year to know if a retirement plan is in the cards. Rather than the current requirement that a plan be adopted before the plan sponsor’s year end, RESA would permit the adoption of a plan up to the date on which the sponsor’s tax return is due (including extensions). This gives employers time to assess the financial realities of the prior year before they adopt a plan and mirrors the requirements for IRA establishment. This change truly has no downside but can encourage the formation of plans applicable to an earlier year than is otherwise the case.
RESA does not fully encompass all of our wishes for retirement plan simplification or improvement, but it is a good start. It is not the only game in town—for example, Congressman Richard Neal (D-Mass.) has also repeatedly offered up legislation to modify retirement plan rules for the better. Nonetheless, the passage by Congress of this bill would be a great help to retirement plan formation and a lovely send-off for a hardworking Senator in his last year in office.