September 10, 2015
- PBGC Issues Final Regulations on ‘Reportable Events’
- IRS Finalizes Rules for Minimum Required Pension Contributions
- House Subcommittees Scrutinize DOL Fiduciary Definition Rule
- GAO Report Examines Default 401(k) Investments
PBGC Issues Final Regulations on ‘Reportable Events’
Final rules addressing defined benefit plan reportable events under ERISA Section 4043 — events that indicate potential problems and may signal the possible future underfunded termination of a pension plan — were released by the Pension Benefit Guaranty Corporation (PBGC) on September 10. Such reportable events, under certain circumstances could justify closer scrutiny of the plan by the PBGC. An official fact sheet is also available.
The changes made by the final rule are applicable to post-event reports for reportable events occurring on or after January 1, 2016, and to advance reports due on or after that date.
The PBGC initially proposed rules in November 2009, then re-proposed the rules in April 2013 to reflect changes resulting from the Pension Protection Act of 2006 (PPA). The Council filed written comments in response to the latter proposal, expressing serious concern with the agency’s intention to use “financial soundness” of a plan sponsor as a factor in its exercise of enforcement and interpretive authority.
The core of the final rule is a change to the previous waiver structure for reportable events, which primarily focused on the funded status of a plan. The final rule includes a reporting exception based on plan funding that is based on the payment of variable rate premiums and is therefore more lenient than the 2013 proposal. However, like the proposed regulations, the final rule continues to focus closely on the risk of default based on the company’s financial status. The “financial soundness” safe harbor was also renamed the “low-default-risk safe harbor,” which the PBGC emphasized is voluntary and was never meant to measure the overall financial prospects of a company.
The Council, in its earlier comments, objected to the PBGC’s wholesale elimination of reportable event waivers and extensions. The final rule does provide public company waivers for five specific events: active participant reductions, substantial owner distributions, controlled group changes, extraordinary dividends, and benefit liabilities transfers.
In its 2013 letter, the Council also expressed concern about institution of a financial soundness test (now the “low-default-risk safe harbor”), which exposed plan sponsors to aggressive enforcement under ERISA Section 4062(e) prior to recent legislative changes. This approach was modified in the final rule, but it nevertheless extends the requirements for the risk-based safe harbor to both the immediate plan sponsor and the highest level U.S. parent of the contributing sponsor. We remain concerned that PBGC’s use of financial soundness as a trigger for additional burdens makes it more difficult for plan sponsors to recover and thus increases the likelihood of liabilities being turned over to the PBGC.
The Council is continuing to analyze the final rule and will provide additional details as necessary. For more information, contact Jan Jacobson, senior counsel, retirement policy, or Lynn Dudley, senior vice president, retirement and international benefits policy, at (202) 289-6700.
IRS Finalizes Rules for Minimum Required Pension Contributions
The U.S. Treasury Department and Internal Revenue Service (IRS) have released final regulations providing guidance on the determination of minimum required contributions for purposes of the funding rules that apply to single-employer defined benefit plans. The final regulations also address application of the excise tax for failure to satisfy the minimum funding requirements. The new rules apply to plan years beginning on or after January 1, 2016.
These rules, initially proposed in April 2008, stemming from enactment of the Pension Protection Act of 2006 (PPA), explain how to calculate minimum required pension contributions based on whether the value of plan assets – especially those reduced by certain funding credit balances – exceeds the plan's funding target for the plan year. Very generally, funding credit balances are employer contributions for previous years in excess of the minimum required contributions (unless they were made to avoid restrictions). The plan’s funding target for the year is an amount of funding calculated using various rules required under the PPA and subsequent legislation.
Since 2008, there have been a series of legislative changes to the funding rules. Treasury and the IRS have done a tremendous amount of work in issuing prompt guidance with respect to those legislative changes. Today’s regulations address some leftover issues that needed attention after those more pressing issues had been taken care of.
In the Council’s written comments to Treasury and IRS following the issuance of the proposed regulations, we identified a number of long-term issues of concern to plan sponsors, including the use of funding balances to make quarterly contributions. The Council is very pleased that the final regulations adopt our recommendation to permit standing elections to apply funding balances to quarterly contribution obligations (some plans are required to make quarterly contributions based on their funded status). Unfortunately, the final regulations did not follow our recommendation regarding the mechanics of such standing elections, so that the standing election must use the quarterly contribution safe harbor based on the contributions required for the prior year until the current year obligation is determined.
We were also very pleased that the regulations addressed a significant problem under the proposed regulations that had a punitive effect on plans that had outstanding liquidity shortfalls. The regulations generally followed the recommendations of the Council’s April 2014 comment letter. A liquidity shortfall results in additional required quarterly contributions generally calculated based on the amount of distributions made in a 12-month period.
As noted, since the issuance of the proposed rules, Congress has enacted a number of measures further modifying the funding rules, including the Moving Ahead for Progress in the 21st Century Act of 2012 (MAP-21) and the Highway and Transportation Funding Act of 2014 (HATFA), both of which further extended temporary revisions to the calculation of interest rates used in determining minimum funding requirements. The final regulations have been modified to reflect this interim legislation.
Specifically, the final regulations address:
- Determination of minimum required contributions including elections with respect to a plan’s prefunding balance and funding standard carryover balance
- Interest rate calculations
- Payment of minimum required contributions including requirements for quarterly contributions and liquidity shortfalls
- Taxes on failure to meet minimum funding standards
Section 4971 of the tax code imposes an excise tax on the employer for a failure to meet applicable minimum funding requirements. The rules for application of this excise tax on both single-employer and multiemployer plans are spelled out in Part 54 of the final regulations, including detailed examples. These excise tax rules generally apply to taxable years beginning on or after January 1, 2008.
For more information, or to provide feedback on additional regulatory concerns, contact Jan Jacobson, senior counsel, retirement policy, or Lynn Dudley, senior vice president, retirement and international benefits policy, at (202) 289-6700.
House Subcommittees Scrutinize DOL Fiduciary Definition Rule
In a joint subcommittee hearing on September 10, Republican and Democratic lawmakers both expressed concerns about the U.S. Department of Labor’s (DOL) proposed “conflict of interest” rule re-defining who is a retirement plan fiduciary.
The U.S. House of Representatives subcommittees on Oversight and Investigations and Capital Markets and Government Sponsored Enterprises collaborated on the hearing Preserving Retirement Security and Investment Choices for All Americans to examine issues surrounding the controversial rule; a previous iteration of the rule was withdrawn in 2009 in light of congressional opposition.
The Council filed a comment letter on July 21, articulating our concerns with the rule’s possible effects on retirement plan administration, and testified before DOL on August 13. Highlighting employer concerns that the new conflict of interest and fiduciary definition rules will generate uncertainty, cost and potential liability, the Council told agency officials that without changes, employers may have to pull back on the educational tools they currently offer to plan participants.
Oversight and Investigations Subcommittee Chairman Sean Duffy (R-WI) led the hearing, arguing in his opening statement that the “poorly designed regulations” will “limit investment choices.” He also invited discussion of the Retail Investors Protection Act (H.R. 1090), sponsored by subcommittee member Ann Wagner (R-MO), which would require the DOL to delay publishing a final rule until 60 days after the Securities and Exchange Commission (SEC) finalizes its rule relating to the standards of conduct applicable to brokers and dealers.
Capital Markets and Government Sponsored Enterprises Chairman Scott Garrett (R-NJ), in his opening statement, expressed similar concerns with the proposal, and noted that the DOL regulations, if finalized, would be incompatible with the SEC rule.
The committee heard testimony from the following witnesses:
- Paul Schott Stevens, president and chief executive officer of the Investment Company Institute (a Council Policy Board of Directors organization), called the proposal “deeply flawed,” saying the proposal would increase costs and limit the ability of investors to receive guidance. He noted that the economic analysis used to justify the rule is based on outdated and incorrect assumptions and ignores relevant information. (The Council’s March 26 Benefits Blueprint provides a similar, detailed analysis of the study.)
- Caleb Callahan, senior vice president and chief marketing officer of ValMark Securities, on behalf of the Association for Advanced Life Underwriting, lamented that the DOL chose not to build on the existing SEC regulatory framework or the defined contribution plan disclosure regime under ERISA Section 408(b)(2). He identified a number of potential problems with the proposal, saying that it would most disrupt financial advice for small investors, particularly with respect to participant decisions about Social Security and lifetime income options.
- Mercer Bullard, professor at University of Mississippi School of Law, called the proposed rule “long overdue,” and opposed any further delay as prescribed by H.R. 1090. He focused on the problematic disparity between incentives for “high-risk” stock funds and short-term bond funds, saying that the proposed rule would prevent advisers from recommending investments based solely on their own compensation.
- Juli McNeely, owner of McNeely Financial Services, Inc. and president of the National Association of Insurance and Financial Advisors, described the experience of small and independent financial advisers and their clients, who are primarily low-balance savers and investors. She said that these investors need “more, not less advice,” and the risk of litigation created by the proposed rule would restrict access to such advice.
- Scott Stolz, senior vice president of Private Client Group Investment Products at Raymond James & Associates, Inc., predicted that the proposed rule would encourage advisers to make decisions based on limiting liability, precipitating a shift to “one-size-fits-all” investment approaches (including so-called “robo-advisers”), which are not in investors’ best interests.
During the question and answer period, lawmakers and witnesses discussed a number of controversial issues.
Duffy asked how the rule would affect smaller advisers and investors, given its designed intent to move investors from commission-based pricing to fee-based pricing. McNeely said that the asset-based limits and unworkable fees would prevent her from working with many of her current clients.
Garrett attempted to draw a distinction between the SEC’s existing “suitability” standard and the “reasonableness” standard embraced by DOL. Stolz noted that there are already rules in place protecting the needs of clients, while Callahan noted that certain circumstances would give rise to conflicts between the two different standards.
Representative David Scott (D-GA) observed that the “best interest” contract, even with certain exemptions, would “bring untold lawsuits,” making it difficult for small business owners to sponsor retirement plans, and frighten suspicious consumers away from pursuing advice. Stevens called the best interest contract exemption process “cumbersome and expensive,” creating massive disclosure obligations and opening the door to potential class action lawsuits.
Rep. Brad Sherman (D-CA) expressed concern about the transition for existing customers, given the current eight-month transition period, and asked if a grandfathering rule was feasible. Stevens replied that a longer implementation period was necessary even for a much less complicated rule and suggested that existing relationships should be exempted entirely to prevent disruption.
Rep. Ed Royce (R-CA) described the failure of a similar rule in the United Kingdom, where access to advice was inadvertently limited for low balance investors because they could no longer be charged on a commission basis.
Many of the lawmakers and all of the witnesses except for Bullard expressed support for H.R. 1090, although many also conceded that the SEC has been either slow or reluctant to act on its own rule. The House Financial Services Committee shares jurisdiction on this matter with the House Education and the Workforce Committee. A markup of the measure may be scheduled before the end of the year.
The DOL is accepting additional written comments through September 24. For more information, contact Jan Jacobson, senior counsel, retirement policy, Diann Howland, vice president, legislative affairs, or Lynn Dudley, senior vice president, retirement and international benefits policy, at (202) 289-6700.
GAO Report Examines Default 401(k) Investments
In a new report, the Government Accountability Office (GAO) identified a number of retirement plan sponsor “challenges” related to the provision of a default investment vehicle in automatic enrollment 401(k) plans. The report recommends that the U.S. Department of Labor (DOL) “assess the challenges” and “implement corrective actions.”
DOL created a regulatory safe harbor in 2007 to limit plan sponsor liability for investing contributions on behalf of employees into default investments when employees do not otherwise make an election. In doing so, DOL identified three default investments that, if selected by sponsors, would qualify a plan for safe harbor protection: target date funds, balanced funds or managed account services.
The GAO found that the majority of employers who sponsored 401(k) plans use a target date fund as the default fund, with fewer employers using balanced funds or managed account services. The study generally describes the plan investment selection and monitoring process and lists a number of related challenges cited by plan sponsors, including regulatory uncertainty, liability protection, and the adoption of innovative products.
In particular, plan sponsors who were interviewed by GAO said that existing regulations are unclear as to how sponsors could fulfill the regulatory requirement to factor the ages of participants into their default investment selection, whether each default investment provided the same level of protection or whether they were allowed to incorporate other retirement features (such as products offering guaranteed retirement income) into a plan's default investment.
“Such uncertainty could lead some plan sponsors to make suboptimal choices when selecting a plan's default investment that could have long-lasting negative effects on participants' retirement savings,” the report said.The Council understands that representatives of several “plaintiffs” law firms have attended some of the target date fund hearings held by regulatory agencies including the DOL, perhaps indicating that target date funds could be the subject of future participant lawsuits if stock and bond market volatility or another significant event arguably results in an quantifiable loss to participants.
There are no outstanding regulatory projects addressing default investments. The Council will continue to monitor DOL activity in this area. For more information, contact Jan Jacobson, senior counsel, retirement policy, or Lynn Dudley, senior vice president, retirement and international benefits policy, at (202) 289-6700.