I’ve written that IRA is not a kid anymore. From its humble beginning in 1974 as part of the Employee Retirement Income Security Act of (ERISA), the Individual Retirement Account (IRA) along with cousins Roth, SEP, and SIMPLE, has grown up. It’s now an increasingly important investment vehicle for retirement savings and tax planning. And it will become even more so as the Boomers start retiring, and the distribution phase begins. But, darn, the rules are complicated. So where do you go for help? You can start at the source, IRS Publication 590, Individual Retirement Arrangements (IRAs). Or you reference, a handy Summary Table of Traditional IRA and Roth IRA Tax Rules on the Skilled Investor website. Or maybe, it’s one of those "kids, don’t try this at home" situations, and you should talk to a qualified tax advisor.
Got the Pension Tension Blues?
If dealing with pension and fiduciary issues are getting you down, then you’ve got the Pension Tension Blues. Dr. Susan Mangiero, founder and President of Pension Governance, and Steve Zelin, the Singing CPA, have co-written a satirical song on the current state of affairs for retirement plan sponsors and participants. I’ll never see them on stage at Buddy Guy’s Legend’s, but pretty good for a Ph.d. and a CPA. Take a listen here.
It’s all over but the shoutin’. Stable value funds unlikely to be Department of Labor default fund option
Earlier this month in my article, It ain’t over till it’s over, I discussed the insurance industry’s objection to stable value funds not being part of the Department of Labor (DOL) regulation for default funds. The Pension Protection Act of 2006 directed the DOL to designate “default” investment elections that employers could select to meet their fiduciary responsibilities when an employee does not make an an investment election.
The historical selection by most employers has been a fixed income fund – money market fund or stable value. The proposed DOL regulation, however, includes only options having equity exposure, i.e., asset allocation funds, target-maturity funds, or managed accounts. And with over $300 billion at the end of 2005 in stable value funds according to the Investment Company Institute, most of which is managed by insurance companies, the insurance industry went to work in Washington to get stable value funds added as a fourth option. But it looks like it’s over. Investment News reports that the DOL’s final regulation to be issued next month will continue to reject stable value funds as too conservative and will not include this asset class as a default option.
If, indeed, this is the case, it will be interesting to see how it will play out after the regulation is finalized. Will some employers continue to include stable value funds as their default fund? And what will the reaction be if there is a market turndown and participants in default funds lose money? So, it’s really not over – particularly if the insurance industry convinces Congress to get involved.
Will 403(b) plans ever be subject to ERISA?
A few months ago, I wrote about the possibility that a class action law suit might be filed against the National Education Association (NEA). Well, now it’s happened. The law suit claims that the NEA accepted payments from the 403(b) providers to endorse those retirement plans, and that the fees and expenses charged by the provider were far higher than those charged by comparable and better-performing plans available on the market.
One of the interesting arguments the plaintiff attorneys is making is that the NEA’s active endorsement of the annuity products made it a plan sponsor and subject to ERISA’s fiduciary standards. As I understand ERISA (and I’m not an attorney) Title I which includes the fiduciary requirements applies to "employee benefit pension plans" which do not include Section 403(b) salary reduction plans.
Steve Rosenberg in his article, High Cost Investments, Payments to Sponsors, and the National Education Association, on his ERISA and Insurance Litigation Blog comments on the ERISA argument:
With regard to this problem, concerning the plaintiffs’ need to figure out the best manner to structure their lawsuit, what you are really seeing is the problem of forcing a square peg into a round hole. I have argued in other posts that, as we move decisively from a defined benefit plan world to a defined contribution world, and thereby make plan participants the bearers of all the risks of their retirement investments, we need to simultaneously provide those plan participants with the legal protections and tools to manage those risks, including the types of risks alleged in this case, of misleading investment recommendations, undisclosed payments, and excessive costs.
Steve further goes on to say:
I hope to keep an eye on this case going forward, as it may provide an excellent window on the question of whether, and if so how, the law can evolve to deal with these changes in the real world environment in which people now must prepare for retirement.
It’s an important social issue with an estimated $650 billion in 403(b) plans. The legal evolution that Steve discusses may take a while. But the regulatory evolution is about to happen January 1, 2008 when proposed IRS 403(b) regulations become effective. This evolution includes a new regulatory requirement that employers create a plan document that includes the plan’s rules. And maybe the evolution will become a revolution if employers are made responsible for managing and operating the plans. Round peg in a round hole?
The tax cost of ESOPs (and other benefits)
The term "tax breaks" was used in a few instances in commentary on the Tribune/Sam Zell ESOP. We know that the major tax advantages include a deduction for principal and interest to payoff the ESOP debt, a tax free rollover for the selling shareholder, and the non-taxability of the ESOP’s share of corporate profits for S corporation ESOPs. All, of course, subject to specific limitations under the tax laws. So ignoring the public policy reasons for ESOPs for purposes of this discussion, how much exactly did these "tax breaks" cost the Treasury?
The answer which may surprise you is less than the cost of the exclusion from tax of reimbursed employee parking expenses. The Office of Management and Budget has calculated the cost of special ESOP benefits at $1.89 billion for 2007, rising to $2.67 billion by 2012. In comparison, the exclusion of reimbursed employee parking expenses will cost $2.89 billion while 401(k) plans will cost $42.4 billion and IRAs $5.7 billion.
Hat tip to Corey Rosen, Executive Director of the National Center for Employee Ownership (NCEO).
Investment seminars for seniors make Top 10 List for first time
No, it’s not a David Letterman list. It’s more akin to the FBI’s Ten Most Wanted List. The list that "investment seminars" made for the first time is the annual list of Top 10 Traps for Investors put out by the North American Securities Administrators Association (NASAA), the oldest international organization devoted to investor protection. The NASAA is a voluntary association whose membership consists of 67 state, provincial, and territorial securities administrators in the 50 states, the District of Columbia, Puerto Rico, the U.S. Virgin Islands, Canada, and Mexico. Here’s what NASAA had to say about investment seminars:
Promoters of unsuitable investments are increasingly seeking potential investors, particularly seniors, by offering seminars, many of them promising a free meal along with “higher returns and little or no risk.” Unfortunately, in many of the cases that securities regulators see, it’s just the opposite: high risk and no returns, just disastrous losses. Remember: There’s no such thing as a free lunch.
The vast majority of advisors are, of course, honest. But with 77 million Americans reaching age 55 between now and 2020, the amount of money available for investment is staggering. And promoters do follow the money. Whether the regulators can keep up will be the challenge.
Here’s a link to NASAA’s press release which has the entire list in alphabetical order.
Defined benefit pension plans vanishing quicker than expected
Here’s some financial juxtaposition to consider. As the stock market reached a new high which makes 401(k) participants happy, a survey released this week shows a speed-up in the decline of defined benefit pension plans. The survey (32 pages, PDF) by industry-supported Employee Benefit Research Institute (EBRI) and Mercer Human Resources Consulting of 162 employers, some of which are the country’s largest, reveals that nearly two-thirds of employers that offer traditional pensions have closed their plans to new hires or frozen them for all employees — or plan to do so in the next two years.
The survey results brings the issue of whether the Boomers will have adequate retirement income to the forefront. Some analysts have said that Boomers with a combination of pensions, 401(k), home equity, and Social Security will be financially ready to retire. It’s time to run the numbers again.
If it looks like a 401(k), acts like a 401(k), and sounds like a 401(k), then it must be a 403(b) – Part Two
Yesterday, I discussed the first of two big changes ahead for 403(b) plans that would make 403(b) plans resemble 401(k) plans, proposed IRS regulations that would be effective in 2008. Here is the second big change, the IRS Universal Availability Project. The IRS is sending out letters and questionnaires to public school districts regarding their 403(b) arrangements to determine their compliance with the Universal Availability requirement for 403(b) plans. The project was initially directed to districts in three states but has now been expanded to cover all 50 states and slated to last through 2008.
The Universal Availability requirement is similar to the eligibility requirement for 401(k) plans under which all eligible employees must be given the opportunity to make elective salary deferrals. The Director of the IRS Employee Plans division has indicated that the data collected so far has revealed "fairly widespread noncompliance by schools with the universal availability requirement for 403(b) plans."
Responding to the inquiry is voluntary, but the IRS has indicated that a failure to respond could lead to an IRS audit. If a school district’s plan does meet the requirement, it could result in loss of 403(b) tax-favored status, i.e., employee contributions to the 403(b) plan and earnings could be immediately subject to income tax. The IRS does, however, provide at least two methods of self-correction which are more favorable than using the other voluntary correction programs.
Regardless of whether school districts receive an IRS letter, all school districts should be concerned about whether they satisfy the Universal Availability requirement in their 403(b) plans and the proposed 403(b) regulations slated to be effective at the end of the year . Accordingly, it may be prudent for a school district to conduct an internal compliance review to determine the level of compliance of its plan… and to get ready for the regulations.
If it looks like a 401(k), acts like a 401(k), and sounds like a 401(k), then it must be a 403(b)
Major changes are on the way for 403(b) plans. Named after Section 403(b) of the Internal Revenue Code enacted in 1958, 403(b) plans are retirement annuity contracts, mutual fund custodial accounts for employees of certain tax-exempt organizations, public educational organizations, and retirement income accounts established by churches or church-affiliated organizations.
The Internal Revenue Service is now putting these plans under the most scrutiny in over 40 years. And there are a lot of dollars in these plans. According to Cerulli Associates, a Boston-based consulting firm, there are approximately $650 billion in 403(b) plans.
The IRS’ objective? To have 403(b) plans look like, sound like, and act like 401(k) plans. In other words, 403(b) plan sponsors will now have to take responsibility for plan monitoring in contrast to the current practice of letting the employees interact directly with the mutual fund or insurance company. The increased IRS involvement is coming in two areas.
- Proposed regulations scheduled to be effective in 2008.
- An outreach program to ensure public schools comply with the Universal Availability rule, i.e., offering the plan to all eligible employees.
Here are some of the rules covered in the IRS regulation:
- A new requirement that there be a written plan document.
- Rules that govern the return of excess employee deferrals.
- New required employer communication and transfer rules.
- Rules governing the timing of depositing employee contributions.
- Coordination of catch-up limits.
- Availability of Roth contributions
- Restrictions on life insurance.
- Ability to terminate the plan.
These are all matter s that 401(k) plan sponsors have been dealing with since the beginning. But for many 403(b) plan sponsors who will be assuming administrative responsibility for these plans for the first time, it’s going to be a difficult process.
Tomorrow, I’ll discuss the IRS compliance initiative.
“It ain’t over till it’s over.” : The Department of Labor’s Proposed Default Regulation
The quotation above is one of the best-known Yogiisms, and it neatly describes the battle that is shaping up before the Department of Labor (DoL) finalizes its proposed regulation on default funds. On one side are the mutual fund companies and on the other are the insurance companies. And here’s what it’s all about. The Pension Protection Act of 2006 (PPA) provided fiduciary relief to employers by designating a “default fund” if the employee failed to make an investment election. It’s an especially important part of the now fully sanctioned automatic enrollment since a default fund would be where the funds of an automatically enrolled employees would be invested.
The PPA also directed the DoL to designate “default” investment elections that employers could select to meet their fiduciary responsibilities which could include a mix of asset classes other than a money market fund which has been the historical selection. And so the proposed regulation that the DoL prepared included balanced funds, target-maturity funds, or managed accounts. No money market fund and no stable value fund which the DoL considered too conservative.
With approximately $400 billion in stable value assets in 401(k) plans and an estimated 14 million more workers that will be brought into the system with automatic enrollment, it’s a real big issue for the insurance industry. And now the lobbyists for the insurance industry are gearing for a major campaign that would result in the DoL including stable value as a default option in the final regulation.
We’ll see who’s scores the winning run.
