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These Six Structural Changes to ERISA Can Improve Employee Retirement Readiness

September 04
00:03 2014

(This is the second and final installment of a two part series.)

Quick fixes will get you only so far (though they were addressed them in the first installment “These Four Quick Fixes for ERISA Can Reduce 401k Fiduciary Stress,” FiduciaryNews.com, September 3, 2014). The problems with ERISA are deep DCF 1.0seated. Congress created the law in response to the failure of economically troubled private companies to fulfill their promise to provide retirement benefits to former employees. Since no one back then (or even today) had figured out how to draw blood from a stone, the government had to create some way to cover these shortfalls. In the spirit of FDIC, the year 1974 saw Washington give birth to not only ERISA, but the Pension Benefit Guaranty Corporation (“PBGC”). (Let’s not forget that same legislation also begat the IRA.)

Perhaps you see the theme here. ERISA came about and addressed concerns primarily in the pension arena. Pensions were the superstars of retirement benefits back in the day when few willingly paid the premium price for unleaded gas. (Indeed, catalytic converters – which require unleaded gas – didn’t become mandatory until 1975 car models.) Today, not only do we limit our use solely to unleaded gas, but most blends contain 10% ethanol. And pensions have gone the way of those non-unleaded gas guzzling cars. In the twenty-first century, 401k plans rule the roost. While it’s tried its best, many wonder if ERISA has kept pace with these changes.

“I think ERISA focuses too much on an all-but-bygone pension type – namely defined benefit,” says Ben Hodge, Retirement Consultant for Retirement Benefits Group in San Diego, California. “Most employers don’t offer a defined benefit plan anymore (or never have). So much of ERISA legislation deals with funding limits, vesting, and other issues prevalent in defined benefit plans. [ERISA] should change to focus more on defined contribution since the majority of folks working today have access to this type of plan.

Despite this need for structural change, we cannot understate the success ERISA has inspired in the retirement savings plan field. “The original intent of ERISA was to provide a retirement savings vehicle, with tax incentives, to encourage the American workforce to save money on their own, for the purpose of supplementing their Social Security, which was becoming more and more insufficient to sustain the modern standard of living,” says H. Grant Perry, Managing Principal & CEO at Pinehurst Capital, Inc. in Pinehurst, North Carolina.

Thanks in particular to ERISA’s ability to conform to the needs of the transformational retirement savings vehicle we call the 401k, workers find they have much greater retirement benefits today than they did in the mid-1970s. “While no system is perfect,” says Robert Kaplan, National Retirement Consultant for Voya Financial (formerly ING U.S.) based in Windsor, Connecticut, “ERISA has been extremely successful in that tens of millions of working Americans are provided the opportunity to save towards a dignified retirement they’ve earned and deserve. In fact, industry data suggests that more working Americans have access to a workplace savings plan today than before the enactment of the law 40 years ago.”

As much improved as the retirement landscape is today, academic studies, especially in the field of behavioral economics, have shown we can do magnitudes better. ERISA then becomes a “glass-half-empty/glass-half-full” type of discussion. Hodge says, “I think ERISA has been a mixed bag, so to speak. On one hand it has worked in putting an onus on employers and plan sponsors to provide retirement plans that meet certain guidelines that help participants. These include reporting requirements (plan summaries, 5500 reporting, vesting), processes for investment committees in hiring/firing investment managers, discrimination testing, fiduciary standards, etc. In other ways ERISA hasn’t evolved the way that some laws may have to better serve today’s employees and plan sponsors. Other laws regulating retirement plans (IRS, DOL, etc) have been slow to evolve as well. The Pension Protection Act did help out some, but generally we really haven’t moved into the 21st century.”

Again, these aren’t quick fixes. Structural problems require much more legwork to repair. But the ones outlined here can have a dramatic long-term positive impact on all citizens. The changes will make Americans more retirement ready and less dependent on Social Security. Here are six long-term fundamental modifications to ERISA our virtual “man-on-the-street” interviews of retirement service providers across the country yielded:

1. Require a ROTH Option
There are two things to consider here. First, 401k ROTH options are growing in popularity within plan documents. Second, while the 401k ROTH option attracts all age groups, it is particularly effective in attracting the millennial age group. Presently, the ROTH remains an optional option – there is no requirement that plans offer them. Perry would like to “require employer sponsored plans to add a ROTH option for tax-savvy employees who understand that traditional pre-tax contributions to a 401k plan can be a tax time bomb. Think about it; most employees opt to make pre-tax contributions of a relatively ‘small bag’ of money each pay period, only to watch it grow tax-deferred into, hopefully, a ‘big bag’ of money down the road. What they fail to consider is that this ‘big bag’ of money will be fully taxed at ordinary income tax rates, that they will be forced to take distributions at age 70½ whether they need the money or not, and more importantly they don’t know what the tax rates will be when that time comes. If they make post-tax contributions to the ROTH option, at least they know what their tax rate is, and historically speaking, tax rates are currently fairly low.”

2. Require both Auto-Enrollment and Auto-Escalation Features
As with the ROTH option, auto-enrollment and auto-escalation appear to be very popular plan preferences. While they, too, are not required, an increasing majority of plans include them. Hodge says, “I’d also like to see a push to include auto-enrollment and auto-escalation in each plan as this would certainly help those less-than enthusiastic employees to save.”

It impacts more than the “less-than enthusiastic,” it helps those who simply don’t have the space of mind to study the intricacies of retirement savings and investment. Kaplan wants to “increase [the] availability of automatic plan design offerings (i.e., auto-enrollment, auto-escalation and auto-investment vehicles) for participants who may not have financial knowledge to know or the time to proactively manage their retirement plan account.”

We shouldn’t minimize the significance of requiring auto-enrollment and auto-escalation. The lack thereof might have a devastating effect on the retirement future of millions of workers. William Peartree, Principal and Director of Retirement Services at Barney & Barney in San Diego, California says, “If more radical steps aren’t taken by ERISA to get (or require) employers to implement auto-enrollment type features, workers throughout most generations will never be in a position to retire.”

Kaplan feels this is only the start. He says, “Automatic enrollment and automatic escalation were developed to help participants – who are now shouldering more responsibility than ever before for funding their own retirement – overcome inertia and encourage automatic savings. While this is the first step in the process, the next step is to increase the default percentage.”

3. Eliminate the Required Minimum Distribution (RMD)
This may surprise some, but remember, the RMD age of 70½ has been around for a long time. In 1974, the average American male was dead by the time he was 70½. Today, based on any number of sources, the average American male will live another five years after the RMD kicks in. Perry would like the RMD eliminated for balances under $1,000,000. He says, “A million dollars doesn’t make you ‘rich’ any more and the RMD on amounts below that aren’t generating significant tax revenue anyway; but they are causing middle-class people to have to pay taxes on up to 85% of their Social Security income, which is a travesty in and of itself.”

4. Change Non-Discrimination Rules
Regulators have long feared Highly Compensated Employees (HCEs) taking advantage of retirement savings plans at the expense of lower paid employees. While this has generally been accepted by the public, like most government mandated limits or dollar definitions, we’ve seen bracket creep ratchet down to hurt employees who, by today’s standards, would not have been considered an HCE in 1974. “Eliminate the contribution limits for ‘Non-Highly-Compensated’ employees,” says Perry. “Highly compensated is currently considered income of $115,000 or higher.” He says eliminating the limits “will allow older individuals to contribute more in order to ‘catch up’ on their retirement nest egg because of having to raise and educate children or take care of aging parents.”

Each year the IRS updates the definition of an HCE. Some say these update have lagged behind the real world definition of an HCE. In addition to addressing this, Peartree also believes non-discrimination testing should be overhauled. He says we need to “get realistic with what an HCE is.”

Philosophically, it gets increasingly difficult to defend HCE limits in a free society. Specifically, Perry would “eliminate the forced reduction in contributions by highly-compensated employees just because there is a lack of contributions by the non-highly-compensated. Nobody should be penalized for someone else’s behavior.”

5. Convert All 403(b) Plans to 401k Plans
Used mainly by non-profits and public institutions, the 403(b) plan is a widely used retirement planning vehicle. There’s been an effort to bring the 403(b) closer to the 401k world, but it remains outside the realm of ERISA. This exposes it to two vulnerabilities. First, 403(b) plans fail to garner the same level of fiduciary protection 401k plans possess. Second, Peartree maintains there are “still way too many plans out of compliance.” He says, “There needs to be a better solution to help these employers become more compliant. How can a 403(b) not be an ERISA plan?”

6. Create Additional Fiduciary Safe Harbors
As we’ve seen repeated throughout this series, the increasing complexity of ERISA, and the attendant personal fiduciary liability that goes with this complexity, causes plan sponsors to reconsider whether or not they should offer a retirement savings plan. “ERISA needs to evolve to the point of developing additional safe harbors to encourage, not discourage, employers,” says Peartree.

Even when it comes to providing income-oriented vehicles – something both plan sponsors and, more importantly, plan participants appear to have rejected – ERISA doesn’t go far enough to allow for honest experimentation. Kaplan says ERISA should be amended to “provide fiduciary safe harbors that would encourage employers to adopt in-plan retirement income vehicles to help investors turn their savings into a guaranteed lifetime income stream upon retirement.”

There you have it. These changes can help Americans become more retirement ready. But the everyday retirement service provider remains skeptical regarding the aims of the those in a position to make these changes. Rather than promoting these obvious modifications, elected officials appear poised to relive the mistakes of the past. “ERISA has evolved into a restrictive, compliance-ridden, tax-generating monster,” says Hodge. “Congress has transformed what was intended to be a boon for the retirement plan industry into a giant, multi-trillion dollar slush fund they can’t wait to get their hands on. Few Americans are aware there was a bill before Congress during the Clinton Administration to levy an across-the-board 10-15% surtax on all plan balances, and even today there is a proposal put forth by House Ways and Means Chairman Dave Camp to impose a 10% surtax on all contributions to employer-sponsored plans. Additionally, there has also been a freeze on increased contribution limits until 2023. Rep. Camp seems unable to comprehend that 401k and other qualified retirement plans are not tax-free; they are tax-deferred, and all future withdrawals will be fully taxed at ordinary income tax rates. His proposal, simply put, is a double-taxation on American workers’ retirement savings.”

ERISA began with the purpose of protecting employees retirement benefits from faulty and/or corrupt employers. What act is needed to provide the same protection from a faulty and/or corrupt government?

Interested in learning more about important topics confronting 401k fiduciaries? Explore Mr. Carosa’s book 401(k) Fiduciary Solutions and discover how to solve those hidden traps that often pop up in 401k plans.

Mr. Carosa is available for keynote speaking engagements, especially in venues located in the Northeast, MidAtantic and Midwestern regions of the United States and in the Toronto region of Canada.

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Christopher Carosa, CTFA

Christopher Carosa, CTFA

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