DC: Where the Action…Isn’t
Washington’s current inactivity poses a challenge for defined contribution (DC) plan sponsors, investment management providers and record keepers. We’ve heard rumblings of legislative, regulatory and perhaps even taxation changes…but what changes seem likely to happen?
There are two schools of thought being discussed among policymakers in Washington about DC plans. One camp believes we should either replace the whole DC system because it’s not working or, at least, reduce the amount of tax expenditures that are being given up to retain the current system. The other camp believes the system is fine, but that we need to make some targeted changes to improve participant outcomes.
Approach #1: Overhaul or Replace
Perhaps the most far-reaching proposal from the “start from scratch” group is what’s called guaranteed retirement accounts—essentially a government-maintained DC program, similar to Social Security. The guaranteed retirement account would call for a mandatory 2.5% deduction from employees’ paychecks, with a matching 2.5% employer contribution. This would go into a government-maintained account, and the government would credit that account each year with $600. At retirement, the account would pay out in the form of an annuity.
Needless to say, there isn’t much appetite these days for any sort of mandate. Nonetheless, this concept has been tossed about Washington for the past several years and will likely continue to be discussed in some form.
That same camp that wants to replace or overhaul the DC system has forwarded various proposals to limit the tax expenditures for retirement plans—meaning, the tax deferrals that most retirement plan contributions receive. (The exception is for Roth contributions, which use after-tax dollars that then grow tax-free in retirement accounts. However, some skeptics wonder whether Washington will, at some point, want to tax the investment growth of these retirement assets as well.) Some in Washington look at these retirement plan expenditures as one of the biggest pots of currently non-taxed money in the tax code, second only to employer-provided healthcare.
One idea, from the Obama administration’s budget proposal, is to cap the value of exclusions or deductions at 28% of contributions. Another idea would be to cap contributions once the taxpayer’s aggregate retirement plans reached a balance of approximately $3 million. And then there’s the “blank slate” approach: what tax code deductions would Congress include if they could start with a blank slate?
Approach #2: Targeted Changes
But ideas from the other camp—advocates of the “targeted change” approach—have actually made significant contributions to participant outcomes recently. I’m referring to the Pension Protection Act of 2006 (PPA), with its incentives for automatic enrollment and relieving plan sponsors of fiduciary liability for default investing, which goes hand-in-hand with automatic enrollment.
Another targeted change under discussion in Washington is to encourage plans to increase the automatic enrollment and automatic escalation levels. Up until now, there has been a centering around an initial deferral percentage of 3% for automatic enrollment, because that number was in an old IRS revenue ruling and is also the minimum percentage in the PPA’s automatic enrollment safe harbor, but it’s not adequate.
Other ideas look to reduce leakage from DC plans—for example, allowing people who take hardship distributions to continue to participate in the plan rather than being forced out of the plan for six months. And finally, we’re seeing proposals encouraging the adoption of lifetime income, from both the Department of Labor (DOL) and Congress that would require DC plans to illustrate participants’ account balances in terms of future income.
So, there appear to be a number of DC plan components that the DOL and Congress may likely tinker with around the edges.
All Quiet on the Legislative Front?
Since 1947, Congress has enacted an average of 314 laws each year. Two-thirds of the way through 2013, Congress has managed to pass around 30 laws—many of them not particularly significant.
So, it seems unlikely that we’ll see anything happen on tax reform or pension legislation in the near term. The most likely area of action would come from regulatory agencies. But even this part of Washington is experiencing headwinds of hesitation. For example, we’re seeing further delays before the DOL publishes its revised definition of fiduciary proposal. This had been slated for October, but now will most likely not occur until early 2014. The DOL floated the original proposal in 2010 but later withdrew it amid a flurry of criticism from several quarters, including from members of Congress on both sides of the aisle. Even though the DOL has indicated that they will attempt to address some of the concerns raised by critics of the original proposal, the changes could be significant for some investment professionals and other providers of services to ERISA plans and IRAs.
Whatever future course Washington takes toward DC plans, greater clarity—rather than today’s uncertainty—would likely help plan sponsors move forward in their quest to provide better retirement outcomes for their plan participants.
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