JCiardiallloOn Wednesday, June 8, I testified as part of a panel before the ERISA Advisory Council. The EAC consists of 15 members appointed by the Secretary of Labor, representing labor, employers and the general public and the fields of insurance, corporate trust, actuarial counseling, investment counseling, investment management, and accounting. Each year it considers and hears testimony on selected issues and then makes recommendations to the Department of Labor (DOL). The topic of this hearing was “Participant Plan Transfers and Account Consolidation for the Advancement of Lifetime Plan Participation.”
In my view, the transition from a defined benefit (DB) to a defined contribution (DC) system presents three fundamental challenges for sponsors and policymakers: (1) getting participants to put enough money into DC plans; (2) getting participants to invest their savings efficiently; and (3) distributing benefits in a way that protects against participants outliving their assets. In our economy a fundamental element of challenge (1) (getting enough money in) is preventing retirement savings from being cashed-out every time an employee changes jobs. That is, basically, the issue the EAC was addressing at this hearing.
A terminating participant has, more or less, three choices: take her benefit in cash; roll her benefit over to an IRA; or transfer her benefit to her new employer’s plan. Currently, the easiest thing for a terminating participant to do is to take cash. The second-easiest option is typically to roll her money over to an IRA—many IRA providers have engineered the rollover process so that it is all-electronic and nearly painless.
The hardest thing to do is to roll your money over to your new employer’s plan. Revenue Ruling 2014-9 describes what the participant must in that case:
Employee A requests a distribution of her vested account balance in Plan O and elects that it be paid to Plan M in the form of a direct rollover. The trustee for Plan O distributes Employee A’s vested account balance in a direct rollover to Plan M by issuing a check payable to the trustee for Plan M for the benefit of Employee A, and provides the check to Employee A. Employee A provides the plan administrator for Plan M with the name of Employee A’s prior employer and delivers the check, with an attached check stub that identifies Plan O as the source of the funds, to the plan administrator. Employee A also certifies that the distribution from Plan O does not include after-tax contributions or amounts attributable to designated Roth contributions.
That is a process that someone living in the 19th century might think of as “easy.” Or even rational. It’s no surprise that only a minority of participants avail themselves of this bizarre procedure. According to a 2011 AON Hewitt survey, 42% of terminating employees take cash; another 29% roll over to an IRA. (Leakage of Participants’ DC Assets: How Loans, Withdrawals, and Cashouts Are Eroding Retirement Income, 2011. AON Hewitt, 2011)NEXT: The IRS is getting income
Typically, it’s younger, lower-paid participants, with small account balances, that take cash. And while the amounts cashed out are generally small, because it’s younger participants that are cashing out, the long-term consequences are significant. EBRI found that, if the retirement income target is 60% income replacement, nearly 40% of participants in the bottom income quartile will not hit that target simply because of cash-outs. (ERISA Advisory Council Hearing on: Lifetime Participation In Plans (2014), statement for the record of Jack VanDerhei, Ph.D., Research Director, Employee Benefit Research Institute (EBRI)).
One more piece of data: cash outs are a significant source of revenue. A Government Accountability Office (GAO) report from 2009 stated:
Because the incidence and amount of leakage from 401(k) accounts have remained relatively steady, the 10 percent penalty has continued to provide a steady source of revenue to IRS. Officials told us that the penalty serves a dual purpose: it deters participants from tapping into their 401(k) account when they have other sources of money available, and it allows the federal government to recoup a portion of the subsidy provided to keep the money tax-deferred. According to published IRS data on early withdrawals from qualified retirement plans, including 401(k) plans and IRAs, more than 5 million tax filers paid $4.6 billion in early withdrawal penalties in tax year 2006.
The IRS was making $4.6 billion a year in 2006 (what is that number today?) from cash outs. It was collecting this money typically from low paid employees who generally pay no other income tax. And IRS officials seemed (in 2006 at least) to think that that was a good thing. Talk about upside down priorities.
In my testimony, I advocated for going to a default money-follows-the-employee system: When an individual under age 65 quits work at employer A and goes to work at employer B, if he does nothing, his retirement assets should simply show up on his next statement from the employer B plan. If there is no employer B plan, then his assets are parked in a MyRA. And, of course, any individual would be allowed to opt out of this default treatment—elect an IRA rollover or take cash.
If I had my way, I would make sponsor participation in such a system a condition of plan qualification.
I realize that this proposal is very much “easy to say, hard to do.” Sponsors and providers will have to do a lot of work to build an infrastructure that, e.g., reconciles different recordkeeping systems and matches assets with employees as they change jobs.
If we’re going to ask sponsors and providers to undertake such an effort, then I think it’s also fair to ask regulators to accommodate such a system.
This is about priorities.NEXT: Can regulators make changes?
If the highest priority is collecting tax revenues from terminating participants, then you won’t like my proposal. If, however, the highest priority is keeping young, low-paid employees’ assets in the retirement system, then we must change regulatory policy in three critical areas:
1. Sponsors must no longer be required to expend effort verifying that money being rolled in is “qualified.” If the money is being wired from what purports to be a qualified plan, a simple employee certification should be sufficient (at most). There is no evidence that there is a huge risk of abuse in this area—that somehow employees are trying to sneak money into this system.
2. Sponsors and providers must be allowed to operate this system electronically. A participant should be required to affirmatively request (in writing) that the plan use paper when communicating with him. We have to get this industry into the 21st century.
3. Sponsor fiduciaries should not be exposed to fiduciary risk for recommending that participants leave their money in the system. This feature of the new fiduciary rule must be clarified.
If regulators are not prepared to change on these issues, then we are wasting our time here.
Can regulators make these changes? Do they have authority to do so?
We just witnessed a project in rulemaking the end result of which was, among other things, the extension of the DOL’s substantive fiduciary authority to IRAs. Before that project, few thought DOL had that sort of authority. But, as the head of the EBSA said: “We had to be creative to try to find a way to make the responsibility for acting in your client’s best interest, the fiduciary responsibility, enforceable in the IRA context. That’s how we came up with the best interest contract exemption.” (DOL Will Rely on Consumers, Advisors to Help Enforce Fiduciary Rule: Borzi, ThinkAdvisor (May 25, 2016)).
So, it turns out, the regulators can be creative when they want to. With respect to this issue—keeping terminating participants’ assets in the system—the question is, do they want to? As I said, it’s about priorities.
You can read the testimony of my fellow panelists, Allison Klausner, Director of Government Relations - Buck Consultants at Xerox (on behalf of the American Benefits Council) and Kent Mason of Davis & Harmon, at https://www.dol.gov/ebsa/aboutebsa/erisa_advisory_council.html.
Michael Barry is president of the Plan Advisory Services Group, a consulting group that helps financial services corporations with the regulatory issues facing their plan sponsor clients. He has 40 years’ experience in the benefits field, in law and consulting firms, and blogs regularly http://moneyvstime.com/ about retirement plan and policy issues.
This feature is to provide general information only, does not constitute legal or tax advice, and cannot be used or substituted for legal or tax advice. Any opinions of the author do not necessarily reflect the stance of Asset International or its affiliates.