ERSA Redux "Better", But Doubts Linger

February 3, 2004 ( - As Punxatawny Phil emerged from his burrow this week, the Secretary of Treasury also unveiled, along with President Bush's budget proposal, a new version of retirement savings programs.

>The programs, which had been introduced a year earlier (See  ERSAs Bear Major Changes for Plan Sponsors ), represented more than a mere rehash of the earlier proposals.   Indeed, in the intervening months, Administration officials had been actively talking to, and meeting with various industry representatives to refine the proposals (see  ERSAs on Comeback Trail ).   As with last year’s proposal, ERSAs would replace existing 401(k), 403(b), governmental 457, SIMPLE, and grand-fathered SARSEP plans with a single plan available to all employers with rules essentially similar to existing rules governing 401(k) plans.   ERSAs would still be subject to current plan restrictions on contribution and compensation limits, catch-up contributions, and distribution rules (see  They’re Back )   

But a year ago the reaction was stunned, even confused, as plan sponsors struggled to comprehend the implications of the sweeping proposal, which included programs with the acronyms ERSA, LSA and RSA (employer retirement savings accounts, lifetime savings accounts, and retirement savings accounts).   At the time, concerns revolved around two main concerns; that the proposed new Lifetime Savings Accounts (LSA) will effectively siphon off employee dollars normally flowing into company retirement plans and that small business owners may be dissuaded from starting a company plan in the first place (see  Industry Groups Fret About Impact of Bush Proposal ).   At the time, Brian Graff, executive director of the American Society of Pension Actuaries (ASPA) said, “The proposal’s substantial expansion of tax-favored opportunities to save on an individual basis will eliminate the incentive for many small business owners to incur the cost and administrative burdens of establishing a retirement plan for their small business employees.”

Support Shift  

>This week Graff noted in response to the new proposals, “ASPA no longer opposes the proposals, provided the LSA/RSA contribution limit does not exceed $10,000. In fact, ASPA believes that on balance the combined revised LSA/RSA/ERSA proposals, if enacted, would result in greater retirement plan coverage and consequently greater retirement savings for working Americans.”

>The new proposals do address some of the “siphoning” concerns of the earlier proposal.   For example, the contribution limits for the Lifetime Savings Accounts (LSAs) and the Retirement Savings Accounts (RSAs) have each been reduced from $7,500 to $5,000 per year/per individual (indexed).   Additionally, LSA family transfers are now only permitted between spouses and not other family members, unlike last year’s proposal, ensuring that the limit cannot be circumvented by contributions directed through other family members, according to ASPA.

Significantly, the revised proposal clarifies that an RSA can be permitted as an add-on to an employer plan, according to ASPA.   Since there are no income limits on RSAs, this would in effect increase the contribution limit in the employer plan without impacting the employer plan contribution limits or nondiscrimination tests (i.e., similar to catch-up contributions, but without age requirements, according to ASPA).  

>ASPA notes that when the EGTRRA limit increases are fully phased in, the ERSA elective deferral limit for a 50 year old would be $25,000 (recognizing that the $5,000 RSA add-on would have to be on an after-tax basis while the remaining deferrals could be either on pre-tax or post-tax basis).  

>Concerns do remain in some parts about the potential drain of contributions from employer-sponsored alternatives, not just among highly compensated, but among the NHCE group as well.   "The real questions is to what extent the proposals would impinge on retirement savings. That's pretty much the key issue for folks who look at this from a retirement perspective," according to James Klein, President of the American Benefits Council.   Janice Gregory, senior vice president at the ERISA Industry Committee (ERIC) echoed that sentiment, noting, "LSAs are likely to have a greater impact on Americans' savings patterns. I think there will be a lot of discussion about what those patterns will be. Does it mean that people will end up with less retirement savings or with savings where they had none before?"

>In fact, it's not at all certain at this juncture whether assimilating all employer-sponsored retirement programs under one umbrella will be welcomed by all.   "There is still some question about whether the ERSA can be a true "one size fits all" plan," says Gregory.   "While there shouldn't be a problem with 401(k) plans, it remains to be seen how the ERSA model will "fit employers with 403(b)s, 457s, etc.," she said.   "They (the government) may have some other types of issues that they have work through before a one size fits all employer sponsored plan becomes a reality"

>Even this week ASPA acknowledged the concerns that LSAs, which would allow distributions without restriction, will "…displace participation in employer-based retirement plans by lower income workers. In other words, if the LSA is enacted, lower income workers are going to save in the LSA in lieu of saving in an employer-sponsored ERSA."   However, ASPA goes on to say that in the organization's views, "such concerns are not warranted," going on to cite the success of retirement plans in today's workplace, fostered by payroll deductions, the incentive of a match, and the "culture of savings."

"Still" Standing

>However, aside from the potential siphoning effect, the new Employer Retirement Savings Accounts (ERSAs) have several features of keen interest to plan sponsors.   Treasury has agreed to retain the current-law cross-testing, average benefit percentage testing, and permitted disparity rules in place without modification, though current-law top-heavy rules would also be retained, according to ASPA.   Additionally, custodial account ERSA plans, similar to SIMPLE IRAs, would be permitted, but only for employers with less than ten employees.   Neither the definition of compensation nor the definition of highly compensated employee would be changed under the new proposal (just like last year's proposal).  

>One thing that would change - the ADP/ACP nondiscrimination tests would be repealed and replaced with a less onerous nondiscrimination test, according to ASPA.    Under the proposed new test, if the average deferral percentage for non-highly compensated employees (NHCE) is greater than 6%, there would be no restrictions on the deferral percentages of highly compensated employees. If, however, the average deferral percentage of NHCEs is equal to or less than 6 percent, then the average deferral percentage for highly compensated employees may not exceed two times the deferral percentage for non-highly compensated employees.  

>The proposal would provide for two safe harbors in order to avoid any nondiscrimination testing; one the same as that under the current law safe harbor (exempting the plan from nondiscrimination testing if it provides a 3% of pay contribution to participants regardless of whether they save on their own), and an alternative that would exempt the plan from nondiscrimination testing if a 50 percent match on employee contributions up to 6% of pay (or a more generous formula) is provided.   The changes to the nondiscrimination rules in ERSA could materially reduce the cost—both the administrative and employer contribution costs—of small businesses considering whether to adopt a retirement plan for their workers.   As under current law, safe harbor contributions would have to be 100% vested, but there would no longer be a specific matching contribution test (just satisfy the Section 401(a)(4) nondiscrimination rules).

>Governmental plans would be completely exempt from any nondiscrimination rules applicable to ERSAs, and charitable organizations would also be exempt, provided all employees are eligible to participate and the plan does not accept after-tax contributions.

>With the ink on the new proposal still wet, ASPA has already put forth a number of additional suggestions regarding the proposal, notably to consider retaining the 401(k) name since it has significant public brand recognition.   ASPA says it has also discussed with Treasury expanding the present-law  SAVER's credit  as a supplement to the RSA and ERSA proposals, and expanding it to cover taxpayers with slightly higher/more moderate incomes. Further, the credit should be refundable so it is also available to individuals who might not have to pay any tax in a particular year.