Category Archives: Investing and fiduciary requirements

Obama budget to cap retirement deductions

Some caution that political wrangling could mean revenue proposal has good chance of adoption

By Hazel Bradford | April 15, 2013


The retirement- and investment-related tax proposals in President
Barak Obama’s fiscal 2014 budget are bargaining chips in the
administration’s battle with Republicans, Washington insiders say.
As a result, they can’t be discounted as dead on arrival,
even though they are drawing criticism from the industries they target.

Perhaps the most striking proposal is a limit on tax-favored accumulation of
all private retirement assets, including defined benefit and defined
contribution plans. The budget would allow an annual benefit of $205,000
at age 62, resulting in a cap of $3.4 million at current interest

While there were few additional details, the Office of
Management and Budget estimates that the account cap would raise $9.3
billion over 10 years.

Derek B. Dorn, a partner in the Washington
law firm of Davis & Harman who represents plan sponsors and service
providers, cautioned against taking the ideas too lightly, since Mr.
Obama gave up some ground on other fiscal issues such as growth in
entitlement spending.

“The president stakes out some compromise  positions, so we should take this proposal more seriously than past
versions, which were often deemed dead on arrival,” said Mr. Dorn.

Mr. Obama’s top economic adviser, Gene Sperling, agreed, saying in a press
briefing that the budget package hits “a fiscal sweet spot” that shows
the country is serious about dealing with its fiscal problems.

The president’s proposed budget repeats many revenue-raising ideas familiar
to professionals in the retirement and investment industries.

Still, the package unveiled April 10 followed through on the theme of limiting
tax advantages for more affluent taxpayers. That was behind the call to
reduce the value of tax deductions, including retirement contributions,
to 28% of income.

ESOPs on the table

The budget proposal also eliminates the tax deduction for employee stock ownership plans, which drew some criticism.

“It’s baffling to hear the administration preach about creating jobs and then
take away a proven policy that sustains jobs,” J. Michael Keeling,
president of the ESOP Association, Washington, said in a statement.

The White House budget also proposes giving the Pension Benefit Guaranty
Corp. the authority to raise premiums to address its funding shortfall, a
change that Director Joshua Gotbaum has pushed since joining the PBGC
in 2010.

Another portion of the budget proposes a savings of $20
billion over 10 years by increasing the amount federal employees
contribute to their pension plan, the Federal Employees Retirement
System, Washington. People hired after 2012, who contribute 3.1% of pay,
would contribute an additional 1.2% over three years. Federal employees
hired before 2012 contribute 0.8%.

The budget also revives a proposal to eliminate the carried interest deduction paid by general
partners in private equity and other partnerships. Carried interest, the
president’s proposal said, “creates an unfair and inefficient tax
preference” for such partnerships, especially as that advantage has
grown in recent years. Private equity lobbyists said they were not
alarmed, given that the idea has become a perennial non-starter in

Recognizing a greatly expanded regulatory and
enforcement workload that includes oversight of investment advisers at
the Securities and Exchange Commission, the White House budget calls for
adding 676 staff positions, an increase of 15%, for examinations,
enforcement and risk-based oversight programs.

Calculating retirement income limits

Mr. Obama’s $205,000 annual retirement income limit is calculated
for someone age 62, to mirror the current IRS limit for qualified
defined benefit plan annuities. Current law prevents anyone getting a
benefit above that amount under a qualified defined benefit plan;
benefits above that level are paid from non-qualified plans and are
taxable. At today’s interest rates, a $205,000 annual benefit (for 100%
joint and survivor) works out to a maximum permitted accumulation of
$3.4 million, the administration calculates.

But when the interest rates used to determine those annuity levels start rising, the
$3.4 million cap can be much lower, and hit workers at an earlier age.

While the mechanics of adjusting for interest-rate changes would still need
to be worked out, Mr. Sperling defended the idea of a formula capping
retirement tax benefits. “Once you have an amount sufficient to retire
at that number, you shouldn’t get a tax break,” he told reporters.

But officials of organizations representing plan sponsors fear a monetary
cap will chill the incentive for employers to offer such plans,
especially small-business owners whose tax rates would also increase
under other provisions of the budget proposal. “I’m worried about who
will calculate the right amount you need, and that it lessens the
interest in a qualified plan,” said Lynn Dudley, senior vice president
of policy for the American Benefits Council in Washington.

There is also concern about how such a dollar-capped account would be
administered.The new approach requires plan sponsors and IRA trustees to
report each participant’s account balance at the end of the year, and
makes any excess contributions taxable as ordinary income. Investment
earnings and cost-of-living increases would be excluded from the

“It would certainly add another layer of complexity
on the part of the plan sponsor,” said Scott Macey, president and CEO
of the ERISA Industry Committee in Washington. “There are all types of
limits now. This is just an unnecessary burden. I’d hate to see us drive
retirement policy on a few aberrational situations.”

Worry over PBGC authority

Defined benefit plan groups were also unhappy with the White House
granting the PBGC the authority to set, and raise, premiums. Mr. Gotbaum
said in an e-mailed statement that without the change, “PBGC will be
faced with requesting a taxpayer bailout or shutting down.”

But Mr. Macey and others worry the change “puts too much discretionary authority” in the agency’s hands.

Despite their initial alarm at the White House proposals, advocates for pension
plan sponsors and service providers are confident that any public
consideration of the ideas will calm things down. The $3.4 million cap,
for example, “would have a hard time” gaining congressional approval,
said Ms. Dudley.

For attendees at the Defined Contribution Institutional Investment Association’s Washington meeting April 11, “the
clear consensus of the experts we heard from was that the direct and
unintended consequences of these proposals will take us in the wrong
direction in meeting the public policy imperative we face of getting
people to save more for retirement,” said Executive Director Lew Minsky.

Brian Graff, executive director and CEO of The American Society
of Pension Professionals & Actuaries, Arlington, Va., agreed that
the “outrageous” idea will lose steam under scrutiny. “I’m optimistic
that members of Congress will see this as an attack on small business,”
said Mr. Graff in an interview.

“From an administrative  standpoint, it’s a nightmare,” Ed Ferrigno, vice president of Washington
affairs for the Plan Sponsor Council of America, said in an interview.
“You don’t want to pit plan sponsors against the participants. This is
the philosophy of class warfare.”

Fiduciary Checklists for Monitoring Major Risks to 401(k) and Other Plan Investments

For nearly a decade, there has been an escalation in the fiduciary demands
— and personal liability risks — associated with the monitoring of
401(k) and other retirement plan investments.  Corporate officers and directors should consequently establish practical systems for tracking both the investment performance of plan assets, and
new developments in governmental regulation and ERISA litigation. The
best approaches that we see tend to center on quarterly meetings that
include reports from plan administrators, investment professionals, and
legal counsel.

Employer representatives nevertheless need to stay on guard; to not settle for
superficial assurances of sound operations. With that in mind, presented
below are two checklists focused on the monitoring of plan investments.
The first takes a macro view, itemizing common issues that warrant a
deeper dive for fiduciary understanding. The second relates solely to
target date funds, in order to assure attention to eight items that the
Department of Labor identified in a notice issued earlier this year.

Checklist #1: Plan Investment Issues to Consider

?   1.  Section 404(c) Compliance. Fiduciaries
of 401(k) and other defined contribution plans that have
participant-directed investments should verify that the plan satisfies
the requirements of Section 404(c) of ERISA.  If these requirements are
met, the plan’s fiduciaries will not be personally liable for . . . continued at ERISA 404(c) Safe Harbor.

? 2.  Excessive Fees, and Cost-saving Alternatives. Over
the past several years, there has been a proliferation of ERISA cases
alleging that plan fiduciaries paid unreasonably high fees for
investment funds that they offered for participant-directed investments.
See Excessive Fee Litigation. As
a result, plan fiduciaries should beware of and regularly review the
fees and expenses that the plan pays for its investments. See Fee Disclosure Rules. For one cost-saving alternative, see Separately-managed Accounts under Investments.

?   3.  Target Date Funds. The
Department of Labor has provided detailed “tips” that place plan
fiduciaries on notice about issues to address for any target date funds
within their 401(k) and other retirement plans. See “Checklist #2 below
for a link. Further discussion of diligence requirements, and relevant
litigation, at Target Date Funds.

?   4.  Stable Value Funds. Although
these funds are often described as “safe” investment choices for
participants, they typically consist of one or more fixed income
portfolios that a bank or insurance company provides through a “wrapped”
contract.  A stable value fund’s suitability as a “safe” investment
may, however, be undermined by (i) investments in mortgage-backed
securities and other toxic investments, (ii) securities lending by the
fund, with the consequent risks noted above, and (iii) any financial
distress that the current economic crisis causes for the insurance
company or bank that provides the wrap contract. More information at Fixed Income Investments.

?   5.  Money Market Funds. A
critical operational feature of money market funds involves maintaining
a share value of one dollar.  The 2008 financial crisis caused some
share values to risk falling below one dollar (so called “breaking the
buck”), with desperate measures resulting in the form of calls on the
plan sponsor for added plan contributions, and for the money market fund
manager to impose unexpected moratoriums on customer withdrawals (in
order to buy time for the dollar value to be re-established). More information at Fixed Income Investments.

?   6.  Employer Stock. Ever
since the Enron collapse over a decade ago, downturns in the value of
employer stock funds have been stirring “employer stock drop” litigation
against 401(k) and other defined contribution plan fiduciaries. Those
who serve as corporate executives and as plan administrators or trustees
face the greatest risks, because the information they receive as
executives opens the door for second-guessing about whether they
breached their ERISA loyalty and prudence rules. The litigation risks
are even greater for Employee Stock Ownership Plans, because executives
are often plan trustees and significant stockholders — with the power
to steer executive compensation in ways that can lead to conflicts of
interest. For further information, see Employer Stock Funds.

? 7.  Mortgage-Backed Securities.
Some fund managers became overexposed in collateralized debt
obligations or CDOs and other non-agency rated mortgage-backed
securities that are now illiquid and difficult to value.  Some of these
funds have fixed income or other investment objectives that could be
viewed by participants as inconsistent with this approach. More information at Investments.

  • 2013.Apr.03 Mere Investment Losses Insufficient for ERISA Claim. The decision in PBGC v. Morgan Stanley
    begins by explaining that “the complaint relies on the decline in the
    market price of mortgage-backed securities . . . to suggest a reasonable
    investor would have viewed those securities as imprudent investments.”
    The 2nd Circuit dismissed that ERISA claim. Further discussed at Investment Monitoring.

?   8.  Securities Lending.
Many mutual funds, collective trusts and investment managers of
separately managed accounts engage in securities lending.  Securities
lending involves he short-term loan of securities from a retirement plan
to short sellers and other borrowers in exchange for cash collateral.
The cash collateral is then invested in “safe” investments such as
Treasury bills and money market funds, with the goal of achieving a rate
of return that is split among the investment fund, the lending agent,
and the borrower.  However, losses can occur from this, and . . . continued at Investments.

? 9.  Fraud or Misconduct by Fund or Advisor.
The Bernard Madoff scandal showed that Ponzi Schemes and other
investment fraud may fool financially sophisticated individuals and
their professional investment advisors.  Plan fiduciaries should review
their plan investments to make sure that due diligence has been
performed that would detect fraud.  For example, custody of assets and
purported investment holdings should be independently verified.

? 10.  Mistakes and Misconduct by Employer’s Fiduciaries. See generally Failure to Monitor / Diversion of Assets / Misleading Communications (with plan participants).

ING to rebrand as VOYA in the next two years

ING announced yesterday that it will rebrand to Voya
in the next 20-24 months. As part of its bailout package in 2008, ING
was required to divest its North American holdings by the end of 2013.
While ING Direct was sold to Capital One, the company was granted an extension last November to divest the retirement and investment management group.

The announcement should help ING, since some advisors and plan
sponsors may have been reluctant to do business with them because of the
uncertainty. This may be especially true in the larger market, where
ING has a strong presence as a result of its CitiStreet acquisition.

The announcement of the new name takes ING one step closer to an IPO
as opposed to a potential sale to a competitor, which most experts
always thought was unlikely. The expected proceeds of $600 million from
the IPO is less than the rumored price
that ING paid for CitiStreet, but the company will exit the IPO process
as a top-three provider as measured by DC assets, plans and
participants — with a strong presence in the small and mega markets and
well positioned to descend on the mid-market. It also runs one of the
largest MEPs (in cooperation with the American Bar Association), and
works with a number of 403(b) and 457 plans.

Mutually owned providers like MassMutual may argue that their
structure is better for the DC market, which requires patience and
investments, but publicly traded companies have access to relatively
cheap capital.

The ING announcement and pending IPO is another major move by a
Hartford-based insurance company, following the sale of The Hartford’s
retirement division to MassMutual last year.

CFOs React to Auto-IRA Proposal in Obama’s Budget

•4/15/13 | Napanet
Lost in the great debate about President Obama’s
2014 budget, which would impose a $3 million limit on retirement
accounts, was a proposal to require small employers to offer an auto-IRA
for those not currently covered by a 401(k) plan.

CFOs generally support the proposal, which defines small employers as those with less than $20 million in annual revenue.

They do have some reservations, however, including:

• Increased costs and administrative work

• The perception that a worker’s pay is being reduced

• Liability for mistakes – who is the fiduciary?

• Lack of detail

While ERISA provides very specific guidelines about the role of the
employer, CFOs are concerned about whether they will be given sufficient
guidance. One CFO suggested that 401(k)s be improved — for example, by
creating a new tax credit for employers that offer investment education
to plan participants.

Firms Mislead Workers on 401(k) Rollovers: GAO

I have been telling employees this for years.  It’s simple – You cannot borrow against the money in your IRA, but you can in the 401(k).  For most employees under age 55 or so, that is normally their best option.  And nowadays, (especially my) clients are very conscious of fees, while many firms charge larger amounts for IRA’s. – Reeve Thursday, 4 Apr 2013 | 9:08 AM ET

Workers encounter confusion and
misleading information when they leave their jobs and roll over their
retirement money into individual retirement accounts, or IRAs, from
company-sponsored 401(k) plans, according to a report released on
Wednesday by the Government Accountability Office.

The  government watchdog did not name any of the firms where it found
misleading practices. Almost all U.S. workers shift money from 401(k)
accounts, administered by employers, into IRAs, which must be
individually overseen, when they leave a job even though other options
are permitted and may be more beneficial, the GAO said.

“The financial services industry spends substantial time and effort into
marketing IRAs that may not be in the best interests of account
holders,” Representative George Miller, Senator Tom Harkin and Senator
Bill Nelson said in a statement. The three Democrats requested that the
GAO research the rollover issue.

“This comes as no surprise since IRAs often come with higher costs when compared to a 401(k),” the three said.

Harkin is chairman of the Senate Committee on Health, Education, Labor
and Pensions; Nelson is chairman of the Senate Special Committee on
Aging; and Miller is chairman of the House Committee on Education and
the Workforce.

IRAs have become the key retirement savings
vehicle for individuals, small business owners, independent contractors
and any other worker not covered by a company-sponsored retirement plan.
401(k) plans, on the other hand, are funded by workers, who typically
receive matching funds from employers.

The GAO report said 401(k) plan service providers encourage customers to roll over money
into IRAs, but may offer little information about other options.
“During our investigator’s calls, about a third of call center
representatives of 401(k) plan service providers encouraged the caller
to roll over 401(k) plan savings from the ex-employer’s plan to the
service provider’s IRA products, and 12 did not mention the option to
leave money in the current plan,” the GAO said.

IRA assets totaled $5.1 trillion by mid-year 2012, accounting for 28 percent of
U.S. retirement assets, according to the Investment Company Institute in
Washington, D.C.

Multiple websites reviewed by the GAO also
showed that fee disclosure was located in small print in footnotes,
sometimes contradicting the main body of information.

“For example, one website stated in the main body of information on fees that
it had no fee for selling funds, but a footnote stated that the $49.95
fee would be charged on redemption of funds held for 90 days or less if
they were purchased through a proprietary service,” the GAO said.

In one rollover application, the schedule of fees was located in the last section of a 49-page supplement, the report said.

Rollovers have become the largest source of contributions to IRAs, the GAO said, citing ICI data.

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Reeve Conover is a Registered Representative. Securities offered through Cambridge Investment Research, Inc., a Broker/dealer member FINRA/SPIC. Cambridge and Conover Consulting are not affiliated. Licensed in SC, NC, NY, CT, NJ, and CA. - SIPC - Brokercheck