Compliance June 14, 2018

Reflections on a Dramatic Year for Retirement Plan Regulation

From the unexpected derailment of the DOL fiduciary rule to the expanding debate about so-called ‘open MEPs,’ your plan sponsor clients face a tremendous amount of uncertainty in 2018.
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On the opening day of the 2018 PLANSPONSOR National Conference in Washington, D.C., trusted Employee Retirement Income Security Act (ERISA) attorneys dove deep into the latest legislation, regulation and judicial actions affecting retirement plan sponsors and participants.

Closing out the first day’s panel discussions, conference attendees heard detailed commentary from David Levine, principal at Groom Law Group, and Jodi Epstein, a partner with Ivins, Phillips and Barker. The pair walked attendees through a laundry list of compliance concerns, starting with the implications of the Department of Labor (DOL) fiduciary rule being vacated by the 5th U.S. Circuit Court of Appeals. As Levine and Epstein explained, that decision threw a dramatic new element of confusion into the epic regulatory saga that has been the rollout of the fiduciary rule—crafted as it was by the Obama administration but left to the more or less opposite-minded Trump administration to implement.

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Levine and Epstein noted that, while some retirement plan advisers may be relieved to see the DOL fiduciary rule tossed aside by an appeals court, retirement plan sponsors now face the challenging and perplexing task of identifying what this unexpected reversal means for all of their various service provider relationships. The matter is made even more difficult considering the emerging effort at the Securities and Exchange Commission (SEC) to tackle some of the same issues through its own Regulation Best Interest. The SEC’s release of a thousand-page conflict of interest rulemaking package, applying to all brokers and investment advisers whether they serve retirement plans or retail clients, is being hailed as a victory by some and a deep disappointment by others; either way, it’s the start of another long chapter in the epic industry battle over federal conflict of interest regulations.

“Sponsors are naturally wondering, what are my service providers going to do?” Levine observed. “With the defeat of the DOL rule and the SEC potentially picking up the task of more aggressively policing conflicts of interest, they wonder, what does it all mean?”

At this interim stage there is not a whole lot of practical advice to give plan sponsors apart from urging them to take time to study and understand what each service provider is doing in terms of either taking on fiduciary status or avoiding it. The attorneys agreed it is especially important to do this analysis with respect to a plan’s recordkeeper, given that recordkeeping service models and compensation have shifted substantially in the last several years as the DOL fiduciary rulemaking unfolded. But it is also important to carefully run such an analysis when it comes to all of the other service providers touching the retirement plan—including for your services as the adviser.

Moving on to the topic of recent legislative changes that plan sponsor clients must consider, Epstein and Levine pointed to several key provisions embedded in the 2017 Tax Cuts and Jobs Act. For example, while the topic didn’t receive much attention during the debate and passage of the tax cut package, the law in fact made substantial changes to the safe harbor that surrounds participant hardship withdrawals.  

The two warned that the tax cut law also impacted the definition of compensation for the purposes of both defined contribution (DC) and defined benefit (DB) plans—so it will behoove plan sponsor clients to carefully check plan documents and ensure they understand how they define compensation as well as ensure they meet the requirements of the new tax law. Epstein pointed to the particular example that employees’ reimbursed moving expenses now count as compensation.

When it comes to the long list of examples of retirement reform legislation circulating around Congress, Epstein and Levine said they are most closely following the effort to expand access to so-called “open multiple employer plans,” or open MEPs. Both also warned that there is some increasing chatter on the Hill to the effect that another round of tax reform could be high on the agenda for the remainder of 2018—and, as a part of this, there could be another round of debate about the “Rothification” of the 401(k) plan industry.

Concluding the panel discussion, Epstein and Levine noted that the subject of missing participants has become a major focus of DOL and IRS audits in 2017 and 2018. Both said they have seen DOL and IRS auditors dive deep into plan sponsors’ stated policies and procedures for locating missing participants—and they very often find plan sponsors at fault for not making a good faith effort to locate them. The attorneys said it is absolutely crucial for plan sponsors to review their procedures for this topic and make sure they know what their recordkeeper and other service providers are doing, or perhaps more importantly, not doing.

“You need to have a process for finding beneficiaries, as well,” Levine pointed out. “We highly recommend rechecking your fiduciary breach insurance coverage, to see whether it covers this topic. In a phrase, it should.”

The Markets June 4, 2018

Roth Conversions Part of the Tax Diversification Tool Belt

Under IRS guidance, participants can select to convert their entire pre-tax balance or a portion of it; they often have a lot of questions about the right amount to convert, and when to make the move.
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Roth defined contribution (DC) retirement plan accounts have seen a surge in interest, especially with retirement plan sponsors, since their introduction in 2001.

According the 2017 PLANSPONSOR Defined Contribution Survey, 68.5% of plan sponsors offered Roth accounts in 2017, compared to 52.4% in 2013.

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The Economic Growth and Tax Relief Reconciliation Act of 2001 (EGTRRA) introduced Roth accounts to defined contribution plans. The accounts allow plan participants to contribute after-tax money to their savings on which they will owe no taxes on qualified distributions. The provision of Roth accounts was set to end in 2010, but the Pension Protection Act (PPA) in 2006 made the accounts permanent.

The Internal Revenue Service (IRS) issued guidance in 2010 allowing for participants to do an in-plan rollover, called conversions, of pre-tax accounts to Roth accounts upon a distributable event. But, in 2012, it expanded that ability to non-distributable amounts. The 2017 PLANSPONSOR Defined Contribution Survey found 41.2% of plan sponsors offered an in-plan Roth conversion.

“A Roth conversion involves taking assets that have been contributed on a pre-tax basis and just like it sounds, converting them into Roth dollars,” says Meghan Murphy, vice president of Fidelity Investments. “But, in the process, that means you have to take taxes within the year that you complete the conversion on that dollar amount.”

Participants can select to convert their entire pre-tax balance or a portion of it. According to Murphy, most participants will choose a specific dollar amount, in order to promote tax diversification in retirement. Additionally, Jana Steele, senior vice president and defined contribution consultant at Callan Associates, says taxes can play a part in considering the amount of money to convert.

“If you’re going to convert your entire balance, depending on what that balance is, [taxes] can be a significant amount,” she says.

Once participants complete a conversion, they are issued a record of the conversion amount to be included as income for that year, says Murphy. Going forward, dollars converted will be treated as Roth dollars in any earnings of that money, and as long as the cash remains invested for five years (meaning no distributions from the account can be taken), it will stay tax-free for retirement.

Roth DC plan accounts can serve as a notable benefit for participants within a lower tax bracket than they expect to be in the future, since these taxes would be paid now rather than higher taxes in years to come. Furthermore, Steele says smaller taxes are dependent upon legislation, including the recent joint Tax Reform bill reported in December of last year. 

“It depends how much legislation changes over the next couple of years, but the way the tax cut bill was written in December, the individual tax rates will increase over five years, which means that participants know they’re paying a lower tax rate now than in the future,” she says.

As the money grows within the Roth DC plan account, participants will need to be aware of its requirements. Whereas distributions for a Roth IRA can be made at any point, if participants want a penalty-free distribution from Roth DC plan accounts, there are specific requirements.

Steele explains, “In order to take a qualified distribution from a Roth, and take advantage from the tax efficiencies, you have to leave the money in the plan for at least five years, and you have to be older than 59 and a half.”

Considerations for plan sponsors

For those plan sponsors who are considering a Roth feature in their plan’s design, Steele says they must amend their plan document and update their summary plan description (SPD). She recommends implementing a strong education blast aimed towards participants, given the complicated benefit.

Even before adding the feature, Steele suggests plan sponsors run a “test” to understand its impact towards deferrals being made into the plan.

“We’d recommend doing a cost-analysis, or a cost review in order to understand if there’s going to be any implications to the actual cost to the plan, and if there are going to be any implications to [discrimination] testing from ongoing Roth contributions,” she says. Unlike other after-tax contributions made by participants, Roth contributions are included in the actual deferral percentage (ADP) test and not the actual contribution percentage (ACP) test.

Having an understanding about how conversions will impact the plan gives plan sponsors an idea about how to work the amendment, Steele says. Other considerations include available sources [of assets] for Roth in-plan conversions, timing of availability to convert amounts and what the recordkeeper can accomplish. The plan can permit amounts in pre-tax, match, after-tax and/or profit sharing accounts to be converted.

“Not all recordkeepers can administer the Roth in-plan conversions with the same degree of flexibility, so [plan sponsors] may be curtailed somewhat depending on who their recordkeeper is,” she says.

Murphy says that from a recordkeeping standpoint, plan sponsors should focus on the operational process associated with Roth, since it impacts taxes.

“We would always explain the process and how long it would take, for the most part, and we work with employers on communicating how it works with their employees,” she says. “We would want to develop a campaign where employees are aware of their options and that they’re getting the education they need to make the right decision for them.”

Educating participants about Roth accounts

Given its confusing nature of Roths—not only in the conversion process—Murphy recommends plan sponsors educate their employees about Roth as a whole. 

“Roth is one of those areas that we always advocate for more education,” she says. “Not only about Roth conversion, but Roth in general.”

Steele says that typically, plan sponsors would apply larger educational campaigns focused on displaying the features’ availability, explaining how it is used, and what it means. However, she believes applying personalization and customization tactics can influence greater impact.

“By providing the specific account balance or the different types of sources that the participant currently has in the plan, that helps the argument because it becomes a more intimate conversation rather than a less specific blast that doesn’t address the participants or their current needs,” she says.

Murphy agrees, adding that it all boils down to understanding participants’ needs.  

“A lot of it goes back to knowing your employees,” she says. “Targeting communications to people who may be interested. Getting the right message to the right person.”

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