ERISA Industry Stakeholders Analyze Auto-Portability Potential

Earlier this month, the U.S. Department of Labor (DOL) issued a notice of a proposed exemption from certain prohibited transaction restrictions of the Employee Retirement Income Security Act (ERISA) to Retirement Clearinghouse (RCH) for use of its auto-portability solution.

Explaining why it is proposing this exemption and calling for industry comments about the broader subject of auto-portability, the DOL says Section 4975(c)(1)(D) of the Internal Revenue Code prohibits a fiduciary from causing a plan to engage in a transaction, if he knows or should know that the transaction constitutes a direct or indirect transfer to, or use by or for the benefit of, a party in interest of any assets of a plan. The following Section 4975(c)(1)(E) of the Code prohibits a fiduciary with respect to a plan from dealing with the assets of the plan in its own interest or for its own account. Thus, without the exemption, RCH’s receipt of an additional fee in connection with transferring assets from a default IRA to an individual’s new plan account, without the individual’s affirmative consent, violates these Code sections.

While limited to RCH’s offering, the still-preliminary move from DOL quickly gained attention in the retirement plan industry, wherein the wider topic of automatic account portability has been touted as a primary way to reduce leakage from tax-qualified retirement savings accounts.

Interpretation from ERISA attorneys

In a client update examining the DOL proposal, attorneys with the Wagner Law Group note that the goals of an auto-portability program, generally speaking, are to rationalize individuals’ overall asset allocations by consolidating small retirement savings accounts, to do away with duplicative fees for small retirement savings accounts and to curb the leakage of savings from the tax-deferred retirement saving system.

According to the Wagner attorneys, it is important to keep this regulatory action in perspective. As they point out, the DOL exemption as proposed would ease some of the fiduciary burden around auto-portability, but it does not address the full set of fiduciary issues relating to decisions on the investment of assets rolled into a new employer’s plan, including application of the broader qualified default investment alternative (QDIA) regulations.

“The advisory opinion also did not address the prohibited transaction implications of RCH receiving additional fees as a result of exercising fiduciary discretion related to the transfers involved in the RCH program, with respect to which RCH was requesting an individual prohibited transaction exemption,” the attorneys say.  

The Wagner attorneys note that, even if this proposal takes effect, choosing to have a plan participant moved into the RCH Program is still very much a fiduciary decision. The decision must, therefore, be “prudent and solely in the interest of plan participants and beneficiaries.”

“The relevant plan fiduciaries must determine that the RCH program is a necessary service, a reasonable arrangement, and that the compensation paid to RCH is reasonable,” they say. “The responsible plan fiduciaries must also monitor the arrangement and ensure that the plan’s continued participation is consistent with ERISA’s standards. As a concrete illustration of this requirement, the DOL indicated that to the extent the RCH program is more costly than a default IRA program without the portability services, the adopting plan fiduciaries should consider whether the number of successful matches and account consolidation transfers to new employers through the use of the RCH program merit the additional expense of being part of the program.”

As the Wagner attorneys see it, with respect to the fiduciaries of the former employer’s plan, although they were fiduciaries in deciding to transfer accounts to the default IRA and participating in the RCH program, they would have no involvement or responsibility for the decision in individual cases to transfer IRA assets into a new employer plan.

“With respect to the fiduciaries of the new employer’s plan, although they would be responsible for determining whether the roll-in of assets from the default IRA is consistent with plan terms and for accepting the roll-in and allocating the assets to investment alternatives in the new plan, these actions do not cause the fiduciaries of the new employer’s plan to exercise fiduciary authority in connection with RCH’s separate decision to rollover the IRA assets into the new employer plan,” they say. “These conclusions by the DOL are consistent with the general proposition under ERISA that fiduciary status is not an ‘all or nothing’ proposition.”

An investment provider’s take

In an interview on the topic with PLANADVISER, Anne Lester, portfolio manager and head of retirement solutions for J.P. Morgan Asset Management, said this proposal from DOL is a “very welcome first step” with respect to improving retirement plan outcomes in the U.S. She expects the comments DOL will receive on the proposal will broadly be positive and will likely contain some fresh ideas about how to address the difficulty of conducting rollovers—whether from a plan to an IRA, from an IRA to another IRA, or from an IRA to a new plan.

“This is a welcome step because leakage is an enormous problem for the defined contribution plan industry and all its stakeholders,” Lester said. “The problem is coming to a head because we have an ever more transitory workforce in many industries. People are changing jobs more commonly, both by choice and not by choice. The problem is that, as the system is set up today, it’s typically much easier to either just leave the money or cash the money out and walk away, rather than to transfer it to an IRA or a new plan.”

Lester said she has direct personal experience with the portability challenge—having helped her husband conduct several rollovers. She also pointed to the time when, leaving her first job, she decided to cash out an $800 account.

“Frankly, my 25-year old self was stunned and appalled by the tax bill I received,” Lester recounted. “I didn’t really understand beforehand how significant are the excise taxes. Years later, when helping my husband conduct his rollovers, it was truly a confusing, white-knuckle experience to make sure we were checking all the necessary boxes and meeting all the deadlines. I say this as an executive in the retirement planning industry who works full time on these issues. So, clearly the portability system is not working as it should.”

Lester was quick to add that the current system is “not the result of anybody making a direct effort to make the rollover and portability system difficult.” Instead, the current system was more or less developed by accident and in quite the piecemeal fashion.

“Today we finally have an opportunity to make the system work better,” Lester said. “This is an area where automation can be so powerful, and where we have an obligation as providers to do better. We know that participants really want to do the right thing here, but they aren’t quite sure how to navigate the system. Given half a chance, they will be able to succeed.”

Auto-portability in context

Back in June, the Employee Benefit Research Institute (EBRI) issued a report that considers how auto-portability of retirement plans from one company to another would eliminate cash-outs, which are particularly common for plans with low balances. According to EBRI, if auto-portability were combined with the other features of the Automatic Retirement Plan Act of 2017, the overall package would reduce the retirement savings shortfall in the U.S. by an additional $287 billion, for a total reduction of $932 billion, or 22.6% of the total deficit.

“In other words, the analysis shows that while policies to expand retirement plan coverage can significantly impact aggregate savings shortfalls, initiatives to reduce plan leakage can materially augment such efforts,” EBRI says.

According to related research published by Callan, most plan sponsors (79.6%) have taken steps in the recent past to prevent plan leakage, but they have met only moderate success. Some of the more common strategies observed by Callan researchers include offering partial distributions and encouraging rollovers in from other qualified plans, which tied for the most common strategies cited by plan sponsors, both at 56%. Slightly more than half offer installment withdrawals, while nearly two-thirds anticipate taking additional steps to prevent plan leakage in the near-term—most notably, more actively seeking to retain terminated/retiree assets.

Jana Steele, senior vice president and researcher for Callan, says auto-portability is the next natural extension of plan design innovations from the past decade, including auto-enrollment, auto-escalation, and auto-investment allocation via target-date funds and managed accounts.

“These solutions seek to overcome behavioral barriers that impede retirement savings,” she says. “The proposed rule and further auto-portability guidance would allow plan sponsors to simplify their plan’s administration and fiduciary risk. At this stage, it is unclear what responsibility the plan sponsor would retain for data security and accurate processing. Further, auto-portability programs may be limited by recordkeepers’ willingness to share participants’ personally identifiable information with a third party and may also be hindered by administration and transfer fees.”