Compliance October 4, 2023

Will ESOPs Finally Get Regulatory Clarity?

SECURE 2.0 requires DOL to create rules for ESOP valuation.

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One of the key obstacles to the creation of employee stock ownership plans is the lack of clear rules from the Department of Labor on private stock valuation.

ESOPs are employer-sponsored, tax-advantaged and ERISA-governed plans that provide company shares as part of employee compensation.

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A report published by Matrix Global Advisors on Tuesday stated that regulatory uncertainty “has a chilling effect on investment and innovation” because it makes it difficult to “assess risk.” Without clear regulatory guidance on how private equity should be valued, ESOP sponsors rely on court judgments and DOL enforcement actions as guidance for stock appraisal.

In this context of ambiguity, ESOPs are vulnerable to lawsuits because there are no clear rules for pricing such stock. This increases costs and risks and deters potential ESOP sponsors, according to the report.

Alex Brill, a senior research fellow at the American Enterprise Institute and the author of the report, says, “I think the regulatory uncertainty around ESOP valuation is a significant impediment for the industry, the most pressing concern right now.”

Michael Kreps, a principal in Groom Law Group, explains that public stock can easily be valued because it has a market price. Private equity does not have that benefit, but the appraisal industry has its own standardized methods for determining prices.

Kreps says the lack of effective rules from the DOL leaves industry actors asking, “Will the regulators accept their methodologies” of appraisal? The challenge for ESOPs, Kreps continues, is that they need to figure out “what the DOL can live with.”

According to Kreps, the DOL proposed a valuation rule in 1998, but that process was abandoned. In the meantime, DOL has “preferred not to tell us” what methods should be used and instead has relied on an approach of “we know when we see it, and when we don’t like it, we will deal with it through litigation.” This approach has a “destabilizing” influence on ESOP sponsors, Kreps says.

He says a new rule from the DOL “needs to focus on substance. We need to move past procedure.” Kreps wants the DOL to describe how to value different interests, some of which can be difficult to appraise, such as “control and appreciation rights,” as well regulatory risks.

The SECURE 2.0 Act of 2022 requires the DOL to create regulations for ESOP valuation, but no deadline was set. Brill said he hopes for a proposal in early 2024, and Kreps adds employee ownership has been a high priority for the administration of President Joe Biden, but he is unsure of when to expect a proposal.

Data & Research October 4, 2023

Americans Underestimate Health Care Costs’ Impact on Retirement Decisions

Health savings accounts and cash flow from annuities can help mitigate too-rosy thinking, says retirement income association fellow.

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Many Americans underestimate the impact of health care costs and the challenges on their retirement savings, according to recent research from the Alliance for Lifetime Income and Cannex Financial Exchanges Ltd.

The issue is particularly important as the U.S. reaches Peak 65 next year, when the country will have its greatest number in history of people turning 65, according to the Alliance and Cannex, which does pricing and analytics for annuities and bank products. Currently, on average, more than 10,000 people in the U.S. turn 65 every day, and that will increase to 12,000 per day in 2024.

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The joint Protected Retirement Income and Planning Study released in September found that 84% of working Americans do not expect health reasons to be in their top three reasons for retiring. That may be optimistic, however, as 38% of retired Americans ages 45 to 75 named health as the reason they or a loved one retired, the Alliance and Cannex found.

That reality could bring an unexpected shock to the retirement saving plans and outcomes of workers. But solutions do exist, according to Jae Oh, an education fellow at the Alliance for Lifetime Income’s Retirement Institute and author of “Maximize Your Medicare.”

Health savings accounts are one key vehicle to prepare both for unexpected health costs and retirement planning, Oh says. These vehicles provide “multiple advantages” for both retirement and health care, he notes, including:

  • Contributions to an HSA account are tax-deductible at the time of deposit;
  • There are catch-up provisions for people aged 55 and older;
  • The funds can be invested in mutual funds, depending on the operating bank; and
  • Withdrawals are tax-free, as long as money is used on qualified health expenses as defined by the IRS (Publication 502), notably including Medicare Part B premiums and long-term care insurance premiums.

Use With Care

Oh does note that “caution is required if a person works beyond 65, enrolls in Medicare Part A and continues to work with employer-sponsored health insurance that includes an HSA contribution.” In that case, “no contributions can be made while enrolled in any part of Medicare, and there is a Part A look-back feature, which will set the Part A coverage date six months prior to application if the person applies for Medicare at any point after reaching 65.5 years old. Exceeding the annual contribution limit will result in a tax violation.”

For anyone using an HSA, Oh emphasizes, it is important to work with a human resources expert or a financial planner to consider its uses both prior to and during retirement. Employees also sometimes confuse HSAs with health reimbursement arrangements or flexible spending accounts, so care should be taken in employer communications.

That said, an HSA is a particularly strong option because it is not a “use it or lose it” investment vehicle, Oh notes. “In fact, an HSA is a bank account, owned privately by the employee,” he says.

The House Committee on Ways and Means is working to pass legislation that would expand eligibility for HSAs, along with raising contribution limits. Two related bills are pending vote in the full House of Representatives.

A recent report by financial services firm Voya found that knowledge about HSAs is still lacking among employees. The study, which compared employee HSA knowledge from 2020 with that found in 2023, found that general understanding of the savings vehicles showed no discernable increase.

Annuities, Too

The Alliance and Cannex also pointed to annuities as a way to shore up retirement income, even in the face of health care costs. The researchers noted that 97% of consumers say that having guaranteed lifetime income in addition to Social Security is valuable, but only 43% of people between the ages of 45 and 75 have protected income through a pension or annuity.

Oh notes that annuities are a benefit in providing guaranteed cash flow, and they are also potential tax advantages that could lower the cost of health insurance.

When using an annuity, “not all of the cash is taxed due to the exclusion ratio,” he says. “The result is that a person could qualify for the Advance Premium Tax Credit under the Affordable Care Act or possibly avoid higher Medicare IRMAA surcharges, depending on the household’s modified adjusted gross income (which is slightly different for health insurance calculations).”

“Second, many deferred annuities have features in which a guaranteed lifetime income rider includes an enhanced income level, for certain periods, if a person cannot fulfill the required number of activities of daily living,” he continues.

An annuity is also valuable, according to the research report, in managing the potential for cognitive decline, during which wealth management can become complicated. The researchers found that only 8% of soon-to-be-retired or retired consumers who work with a financial professional regularly talk with their adviser about the possibility of cognitive decline.

“Financial professionals should discuss health, including cognitive decline, and the important role that protected income can play to help manage the various health-related risks Peak 65ers could face in retirement,” Jean Statler, CEO of the Alliance for Lifetime Income, said in a statement accompanying the report. “Start these conversations now to protect your clients and their families.”

The Alliance for Lifetime Income and Cannex surveyed 2,507 consumers in the U.S. ages 45 to 75 and 519 financial professionals who conduct retirement planning for individual clients.

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