Marcia S. Wagner, Esq.

IMPORTANT PENSION CHANGES –

WASHINGTON & REGULATORY UPDATE

Transformation of Retirement System

DOL Interaction with White House◦ Working with White House’s Middle Class Task Force◦ Coordinated actions to improve retirement security

DOL rollouts in 2012 & 2013:◦ Fee disclosures for plan sponsors◦ Participant-level fee disclosures

New 6-month reset of annual disclosure date◦ Participant investment advice

2014 / 2015 DOL regulatory initiatives include:◦ Tips on selection of target date funds◦ Inclusion of lifetime income streams in benefit statements

Global Impact of ACA & Tax Reform Purposes.◦ Unforeseen changes to retirement system

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Introduction

1. Target Date Funds2. Lifetime Income Initiative3. Tax and Healthcare

Reform

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Background on Target Date Funds

Popular default investment vehicle for 401(k) plans. Typically, formed as open-end investment

companies registered under Investment Co. Act.Defining characteristic – “glide path” which

determines overall asset mix of fund.Performance issues in 2008 raise concerns,

especially for near-term TDFs.

◦Based on SEC analysis, average loss for TDFs with 2010 target date: -25%.

◦ Individual TDF losses as high as: -41%.

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DOL Tips for Selecting a TDF

Start process by examining TDF prospectus

Identify Plan objectives◦ Preservation of savings◦ Maximizing income◦ Stable retirement spending

Relate TDF characteristics to plan objectives◦ Investment performance◦ Fees & expenses◦ Glidepath◦ Landing point

Document decision-making process

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Understanding the Glidepath and Landing Point Determine Fund’s relative allocation to equities and

fixed income investments◦ Starting point◦ Landing Point

Determine rate of conversion

“To” or “Through” investment philosophy◦ Significant equity allocation through death matches plan

with gradual withdrawal pattern◦ Most conservative fixed income position at landing point

matches plan where most participants cash out at retirement

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Consideration of Demographic Factors in Selecting a TDFConsider alignment of TDF with the

following factors:

• Withdrawal patterns

• Participant ages and likely retirement dates

• Participation in DB plan

• Salary levels

• Turnover rates

• Contribution rates

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TDF Investment Strategy

Identify TDF asset classes other than equity & fixed◦ Real estate with capacity to address inflation risk◦ Commodities◦ Inflation-adjusted bonds (TIPS)◦ Cash

Know investment style◦ Passively vs. actively managed◦ Impact on fees

Understand investment form◦ Mutual funds◦ ETFs◦ Collective trust◦ Separately managed account

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Customized Target Date Funds

Advantages of custom TDF◦ Incorporation of plan’s core funds◦ Inclusion/exclusion of specialized asset classes◦Broader asset diversification◦Diversifying exposure to investment providers◦ Improved investment performance◦ Flexible glidepath design◦Elimination of tiered mutual fund fees

Disadvantage◦Generally higher fees

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Monitoring TDF Modifications & PerformanceERISA prudent process requires periodically

monitoring TDF characteristics◦ Management team◦ Investment strategy◦ Effective implementation of strategy

Periodically review whether TDF continues to meet plan objectives and demographics

TDF changes or mismatch may require replacing fund

Check underlying funds/investments

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Employee Communications for TDFs

Participant-level disclosure requires annual comparative chart and disclosure of plan-related fees

DOL proposed enhancement to comparative chart requires appendix for TDFs◦ Explanation & graphic illustration of TDF glidepath

◦ Relevance of date in TDF name (e.g., 2030)

◦ Statement that TDF may lose money near or after retirement

DOL proposed change to QDIA notice◦ Same as required on appendix to comparative chart

◦ TDF investment objectives and principal strategies

◦ Assets held by TDF/QDIA and historical investment performance

◦ Disclaimer as to performance

No DOL model notice

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Target Date Fund – Role of Advisors

Provide meaningful TDF disclosures to participants as “best practice” right now◦Explain key information

Glidepath Landing point Potential volatility

Facilitate sponsor’s prudent review of TDF◦Assist in fiduciary review of glidepath, tiered

funds structure, underlying funds & risk Special review of TDFs with near-term (2015) target date

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1. Target Date Funds2. Lifetime Income Initiative3. Tax and Healthcare

Reform

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Goals of Policymakers

Help retirees take plan distributions without outliving them◦ Motivate retirees to annuitize accounts◦ Retirement paycheck for life

Encourage plan sponsors to voluntarily offer annuity options◦ Permit longevity annuities◦ Remove regulatory hurdles◦ Facilitate default annuities◦ Promote education and disclosures

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Lifetime Income Solutions for DC Plans

Three Basic Approaches1) External Solution (Outside of Plan) 2) Distribution Option Within Plan 3) Investment Vehicle Within Plan

External Solution• Participants purchase IRA Annuities.• Annuitization occurs outside of plan through rollovers.• Internet portals can improve participant access.

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“In Plan” Lifetime Income Solutions

Distribution Option Within Plan• Plan purchases Distribution Annuities• Immediate annuity purchased at time of distribution• Annuity contract is distributed to participant

Investment Vehicle Within Plan◦ Plan invests in Group Annuity◦ Offers various investment and distribution options◦ Participant’s account converted to lifetime income

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Comparison of Retirement Income Strategies

Guaranteed Access to

Cash Income? In Retirement?

Systematic Withdrawals No Yes

Managed Payout No Yes

Distribution Annuities Yes No

Group Annuity (Traditional) Yes No

Longevity Insurance Partial Partial

GLWB (Group Annuity) Yes Yes

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Guaranteed Living Withdrawal Benefit (GLWB)Guaranteed Withdrawal

Guaranteed percentage of “Benefit Base” may be withdrawn annually during retirement years.

Guarantee takes effect when account’s investment value is insufficient to cover guaranteed withdrawals.

Benefit Base Initial value is based on contributions.Future value may “roll up” by fixed percentage

each year, or “step up” based on anniversary value of account.

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Need for Additional Fiduciary GuidanceSelection of Annuity Provider and

Annuities Subject to ERISA fiduciary standards. Must act in accordance with duty of prudence and

loyalty.

Existing DOL Guidance 1995 guidance on Distribution Annuities for DB plans. 2008 safe harbor on Distribution Annuities for DC plans. No clear guidance on other annuities for DC plans.

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Current Fiduciary Standard for AnnuitiesDC Plans and Lifetime Income

Lack of clear guidance has not stopped DC plan sponsors (e.g., United Technologies adds GLWB annuity option)

Selection of Annuity Provider and Annuities• Subject to ERISA fiduciary standards.• Act in accordance with duties of prudence and loyalty• 2008 DOL safe harbor on Distribution Annuities for DC plans:

1. Procedural prudence 2. Insurer’s ability to pay2. Cost 4. Draw appropriate

conclusions 5. Seek expert advice

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First Step in Annuity Selection(Procedural Prudence)Engaging in Objective, Analytical Process

Prudence of fiduciary act is based on processMust conduct appropriate investigation of annuity

investment

Documentation of Selection ProcessMaintain minutes of fiduciary reviewsRecords for ongoing monitoring

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2nd Step for Annuity Selection(Insurer’s Ability to Pay)Obtaining Sufficient Information

Insurer’s experience and expertise Level of capitalRatingsContract’s structure and benefit guaranteesProtection through state guaranty associations

DOL ProposalProposed amendment to DOL safe harbor

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3rd & 4th Steps for Annuity Selection(Cost and Appropriate Conclusions)

Considering Annuity’s CostCost considered in relation to benefits and services.Evaluate fees, commissions and other charges.No requirement to select cheapest annuity.

Drawing Informed ConclusionsConclude insurer will be able to make future

payments.Conclude annuity’s cost is reasonable.

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5th Step for Annuity Selection(Seeking Expert Advice)Necessity of Hiring Expert

Must hire expert if plan fiduciary cannot properly evaluate annuity providers, contracts and costs.

Procedure for Hiring Insurance Advisor Investigate advisor’s qualifications. Identify advisor’s compensation.Provide complete information to advisor.Ensure reliance on advisor’s advice is reasonable.

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Removing Regulatory Obstacles to Annuity Distributions

Rollovers to DB Plans◦Rev. Rul. 2012-4.◦ 401(k) accounts may be rolled over and

converted to DB plan annuity benefits◦Provides favorable annuity rates for participants

Relief for DC Plans With Deferred Annuities◦Rev. Rul. 2012-3◦Ruling confirms 401(k) plans with deferred

annuities can avoid onerous death benefit rules

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Promoting Longevity Annuities

New IRS regulation relaxes required minimum distribution rules◦RMD rules mandate start at age 70 ½ but

longevity annuities provide income stream for later in life

Final Regulation provides:◦RMD exception for investment in QLAC◦ Investment in QLAC capped at $125,000 or 25%

of account◦QLAC payments to start no later than age 85◦Applies to annuity purchases on/after July 2,

2014

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Default Annuities

Should annuity option be default for plan?

Possible Approach: Amend QDIA Rules◦Permit annuity option to qualify as QDIA.◦Critics argue annuities not appropriate for all.◦Default annuity investments not easily reversed.

Possible Approach: 2-Year Trial Period◦Retirees receive annuity during trial period

(unless opt out).

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Education and Disclosures for Participants

GAO Recommendations◦Update DOL’s “investment education” guidance

to cover decumulation◦But DOL is concerned about conflicts◦Guidance likely to restrict sales pitches

Lifetime Income Disclosure Act◦Plan to show account balances converted into

guaranteed monthly amount◦Encourages participants to think about retirement

paycheck for life

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DOL Proposal for Lifetime Income Disclosures

Advance Notice of Proposed Rulemaking Lifetime income illustration in participant statements Must provide estimated income streams based on

(1) current account and (2) projected account at NRA

Safe Harbor for Projected Account Assume 7% investment return Assume current contribution level, with 3% increase Use 3% discount rate to convert to current dollars

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Lifetime Income Illustration

• Illustration for 50-Year Old Participant

Account Estimated Monthly

Balance Lifetime Payment

Current Account (2014) $125,000.00 $ 700.00

Projected Amount (2029) $500,000.00

Projected Account (Current Dollars) $321,000.00 $1,800.00

● Required Disclosures/Disclaimers - Explanation of assumptions - Estimates are not benefit guarantees

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1. Target Date Funds2. Lifetime Income Initiative3. Tax and Healthcare

Reform

31

Administration Initiatives to Increase Retirement Savings Through IRAsAdministration pushing automatic IRAs featuring:◦ 3% default contribution rate◦ Choice of traditional pre-tax IRA or after-tax Roth◦ Multiple alternatives for selecting IRA provider◦ Government designated default investments

MyRA Initiative◦ Starter program does not require legislative

authorization◦ Contributions to Roth accounts◦ Permits small investments ($25 / $5)◦ Low rate of return from Treasury bonds◦ Maximum $15,000 balance

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Limiting Tax Cost of Retirement Plans

Impact of retirement plans on federal deficit◦DC / 401(k)

• $61 billion (2015)

• $414 billion (2015 – 2019)

◦ DB

• $42 billion (2015) • 235 billion (2015 – 2019)

Tax reform Pension system reform

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Limiting Contributions & Benefits

• 2014 Plan limitations that can be reduced to limit deficit:

◦ Annual additions from all sources - $52,000

◦ Elective deferrals - $17,500

◦ Plan sponsor deduction - 25% participant compensation

◦ Compensation limit to determine benefits/contributions - $260,000

• Proposed Tax Reform Act of 2014

− Freezes DC limits until 2024 ‒ $63.4 billion revenue gain over 10 years ‒ Additional $144 billion from treating half of 401(k) deferrals as Roth

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Administration Tax Proposals

Obama FY 2015 proposed $3.2 million cap on aggregate lifetime contributions

• Cap to vary based on age. • Double tax if prohibited amount not withdrawn

Obama proposal limiting tax deductions for plan contributions

• 11.6% tax on employer & employee plan contributions - High earners only - Basis adjustment for extra tax

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Pension System Reform - Federal LevelUSA Retirement Funds

• USA Retirement Funds proposed by Sen. Tom Harkin in 2014

Harkin “report” in July 2012 proposes new retirement system - Automatic/universal enrollment required by employers with no plan- Regular stream of income starting at retirement age- No lump sum withdrawals- Financed by employee payroll contributions & government credits- Privately managed investment by new entities: USA Retirement Funds- Limited employer involvement; no fiduciary responsibility

- Unspecified level of required employer contributions. - Employees can increase/decrease contributions or opt out.

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Pension System Reform – State Proposals State-managed plans for private-sector workers◦ Intended to expand access to retirement saving◦ States would mange investments

California Secure Choice◦ Mandatory auto-IRA◦ Pooled investments managed by state and

guaranteed returnsNCPERS Proposal◦ State managed investment and guaranteed returns◦ Exposure to lifetime benefit obligation

Backstopped by taxpayers

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Summing Up Significant Transformation of Private Retirement System

Possible.

Tax Reform.

• Reducing tax incentives will shrink system.

° Lower contributions at all income levels result if tax exclusions cut back.

• Obama proposal for general limit on benefit from tax exclusions.

° Does not focus directly on 401(k) contributions.

° Provides political cover.

° Same effect on contributions as direct cutback on excludible amount

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Summing Up (cont’d)− Systemic Changes • Intended to create access for low-wage employees

• Government will replace private employers in system °Mandated benefits °Guaranteed benefits and/or investment results °Creation of new interest group to lobby for expansion of benefits

°Government influence in choosing investment managers or control of investments could drive many out of the retirement industry.

• State-level programs may cause breakdown in uniformity of pension laws, effective since enactment of ERISA

• Inflection Point regarding the types of Retirement Schemes Nation wants and needs

• Interesting Times ……

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Effect of PPACA on Employees Earlier plan distributions, because employees will not be

tied to their jobs in order to maintain health insurance◦ New investment and liquidity strategies needed

Older generation of workers to be replaced more quickly by younger less experienced employees◦ Lower salaries will result in smaller plan contributions

◦ Some industries could experience higher pay and larger contributions

◦ New generation will be less vested making plans less expensive

Low-paid workers will choose health insurance over 401(k) contributions◦ ADP/ACP problems and issues with discrimination testing may

result

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Effect of PPACA on Employers

PPACA-mandated healthcare benefits likely to reduce level of employer support for 401(k) plans◦ Knock on effect of smaller match; smaller employee contributions◦ Shrinking employee contributions exacerbates discrimination

issues

PPACA disincentive to maintain 401(k) plan◦ $3000 per head penalty for unaffordable health insurance avoided if

cost of single-person coverage not in excess of 9.5% W-2 wages◦ 401(k) reduction of wages makes avoiding penalty harder

PPA 90-day rule for health plan availability can compromise overall plan administration◦ Delay greater than 90 days for entry into all benefit plans no

longer possible◦ May necessitate enrollment at different times

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PPACA Effect on Retirement Industry

Increased competition in healthcare marketplace◦ Government-regulated exchanges

◦ Reduced brokers’ commissions

◦ Potential expansion of healthcare brokers into retirement plan industry

New legislatively-mandated retirement plan models◦ Reduces/eliminates role of employer

◦ Marketing focus redirected to employees

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Marcia S. Wagner, Esq.

99 Summer Street, 13th FloorBoston, Massachusetts 02110

Tel: (617) 357-5200 Fax: (617) 357-5250 Website: www.wagnerlawgroup.com

marcia@wagnerlawgroup.com

A0128703.PPTX

IMPORTANT PENSION CHANGES−

WASHINGTON & REGULATORY UPDATE