By Jason Hammersla, Director of Communications, American Benefits Council
The congressional elections of 2010, and the resulting Republican takeover of the U.S. House of Representatives, represented a political "re-set." The newly divided Congress creates an entirely new legislative dynamic, while President Obama has been forced to move toward the center.
Domestic policy priorities have changed, as lawmakers pivot sharply from aggressive reform of social and financial institutions to a broader discussion of deficit relief and economic recovery. As outlined in President Obama’s Fiscal Year 2012 budget proposal, this new agenda is expected to encompass debate over deep spending cuts, revisions to the tax code and targeted investment in business.
Economic, Fiscal and Tax Policy
Retirement benefits policy is, of course, a key element of this debate. As we witnessed in late 2008, the health of workplace and pension and savings plans is tied directly to the health of our financial markets: The market calamity in late 2008 resulted in significant volatility both with respect to 401(k) plans, whose participants saw enormous swings in their account values, and in pension funding liabilities, placing intense financial pressure on many plan sponsors.
The concern over the impact of the market and public policy surrounding retirement plan assets is a testament to the size and success of the retirement system. According to the Federal Reserve, at the end of 2010, assets in traditional defined benefit pension plans provided more than $2 trillion in investment capital, while assets in defined contribution arrangements, like 401(k) plans, accounted for more than $3.5 trillion. Individual Retirement Accounts represent more than $4 trillion in financial assets.
Just as retirement savings programs generate substantial investment capital for the economy at large, these programs are fueled by popular and effective tax incentives. The Congressional Budget Office estimates the tax deferral for contributions to defined contribution plans is projected to cost $356 billion in federal tax revenue over the next five years (the fourth largest tax expenditure over that period) and the tax exclusion for employer contributions to defined benefit plans is projected to cost $249 billion (10th largest) over the same period. No matter how successful these retirement incentives have been, their significant price tags make them an easy target.
So the question becomes: Are the tax incentives and related benefits set to appropriately support and encourage savings for retirement? For example, if lawmakers were to set a lower flat tax rate for most people but change the 401(k) or pension tax benefits, will workers and employers still save? Will they save more? Will employers offer the same plan?
The defined contribution plan system has been unquestionably popular with plan participants and plan sponsors. Nevertheless, some academic experts have recently argued the current tax incentive system is not the optimal structure, suggesting after-tax contributions, paired with a tax credit, and capped at a dollar amount or on a percentage basis, would work better than the current system of exclusions and deductions.
The president’s blue-ribbon National Commission on Fiscal Responsibility and Reform, in its final report, released in December, recommended all retirement accounts be "consolidated," although the precise meaning of that recommendation was left unclear. Specifically, the panel suggested limiting tax-preferred contributions to the lower of $20,000 or 20 percent of income, although it is not clear which retirement plans would be subject to this new cap or whether it would apply to employer contributions. Ultimately, the commission’s report failed to achieve the necessary supermajority required to formally transmit the recommendations to Congress. Of course, the president or other lawmakers may choose to take up some of the report’s proposals individually.
Defined Contribution Plan Reforms
In the absence of wholesale defined contribution plan reform, we can expect continued legislative efforts targeting smaller, individual elements of these plans.
For several years, lawmakers have offered solutions to what some perceive as excessive plan fees charged by service providers to plan sponsors and participants. Policymakers are pursuing efforts to strengthen the responsibilities of fiduciaries that began with Representative George Miller’s 401(k) fee disclosure legislation and the U.S. Department of Labor (DOL) regulations, both with respect to service provider to plan sponsor disclosure requirements and, most recently, requirements related to disclosures directly to plan participants. One of the most notable changes, still in the implementation stages, is the provision of information about plan investments in a chart that is intended to facilitate participant understanding in the allocation of plan assets. DOL officials still are grappling with a number of questions arising on how and what information should be displayed. This effort has expanded to include the proposal of a new definition of “fiduciary.”
Even while there is ongoing debate over the definition of a fiduciary, that will inevitably affect the provision of investment advice to plans and participants, the business community is still awaiting final resolution of DOL’s guidance on investment advice under the Pension Protection Act of 2006 (PPA). A year ago, the department proposed regulations clarifying the exemption from ERISA’s prohibited transaction provisions to allow plan fiduciaries to give investment advice to 401(k) plan participants through the use of a certified computer model or through an adviser compensated on a level-fee basis.
The next retirement plan priority for DOL is an examination of “lifetime income options,” annuities or other arrangements designed to provide a stream of income through retirement. Together with the U.S. Treasury Department, the agencies gathered comments and testimony throughout 2010 and may propose rules in 2011. Congress also is exploring this area, with Senators Jeff Bingaman (D-NM), Johnny Isakson (R-Ga) and Herbert Kohl (D-Wis), reintroducing the Lifetime Income Disclosure Act. This bill requires 401(k) plan sponsors to inform participating workers of the projected monthly income they could expect at retirement based on their current account balance.
Another area consistent with the DOL interest in fiduciary responsibility is the growing market for target-date funds. In October 2010 testimony before Congress, Assistant Secretary of Labor for the Employee Benefits Security Administration, Phyllis C. Borzi, indicated “these funds should be closely reviewed to help ensure that employers that offer them as part of 401(k) plans can better evaluate their suitability for their workforce and that workers have access to good choices in saving for retirement and receive clear disclosures about the risk of loss.”
DOL issued proposed rules late in 2010, following the issuance of proposed rules by the Securities and Exchange Commission (SEC), addressing advertising and marketing of these funds. Sen. Kohl, as chairman of the Senate Special Aging Committee, also expressed interest in the matter, soliciting testimony from DOL and SEC officials.
Defined Benefit Funding Relief
Lawmakers have been focused more on refining the defined contribution plan system, as it has taken over as the primary retirement savings vehicle for most current American workers. Over the last three decades, the number of traditional pension plans has dwindled from more than 148,000 to fewer than 50,000.
Beginning in 2008, the proverbial “perfect storm” of declining asset values, low interest rates and new PPA funding rules artificially inflated companies’ defined benefit pension obligations. Millions of dollars, earmarked for job creation and capital investment, were consequently diverted to healthy pension funds.
In mid-2010, Congress enacted temporary funding relief for employer plan years 2008 through 2011. However, technical corrections to the measure have yet to be approved, and because interest rates have remained stagnant, the specter of an even more disturbing funding crunch looms in 2012. Not only will another temporary funding relief measure be necessary to promote new job growth, but if the defined benefit pension system is to be preserved, it will be essential for lawmakers to decisively address the persistent volatility and unpredictability of defined pension funding.
As if the other challenges were not sufficient, defined benefit plans also are not immune from the federal deficit problems. President Obama’s budget proposal – taking a page from the bipartisan deficit commission – included a recommendation that after a two-year study period, the Pension Benefit Guaranty Corporation (PBGC) be able to set unilateral premium rates. The exact details of this plan have yet to be revealed, but the new approach would, in part, be related to a plan sponsor’s overall creditworthiness – not simply its defined benefit plan’s funded status.
Off Capitol Hill, in late 2010, the Financial Accounting Standards Board (FASB, the designated private sector organization establishing standards for financial accounting and reporting) issued an exposure draft proposing new financial reporting disclosure rules for entities that participate in multiemployer pension and other postretirement benefit plans, including retiree medical plans. The proposal substantially increases reporting requirements for plan sponsors, mandating immediate accounting for all estimated changes in the cost of providing these benefits and all changes in the value of plan assets. This is a new presentation approach that would clearly distinguish between different components of the cost of these benefits and clearer disclosure about the risks arising from defined benefit plans. This exposure draft was part of FASB’s ongoing effort to converge U.S. and International Accounting Standards. At some point over the next decade, the SEC is expected to adopt international accounting standards for use by U.S.-based companies.
For years, the one bright light remaining in the defined benefit plan world has been hybrid plans – arrangements that combine features of defined benefit and defined contribution plans. After more than a decade, the IRS released final and proposed regulations for hybrid plans pursuant to new language in the PPA. The agency is expected within a year to finalize the proposed regulations, which focus on a hybrid plan’s permitted “market rate of return” assumptions.
Perhaps the most significant pension policy development in 2010 was not even included in legislation that primarily dealt with pensions. The Dodd-Frank Wall Street Reform and Consumer Protection Act, the landmark financial services regulation bill, mandated extensive new rules for accountability in the derivatives market, including regulation of over-the-counter “swaps” transactions. However, this has significant implications for retirement security.
Employer sponsors of pension plans use swaps to mitigate risk and reduce the volatility of the plan funding obligations, but hurried rulemaking by the Commodity Futures Trading Commission (CFTC) has failed to account fully for defined benefit plan activity, adding new layers of legal complexity to formerly innocuous transactions. If plans’ ability to hedge effectively with swaps is curtailed by the new rules, funding obligations will become more volatile. This – like the aforementioned funding crunch – will force many employers to reserve large amounts of cash to cover possible funding obligations, diverting cash from critical job retention, business growth projects and future pension benefits.
Other Issues
Perhaps the most serious threat to our voluntary, employment-based retirement system is not legislation addressing the plans themselves but, well-intentioned, yet problematic scrutiny of plan sponsors and their corresponding fiduciary duty.
In October 2010, DOL proposed regulations that significantly expand the definition of the term "fiduciary" with respect to investment-related advice provided in conjunction with defined benefit pension plans, defined contribution plans or other individual retirement accounts. The proposal is designed to protect participants from conflicts of interest and self-dealing by giving a more broad and clear understanding of when persons providing such advice are subject to ERISA’s fiduciary standards. As DOL moves toward finalization of these regulations, the challenge will be how to facilitate participant education and engagement with respect to effective investment strategies, while at the same time protecting participants from misleading self-interested advice. And, more broadly, what will be the implications for these new rules with respect to other kinds of plans and elements of those plans?
More specifically, we are likely to see renewed efforts to amend the nondiscrimination rules. Lawmakers already have begun circulating proposed legislative concepts directing the Secretary of the Treasury to review the current retirement plan nondiscrimination rules under the tax code and modify the regulations to address perceived disparities between highly-compensated and non-highly-compensated employees. Such legislation would call on the Treasury Department to modify the interest rate used for purposes of “cross-testing” defined contribution plans or to scrutinize certain executive compensation arrangements like Qualified Supplemental Executive Retirement Plans (QSERPs). Possible remedies include revising the treatment of part-time employees under the coverage rules, so certain part-time employees are treated as a fraction of an employee for testing purposes. This provision, aimed at certain abusive practices, could impose significant burdens on many employers not engaging in such practices. Because it could be viewed as a way to squeeze additional revenue at the expense of highly-compensated individuals, it may receive more bipartisan support in the current legislative and political environment.
The Coming Year
The “re-set” of the new legislative dynamic could be a formula for gridlock, or it could be an opportunity to seriously address these challenges. The decisive question will be, as always: How much of a role should the federal government play in providing the financial security of its citizens?
The prominence of retirement benefits in the federal budget means these issues will be “in play” as Congress examines changes to the budget and the tax code. This leads us to an equally important question: What kind of role should employers play in providing for the financial security of its workers? Stakeholders in the voluntary, employer-sponsored system should be prepared for a complicated answer.
About the Author:
Jason Hammersla is the director of communications for the American Benefits Council, a trade association based in Washington, D.C. representing primarily 
Fortune 500 companies that either sponsor or administer health and retirement benefits covering more than 100 million Americans. Jason directs the American Benefits Council's communications strategy and serves as the liaison for media inquries. Since joining the Council as a public relations associate in 1999, Jason has held a variety of roles in the communications department, maintaining primary responsibility for internal and external communications such as the Council's Benefits Byte membership newsletter and media releases on the full range of Council issues. He also serves as the Council's webmaster and resident desktop publishing expert. Jason is also a published poet, lyricist and arts critic and is the starting pitcher and leadoff hitter for his recreational softball league. Jason earned his Bachelor's degree in psychology after four years at the University of Rochester and is still thawing out.
Fortune 500 companies that either sponsor or administer health and retirement benefits covering more than 100 million Americans. Jason directs the American Benefits Council's communications strategy and serves as the liaison for media inquries. Since joining the Council as a public relations associate in 1999, Jason has held a variety of roles in the communications department, maintaining primary responsibility for internal and external communications such as the Council's Benefits Byte membership newsletter and media releases on the full range of Council issues. He also serves as the Council's webmaster and resident desktop publishing expert. Jason is also a published poet, lyricist and arts critic and is the starting pitcher and leadoff hitter for his recreational softball league. Jason earned his Bachelor's degree in psychology after four years at the University of Rochester and is still thawing out. 
