Marcia S. Wagner, Esq.

1

• IMPORTANT PENSION CHANGES
• WASHINGTON REGULATORY UPDATE

• Marcia S. Wagner, Esq.

2
Transformation of Retirement System

• DOL Interaction with White House
• Working with White Houses 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

3
Introduction

• 1. Target Date Funds
• 2. Lifetime Income Initiative
• 3. Tax and Healthcare Reform

4
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 Funds 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 TDF

• Consider 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

9
Customized Target Date Funds

• Advantages of custom TDF
• Incorporation of plans 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

10
Monitoring TDF Modifications Performance

• ERISA 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 sponsors 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 Funds
• 2. Lifetime Income Initiative
• 3. 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 Approaches
• 1) 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
• Participants 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 accounts 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 Guidance

• Selection 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 Annuities

• DC 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. Insurers
  ability to pay
• 2. 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 process
• Must conduct appropriate investigation of annuity
  investment
• Documentation of Selection Process
• Maintain minutes of fiduciary reviews
• Records for ongoing monitoring

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2nd Step for Annuity Selection(Insurers Ability
to Pay)

• Obtaining Sufficient Information
• Insurers experience and expertise
• Level of capital
• Ratings
• Contracts structure and benefit guarantees
• Protection through state guaranty associations
• DOL Proposal
• Proposed amendment to DOL safe harbor

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

• Considering Annuitys Cost
• Cost considered in relation to benefits and
  services.
• Evaluate fees, commissions and other charges.
• No requirement to select cheapest annuity.
• Drawing Informed Conclusions
• Conclude insurer will be able to make future
  payments.
• Conclude annuitys 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 advisors qualifications.
• Identify advisors compensation.
• Provide complete information to advisor.
• Ensure reliance on advisors 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 DOLs 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 Funds
• 2. Lifetime Income Initiative
• 3. Tax and Healthcare Reform

32
Administration Initiatives to Increase Retirement
Savings Through IRAs

• Administration 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 returns
• NCPERS 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 (contd)

• - 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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IMPORTANT PENSION CHANGES- WASHINGTON
REGULATORY UPDATE

• Marcia S. Wagner, Esq.
• 99 Summer Street, 13th Floor
• Boston, Massachusetts 02110
• Tel [phone] Fax [phone]
• Website www.wagnerlawgroup.com
• marcia_at_wagnerlawgroup.com
• A0128703.PPTX