Don’t Get Burned: Marcia Wagner’s Top 401k Regulatory Risks

We asked the high-profile ERISA expert about the legal and legislative issues she’s watching. She laughed, but then she graciously offered to sound off on those most pressing now, as well as just over the horizon. Here’s what to watch out for.

Watch out for Wagner's warnings.Watch out for Wagner's warnings.

401k Tax Status

Legislators and policymakers know the amount of tax revenue forgone from 401k plans is extremely large, which makes for easy targets when discussing revenue-raising initiatives. In 2015, the Office of Management and Budget projected the amount of missed revenue attributable to defined contribution plans (such as 401ks and 403bs) reached $61 billion, and would increase annually thereafter. The period between 2015 and 2019 is expected to be a cool $414 billion.

Defined benefit plans are expected to add $42 billion and $333 billion, respectively, to these amounts, and individual retirement accounts would also increase the overall retirement savings tax expenditure, again respectively, by an additional $17.5 and $98 billion.

401ks are considered tax-advantaged because neither the original plan contributions, nor the investment returns on those contributions, are taxed until benefits are paid. And for various reasons, the amount of taxes foregone from 401k contributions tends to be considered a permanent expenditure. However, as pressure builds to control the federal deficit, legislative proposals will be introduced to reduce retirement plan tax costs.

The tax code already contains various limitations on plan contributions that could be adjusted from current levels for the purpose of both reducing tax expenditures and raising government revenue.

For example, in the case of 401k plans, the maximum amount of annual contributions from all sources for any employee is $54,000, a limit that increases to $60,000 if the employee is at least age 50 and eligible for catch-up contributions. This annual contribution limit includes elective deferrals by 401k participants, which themselves are capped at $18,000, all of which could be reduced.

Another limitation subject to a legislatively-driven reduction is the cap on the 401k plan sponsor’s deduction for matching contributions, which is equal to 25 percent of the compensation otherwise paid to plan participants during the taxable year. And don’t forget—compensation in excess of $270,000 cannot be considered in calculating contributions to a plan participant’s account.

Over the years, Congress has raised and lowered these amounts to suit a given fiscal situation. The last major tax reform effort, in 1986, reduced elective deferrals from $30,000 to $7,000.

More recently, the Tax Reform Act of 2014 proposed by Rep. Dave Camp, the now-retired chair of the House Ways and Means Committee, would have frozen various defined contribution limits in place until 2024. At that time, they would have again been allowed to rise in accordance with cost of living increases, but not before raising $63.4 billion in revenue over 10 years.

Thankfully nothing came of it, but legislators like these numbers, so expect to see similar proposals soon.

401k State Proposal

Critics of the current retirement plan system propose supplementing its private nature with various government-controlled retirement schemes. It something that resonates at the state level in particular, where various legislative bodies are considering state management of retirement plans for private-sector workers.

Their somewhat seductive, yet problematic, argument is that too many workers simply do not have access to 401ks and similar plans, and those who do aren’t saving enough and invest unwisely. They also argue that converting defined contribution account balances into lifetime annuities is just too difficult. The Obama administration was sympathetic to their concerns, and in November 2015, the DOL issued an interpretive bulletin (2015-02), as well as a proposed regulation, intended to facilitate and encourage these programs. Both focus on the issue of ERISA preemption.

Under the interpretive bulletin, the DOL clarified that ERISA permits states to administer multiple employer plans, in which participating employers are considered to have a common nexus or link due to a state’s inherent interest in the health and welfare of its citizens. The bulletin related to programs by which a state would manage a defined contribution plan for private-sector employees, or establish similar arrangements, such as state-sponsored online marketplaces that connect employers with private-sector providers. The proposed regulation, for its part, dealt with state auto-IRA programs.

The DOL finalized both rules in August of last year, enabling states to move forward with retirement savings programs. It provided guidance for designing programs by, among other things, providing a safe harbor from ERISA coverage in order to reduce the risk of ERISA preemption of the relevant state laws. It also protects employees’ rights by ensuring the ability to opt out of the auto enrollment arrangement.

The State of California took the first steps to authorize the program.

Under its Secure Choice program, private employers with five or more employees, and no other retirement plan, will be required to participate, and their employees will automatically be enrolled at 3 percent of pay through the employer’s salary-deferral system (again, unless they opt out).

No employer contributions will be permitted, primarily due to fear that it would inadvertently create an ERISA-covered plan, subjecting employers to the responsibilities therein. The California program provides a guaranteed return on employee contributions, to then be pooled and invested by state-selected managers.

Implementation of the program was conditioned on receiving an IRS ruling that contributions would be pre-tax, as well as DOL approval that the program is indeed not subject ERISA. On the same day the DOL published its final rule, the California state assembly approved the Secure Choice program, which Governor Jerry Brown signed into law in September. There are currently eight other states that have already enacted similar legislation.

401(k)-to-IRA Rollovers

The fiduciary rule requires 401k advisors to internally document why a rollover may (or may not) be in the best interest of the 401k participant. Even if the fiduciary rule is repealed, rescinded, repurposed, re-proposed or whatever else, advisors should have standard procedures to keep the tort lawyer hounds at bay. They include, by way of example and are not limited to, the following checklist:

  1. That the rollover has no adverse tax effects to the advice recipient (e.g., that if there is any Roth money, that the requisite five-year holding period has been met);
  2. That the rollover would provide for a broader range and better quality of investment options;
  3. That the cost of the IRA is either comparable to, or not unreasonably greater than, the cost of the existing plan, given the additional services that can be provided;
  4. That under a rollover the advisor may provide better services—for example, personalized financial advice services, consultation, initial and ongoing access to third party money management, discretionary and nondiscretionary investment advice and customized reports;
  5. That there is no need for the participant to receive a loan;
  6. If the participant is not a 5 percent owner of the employer, that the participant is continuing employment after the age of 70 ½;
  7. There is no employer stock in the amount to be rolled over that has “net unrealized appreciation;”
  8. There are better estate planning alternatives with the IRA;
  9. That alternatives to the rollover have been considered;
  10. That the creditor protection laws in the states are either as strong as ERISA, or no creditor protection is needed;
  11. The participant was not born before January 2, 1936. As in such circumstances, capital gain treatment and/or 5 or 10 year forward averaging may be used.

Since 1996, The Wagner Law Group has provided a practical approach and sophisticated legal solutions while offering the personalized attention of a boutique law firm. Our practice areas include: ERISA Law, Employment Law, Labor and Human Resources, Employee Benefits, Welfare Benefits, Privacy & Security, Corporate Law, Tax, Estate Planning and Administration, Real Estate and Litigation. Marcia Wagner can be reached at [email protected]

Be the first to comment on "Don’t Get Burned: Marcia Wagner’s Top 401k Regulatory Risks"

Leave a comment

Your email address will not be published.