Important Pension Changes From D.C. - What Do You Need to Know?

Important Pension Changes From D.C. - What Do You Need to Know? Marcia S. Wagner, Esq.

Transforming the Retirement System • Regulatory landscape is changing. • DOL is rolling out new rules for 2012. • Fee disclosures for plan sponsors • Participant-level fee disclosures • Participant investment advice • Proposed Rulemaking • DOL Interaction with White House • Working with White House’s Middle Class Task Force • Coordinated actions to improve retirement security

1. Fee Disclosures to Participants2. Participant Investment Advice3. 408(b)(2) Disclosures4. Broader “Fiduciary” Definition5. Default Investments - TDFs 6. Lifetime Income Options

DOL Finalizes Participant Fee Disclosure Regulations • DOL issues final reg’s on Oct. 14, 2010. • DOL press release explained that existing law did not require plans to provide necessary information. • New rule requires comparison of plan’s investments. • Types of plans covered • New reg’s apply to DC plans with participant-directed investments. • Covers plan even if not designed to comply with ERISA Section 404(c). • Coverage of participants • New reg’s apply to all eligible employees.

Annual and Quarterly Disclosure of Plan-Related Information • Must disclose general info about plan. • Must include explanation of general admin. service fees and individual expenses on annual basis. • Must disclose dollar amount of fees/expenses charged to participant accounts on quarterly basis. • Disclosure only required for fees/expenses not embedded in expenses of investments. • If service provider only receives indirect compensation from investments, provider’s fees are not subject to this disclosure requirement. • But must disclose that a portion of general admin. service fees is paid from expenses of investments.

Annual Disclosure of Investment-Related Information • Must disclose fee and performance-related info for plan’s investment alternatives. • This disclosure must be in comparative format. • Must be provided on annual basis. • Required information for disclosure in comparative format includes: • Name and type of investment option • Investment performance data • Benchmark performance data • Total annual operating expenses for each investment and any extra shareholder-type fees. • Internet website address

Other Requirements • Info that must be available upon request • Prospectuses, shareholder reports and financial statements provided to plan. • Form of disclosure • Must be understood by average participant. • Impact on sponsor’s other fiduciary duties • No relief for duty to prudently select/monitor plan’s providers and investments. • New reg’s modify ERISA 404(c) disclosures. • Effective date • Plan years beginning on or after Nov. 1, 2011. • Initial disclosures due August 30, 2012 for calendar year plans.

Fee Disclosures to Participants Practical Implications • Automatic delivery of fund prospectuses will no longer be required under ERISA 404(c). • General administrative service fees must be explained but need not be itemized. • Impact on Financial Advisors • Brokers/RIAs – no reporting of annual and quarterly fees if compensation fully reflected in total annual operating expenses of plan investment.

Fee Disclosures to ParticipantsPractical Implications Advisers can help sponsors prepare. • Complete the investment portion of comparative table (e.g., investment and benchmark performance data). • Discuss with plan’s recordkeeper the impact of the new rules on existing fee disclosures. • Meet with participants and review investment and fee information through educational sessions. • If plan sponsor has fee-related concerns, remind plan sponsor that its fiduciary review process can be enhanced.

How Can Inv. Advice Be Conflicted? • Non-fiduciary provider receives variable compensation from plan’s investments. • Broker-dealer receives different 12b-1 fees. • Fund platform offers proprietary funds to plan clients. • Provider has incentive to steer participants. • Cannot provide fiduciary advice to participants. • Conflicted advice triggers prohibited transaction (PT). • PT occurs even if advice provided in good faith.

DOL Final Rules for Participant Advice • Pension Protection Act included statutory exemption for participant-level advice. • Fiduciary Adviser must be RIA, bank, insurer or broker-dealer. • Eligible Investment Advice Arrangement must have: (1) Fee-Leveling (Fiduciary Adviser’s fees do not vary) (2) Computer Model certified by expert. • Other conditions for exemption. • Authorization from separate plan fiduciary. • Annual review by independent auditor. • Advance notice to participants with disclosures for fees and material affiliations of parties (i.e., conflicts).

Fee-Leveling Arrangement • Fiduciary Adviser’s fee must not vary. • Fiduciary Adviser’s employee/rep must receive level compensation. • Fiduciary Adviser’s affiliate may receive variable compensation. • Example: ABC Fund Platform for Plan Clients • Plan invests in ABC Funds and third party funds. • ABC Fund Manager cannot give participant advice (due to incentive to steer participants to ABC Funds). • New affiliate, ABC Fiduciary Adviser, is created to provide advice to participants. • DOL imposes fee-leveling on ABC Fiduciary Adviser. • But ABC Fund Manager can earn compensation that varies with participants’ allocation decisions.

Computer Model Arrangement • Advice must be from computer model. • Model must be certified by investment expert. • Must consider participant’s personal info. • Fiduciary Adviser may receive variable compensation. • Does DOL favor index funds? • Proposed rules suggested that model should favor cheapest menu option in each asset class. • Fortunately, DOL backed away from this approach. • Can a Computer Model be used for IRAs? • DOL permits it. • But are Computer Models capable of advising IRA owners? • DOL rules became effective on Dec. 27, 2011.

Participant Investment Advice Practical Implications • Most advisors will continue to rely on pre-PPA DOL guidance. • Benefit platform providers may find the fee-leveling exemption useful: • RIA receives level fees. • Affiliated recordkeepers receive variable fees from funds in a plan’s menu. • Individual advisors dislike computer model advice: • Model portfolio creation is advisor’s job. • It should not be delegated to a computer program.

When Are Service Providers Conflicted? • Plan sponsor is looking for provider of administrative services. • Provider offers two options: • Services ordered a la carte: $10,000.00 • Pre-packaged services and menu: $ 4,000.00 • Plan sponsor may incorrectly conclude pre-packaged option is best for participants. • Doesn’t realize that provider receives “hidden” compensation from funds and fund managers. • Full compensation may be more than $10,000. • Hidden cost is actually shifted to participants. • Provider has incentive to steer uninformed clients to more profitable option.

Retirement Security Initiative • Improving transparency of 401(k) fees. • Administration’s goal is to make sure workers and plan sponsors are getting services at a fair price. • Final regulations issued February 2, 2012. • Initial disclosures due July 2, 2012. • Rationale for 408(b)(2) reg’s. • DOL efforts to educate plan sponsors about 401(k) plan fees started with Nov’ 97 hearing. • Plan sponsors still not asking the right questions. • DOL will now require providers to furnish the fee info sponsors should be requesting.

Covered Plans • All employee pension plans must receive fee information except: • IRAs • Simplified Employee Pensions • SIMPLE accounts • Legacy 403(b) (no employer contributions after 2008)

Covered Providers and Disclosures • Covered Service Providers (compensation of $1,000 or more) • Fiduciaries (including ERISA fiduciary, fiduciary of look-through investment, and RIA). • Providers of recordkeeping and brokerage services. • Providers of accounting, actuarial, legal and other professional services if they receive indirect fees. • Required to disclose compensation in writing. • Must be provided before entering into contract. • Formal contract not required. • Indirect compensation requires more detailed disclosure. • Service-by-service disclosure of fees is generally not required.

Disclosure of Compensation • Format and manner of disclosure • Dollar amount, formula, percentage of plan assets, per capita charge, or any other reasonable method. • Whether fees will be billed or deducted and any other manner of receipt must be disclosed. • Compensation shared among related parties • Generally, compensation paid to affiliates or subcontractors does not have to be disclosed. • But must disclose if payment flows to related party on transactional basis (e.g., commissions, 12b-1 fees). • Special Rules for Platform Providers • Must provide basic fee information for each investment alternative. • Requirement can be met by passing through fund prospectuses if issuer is regulated.

Form of Disclosures • Disclosure may be provided through multiple documents. • Likely format of Disclosure Summaryto be required by DOL in future: • 2 column chart • Column 1: direct, indirect, shared compensation, fees and expenses relating to investments. • Column 2: location of items listed in first column.

Timing of 408(b)(2) Disclosures • Required Deadlines • Disclosure must be made reasonably in advance of starting or renewing services. • Changes to info must be made no later than 60 days after provider becomes aware of change. • Final rule allows recordkeeping platforms and fiduciaries of look-through investments to report changes annually. • Erroneous info will not result in violation if provider has acted in good faith and with diligence. • Errors and omissions must be disclosed within 30 days after coming to light.

Prohibited Transactions and 408(b)(2) Regulations • If provider fails to make disclosure, plan’s payment of fees is a prohibited transaction. • Disclosure failures can be cured. • Plan must make written request for information, and provider must respond within 90 days. • Refusal or inability to comply with request requires plan fiduciary to notify DOL, and decide whether to terminate service arrangement. • Outlook • Effective date July 1, 2012.

408(b)(2) DisclosuresPractical Implications • Providers must furnish detailed fee disclosures by July 2, 2012. • Vendors, including platform providers, are responding in different ways: • Some are bundling all services (e.g., RIA and B-D), • Some are merely disclosing their own fees, without reference to other providers. • Some providers are subcontracting this disclosure responsibility . • The FA should determine who is responsible for disclosure and who is making which disclosures. • Financial advisors can add value by “quarterbacking” to make sure all providers know and make disclosures, and keep their plan sponsors informed as to what they will be receiving and from whom.

408(b)(2) Disclosures Practical Implications • Plan sponsors have duty to ensure plan’s fees are reasonable under ERISA. • Plans sponsors are likely to need assistance in light of complexity of plan arrangements. • Advisors can assist with: • Prudent evaluation of fees, • Negotiating lower fees and/or expanded services, and • Search for alternative arrangements, if necessary.

1. Fee Disclosures to Participants2. Participant Investment Advice3. 408(b)(2) Disclosures4. Broader “Fiduciary” Definition 5. Default Investments - TDFs 6. Lifetime Income Options

DOL’s Campaign to Expose Conflicts • DOL Strategy • Roll out new fee disclosure rules. • Impose fiduciary status on more providers. • Force non-fiduciary advisors to make disclaimers. • DOL releases proposed reg’s on Oct. 21, 2010. • Broadens “investment advice fiduciary” definition. • Withdrawn on September 19, 2011. • To be re-proposed with more input from public. • If you provide investment advice, you are automatically deemed a fiduciary. • DOL’s current definition for investment advice is based on 5-factor test.

Overview of DOL’s Initial Proposal • Existing Definition • Advice may be investment advice if it is a primary basis for plan decisions and given on regular basis. • DOL’s Initial Proposal • Include any advice that may be considered by plan. • May include casual advice or one-time advice. • Non-fiduciary advisors must make disclaimer: (1) advisor is acting as seller of securities. (2) advisor’s interests are adverse to client. (3) advice is not impartial.

Broader “Fiduciary” DefinitionPractical Implications • Non-Fiduciary Advisors • Would need to change service model. • Must disclose they are not providing impartial advice. • Or they could accept fiduciary status and become subject to ERISA. • Re-proposed Rule in 2012 • New definition to include individualized advice only. • Will be similar in approach to DOL’s initial proposal. • DOL is coordinating with SEC.

Broader “Fiduciary” DefinitionPractical Implications • DOL proposal likely to pressure advisors to provide fiduciary services for level fees. • Advisors unwilling to serve plan clients on these terms may be forced out of retirement space. • Advisors, especially non-fiduciaries, should re-evaluate business model for plan clients. • Explore working with recordkeeping platforms that have ability to offer level payouts. • Explore use of ERISA fee recapture accounts to ensure advisor retains level fee only. • Consider becoming “dual registrant” and charge level asset-based fee as RIA. • No easy “one size fits all” solution for firms.

Background on Target Date Funds • Popular default investment vehicle for 401(k) plans. • Typically, formed as open-end investment companies registered under the Inv. Co. Act. • Defining characteristic – “glide path” which determines the overall asset mix of the fund. • Performance issues in 2008 raise concerns, especially for near-term TDFs. • Based on SEC analysis, the average loss for TDFs with a 2010 target date was -25%. • Individual TDF losses as high as -41%.

Recent Developments for TDFs • DOL and SEC at Senate Special Committee on Aging hearing on TDFs (Oct. 28, 2009). • Investor Bulletin jointly released by DOL and SEC. • DOL’s fiduciary checklist on TDFs is pending. • SEC proposal for TDF advertising materials. • If name has target date, “tag line” disclosure needed. • Advertising must include glide path information. • On Nov. 30, 2010, DOL proposes rules on TDF disclosures for participants, amending: • QDIA reg’s issued under PPA of 2006 • Participant-level fee disclosure reg’s that were finalized on Oct. 14, 2010 but are not yet effective.

DOL’s Proposed Changes to QDIA Reg’s • Background on QDIA Reg’s • Participant deemed to be directing investment to default choice if QDIA requirements are met. • Default investment must be a QDIA, and QDIA notices must be provided to participants. • DOL proposes change to QDIA notice for TDFs. • Explanation and illustration of TDF’s glide path. • Relevance of target date (e.g., 2030) in TDF name. • Disclaimer that TDF may lose money after retirement. • DOL also proposes general changes to QDIA notice (even if not a TDF).

DOL’s Proposed Changes to Participant-Level Fee Disclosure Reg’s • Background (recap) • New rules will require disclosure of plan-related fees and annual comparative chart for plan’s investments. • DOL proposes change to annual comparative chart for TDFs (even if not a QDIA). • Must include appendix with additional TDF info. • Same info as required for QDIA notice. • Informal follow-up guidance from DOL • TDF prospectus is unlikely to satisfy QDIA notice and annual comparative chart requirements, as proposed. • DOL will not provide “model” target date disclosures.

Conflicts of Interest in TDFs • Conflicts arise when a “fund of funds” invests in affiliated underlying funds. • Conflicts are permitted because fund managers are carved out from ERISA’s fiduciary requirements. • Are fund managers ever subject to ERISA? • Firm requested clarification on scope of carve-out. • In Adv. Op. 2009-04A (Avatar Associates), DOL declined to rule that the TDF managers are fiduciaries. • Implications of DOL guidance • Plan sponsors are alone in their fiduciary obligation. • Must ensure TDFs (and underlying funds) are appropriate plan investments.

Congressional Proposal for TDFs • Senator Kohl announced his intent to introduce new legislation (Dec. 2009). • Concerns over high fees, low performance or excessive risk in many TDFs. • Would impose ERISA fiduciary status on TDF managers when TDF used as QDIA in 401(k) plans. • Senator Kohl’s proposal differs from DOL approach to improve disclosures to employers and participants.

Default Investments – TDFs Practical Implications • Provide meaningful TDF disclosures to participants as a “best practice” right now. • Provide key information about TDF’s glide path, landing point and potential volatility. • Also facilitate sponsor’s prudent review of the plan’s TDF series. • Assist in the fiduciary review of the “fund of funds” structure, glide path, underlying funds and risk. • Special review of TDFs for participants in or nearing retirement (e.g., 2015 TDF).

Retirement Security and Annuitization • Obama Administration believes lifetime income options facilitate retirement security. • Initiative to reduce barriers to annuitization of 401(k) plan assets. • DOL / IRS issue joint release with requests for information on Feb 2, 2010. • RFI addresses education, disclosure, tax rules, selection of annuity providers, 404(c) and QDIAs. • The Retirement Security Project • Released 2 white papers on DC plan annuitization. • Proposed use of annuities as default investment. • Utility of default annuities limited because of different needs to retirees and difficulty in reversal.

Other Recent Developments in DC Plan Annuitization • Two types of legislative proposals. • Encourage annuitization with tax breaks: Lifetime Pension Annuity for You Act, Retirement Security for Life Act. • Annual disclosure of what 401(k) plan balance would be worth as annuity: Lifetime Income Disclosure Act.

Lifetime Income Hearing bySenate Special Committee on Aging • Senate hearing held on June 16, 2010. • The Retirement Challenge: Making Savings Last a Lifetime. • Start of legislative debate on lifetime income options. • DOL and Treasury provide early analysis on RFI concerning lifetime income options. • More than 800 responses to RFI. • Concerns expressed against government takeover of 401(k) plans. • DOL and Senator Kohl clarify that there is no interest in mandating lifetime income options.

Joint Hearing by DOL, IRS and Treasury in September 2010 • Purpose is to investigate 5 focused topics. • 2 areas of general policy-related interest. • Specific concerns raised by participants. • Alternative designs of in-plan and distribution lifetime income options. • 3 areas of specific interest. • Fostering “education” to help participants make informed retirement income decisions. • Disclosure of account balances as monthly income streams. • Modifying fiduciary safe harbor for selection of issuer or product.

IRS TAX RELIEF for Lifetime Income Options • Proposed Regs and Rulings on Required Minimum Distributions • PLR 200951039: no surprises as to age 70 ½ interpretations. • Proposed Reg. (Feb. 2012): longevity annuity beginning at age 80 or 85 will not violate required minimum distribution rules. Annuity premium lesser of $100,000 or 25% of account balance. • Proposed Reg. (Feb. 2012): split distribution options consisting of annuity and lump sum approved. • Rev. Rul. 2012-4: participants can rollover 401(k) balance to same employer DB plan and convert to annuity from DB plan. • Rev. Rul. 2013-3: deferred annuities in 401(k) plan will not trigger IRS death benefits for surviving spouse.

Lifetime Income Options Practical Implications • Anticipate future legislation or regulation. • Most likely: DC plans must disclose monthly or yearly lifetime income that account balance can provide through annuity purchase. • Also possible: DC plans must offer life annuities as benefit distribution option. • Be prepared to explain concept of longevity annuities.

Important Pension Changes From D.C. - What Do You Need to Know? Marcia S. Wagner, Esq. 99 Summer Street, 13th Floor Boston, MA 02110 Tel: (617) 357-5200 Fax: (617) 357-5250 Website: www.wagnerlawgroup.com marcia@wagnerlawgroup.com A0070884

Important Pension Changes From D.C. - What Do You Need to Know?