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 ParticipantsPractical Implications To-Do List: • 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.

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, with presumption being termination. Marketing Tip – if 408(b)(2) notice is incomplete, remind plan sponsors of this vendor termination presumption.

Best Practices for Fiduciary Review of Fees • ERISA 408(b)(2) effectively “raises the bar” for fiduciary review of plan fees. • Consider adopting best practices for evaluating fee disclosures. • Establish prudent review process. • Basic Procedural Steps and Principles • Focus on provider’s qualifications and provider’s quality of services (in addition to considering fees). • Conduct reviews regularly. • Consider provider’s total compensation. • Evaluate fees in propercontext. • Document reviews.

Best Practices – Value Proposition and FPS • Consider provider’s value proposition. • Don’t look for provider with cheapest fees. • Make inquiries about service offering. • Evaluate fees in light of services provided. • Adopt a fee policy statement (FPS). • FPS offers procedural discipline for plan fiduciary’s review of fees. • Reviews under FPS should be coordinated with IPS. • FPS itself can help demonstrate procedural prudence.

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.

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.

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 A0078215

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