Op-Ed

Good news for retirement policy in spite of gridlock

Joshua Gotbaum and William G. Gale

It has been clear for many years that retirement insecurity is a primary form of economic insecurity, even among those who are years from actual retirement. There are many contributing factors: concerns about Social Security, a decline in retirement savings accounts as a result of the Great Recession, the continued exodus from traditional pensions, and the underfunding of public plans, just to name a few.

What is most striking, however, has been the lack of governmental action in response. There is bipartisan agreement that retirement insecurity is a major problem. There have been multiple bipartisan task forces on retirement and dozens of well-intended proposals to increase retirement savings via tax incentives, expansion of automatic saving features, more effective regulation, or better consumer financial education. However, there have been virtually no legislative agreements. [1] Even proposals that once had bipartisan support, such as payroll automatic enrollment, have become casualties in disputes over the role of government and broader tax reform.

In 2015, after years of stalemate with Republicans in Congress and with only limited time remaining, the Administration decided to act on its own with a wide range of administrative actions. Taken as a whole, the Administration’s actions undertaken in 2015 are likelier to have a positive effect on retirement security than anything that any administration or the Congress has done in many years.

  • Payroll Savings are Key to Retirement Security. By far the greatest success in saving for retirement occurs when saving is done automatically by deducting funds from a paycheck and having them invested automatically in a professional retirement program. However, under Federal law, such programs are entirely voluntary and employers that provide them must meet the many legal fiduciary, disclosure, and eligibility requirements of the Employee Retirement Income Security Act (ERISA) and the Internal Revenue Code. As a result, most employers, especially small businesses with fewer employees, decline to provide these programs.
  • Auto-IRA: Gridlocked in Washington, Unlocked in the States. In 2008, both major presidential candidates endorsed a proposal [2] by J Mark Iwry (then of Brookings) and David John (then of the Heritage Foundation) to require those small businesses without a plan automatically to enroll their employees in an Individual Retirement Account. Upon becoming President, President Obama proposed an “Auto-IRA” program in 2009. Unfortunately, the debate over the Affordable Care Act tainted any “employer mandate” among congressional Republicans.

    Fortunately, California and other states stepped in and proposed “Secure Choice” programs: a requirement that employers without a plan automatically enroll their employees (who could opt out at any time) into a professionally-managed retirement program, probably an IRA, that would be established by a state board. Legislation establishing such state boards to study and/or implement programs was enacted by California, Illinois, and Oregon. Many other states are considering doing so [3]; however, these state efforts were opposed both by local financial firms and, ironically, by the U.S. Department of Labor (DOL), which viewed them as an evasion of ERISA.

  • DOL Allows Businesses to Encourage Retirement Saving without Full Federal Regulation.This year, the Administration and DOL changed course. In July [4], the President announced that DOL would issue regulations and guidance to advance state savings plans. In November, DOL did so, publishing a proposal [5] under which state-sponsored IRA programs would exempt employers from ERISA fiduciary and other requirements.

    DOL is doing more than just “legalizing” the IRA model that Illinois has legislated and other states are considering. They have also published a bulletin [6] outlining the ways they are willing to modify traditional ERISA requirements in order to facilitate state-sponsored pension and 401k-type plans. This would significantly increase and improve the options available for states to consider.

    Adoption by states of an auto-enrollment requirement would extend coverage to an estimated 50-70 million working Americans who currently have no private retirement savings. It would be the largest expansion of retirement savings in more than 50 years.

  • Reducing Conflicts in the Marketing of Retirement Plans. After a false start in 2010, this year DOL proposed new regulations intended to limit the “conflict of interest” effects of commissions in biasing the advising and marketing of retirement products. DOL and others had shown that the presence of product commissions led financial advisors to favor the higher-commission retirement options. One survey by the Council of Economic Advisors estimated that biased compensation arrangements might result in extra fees on the order of $17 billion annually. [7]

    DOL proposed that all advisors either forego product commissions in favor of asset-based or per-session compensation or that they enter into a legally-enforceable “Best Interests Contract” that both disclosed all fee arrangements and committed the advisor to placing client interests first. Although DOL’s proposal did not go as far as actions taken in the UK and elsewhere – which banned product commissions entirely—it has nonetheless generated substantial controversy. Many financial service firms and advisors argued that the DOL action is unnecessary, that it would reduce the supply of retirement advice, and/or that potential conflicts can be handled through existing industry self-regulation and by the Securities and Exchange Commission. (The SEC had been directed by Congress to provide guidance in 2010, but five years later had failed to reach any agreement.) Various Brookings scholars have studied these issues. Martin Baily and Sarah Holmes, reviewing the academic literature, concluded that conflicted advice is significant and that the approach proposed by DOL could, on net, benefit the country if it incorporated modifications to preserve investor education efforts and to reduce the likelihood that investors would avoid getting any advice at all. [8]

  • Offering a Federal Private Retirement Savings Option. Frustrated by Congressional unwillingness to legislate the Auto-IRA, the President announced in 2014 that Treasury would set up a voluntary retirement savings plan, My Retirement Account (“MyRA”) allowing voluntary payroll deductions to purchase a special Federal bond “to help millions of Americans save for retirement” [9]. Since the Administration had no authority to require employers to auto-enroll their employees in MyRA and there has not been significant willingness of employers to do so voluntarily, this year the Treasury announced that individuals would be permitted to join MyRA and make automatic contributions directly from their bank accounts. Nonetheless, there’s little evidence that this will lead to significant additional savings.
  • Limiting Employers’ Ability to Cash Out their Pension Obligations via Lump Sum Payments. ERISA’s intention was to preserve traditional defined benefit (DB) pension plans and ensure that pension commitments, when made, were honored. Ironically, the response by most employers has been instead to limit their DB obligations; DB plans now cover only a small minority of private sector workers and many current DB plan sponsors are “de-risking” either by freezing their plans and purchasing annuities to replace them, or by offering to cash out individual pension obligations via lump sum payment. Unfortunately, the passage of the Pension Protection Act of 2006 accelerated “de-risking” activity.

    While companies can de-risk either via annuity purchase or lump sum, the consequences on individual retirement security are very different. Many retirement experts view lump sum payments that substitute for pensions to be pernicious because they divert professionally-managed accounts and instead put large sums in the hands of individuals who have little or no investment expertise. Nonetheless, federal law and regulation has “protected” pensioners’ right to lump sum payments, and done so in ways that incentivize employers to offer lump sums in preference to purchasing annuities or maintaining a pension. IRS regulations specify the use of outmoded mortality tables and allow employers to pick interest rates that undervalue the pension right. As a result, employers can often reduce their pension obligations by between 10 percent and 20 percent if they can convince employees to choose a lump sum.

    Unfortunately, IRS has not acted to reduce this incentive, and neither Treasury nor DOL requires employers to disclose this when they offer a lump sum. This year, however, the Treasury did announce that it would no longer permit the offering of a lump sum to a retiree once retirement payments have commenced. [10] This action could preserve the pensions of hundreds of thousands who otherwise might “take the money and run.”

Related

The administrative actions started in 2015 were not without controversy. There were many attempts to convince the Administration to change course and several attempts in Congress to prevent DOL from undertaking any action at all. As of this writing, none of the legislative prohibitions has been enacted.

If the Administration in 2016 follows through and implements the initiatives it started in 2015, then 2015 may come to be seen as the year that the logjam finally broke and the nation’s retirement needs finally got the attention they deserve.


 

[1] The only significant exception was the enactment, but only in the lame duck session after the 2014 election, of the Multiemployer Pension Reform Act. MPRA was narrowly targeted rescue legislation. “Protecting Retirement: A Quick Guide to Bipartisan Victory” Joshua Gotbaum Politico December 23, 2014 https://www.brookings.edu/research/opinions/2014/12/23-congress-cutting-pensions-gotbaum

[2] “Pursuing Universal Retirement Security Through Automatic IRAs” J Mark Iwry & David C. John (Brookings 2009-3) https://www.brookings.edu/~/media/research/files/papers/2009/7/automatic-ira-iwry/07_automatic_ira_iwry.pdf Mr. Iwry is currently Senior Advisor to the Secretary of the Treasury on employee benefit matters. Dr. John is currently Deputy Director of the Brookings Retirement Security Project and a senior policy adviser at AARP.

[3] Structuring State Retirement Saving Plans: A Guide To Policy Design And Management Issues, William G. Gale and David C. John (Brookings, Oct 7, 2015) https://www.brookings.edu/research/papers/2015/10/07-design-management-retirement-savings-plans-gale-john

[4] “Obama acts to help states expand retirement coverage — most significant retirement move of the Administration” Gotbaum (Brookings July 14, 2015) https://www.brookings.edu/blogs/up-front/posts/2015/07/14-administration-help-states-expand-retirement-coverage-gotbaum

[5] “Savings Arrangements Established by States for Non-Governmental Employees” NPRM US Department of Labor Employee Benefits Security Administration 29 CFR Part 2510 RIN 1210-AB71 Federal Register 80:222 November 18, 2015 http://webapps.dol.gov/FederalRegister/HtmlDisplay.aspx?DocId=28542&AgencyId=8&DocumentType=1

[6] “Interpretive Bulletin Relating to State Savings Programs That Sponsor or Facilitate Plans Covered by the Employee Retirement Income Security Act of 1974” US Department of Labor Employee Benefits Security Administration Federal Register 80:222 November 18, 2015 http://webapps.dol.gov/FederalRegister/HtmlDisplay.aspx?DocId=28540&AgencyId=8&DocumentType=3

[7] “The Effects Of Conflicted Investment Advice On Retirement Savings” (CEA February 2015) https://www.whitehouse.gov/sites/default/files/docs/cea_coi_report_final.pdf

[8] “Serving the Best Interests of Retirement Savers: Framing the Issues” Martin Neil Baily and Sarah E. Holmes (Brookings July 2015) https://www.brookings.edu/research/papers/2015/07/29-best-interest-retirement-savers

[9] “The State of the Union Fact Sheet: Opportunity for All” The White House January 28, 2014 https://www.whitehouse.gov/the-press-office/2014/01/28/state-union-fact-sheet-opportunity-all

Authors

[10] IRS Notice 2015-49 July 14, 2015.

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