From the June 2005 issue of Investment Advisor • Subscribe!

June 1, 2005

Progress for Pension Reform

DOL and Congress propose medication for a sickly DB system

Members of Congress and the Department of Labor (DOL) are moving full steam ahead with their plans to reform the pension system.

In late April, Reps. Rob Portman (R-Ohio) and Ben Cardin (D-Maryland) introduced their pension reform bills. At press time, Rep. John Boehner (R-Ohio), chairman of the House Committee on Education and the Workforce, was gearing up to introduce his bill designed to fix the ailing defined benefit system. Boehner's bill will also include a provision on investment advisors providing advice to plan participants. Rick Lawson, VP of federal government relations for The Principal Financial Group, says he's confident that Boehner's bill "will allow advisors to give investment advice to plan participants." Senate Finance Committee Chairman Charles Grassley (R-Iowa) reintroduced his reform bill, the National Employee Savings and Trust Equity Guarantee Act (NESTEG), in February. Grassley, along with Montana Democratic Senator Max Baucus, the ranking member who co-sponsored NESTEG, are planning more changes to the bill this summer, including a provision addressing the investment advice issue. Grassley also plans to introduce his Social Security bill this summer. Meanwhile, the DOL is mulling a number of regulatory initiatives, including providing guidance on fee disclosure and on what types of information plan sponsors should report to DOL.

Portman's bill, The Individual and Workplace Retirement Savings Promotion Act of 2005, HR 1960, and Cardin's bill, the Pension Preservation and Savings Expansion Act, HR 1961, are virtually the same. Both would create Retirement Savings Accounts (RSAs), which mirror Roth IRAs but would be made available to Americans of all income levels. Each bill would also allow tax refunds to be directly deposited into retirement accounts. Both bills also promote automatic enrollment and automatic increases in retirement plans. With automatic enrollment, employees automatically participate in their employer's plan unless they opt out. With automatic increases, also known as auto acceleration, employee contribution levels increase automatically each year unless the plan participant opts out. Both bills would also make all of the retirement savings and pension reform initiatives that were contained in the 2001 tax relief act--catch-up provisions, contributions to small-business pension incentives, expanded IRAs and 401(k)s--permanent.

Another provision contained in both bills would ensure that workers moving between tax-exempt and for-profit employers can roll over their after-tax contributions and would permit direct rollovers from employer retirement plans to Roth IRAs. The Roth 401(k)--which is not yet effective--would be "repealed" under both bills. Portman and Cardin argue that Roth 401(k)s only further convolute the crowded retirement marketplace and that the plans would "lose significant amounts of revenue over time," according to summaries of the bills.

The Portman and Cardin bills would also reform the minimum required distribution rules, which force folks to begin taking their retirement plan distributions by age 70, by indexing this age to future increases in life expectancy. In addition, those individuals with less than $100,000 in their combined IRA and 403(b) accounts would be exempt from the rules.

Rep. Boehner laid out some of the specifics of his bill during a conference held by the American Society of Pension Professionals and Actuaries (ASPPA) in Washington last month. He said his bill, which has yet to be named, differs from the Bush Administration's proposal on how to fix the DB system. "The Administration's proposal includes a yield curve, which is controversial," Boehner said. "We need to look at the DB rules or more people will be driven out of them."

Lawson of The Principal says Boehner "wants a permanent interest rate fix as opposed to a permanent interest rate. He is going to introduce some type of modified yield curve, unlike the Administration's." Lawson says Boehner's bill will likely include interest rate assumptions for "three buckets" of employees and participants--young, middle-aged, and older. "We also think that there will be more interest rate smoothing allowed under [Boehner's] approach," Lawson says. "Rather than using today's interest rate, you smooth [the interest rate] out over a period of time so that it more accurately reflects what you expect to happen." The current law is that you smooth the rate out over a four-year period, he explains. "The Administration is cutting that back to 90 days, which would make it very volatile. We're thinking Boehner wants two years, but we haven't seen that in writing."

Adds Lawson: "I think what Congress is trying to do is enact permanent rules that will lead to more stability in the [DB] system. Right now with the corporate bond interest rate expiring at the end of the year, there is a lack of stability."

Indeed, in reintroducing their NESTEG bill--which was introduced last year but didn't go anywhere--Grassley said it's "critically important to remove the uncertainty in our pension system by enacting a permanent replacement to the 30-year Treasury rate for pension funding." Last year, Congress approved a temporary replacement of the 30-year Treasury rate with a long-term corporate bond rate for pension funding purposes. NESTEG, Grassley said, "includes a permanent replacement of the 30-year Treasury rate with a yield curve based on corporate bond rates."

Boehner also said his bill will "ensure that cash balance plans remain a viable part of DB plans." The fight in saving cash balance plans will center on how conversions will occur, he said. Lawson points out that some in the industry argue that some of the past cash balance plan conversions were illegal because they discriminated against older workers. The argument being used "is that if you believe that some of the past conversions have been discriminatory, and you grandfather them, then you'd be grandfathering practices that you don't like," Lawson says. "Boehner's approach, which is correct, is that pension plans are voluntary, so we shouldn't be putting mandates on them. Therein lies the rub with making past conversions legal."

Some seven million workers participate in cash balance plans, which are not covered under the Employee Retirement Income Security Act (ERISA). According to The Principal, in a traditional defined benefit plan, employees earn most of their benefits after 20 to 30 years of employment, and DB plans often encourage early retirement. Cash balance plans, on the other hand, deliver benefits throughout a person's career and offer portability for mobile workers--those who interrupt their careers to raise a family, as well as those who work into their retirement years.

Boehner also said he's "cautiously optimistic" that giving advisors the authority to offer investment advice to plan participants "will be finished this year." Don Trone, president of the Center for Fiduciary Studies in Pittsburgh, says that Boehner's bill will also state that the advice must meet a fiduciary standard of care. "The Department of Labor has never provided a safe harbor that defines what a fiduciary is," he says. "The Boehner bill will."

Boehner also said the Bush Admin- istration's proposal needs modifications in some areas. "Multi-employer plans must be addressed," he said in his speech before ASPPA. Moreover, Boehner argues that ERISA's 30-year-old framework needs to be modernized, and promises, "We are going to look at this."

Two Forms of Reform

Michele Varnhagen, minority labor counsel for the House Education and the Workforce Committee, also spoke at the ASPPA conference. She said pension reform will come in two forms. The first will be legislation introduced by Boehner, Grassley, and Baucus; the second will come from the FY 2006 budget. The budget includes funding for The Pension Benefit Guarantee Corporation (PBGC), which faces a $23.3 billion deficit. The Administration plans to raise PBGC premiums paid by the companies sponsoring the plans to $30 from the current $19 to help shrink the shortfall.

Robert Doyle, director of regulations and interpretations at DOL, told conference goers that DOL is attempting to "provide certainty to employers on when to put money into their DB plans." DOL "is struggling to define what that period is," he said. DOL hopes to have a proposal out this summer, he said, which will include a voluntary safe harbor. The Principal's Lawson says, however, that since modifications are being planned for DB funding rules, "it's more difficult to look at some of the changes in regulation when the whole underlying law might be changed."

Another issue that DOL is looking at is fee disclosure, according to Doyle. "We have an imperative to provide guidance on fee disclosure," he said. "Plan participants should be able to evaluate fees," pointing to the SEC's simultaneous probe of investment advisors providing advice to pension consultants having to disclose conflicts of interest. Doyle said a DOL working group is addressing the issue on two levels. "A plan fiduciary needs to know how to evaluate the reasonableness of compensation, and what their fiduciary duties are under the plan," he said. Plus, "employers must assess if there are conflicts of interest and ask themselves whether the fees are reasonable." Doyle said there could be "room for improvement" to a model fee disclosure rule that was drafted in the 1990s, but said he's not sure if changes should come in the form of regulation. Doyle did note that DOL has "heard there are a lot of efforts by mutual funds to provide more information to plan sponsors."

Another item on DOL's regulatory agenda is deciding on the types of information plan sponsors should report to DOL, Doyle said. "We are adding a new project to our regulatory agenda--40AB2, reasonable compensation and reasonable arrangements." The proposal will go out for public comment. "We are working through how to make this new rule require the service provider to disclose information as opposed to putting the onus on the fiduciary."

DOL is also looking at the content of the annual reporting form, 5500, and the way it should be filed. Only 7% of the forms are filed electronically, he said, which means there is a huge paper trail. "We have to move to an electronically filed system," Doyle said.

Washington Bureau Chief Melanie Waddell can be reached at mwaddell@investmentadvisor.com.

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