On August 16, President Joe Biden signed the Inflation Reduction Act into law, ending months of uncertainty over whether congressional Democrats would ever reach agreement on a compromise budget reconciliation bill. The new law, which required only 50 votes (plus the vice president’s tie-breaker) to pass the Senate, provides incentives to promote energy security and address climate change, extends enhanced Affordable Care Act subsidies, and reduces the deficit in part by imposing a new 15% minimum tax on certain large corporations. The partisan nature of that process, however, did not impede the continuing bipartisan work on a “SECURE 2.0” retirement package. Marking another step in that effort, the Senate Finance Committee in September introduced legislative text for its version of SECURE 2.0, the Enhancing American Retirement Now (EARN) Act (S. 4808). The committee had previously approved a summary of the bill in June.
With the mid-term elections fast approaching, any further significant developments in federal retirement policy are expected to be delayed until after the elections. The impending elections have not, however, had a significant impact at the state level, where several states have taken action in recent months to newly enact, launch, or expand a state-run, Individual Retirement Account (IRA)-based retirement program for private-sector employees. Plan sponsors should also be mindful of a new litigation strategy involving target date funds that has recently been used against several plans. These and other developments are discussed in more detail below.
Inflation Reduction Act. For the retirement industry, the most noteworthy aspect of the Inflation Reduction Act is that it does not include any of the retirement-related provisions that were included in Democrats’ earlier attempts at a reconciliation bill. As such, the two significant retirement provisions included in the November 2021 House-passed version of what was then the Build Back Better Act did not become law, as many last year had expected. One of those provisions would have imposed a cap of $10 million on the amount that an individual may hold in all IRAs and defined contribution plans. The other provision would have prohibited “back door” Roth IRA and Roth 401(k) conversions beginning in 2022 and would have further prohibited all Roth conversions for high-income individuals beginning in 2032. The Inflation Reduction Act does, however, include some important tax-related retirement plan exemptions, including adjustments to the new 15% corporate minimum tax on book income for defined benefit pension plans.
SECURE 2.0. As described in our Second Quarter (Q2) 2022 Quarterly Bulletin, Congress achieved several key milestones in the development of a SECURE 2.0 legislative package from March through June. First, the House passed its version of SECURE 2.0, the Securing a Strong Retirement Act (SSRA) of 2022 (H.R. 2954). Then, in rapid succession, the Senate Health, Education, Labor and Pensions (HELP) Committee released its version of the bill, the Retirement Improvement and Savings Enhancement to Supplement Healthy Investments for the Nest Egg (RISE & SHINE) Act (S. 4353), and the Senate Finance Committee released a description of its proposal, the EARN Act. The two Senate committees held markups in June and approved their respective bills on a unanimous basis. (A summary of several key provisions in the three SECURE 2.0 bills was provided in the Q2 2022 Quarterly Bulletin.)
In September, the Finance Committee introduced bill text for the EARN Act. The introduced bill largely reflects the description of the EARN Act that the committee approved in June, but with some clarifications and changes. For example, the committee-approved EARN Act required all age-based catch-up contributions made by an employee to a 401(k), 403(b), or governmental 457(b) plan to be made as designated Roth contributions if the employee earned more than a specified dollar amount in the prior year. That dollar amount, however, had not yet been determined. The introduced bill now clarifies that the requirement for Roth catch-up contributions would only apply to employees whose wages were over $100,000 (not indexed) in the prior year.
Up next for SECURE 2.0 is for the lead authors of the SSRA, RISE & SHINE Act, and EARN Act, with input from House and Senate leadership, to continue working toward a bipartisan agreement on a final SECURE 2.0 bill that could be included as part of an end-of-year spending package. But the availability of such a package to which SECURE 2.0 can be attached remains unclear and likely won’t be known with more certainty until the weeks following the mid-term elections.
The Department of Labor (DOL) has been relatively quiet regarding its more controversial retirement-related guidance projects and is expected to remain so until after the elections. This includes, for example, the DOL’s efforts to re-propose a fiduciary rule and to finalize the agency’s proposal on environmental, social and governance (ESG) investing and proxy voting. In July, however, the DOL proposed significant amendments to its prohibited transaction exemption for qualified professional asset managers (QPAMs), which raised many questions among the retirement industry. In September, the Treasury Department weighed in on the debate over cryptocurrency in retirement plans, which has continued to draw attention since the DOL made its views on the subject known earlier this year. The Internal Revenue Service (IRS), in the meantime, continues to focus its efforts on emerging from its pandemic-related backlogs, including delays in issuing much-needed guidance under the SECURE Act of 2019.
QPAM Exemption. On July 27, the DOL published proposed amendments to Prohibited Transaction Exemption 84-14, which is the class exemption commonly referred to as the QPAM exemption. ERISA’s prohibited transaction rules generally prohibit any transaction of any kind involving a “party in interest” to a plan. This is particularly a problem for the investment of plan assets. The DOL’s QPAM exemption provides relief for many of the inadvertent prohibited transactions that may occur as managers invest plan assets. The exemption requires several conditions and is generally only available for large, registered investment advisers (RIAs) and certain other financial institutions (such as banks and insurance companies). Because of the reach of the prohibited transaction rules, investment managers of plan assets are expected to qualify as a QPAM. Further, most investment management agreements that investment firms sign, either directly with plans or as subadvisors, require compliance with the QPAM exemption, and many contracts, offering documents, and other agreements that facilitate financial transactions often require the investment manager to represent that it qualifies as a QPAM if it is investing on behalf of ERISA plans.
- Proposed changes affecting all QPAMs. Under the current QPAM exemption, a financial institution must be of a certain minimum size to be eligible to use the exemption. For example, an RIA that is a QPAM must have assets under management of at least $85 million and shareholder or partner equity of at least $1 million. A bank must have equity capital of at least $1 million, and an insurance company must have a net worth of at least $1 million. The DOL has proposed to increase the equity threshold from $1 million to $2.72 million (indexed), and the required assets under management from $85 million to $135.87 million (indexed). Among other changes, the proposal would also require all entities relying on the QPAM exemption to report their reliance by email to the DOL, and QPAMs would be required to maintain for six years records demonstrating their compliance with the exemption.
- Proposed changes relating to criminal convictions. Another condition of the current QPAM exemption is that a QPAM is ineligible to rely on the exemption for a period of 10 years if the QPAM, various affiliates or 5% or more owners of the QPAM are convicted of certain crimes. The DOL’s proposed amendments would make several changes to this condition, including (1) clarifying that the relevant convictions include foreign convictions and (2) expanding the types of conduct that would result in disqualification, including giving the DOL discretion to determine whether certain conduct is disqualifying. In addition, the proposed amendment would require all QPAMs to include a provision in their investment management agreements providing that, in the event that the QPAM or its affiliates engage in conduct resulting in a criminal conviction or receive a written notice of ineligibility from the DOL, the QPAM would not restrict its client plan’s ability to terminate or withdraw from its arrangement with the QPAM and that the QPAM will indemnify the plan for any losses resulting from a violation of applicable laws, a breach of contract, or any claim arising out of the QPAM’s failure to remain eligible for relief under the QPAM exemption as a result of its conduct.
Taken together, all of these changes have raised significant concern among the investment management and plan sponsor community, although many were not surprised at the proposal, as the DOL has in recent years taken a number of steps to reduce the scope of, and impose new conditions on, exemptions that are commonly relied upon.
Cryptocurrency in 401(k) plans. As described in our Q2 2022 Quarterly Bulletin, the DOL’s March 2022 issuance of Compliance Assistance Release (CAR) 2022-01, which states that plan fiduciaries of 401(k) plans should exercise “extreme care” in considering cryptocurrencies as part of a 401(k) investment menu for plan participants, generated significant reaction from Congress and in the form of a lawsuit against the DOL. Attention on this topic has continued, including the July 1 release of a brief report by the Congressional Research Service summarizing CAR 2022-01 and various responses to the release. In late July, Senators Dick Durbin (D-IL) (who is also Majority Whip), Elizabeth Warren (D-MA), and Tina Smith (D-MN) sent an open letter to a large 401(k) provider questioning why the provider has made cryptocurrency available as an investment for plan fiduciaries to select. Most recently, the Treasury Department weighed in on cryptocurrency in 401(k) plans in a report on digital assets it released in September. “[R]egulatory agencies,” Treasury stated, “should use their existing authorities to address current and emerging risks in crypto-asset intermediation to the extent that such activities fall within their jurisdictions. Examples include [DOL’s CAR 2022-01] cautioning retirement plan fiduciaries to be mindful of their stringent obligations of prudence and loyalty in connection with investments in cryptocurrencies.” The Treasury report further expressed that, “to the extent that crypto assets are marketed to retirement plans, [DOL] should conduct investigations to ensure proper fiduciary conduct, and to protect plans and plan participants from aggressive marketing, conflicts of interest, and imprudent and disloyal investments.” In short, it appears that federal policymakers are not backing down from their concerns regarding the use of cryptocurrency in 401(k) plans.
Although retirement plans and policy are generally within the purview of the federal government, the number of states creating state-run IRA programs for private-sector workers continued to grow in 2022. In most cases, these state laws require certain employers to automatically enroll their employees in the program, subject to an employee’s decision to opt out. Employers that already offer a retirement plan are typically exempt from the mandate. Twelve states now have a so-called mandatory IRA program on the books and are in various stages of development or implementation: California, Colorado, Connecticut, Delaware, Hawaii, Illinois, Maine, Maryland, New Jersey, New York, Oregon and Virginia. Recent developments include the following:
- New programs in Hawaii and Delaware. Hawaii and Delaware each enacted a mandatory IRA program in recent months. Although Delaware’s new law is similar to many of the other enacted state programs, Hawaii’s program includes some notable differences. Most importantly for plan sponsors, the Hawaii law only exempts those plan sponsors whose retirement plans cover “all” employees. This appears to mean, for example, that an employer would remain subject to the Hawaii program’s mandate even if it offered a 401(k) plan, but where the plan excludes certain employees in a manner consistent with federal law, such as employees who have not met minimum age and service requirements. Hawaii’s narrow exemption for plan sponsors is likely to raise ERISA preemption concerns, leaving it unclear at this time whether the state will risk a potential challenge to its law or make adjustments to the exemption. (These concerns are unique from the ERISA preemption issues addressed by the Ninth Circuit in its 2021 decision upholding California’s CalSavers program.) Another unique feature of Hawaii’s program is that it does not require covered employers to automatically enroll employees in the program. Covered employers must instead “allow” a covered employee to enroll in the program if he or she chooses.
- Program implementation in Connecticut and Maryland. Connecticut and Maryland each implemented their mandatory IRA programs in 2022, joining California, Illinois and Oregon. “MyCTSavings” launched in March, and “MarylandSaves” launched on September 15. Maryland has taken a unique approach from the other states with mandates in that, instead of imposing penalties on non-compliant employers, Maryland will waive its $300 annual report filing fee as an incentive to comply. The fee waiver is also available to employers that certify they offer an employer-sponsored retirement plan to employees.
- Program expansion in California and Illinois. Some mandatory IRA programs exempt small employers from the mandate if they have fewer than a specified number of employees. As originally enacted, California exempted employers with fewer than five employees from participating in CalSavers, and Illinois exempted those with fewer than 25 employees from participating in Illinois Secure Choice. Both states recently enacted amendments to expand the reach of the employer mandates, with California eliminating the exemption for small employers and Illinois limiting its exemption to employers with fewer than five employees. Small employers in California affected by the expanded mandate are required to begin participating in CalSavers by December 31, 2025, unless they already offer a plan. Illinois has set two registration deadlines to implement its expansion: November 1, 2022, for non-exempt employers with 16-24 employees, and November 1, 2023, for those with 5-15 employees.
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