Using Public Policy to Create IRA Irony

October 26, 2016

Authored by: benefitsbclp

confusionYou might recall that the Department of Labor (DOL) took the position earlier this year that it had to protect individual retirement accounts and annuities as well as IRA owners by extending certain ERISA protections to them. In its promulgation of the amended investment advice regulation (otherwise known as the fiduciary rule) and the related prohibited transaction exemptions, it extended its reach deep into parts of the individual retirement plan structure where it had not ventured before.  (Its authority to do so is presently the subject of numerous lawsuits.)   It did so contending that public policy requires it to protect the IRAs and IRA owners from its perceived conflicts of interest emanating from the investment advisory and sales arms of financial services organizations.

Now, the DOL has done an about face, seemingly in furtherance of a different public policy goal. The policy this time is to enhance savings opportunities for American workers who do not have access to ERISA-protected employer-sponsored qualified retirement plans.  By creating a “safe harbor” that allows states to mandate payroll deduction IRAs for these workers, the DOL fails to provide the protections afforded by ERISA to participants in these State-sponsored IRA plans (other than, presumably, the investment advice rule).  The irony (and intellectual inconsistency) is patent:  IRAs are important enough to be caught within the ambit of ERISA’s fiduciary rule, but large state plans using IRAs can otherwise avoid the myriad of other ERISA protections.

The safe harbor addresses a state law creating an automatic enrollment IRA program with these requirements:

  1. The program is established and maintained pursuant to state law.
  2. The program requires employer participation in the automatic enrollment arrangement.
  3. The program is implemented and administered by the State.
  4. The State is responsible for investing the employee savings and it is the State that selects the investment options for participant direction. (Unlike its ERISA control, the DOL apparently recognizes that it cannot control what the States do to implement, control, and monitor this requirement.)
  5. The State is responsible for securing payroll deductions and savings (although the State need not be a guarantor of them).
  6. The State adopts processes to ensure that employees receive notice of their rights under the program.
  7. The State must create a mechanism to enforce the rights of employees.
  8. Employees may opt out at any time.
  9. All employee rights are enforceable the employee, a beneficiary or the State.
  10. The employer’s involvement is limited to ministerial acts: (i) collecting contributions through payroll deduction, (ii) providing notices and maintaining records regarding collections and remittances, (iii) providing information to the State as needed to assist operation of the program, and (iv) distributing program information to the employees.
  11. The employer cannot contribute or provide savings incentives.
  12. The employer has no discretion, authority or control.
  13. The employer is only paid its approximate reasonable costs.

In “stretching” the definition of fiduciary under ERISA to cover IRAs, the DOL took the position that times have changed and that the marketplace for retirement savings (particularly IRA savings) and investment is very different today than it was when the original regulation (29 CFR § 2510.3-21(c)) was adopted in 1975. However, in creating a safe harbor for State-sponsored IRAs, the DOL relies on another 1975 regulation (29 CFR § 2510.3-2(d)) that apparently is not affected by any change in the retirement marketplace and does not need modification to cause certain IRA structures to gain other ERISA protections.

State-sponsored IRAs are arguably not established or maintained by an employer. But the safe harbor does mandate employer participation, and employers are in a position to control employee deferrals.  Were the plan an ERISA plan, employee deferrals used for prohibited purposes would invoke the prohibited transaction protections of ERISA that the DOL relies on so heavily in imposing the investment advice regulation.  Recognizing that this mandate might be interpreted to cause an employer either to establish or maintain the State’s auto-IRA arrangement and therefore making it subject to ERISA , the safe harbor tries to avoid this by applying the four non-ERISA plan requirements under the 1975 regulation: (i) no employer contributions, (ii) voluntary employee participation, (iii) without endorsement, collect payroll deduction contributions and remit them, and (iv) the employer receives no compensation other than the reasonable cost for servicing the arrangement.

After the 1975 regulation exempting the type of IRA described above, the courts weighed in. One might contend that the DOL has seen fit to bring a traditional IRA into the ERISA arena under the investment advice regulation even though it is not established or maintained by an employer while exempting a new form of IRA structure from ERISA (except for the investment advice regulation, of course) that may violate well-settled case law.

In Donovan v. Dillingham, 688 F. 2d 1367 (2nd Cir. 1982), the court identified the four factors that give rise to an ERISA plan: “a plan, fund or program [established or maintained by an employer] under ERISA implies the existence of intended benefits, intended beneficiaries, a source of financing, and a procedure to apply for and collect benefits.”  Five years later, in Fort Halifax Packing Co. v. Coyne, 482 U.S. 1 (1987), the Supreme Court added a fifth factor:  “ongoing plan administration” such as determining eligibility for benefits, calculating benefit amounts and monitoring plan funding. A State –sponsored IRA program as described in the safe harbor meets the four Dillingham requirements and in many cases will meet the fifth Fort Halifax requirement.  However, isn’t a State-sponsored arrangement a plan, fund or program established or maintained by an employer where that employer is mandatorily obligated to participate in the program?  Regardless, that begs the question:  shouldn’t the IRA accounts in State-sponsored auto-enrollment IRAs get ERISA protections if IRAs generally (including, presumably, those that are part of the State-sponsored programs) are important enough to be subject to the investment advice regulation? Is it good policy to eschew ERISA to enhance employee savings opportunities?

It would appear that the DOL is conflicted by its policy considerations: Protect traditional IRAs and IRA owners by imposing ERISA investment advice rules on them while at the same time enhancing employee retirement savings without the other protections.