With Democrats worried about the repeal of the Affordable Care Act and Republicans focused on reinvigorating their legislative and administrative agendas, national pension and retirement policy questions aren’t at the forefront of Donald Trump’s first-100-days agenda. But given recent regulatory moves in retirement, such as those involving fiduciary rules, Trump’s “pro-growth” agenda, and the current shaky foundation for the future of U.S. retirement, both he and Congress are likely to focus on some of these issues—which matter to both CFOs and rank-and-file alike—in the days ahead.
President-elect Trump is leaning towards either watering down or eliminating the new fiduciary rule all together. That would essentially reverse many, if not all, of the changes that employer plan sponsors and broker/dealers and other retirement-plan service providers have implemented or are planning to implement to comply with the fiduciary rules.
The new U.S. Department of Labor fiduciary rule, which goes into effect in April 2017, expands the “investment advice fiduciary” definition under the Employee Retirement Income Security Act of 1974. The new rule requires all investment advisers, including brokerages, to act as fiduciaries when making recommendations or giving advice on 401(k) plans or individual retirement accounts (IRAs), including in instances of a rollover or distribution.
Today, brokers can market retirement plan services and provide investment information to plan sponsors and participants while charging a commission for their services rather than fully transparent fees. In such arrangements brokers are not required to act in a “fiduciary capacity” (a higher standard of care and independence that requires the adviser to act solely in the best interest of their client). Instead, they may meet the investment suitability rules, which don’t require that the product or service be in the best interests of the buyer/investor, but only that the investment recommendation is suitable.
Allowing brokers to provide advice without being a fiduciary, as the Trump administration might do, would promote an environment which may lead to higher-cost plan services and potential conflicts of interest, as brokers may choose to seek out the arrangements that pay them the most, rather than do what’s in the best interests of plan sponsors and participants.
The Effect of Low Interest Rates on Pension Plans
Unfunded pension obligations have soared since the 2008 economic crisis, triggered by interest rates that have remained at historic lows. Pension plans are highly interest-rate sensitive and would benefit greatly from even a moderate increase in interest rates. With a pro-growth, low tax agenda and the potential end of Dodd-Frank’s regulatory limitations, and a more hawkish Federal Reserve, interest rates are likely to rise. And that would result in broadly improved funded status for pensions.
The End of Dodd-Frank?
President-elect Trump has stated he intends to roll back or scrap the Dodd-Frank regulations, which he believes are placing a stranglehold on the ability of banks to lend and fuel economic growth. Generating more growth would increase capital spending and create more jobs, thus encouraging savings, investment, and consumer spending. With more money to spend and invest, employees should look to save more in their retirement plans, especially in light of lessons learned from the 2008 crisis. Corporations would also be looking for tax deductions, and may elect to increase employer matching and profit sharing contributions.
Trump has indicated he intends to simplify the tax code and make the United States more globally competitive by having only three individual tax rate tiers, reducing the top tax rate from 39.5% to 33% and reducing the corporate tax rate from 35% to 15%. However, he is also likely to reduce or eliminate many tax filer statuses, and eliminate many individual and corporate tax deductions.
Many preferential tax items will be on the table, including the pretax deduction for 401(k) contributions. Congress has been considering eliminating or reducing the amounts employees can contribute to plans on a pretax basis to create a new source of revenue for the federal government. While that may seem preposterous, since pretax 401(k) contributions are only tax deferred until retirement, Congress generally sees the deduction as too costly to the government.
If changed, this would leave most 401(k) plans with either lower savings limits or primarily limited to Roth 401(k) contributions. Those are contributed to 401(k) plans on an after-tax basis, although funds can be withdrawn at retirement on a tax-free basis.
This trade-off of pre-tax deductions for Roth plans would provide more revenue to the federal government today. But it would deprive it of revenue over the long term, as retirees begin to withdraw their funds 5, 10, 20, or even 30 years from now. Removing the tax deduction, which is quite popular with employees and employers, or reducing the contribution limits, would only increase the risk that large swaths of the U.S. population will be unprepared for retirement when it comes.
Social Security Reform
On Social Security, Trump has been vague. But he has indicated it is his intent to improve solvency without cutting benefits. There are very few variables in this equation. To improve Social Security solvency, policymakers can either: (1) reduce monthly benefits; (2) increase contributions by increasing the FICA/FUTA withholding requirement; (3) increase the age at which benefits can be claimed; or (4) a combination of those approaches.
In the past, Republicans have proposed creating “personal accounts” to allow employees to save and invest some of the money they defer into the Social Security program. But if these savings dollars came from the existing FICA/FUTA withholding amount, it would likely reduce funding of the plan for existing retirees and those workers retiring in the near future, thus accelerating the solvency crisis. So while personal accounts may actually have a positive-long term impact on Generation Y and Z workers entering the workforce, the existing trust would still be at risk if no other changes are made.
Another consideration is the impact of increasing FICA/FUTA withholding on the economy. If employees and employers are forced to contribute more to the Social Security program, it would take money out of the economy and result in significant economic drag—a fact which would not be lost on Trump as he tries to jump-start U.S. growth.
There is, however, a reason that politicians have been unable or unwilling to change the system: all of the policy prescriptions available are highly unpopular.
Small Business Open Multiple Employer Plans
Congress is considering a bill to make it possible for small, unrelated employers to join together in groups to offer a single retirement plan for their employees, instead of offering individual plans. Aggregating these employees into large groups (which would effectively amount to group purchasing of 401(k)/retirement services) would provide improved economies of scale and lower pricing for employers and costs to employees. That would also make ERISA compliance easier, while increasing the ability of small employers to offer more robust and valuable retirement benefits.
Given that small businesses are the largest net employer in the United States, this could be an important “assist” to our ability to save for retirement. The problem the bill would solve is that these MEP arrangements aren’t permitted under current law for unrelated employers. Today, employers either need to be related via common ownership, cooperative service organizations or trade associations, and meet certain other criteria in order to be considered eligible to participate in a MEP.
This squeezes out the average small employer and makes plan expenses higher and less attractive for both plan sponsors and participants alike. Open MEPs are popular on both sides of the political aisle and a bill is likely to pass Congress in 2017 or 2018, with the signature by President Trump a high likelihood.
While the above isn’t an exhaustive list, it’s a good starting point on the essentials of retirement post-election. In the days ahead, expect more change and analysis as the implications of the election continue to unfold.
Rob Massa, a wealth adviser, is director of retirement at Ascende, an EPIC Company in Houston.