Laws Affecting Benefits and Compensation Nearly Always Failures

I suspect that the authors of every law that affects employee benefits and compensation have good intentions when they draft those laws. As T.S. Eliot said however, "Most of the evil in this world is done by people with good intentions."

Where do these laws go wrong? To understand this, it's helpful to understand the process.

Usually, bills are drafted by Congressional staffers perhaps with the assistance of outside experts, often lobbyists. From there, bills are introduced and then haggled over by 435 people with no subject matter expertise in one chamber of Congress and then by 100 people with a similar lack of subject matter expertise in the other chamber. Once the sausage has been ground sufficiently, a bill may be approved and passed to the President for signature.

What could possibly go wrong?

Assuming that nothing could go wrong up until that point, these bills that by this point in the process have become laws leave it up to the various government agencies to create regulations that help to implement these laws. Some of the regulations make sense, and then there are the others.

Looking at this as someone who doesn't work for one of those agencies, it strikes me that each of them seeks to assert their power where possible. After all, if a government agency cannot show that it has power, why should it not simply cease to exist?

Further, if between Congress and the various government agencies, a bill and then law has not been messed up, there is still the court system to fall back on.

As an example, let's consider Internal Revenue Code Section 401(k). Essentially, it was added to the Code by the Revenue Act of 1978. And, while it was a throw-in, as we all know, once 401(k) plans were truly discovered, they took off in their popularity.

There are several things that we know about 401(k) plans. They are qualified retirement plans, thus governed by ERISA. They provide tax deductions and are thus also governed by the Internal Revenue Code. They have become very popular, so the amount of plan assets in many 401(k) plans is massive.

So now, let's look at the evolution of a current nightmare.

401(k) plans were created by the Revenue Act of 1978. They provided employees with an opportunity to save money for retirement on a tax-favored basis. Employers have the ability to match those employee deferrals and receive a tax deduction for those matching contributions. The Investment Committee (or some similar name) for the plan or its designee is responsible for selecting and monitoring investments in the plan. In that role, the Committee must act in the best interests of plan participants and in a fiduciary manner.

What does that mean?

The old regulations were very vague. Vagary has led to different courts imparting their wisdom in different ways. To be acting in the BEST interest of plan participants, what does a committee need to do? Does it need to find the LEAST expensive investment options? Does it need to find the HIGHEST returning investment options? If not, then how close to that optimum? Where is the bright line?

So, now we have new Department of Labor (DOL) fiduciary regulations. What they do more of than anything else is make more people fiduciaries of the plans than were before. Or, if they don't, then they certainly make clearer who the fiduciaries are and establish that there are, in fact, a lot of fiduciaries out there. Does this mean that more people will  be sued for fiduciary breaches?

Looking back, Section 401(k) should have been a great addition to the Code. And, weighing everything, perhaps it was (although regular readers of this blog will know my opinion that the addition of Section 401(k), more than anything else, probably ruined the American retirement system). But, over time, through this process, the 401(k) plan has become a mess. Each government agency thinks it has turf to protect. Employers feel that they have to offer a 401(k) plan, but few are equipped to handle one according to the current state of regulation and litigation.

The good news is that 401(k) plans through the Revenue Act of 1978 don't represent the only benefits or compensation law that is broken. Yes, that's also the bad news.

Consider these:

• The Pension Protection Act of 1987 and the Pension Protection Act of 2006 have probably done more to drive down the number of US pension plans than any other laws.
• A provision in the Multiemployer Pension Reform Act of 2014  that was intended to address the problem of serious underfunding in plans such as the Central States Teamsters Plan was dealt its first major setback specifically with respect to the Central States Teamsters Plan.
• The million dollar pay cap in Code Section 162(m) that was designed to limit executive compensation has done more to increase executive compensation than probably all other legislation combined.
• The Affordable Care Act of 2010 as we are seeing with announcements of 2017 exchange premiums is making health care anything but affordable.
• The Pension Benefits Guaranty Corporation's (PBGC) shortsightedness in addressing its self-determined shortfall has taken millions of participants out of the pension system thus increasing the PBGC's shortfall.

I could go, but you get the picture.

Save Our Social Security Act

What a novel idea -- Congressman Reid Ribble (R-WI) who I was completely unfamiliar with previous to today, has introduced into the House of Representatives a bill that incorporates ideas espoused by both parties. That's right, it's somewhat of a compromise bill designed to save our Social Security system by adding some burden to high earners while also increasing retirement ages.

The sad part is that I think that most people will look at this bill and focus on the parts that they, philosophically, don't like rather than emphasizing that it represents an excellent effort at potential bipartisan compromise. I hope I'm wrong.

What's in the bill?

• The Social Security Wage Base, that is the amount subject to the 6.2% OASDI tax that is currently at $118,500, will increase as follows:
• $156,550 in 2017
• $194,600 in 2018
• $232,650 in 2019
• $270,700 in 2020
• $308,750 in 2021
• after 2021, to be determined by the Secretary of the Treasury to capture 90% of all FICA-covered wages
• Change the current 3-band formula for calculating Social Security benefits to a 4-band formula thus allowing that all compensation considered for purposes of Social Security taxes also be considered for Social Security benefits, but not increasing Social Security benefits for the highest earners.
• Beginning in 2022, the Social Security Normal Retirement Age (SSNRA) would again begin to gradually increase. This would have little, if any, effect on people currently close to SSNRA, but would reflect longer work spans and life spans for younger workers. This piece of the bill would be reexamined by actuaries every 10 years to study the effects of mortality improvements.
• Change the basis for calculating the annual COLA for current SS beneficiaries by putting more weight on, for example, food, clothing, and transportation, and by putting relatively lower weight on housing, medical care, and recreation. The intent is to more closely mirror the necessary spending of a senior citizen as compared to that of an average urban wage earner.
• Create a minimum benefit at 125% of the poverty level
• Increase the benefit amount (I can't quite determine how this will work) after a person has been eligible to have been in pay status for 20 years
• Base the SS benefit on 38 years of SS wages rather than 35
• No legislation can be considered that would temporarily lower SS revenue for a year

Is this what I think is the best solution for Social Security? Probably not.

On the other hand, is this the best solution that I have seen that has a chance of passing Congress and being signed into law by the President? In my opinion, it has the best chance since 1983.

Let's see where it goes.

Senate Finance Committee Mulls Executive Compensation Changes

In late May, the Senate Finance Committee released its seventh paper in a series discussing ways on which it might consider reforming the existing Tax Code. Earlier this week, I discussed some of the possibilities in the retirement arena; today, I explore executive compensation.

For years, the intermingling of executive compensation and the Tax Code was a pretty simple consideration. Companies paid their executives a lot of money (but nowhere near as much as they do today). Essentially, executives paid taxes on compensation when it was constructively received and companies got deductions at the same time.

Each time that there was an abuse or perceived abuse, Congress saw fit to fix it through changes to the Internal Revenue Code. Rather than solving a problem, they often created a newer and bigger one. Congress sought to control the amounts that executives are paid by creating the $1 million pay cap under Code Section 162(m). I wrote about this problem back in 2011. Then, there were the Enron and Worldcom debacles and Congress presented us with Code Section 409A as part of a jobs bill of all things.

In any event, here are the proposals that the Finance Committee "may wish to consider" as it moves forward with all deliberate speed.

1. Revise the limits on the deductibility of executive compensation.
1. Repeal 162(m). In my opinion, repealing the limit would allow companies to pay executives more directly and would probably meaningfully decrease executive compensation.
2. Expand the 162(m) group. This, again in my opinion, would serve to increase the number of people for whom large companies would try to get overly creative and overpay their top employees, especially on the sales side.
3. Apply 162(m) to all equity compensation as well. 
4. Change the 162(m) limit to 25 times the compensation of the lowest-paid employee in the company. This would cause companies to eliminate lower-paying jobs. I see no benefit to this proposal.
2. Revise the rules related to nonqualified deferred compensation (NQDC). 
1. Modify or repeal Code Section 409A.
1. Repeal 409A and replace it with Treasury authority to promulgate rules that tax NQDC when it is constructively received. Didn't we used to have these rules?
2. Repeal 409A for private companies. 409A was put in to stop a run on the bank like the one that occurred in the Enron debacle. Private companies truly are a different situation.
3. Repeal the 20% penalty tax under 409A. Hmm! If you take the penalty out of a tax penalty, then you lose its teeth. Either repeal the section or keep it, but don't have it there with no teeth.
2. Repeal NQDC. That is, tax service providers on compensation in the year that it is earned rather than allowing deferral.
1. As an alternative, tax the employer currently on the buildup in deferred compensation.
2. Allow either the company or the executive to pay that tax in the item immediately above.
3. Revise the rules related to equity compensation.
1. Repeal incentive (at the money) stock options. Since ISOs get special tax treatment, repealing them would remove the incentive for grantees of such options to hold the shares once they exercise their options.
2. Modify deductibility of stock options.
1. Limit the deduction to the amount recorded on the company's books when the options are granted.
2. Deduct the stock option cost in the year that it is expenses.
4. Revise golden parachute rules.
1. Essentially repeal the excise taxes and the limitation on employer's deductions. This sounds like the pre-1984 rules.

This is certainly an interesting combination of proposals. I feel sure that even the least observant among my readers can work out which proposal came from Democrats and which from Republicans. Note that not a single one of the proposals talks about repealing Title IX of Dodd-Frank. Alas.

Where Bad Law Comes From -- Anatomy of a Bad Proposal

I'm not sure who writes the Administration's budget proposals. I know who is responsible, but the question is who actually writes them.

I ask because of the revenue-raising proposal to limit tax-favored retirement savings. What has been reported is that tax-favored savings will be limited to $3 million. That's a pretty good amount of money. But, the rumor that is circulating among some people in the know is a bit different.

Here is what it seems to be. For an individual, you take all of their tax-favored savings. That would appear to include Roth 401(k) as well as traditional and Roth IRAs, SIMPLE accounts, Keoghs, qualified defined contribution and qualified defined benefits. Then, you express them all as an annuity as Social Security Normal Retirement Age and the sum cannot exceed the 415(b) limit (currently $205,000 per year).

Do I think that is a bad concept? Well, in theory, limiting what people can save for retirement on a tax-favored basis is already done. The old 415(e) combined limit used to do something like this. But, that was from a single employer.

Suppose we start out simply. Adam (I picked Adam because it starts with an A) has only worked for one employer. He is about to reach his Social Security Normal Retirement Age (SSNRA) and he has the following:

• An accrued benefit in his DB plan of $100,000 per year
• A 401(k) account balance of $1,000,000
• An IRA with an account balance of $1,250,000

Whose responsibility is it to calculate the total limit? Is Adam required to tell his employer about his IRA? How are the conversions done? In this simple situation, it's not easy.

Beth, on the other hand, has jumped around from employer to employer. She is 45 years old and has accrued benefits in two DB plans, account balances in three 401(k) plans and an ESOP. She also has an IRA. One of her DB plans gives her an automatic cost of living adjustment (COLA). Who has to administer this? How? Who is responsible for telling whom what? Suppose Beth works two jobs that both provide benefits and she exceeds the limit, which one gets cut back.

Wouldn't you just love to be the people at Treasury and IRS who have to figure out how to regulate this?

The proposal may not be bad in theory, but as I understand the way it is being proposed, it is a disaster.

Stay tuned ...

SEAL Act Would Help DC Leakage Problems

In 2011, Senators Herb Kohl (D-WI) and Mike Enzi (R-WY) introduced their version of the SEAL Act. Now, two years later, Enzi and Bill Nelson (D-FL) have introduced a nearly identical bill, the Shrinking Emergency Account Losses Act (SEAL Act) into the Senate Health Education Labor and Pensions (HELP) Committee.

Essentially, the bill would accomplish two key purposes:

• Participants who elect to take hardship withdrawals will not have their rights to defer to a 401(k) plan suspended.
• Participants who terminate employment while having an outstanding loan balance in a qualified plan will have additional time to repay that loan before having a deemed distribution.

These are both positive steps that would help more participants to be prepared for retirement.

Philosophically, I have an issue with the first provision, however. A participant who has recently taken a hardship withdrawal has bigger issues than saving for retirement. Typically, that person would not be in a position to be taking money out of income for purposes other than keeping up currently.

The second provision makes sense. Currently, many administrative systems would not be equipped to handle such a provision, but certainly this could be fixed.

We'll see if the 2013 SEAL Act fares any better than its namesake did in the last Congress.

Senator Harkin Proposes Changes to Retirement System

As Congress approached its August recess, Senator Tom Harkin (D-IA) released a position paper entitled “The Retirement Crisis and a Plan to Solve It.” The release of the paper is notable because as the Chairman of the Senate Health, Education, Labor & Pensions (HELP) Committee, Harkin is perhaps the most influential legislator in the entire Congress with respect to qualified retirement plans. Here, I will give you an overview of Senator Harkin’s paper with some commentary. Given his position, should the Democrats retain control of the Senate and the White House, this paper likely signals a directional shift for the retirement industry.

Senator Harkin proposes two very significant changes:

• Development of Universal, Secure, and Adaptable (USA) Retirement Funds 
• Changes to the Social Security structure designed to better finance the program while providing better benefits for the lowest earners and inflation protection better geared to inflation as it affects senior citizens

USA Retirement Funds

Senator Harkin is concerned that so many Americans have essentially no retirement savings including any employer-sponsored retirement plans. The solution, as he sees it, is to give employers a choice of sponsoring their own retirement plans or putting their employees into a USA plan. Plans that are entirely voluntary for employees (401(k) without auto-enrollment or without a sufficient employer match) would not suffice as employer-sponsored. To the extent that they were to go the route of the USA plan, here are the key features as I read Harkin’s paper:

• ·         Auto-enrollment through payroll deduction
• ·         USA Retirement Funds would be professionally managed
• ·         Regions, industries, or collective bargaining agreements might have default funds
• ·         Benefits would be 100% portable
• ·         Retirement benefits would be payable as annuity with survivorship rights for beneficiaries

Senator Harkin notes in his paper that USA Retirement Funds will compete with each other keeping costs low. They will be subject to significant disclosure requirements to ensure transparency.

Social Security Changes

As we all know, the Social Security system is projected to run into a shortfall situation at some point between 20 and 40 years out depending upon which forecast we look at. Senator Harkin’s proposal is designed to address this while improving benefits for certain retirees at the same time. Here are the three key points of his proposal with respect to Social Security:

• ·         Eliminate the Social Security Wage Base (currently $110,100) so that higher earners and their employers would no longer have the phase-out of OASDI taxes. Currently, employees and their employers pay 6.2% of pay up to the Wage Base into Social Security and 1.45% of all pay into the Medicare (HI) part of the system.
• ·         The existing methods for calculating Social Security benefits use a progressive three-tier approach. Currently, 90% of a person’s Average Indexed Monthly Earnings (essentially, their average inflation-adjusted compensation over their career) up to $767 is added to two other components in calculating the benefit. Under Senator Harkin’s plan, that 90% would phase up to 105% over a 10-year period. What this would mean is that low wage earners would receive a larger benefit from the Social Security in retirement than the pay they had been receiving from their employer.

·         Today, the annual inflationary adjustment for Social Security beneficiaries is based on the increase in the Consumer Price Index for all Urban Wage Earners (CPI-W). This index would be replaced by the CPI-E, the Consumer Price Index for the Elderly which places significant emphasis on the rising costs of health care.

Sanity on the Hill for a Change

UPDATE: It's the law now. The President signed it.


Former House Speaker Nancy Pelosi (D-CA) asked us to wait until the bill was passed to see what was in it. We all know that this refers to the Patient Protection and Affordable Care Act (Health Care Reform or PPACA). Most observers would say that the bill (now law) had a number of good things in it. Most observers would also say that it had a number of bad things in it. With regard to some of those elements, however, there was near unanimity. One, in particular, is the requirement that businesses and landlords file a Form 1099 with the IRS for all goods and services purchased with value above $600. Surely, this has something to do with either patient protection or affordable care, but the connection escapes me.

In the House of Representatives, the bill passed by a vote of 314-112. In fact, in addition to Representative Dan Lungren (R-CA) who introduced the bill, there were 273 co-sponsors. That was enough to get it through the House without any of the non-sponsors voting for it. The co-sponsors were from both parties. No Republicans voted against the bill. The Democrats were fairly evenly split with roughly 40% of them supporting passage of the bill.

Yesterday, the Senate acted on the bill, introduced by Senator Mike Johanns (R-NE) and co-sponsored by 10 others representing both major parties. The Senate passed the bill by a vote of 87-12. The Library of Congress website has not yet reported the vote, so I can't report to you who the 12 with particularly lame brains are, but if you find the need to know yourself, check here and click on 'major congressional actions' when that link becomes active.

The bill now goes to the President who I expect will sign it. Now that this is over with, perhaps we can have a budget for Fiscal 2011 before Fiscal 2011 ends.

Ways and Means Chair Sometimes Most Powerful Person in US

It must be that the benefits and compensation worlds are standing still. I'm not inspired right now to write anything truly topical. But, what does the House Ways and Means Committee have to do with this topic anyway?

Well, I'll tell you. The US Constitution says that tax legislation has to start in the House of Representatives. The House rules say that the place where tax legislation will start is in the Ways and Means Committee and the Chair controls the docket. Convinced yet?

OK, then, think about all the pay and benefits that you get from your employer, or, if you are an employer, all the pay and benefits that you provide to your employees. Companies take tax deductions for virtually all of it. But, the amount and timing of those deductions is often a major influence in determining exactly how and how much you are paid or which benefits you receive and how. It seems like taxes shouldn't have much to do with your rewards package, but alas, taxes have everything to do with your rewards package.

What will happen if the US ever adopts a Fair Tax? http://www.fairtax.org/site/PageServer  Well, for one thing, that would mean an end to the Ways and Means Committee and certainly eliminate one of the most highly-sought after positions on the hill.

If you look at the list of former (and current) Ways and Means Chairs, you'll see some names that you recognize: James Polk (became President), Millard Fillmore (became President), William McKinley (became President), Wilbur Mills (got involved with a stripper named Fanne Foxe), Dan Rostenkowski (convicted of mail fraud, but passed more legislation covering employee benefits than all other Ways and Means Chairs combined), and Charlie Rangel (censured by the House for failing to report income on his tax return of all things). There is no other House committee from which I could name 6 Chairs (actually I could name more from this one without using Google or Wikipedia).

The current Chair is a Republican from Michigan by the Name of Dave Camp. He replaced a Democrat from Michigan by the name of Sander Levin. That's two consecutive Michiganders or if you prefer, Michiganas, running this committee. By all appearance, he is not a particularly exciting man. Is this good or bad for the Human Resources world? I don't know. Frankly, Mr. Camp appears out of the current vocal Republican group clamoring for spending cuts.

From my way of thinking, this probably means that Social Security and Medicare reform will be slow (if at all) to happen during Mr. Camp's reign. I don't expect a major tax reform that many clamor for. And, since major benefits legislation always has tax implications, I don't expect much of that either. So, for 2011 and 2012, maybe we get to keep a lot of the status quo.

Republicans Take on Health Care Reform

Today, a group of Republicans in the House of Representatives (I'm not sure, it may have been all of them) introduced the "Repealing the Job-Killing Health Care Law Act" (I don't make up these names, I just report on them). It's only two pages long, but here's what it would do as I read it:

• Restore statutes to what they were before the health care reform legislation (PPACA) was passed
• Repeal the health care related provisions in the Reconciliation legislation that made some technical corrections to health care reform

That's it!

Separately, the Republicans are introducing legislation (as yet unnamed, but I can't wait to see what they call it) that will focus on 12 specific goals with respect to health care (when I can find the 12, I'll post them). In any event, 4 separate committees are directed to create health care legislation that will:

• Lower premiums through increased competition and choice
• Increase the number of Americans who are insured
• Protect the relationship between doctors and patients (I suspect that this has something to do with not having to change doctors and or confidentiality)
• Prohibit taxpayer funding of abortions
• Provide conscience protections of health care providers (somebody must have spent a lot of time crafting those words with the specific goal of confusing me)

Clearly, fun times are ahead for all!