Washington Update A Summary of Key Legislative and Regulatory Developments Affecting Retirement Savings SEPTEMBER 2017 Having returned from its August recess, Congress is now faced with a legislative calendar that is jam-packed with must-pass items. From funding for federal agencies, to addressing the debt ceiling, to reauthorizing numerous agency programs and activities set to expire, Congress will by necessity be forced into legislative activity. A failure of Congress to act on these legislative items could lead to repercussions both economically and politically. Thus, other policy items that fall outside the parameters of these must-pass legislative priorities, such as tax reform, likely must await a clearer legislative calendar before consideration can occur. That said, the goal of both the Trump administration and Congressional leadership remains to enact tax reform legislation into law before 2017 comes to a close. With health care reform having failed to pass through the Senate, Congressional leadership is now shifting its focus to tax reform. Even with a very crowded legislative calendar this fall, the prospect remains positive for Congress to successfully pivot to, and move, tax legislation through to enactment. And, as discussed below, enacting tax reform could have implications for retirement savings policy as well.
Legislative Tax Reform While talk of tax reform has been ceaseless since the swearing-in of the 115th Congress in early January, we have yet to see comprehensive reform legislation introduced in either the House or the Senate by the leaders of the tax writing committees. However, on July 27, a joint statement was released by the Trump administration and Congressional leaders (i.e., the Big Six ) that set forth broad parameters upon which the White House and Senate/House Republicans agreed would form the basis for moving tax reform forward. 1,2 With the Republican-controlled Congress and the White House seemingly on the same page, at least with regard to broad goals and parameters for tax reform, the Ways and Means Committee in the House has begun drafting legislative text. The perceived likely scenario going forward is that the House moves first this fall in passing a comprehensive tax reform package, followed by the Senate, with the ultimate goal to have a final reform bill signed into law by the end of 2017. In theory it sounds simple, but the reality is usually much different. Also, many of the must-pass items mentioned above could alter the calendar for tax reform in such a way that, at the earliest, it moves into 2018 before consideration occurs. That said, with the 2018 mid-term elections fast approaching, enacting tax reform sooner, rather than later, has now become the highest priority of this Congress and administration. THE PROCESS In our inaugural edition of the Washington Update, we indicated that Budget Reconciliation would be the likely means by which tax reform moves through Congress. 3 Our reasoning was simple; using reconciliation would allow for Congress to avoid the procedural pitfalls of moving tax reform legislation via regular order, where a 60-vote threshold would be required in the Senate. With only a simple majority required via reconciliation, tax reform could move through the Senate on a partisan basis, so long as the reform legislation adhered to the reconciliation instructions, and so long as the majority was able to remain unified in their support therefor (with a 52-48 majority, Senate Republicans can afford to lose only two senators and still pass tax reform using reconciliation). In its pursuit of tax reform, a major goal of Congressional Republicans has been to enact permanent reform in a revenueneutral fashion, thus avoiding increasing the federal budget deficit. The practical reality of that goal is that any changes to the tax laws that reduce revenues will necessarily have to be offset with changes elsewhere that raise revenue or reduce spending, thus creating winners and losers in whatever reform package emerges. And, as mentioned above, with Congress likely to utilize reconciliation as the procedural means for moving tax reform, the goals of permanence and revenue neutrality actually become prerequisites. Absent revenue neutrality, tax reform legislation enacted via reconciliation could not be permanent, but rather would have to sunset at some point during the budget window, to avoid losing revenue in the years beyond the budget window (usually 10 years) and thus inviting procedural challenges to its consideration. 5 HOW TAX REFORM COULD STRUCTURALLY CHANGE THE PRIVATE SECTOR RETIREMENT SYSTEM The overriding policy goal of the administration and Congress is to reduce both the complexity of the Internal Revenue Code and the burden it places upon individuals and businesses (corporations and pass-through entities). Yet, achieving a significant rate reduction on individuals and on businesses would lead to substantial losses in federal revenue, and when considered along with other revenue-losing reform proposals under discussion, such as repealing the AMT (e.g., in 2014, the revenue-loss estimate in H.R. 1, for repealing the individual AMT, was roughly $1.2 trillion over the 10-year budget window), achieving revenue neutrality becomes a painful exercise in base-broadening and/or the introduction of new revenue sources into the Internal Revenue Code. 6 For instance, the Joint Tax Committee of Congress, in testimony before the Senate Finance Committee on April 26, 2016, estimated that a one percentage point drop in the statutory corporate income tax rate would lead to a decrease in federal revenues of $100 billion over the 10-year budget window. The Trump Administration has proposed a drop in the statutory corporate income tax rate from 35% to 15%, while House Republicans have proposed a drop to 20%. Either proposal would yield a significant loss in federal 2
revenues, according to the Joint Tax Committee s estimate. One area where policymakers may look for revenue involves retirement savings. An idea that is under consideration by policymakers is to move all, or at least a portion of, the current privatesector retirement system (employersponsored defined contribution plans and Individual Retirement Accounts (IRAs)) towards a Roth IRA model, where employee contributions to a plan would be made with after-tax dollars, and individual contributions to traditional IRAs would no longer be tax deductible. Such a change will likely be accompanied with increased limits on contributions to plans and IRAs and, in the case of plans, in the overall amounts that could be contributed to a plan each year (defined contribution limit). However, existing law treatment for employer matching contributions and for accumulated account balances in plans and IRAs generated with tax-favored contributions prior to enactment, will likely be grandfathered, and remain intact. For more detail on the changes that have been a part of the discussions to date, please refer to the June Update a link to which appears below: https://www.morganstanleyfa.com/ public/projectfiles/b378aaad-0286-4518- bd2a-16ff8945dd50.pdf OUTLOOK With tax reform one of the highest priority issues for both Congressional Republicans and the Trump administration, and with health care reform now at least temporarily sidelined, the imperative for Congress to move tax reform legislation through to enactment has increased significantly. In that regard, Congress and the Trump administration are contemplating several alternative scenarios in order to enhance their legislative prospects. The initial goal is to move through comprehensive reform that lowers the rates and broadens the tax base, in order to achieve revenue-neutral reform in a permanent fashion. It is within comprehensive reform that the prospect for changes to the tax treatment of retirement savings is greatest, as the retirement changes being discussed today may not only fit within a likely theme of simplification, but equally as important, such changes have the potential to raise a significant amount of revenue. 6 However, other options are also possible should revenue-neutral tax reform bog down, including enacting a simple tax cut that would be at most only partially paid for, with provisions not made permanent likely written to sunset at some point during the 10-year budget window. Should a simple tax cut be the end result of the current tax reform effort, then retirement savings provisions may not be included therein, especially if Congress is not seeking to offset those tax cuts or to only partially offset them. The process should begin to unfold in October following the September legislative rush to keep the federal government funded beyond the end of the fiscal year (September 30), and to avoid a default on our government obligations via a further suspension of, or outright increase in, the debt ceiling. Department of Labor Fiduciary Rule Legislative Proposals Republican Members of Congress continue pursuing legislation to repeal or otherwise nullify the Department of Labor s ( DOL ) Final Rule changing the definition of fiduciary investment advice. On June 8, the House passed the CHOICE Act, H.R. 10, legislation to amend numerous provisions of the Dodd-Frank Wall Street Reform and Consumer Protection Act (Dodd-Frank). The CHOICE Act includes, in Section 841 therein, language to provide that the DOL Final Rule shall have no force and effect. 7 Also on June 8, Representatives Phil Roe (R-TN) and Peter Roskam (R-IL), introduced The Affordable Retirement Advice for Savers Act, H.R. 2823. 8 The legislation repeals the DOL s Final Rule (and applicable exemption changes) and instead imposes a best interest standard on advisors under a modified definition of investment advice that would be statutory, and applicable both under ERISA and the Internal Revenue Code. The legislation would also exempt advice from ERISA s (and the Code s) prohibited transaction rules so long as only reasonable compensation is paid and certain disclosure requirements are met. 9 3
Finally, on July 24, the House Appropriations Committee approved the Departments of Labor, Health and Human Services, and Education, and Related Agencies Appropriations Act, 2018 H.R. 3358, legislation to provide funding for the these agencies identified in the title, along with their related programs thereunder for fiscal year 2018. Included in Title I of the legislation, the Department of Labor Appropriations Act of 2018, is section 114, which provides that notwithstanding any other provision of law, the final rule issued by the Department of Labor titled Definition of the term Fiduciary; Conflict of Interest Rule-Retirement Investment Advice and published by the Department of Labor in the Federal Register on April 8, 2016 (81 Fed. Reg. 20946 et seq.), shall have no force or effect. 10 OUTLOOK While the CHOICE Act has already passed the House; H.R. 2823 has moved favorably through the House Education and Workforce Committee (it now awaits consideration by the Ways and Means Committee); and H.R. 3358 has been favorably reported from the House Appropriations Committee (and awaits floor consideration), the overall prospects for the DOL Fiduciary Rule to be repealed or otherwise nullified via one of these (or other likely to be introduced) legislative vehicles remains slim. Neither the CHOICE Act, nor H.R. 2823, will likely move through the Senate on their own, as they lack the bipartisan support necessary to overcome a legislative filibuster. As for H.R. 3358, on paper it has the only realistic chance for passage as it is the appropriations legislation for three key federal agencies, but the reality is the Labor/HHS appropriations legislation always faces difficulty moving through Congress, and invariably becomes part of a larger omnibus legislative package that provides funding for many other agencies and programs. Should the appropriations process follow a more traditional path, with an omnibus spending bill enacted at some point, it is doubtful that the fiduciary language from H.R. 3358 would survive, as an omnibus bill would necessarily have to be negotiated not only between the Senate and House, but between the Majority and Minority parties in each, where opposition to repeal of the Final Rule is as strong as support therefor. Other Legislation Retirement Focused So far this Congress, numerous bills have been introduced in both the Senate and the House, beyond those pertaining to the DOL fiduciary rule, that implicate either in whole, or in part, retirement savings. They cover a broad spectrum of retirement-focused issues (below is a sampling only) such as: Legislation to address financial problems facing the multiemployer pension system S. 489 The Pension Accountability Act S. 1105/H.R. 2713 The Miners Pension Protection Act H.R. 2117, The Multi-Employer Pension Plan Partnership Act S. 1080, The Vested Employee Pension Protection Act Legislation to address leakage from retirement plans H.R. 2020 The Savings Enhancement by Alleviating Leakage in 401(k) Savings Act Legislation to create automatic IRA arrangements for employees of small employers who do not maintain a qualified retirement plan H.R. 3499, The Automatic IRA Act of 2017 Legislation to create a Universal Savings Account H.R. 937/S 323 The Universal Savings Account Act OUTLOOK With the exception for legislation seeking to stabilize the multiemployer pension system, which may move separately this year, most retirementfocused legislation, including those mentioned immediately above, will likely have to be incorporated into tax reform, should a pension title be included therein, to have any chance for enactment. These likely will not move through Congress as standalone measures. Beyond tax reform, the only other viable option for their consideration is if Congress considers multiemployer pension reforms in a legislative vehicle that is expanded in scope to incorporate changes to the single employer retirement system and/ or IRAs, and likely done simply to generate support for the overall package. In such a scenario, the substantive changes under discussion for tax reform are certainly possible, but more likely such legislation would be less expansive, and include targeted changes such as H.R. 2020, above, that seek to address discrete items such as leakage from retirement plans. 4
Regulatory Department of Labor Fiduciary Rule On June 9, 2017, the applicability date for the Fiduciary Rule went into effect setting forth a transition period leading up to full compliance with the Rule, and all applicable exemptions, on January 1, 2018. However, on August 9, 2017, the Department of Labor notified the United States District Court for the District of Minnesota, in the matter of Thrivent Financial for Lutherans v. R. Alexander Acosta, Secretary of Labor, and United States Department of Labor, Civil Action No. 16-cv-03289 (D. Minn.), that it had submitted to the Office of Management and Budget (OMB) a proposed extension of the transition period from January 1, 2018, to July 1, 2019, along with a delay of the Applicability dates for the Best Interest Contract Exemption (PTE 2016-01); the Class Exemption for Principal Transactions in Certain Assets Between Investment Advice Fiduciaries and Employee Benefit Plans and IRAs (PTE 2016-02); and Prohibited Transaction Exemption 84-24 for Certain Transactions Involving Insurance Agents and Brokers, Pension Consultants, Insurance Companies, and Investment Company Principal Underwriters (PTE 84-24) also to July 1, 2019. As of this writing, OMB had not completed its review of the proposed extension and delay prior to the June 9 applicability date, DOL also released Field Assistance Bulletin 2017-02 (FAB 2017-02), indicating, among other things, that it would not pursue claims against firms during the transition period so long as they are working diligently and in good faith to comply with the law. A series of Frequently Asked Questions (FAQs) have also been released to provide clarity on questions surrounding issues that were/ are likely to arise during the transition period. While we provided links to the Field Assistance Bulletin and the first set of FAQs in the June Update, we include them again herein as the transition period remains ongoing: https://www.dol.gov/agencies/ebsa/ employers-and-advisers/guidance/fieldassistance-bulletins/2017-02 https://www.dol.gov/sites/default/files/ ebsa/about-ebsa/our-activities/resourcecenter/faqs/coi-transition-period.pdf On June 29, 2017, DOL also released a Request for Information Regarding the Fiduciary Rule and accompanying Prohibited Transaction Exemptions ( RFI ), seeking public input on the agency s examination of the final rule as directed by the president, on February 3, 2017, with the signing of the Presidential Memorandum on Fiduciary Duty Rule ( Presidential Memorandum ). A link to the RFI is included below: https://www.dol.gov/sites/default/files/ ebsa/about-ebsa/our-activities/resourcecenter/faqs/coi-transition-period-2.pdf https://www.gpo.gov/fdsys/pkg/fr-2017-07-06/pdf/2017-14101.pdf The RFI sought public input in two areas, first whether the January 1, 2018, applicability date of certain provisions in the Best Interest Contract Exemption, the Class Exemption for Principal Transactions in Certain Assets Between Investment Advice Fiduciaries and Employee Benefit Plans and IRA, and Prohibited Transaction Exemption 84-24, should be extended; and second, regarding possible additional exemption proposals or changes to the Fiduciary Rule. Of course, the DOL is conducting this RFI in conjunction with the comments it received based upon its March 2, 2017, request for comments on the issues raised in the Presidential Memorandum. The deadline for submitting comments regarding an extension of the Applicability date were due to the DOL on July 21, 2017, while all other comments were due by August 7, 2017, although the DOL has notified interested parties via its website that comments submitted after this date may still be considered. It should be noted that, despite the activity surrounding the DOL Fiduciary Rule, as of this writing the president had yet to nominate an individual to service in the position of Assistant Secretary for Employee Benefits Security Administration ( EBSA ). The lack of senior Trump administration officials within the DOL, and especially within EBSA, could have implications regarding the agency s review of the Fiduciary Rule. Securities and Exchange Commission In addition to the DOL regulatory activity above, the Securities and Exchange Commission (SEC) has also solicited comments from the public regarding standards of conduct for investment advisers and broker-dealers. The request for comments follows SEC Chair Jay Clayton s comments regarding the agency s interest in moving forward with an examination of the standards 5
of conduct applicable to investment advisers and broker-dealers, and the commitment from both the SEC and the DOL in working constructively and in a coordinated fashion on the issue going forward. A copy of the Chairman s comments, and the questions upon which the SEC is seeking public comments, can be accessed via the link below: Department of the Treasury The Treasury Department, as of this writing, had yet to release its 2017-2018 Priority Guidance Plan, although it did release Notice 2017-28, seeking public comment on recommendations for items to be included in the guidance plan. However, with the position of Assistant Secretary for Tax Policy vacant until the beginning of the Senate s August recess, the release of the 2017-2018 Priority Guidance Plan was necessarily delayed awaiting that person s confirmation. 11 Moreover, with the position of Benefits Tax Counsel within Treasury also lacking a Trump administration appointee as of the August recess, regulatory initiatives regarding retirement benefits have not moved forward. The following link provides access to the October 31, 2016, publication of the Priority Guidance Plan, and includes the items listed below as well as the remaining retirement focused items that were under consideration when the transition in administrations began: https://www.sec.gov/news/publicstatement/statement-chairmanclayton-2017-05-31 https://www.irs.gov/pub/irsutl/2016-2017_pgp_1st_quarter_ update.pdf As discussed in our previous Update, 37 items were carried-over from the Obama administration, identified as those retirement issues upon which Treasury/ IRS intend to work on during the coming year. While some of these items are likely to change with the Trump administration, they nonetheless remain as valid projects pending the release of the 2017-2018 Priority Guidance Plan, with a sampling of the 37 retirementfocused items listed below: Regulations on exceptions to additional tax under IRC Section 72(t) on early distributions from retirement plans and IRAs Final regulations under IRC 417(e) to simplify the treatment of optional forms of benefit that are paid partly in the form of an annuity and partly in a more accelerated form Additional guidance on issues relating to lifetime income from retirement plans and IRAs Guidance on rules applicable to IRAs under IRC Sections 408 and 408A Regulations updating the rules applicable to ESOPs Beyond the Priority Guidance Plan, Treasury/IRS did release IRS Notice 2017-37 on July 17, 2017, that contains the cumulative list of Changes in Plan Qualification Requirements for Pre- Approved Defined Contribution Plans for 2017. The 2017 Cumulative list identifies the qualification requirements required to be taken into account in a plan document submitted to the IRS under the preapproved plan program for purposes of receiving an opinion letter. A link to the Notice can be accessed via this link: https://www.irs.gov/pub/irs-irbs/ irb17-29.pdf Miscellaneous Retirement Plan Limits For quick reference, the 2017 retirement plan limits are listed below: Elective deferral (contribution limit) for 401(k), 403(b), 457 plans $18,000 Catch-up contribution limit for 401(k), 403(b), 457 plans $6,000 Annual contribution to an IRA $5,500 Catch-up contribution limit for IRAs $1,000 SIMPLE employee deferrals $12,500 SIMPLE catch-up deferral $3,000 Annual Defined Contribution limit $54,000 Annual Compensation limit $270,000 Limit on annual benefit under a defined benefit plan $215,000 6
1 The Big Six includes Treasury Secretary Steven Mnuchin, National Economic Council Director Gary Kohn, Senate Majority Leader Mitch McConnell (R-KY); House Speaker Paul Ryan (R-WI); Senate Finance Committee Chair Orrin Hatch (R-UT); and House Ways and Means Committee Chair Kevin Brady (R-TX). 2 The Joint Statement on Tax Reform as published by the White House can be accessed via this link: https://www.whitehouse.gov/the-press-office/2017/07/27/ joint-statement-tax-reform. 3 As mentioned in the June Update, Reconciliation is a tool for moving certain limited types of legislation through the Senate without the ability of the minority party to filibuster. While the minority party can t stop a unified majority party from moving reconciliation legislation through to passage, the rules surrounding reconciliation can impose limits on its effectiveness, or usefulness. The scoring in the out years (several decades beyond the 10-year budget window) may lead to problems in using it, especially if that scoring indicates deficit increases in those out years and the possible sunset problem, that could flow therefrom; the role of the parliamentarian in deciding what meets and what doesn t meet the reconciliation instructions and rules, etc.] Congress must first pass a Budget Resolution that would include instructions to, in this case, the tax-writing committees, to report legislation to achieve the goals that are set forth in the Resolution. For tax reform to utilize Reconciliation, the legislation would be required to comply not only with the instructions set forth in the Resolution, but also the revenue floor that is set forth as well. To the extent a tax provision included in reform did not have a direct revenue impact; it could be challenged and possibly excluded therefrom. 4 There has been talk among some Members of Congress regarding offsetting tax cuts with spending reductions in mandatory spending programs as a means for helping to achieve balance, rather than simply raising taxes elsewhere to achieve balance. 5 Congress could always vote to make permanent tax reconciliation legislation that is enacted with a sunset provision included therein, but to do so would be via regular order and the ability to meet the 60-vote threshold to avoid a filibuster in the Senate. 6 By way of example, when the Tax Reform Act of 2014 (H.R. 1) was introduced by then-chairman Dave Camp (R-MI), the proposal would have required all IRA contributions going forward to be contributed to a Roth IRA account, and for all but the smallest employers would have limited elective deferrals into traditional defined contribution plan accounts (including catch-up contributions for employees 50 and older) to one-half of the maximum annual deferral amount for such plans, with any contributions in excess of half of these limits contributed into a Roth Account. Any employer contributions would continue to be made into the traditional account. These changes (somewhat more detailed and expansive than this brief description) were estimated by the Joint Tax Committee to raise $143.7 billion over the 10-year budget window. 7 The CHOICE Act can be accessed via this link, with section 841 found on page 465 therein: https://www.congress.gov/115/bills/hr10/bills-115hr10rfs.pdf 8 Also on June 8, Senator Johnny Isakson (R-GA), introduced S. 1321, The Affordable Retirement Advice Protection Act, legislation that is similar, but not identical to, H.R. 2823. 9 A copy of H.R. 2829 can be accessed via this link: https://edworkforce.house.gov/uploadedfiles/bill_summary_affordable_retirement_advice_for_savers_act_final.pdf 10 The Conference Report on H.R. 3358 can be accessed via this link, with the language regarding the Fiduciary Rule found on page 161: https://www.congress.gov/115/crpt/hrpt244/crpt-115hrpt244.pdf. It is likely that H.R. 3358 will, prior to floor consideration, be combined with a number of other appropriations bills that fund various federal agencies and programs into a single omnibus bill upon which the House will vote. For purposes of following its progress going forward, H.R. 3354, the Department of Interior, Environment, and Related Agencies Appropriations Act, 2018, will be the vehicle through which all remaining appropriations bills (including H.R. 3358) will be added, and H.R. 3354 will then be retitled the Make America Secure and Prosperous Appropriations Act. 11 David J. Kautter s nomination to be the Assistant Secretary for Tax Policy was confirmed by the Senate on August 3, 2017. On July 20, his nomination was reported. Tax laws are complex and subject to change. Morgan Stanley Smith Barney LLC ( Morgan Stanley ), its affiliates and Morgan Stanley Financial Advisors and Private Wealth Advisors do not provide tax or legal advice and are not fiduciaries (under ERISA, the Internal Revenue Code or otherwise) with respect to the services or activities described herein except as otherwise provided in writing by Morgan Stanley and/or as described at www.morganstanley.com/ disclosures/dol. Individuals are encouraged to consult their tax and legal advisors (a) before establishing a retirement plan or account, and (b) regarding any potential tax, ERISA and related consequences of any investments made under such plan or account. 7
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