Important Pension Changes and Regulatory Updates

1. IMPORTANT PENSION CHANGES – WASHINGTON & REGULATORY UPDATE Marcia S. Wagner, Esq.

2. Transformation of Retirement System • DOL Interaction with White House • Working with White House’s Middle Class Task Force • Coordinated actions to improve retirement security • DOL rollouts in 2012 & 2013: • Fee disclosures for plan sponsors • Participant-level fee disclosures • New 6-month reset of annual disclosure date • Participant investment advice • 2014 / 2015 DOL regulatory initiatives include: • Tips on selection of target date funds • Inclusion of lifetime income streams in benefit statements • Global Impact of ACA & Tax Reform Purposes. • Unforeseen changes to retirement system

3. Introduction • 1. Target Date Funds • 2. Lifetime Income Initiative • 3. Tax and Healthcare Reform

4. Background on Target Date Funds • Popular default investment vehicle for 401(k) plans. • Typically, formed as open-end investment companies registered under Investment Co. Act. • Defining characteristic – “glide path” which determines overall asset mix of fund. • Performance issues in 2008 raise concerns, especially for near-term TDFs. • Based on SEC analysis, average loss for TDFs with 2010 target date: -25%. • Individual TDF losses as high as: -41%.

5. DOL Tips for Selecting a TDF • Start process by examining TDF prospectus • Identify Plan objectives • Preservation of savings • Maximizing income • Stable retirement spending • Relate TDF characteristics to plan objectives • Investment performance • Fees & expenses • Glidepath • Landing point • Document decision-making process

6. Understanding the Glidepath and Landing Point • Determine Fund’s relative allocation to equities and fixed income investments • Starting point • Landing Point • Determine rate of conversion • “To” or “Through” investment philosophy • Significant equity allocation through death matches plan with gradual withdrawal pattern • Most conservative fixed income position at landing point matches plan where most participants cash out at retirement

7. Consideration of Demographic Factors in Selecting a TDF • Consider alignment of TDF with the following factors: • Withdrawal patterns • Participant ages and likely retirement dates • Participation in DB plan • Salary levels • Turnover rates • Contribution rates

8. TDF Investment Strategy • Identify TDF asset classes other than equity & fixed • Real estate with capacity to address inflation risk • Commodities • Inflation-adjusted bonds (TIPS) • Cash • Know investment style • Passively vs. actively managed • Impact on fees • Understand investment form • Mutual funds • ETFs • Collective trust • Separately managed account

9. Customized Target Date Funds • Advantages of custom TDF • Incorporation of plan’s core funds • Inclusion/exclusion of specialized asset classes • Broader asset diversification • Diversifying exposure to investment providers • Improved investment performance • Flexible glidepath design • Elimination of tiered mutual fund fees • Disadvantage • Generally higher fees

10. Monitoring TDF Modifications & Performance • ERISA prudent process requires periodically monitoring TDF characteristics • Management team • Investment strategy • Effective implementation of strategy • Periodically review whether TDF continues to meet plan objectives and demographics • TDF changes or mismatch may require replacing fund • Check underlying funds/investments

11. Employee Communications for TDFs • Participant-level disclosure requires annual comparative chart and disclosure of plan-related fees • DOL proposed enhancement to comparative chart requires appendix for TDFs • Explanation & graphic illustration of TDF glidepath • Relevance of date in TDF name (e.g., 2030) • Statement that TDF may lose money near or after retirement • DOL proposed change to QDIA notice • Same as required on appendix to comparative chart • TDF investment objectives and principal strategies • Assets held by TDF/QDIA and historical investment performance • Disclaimer as to performance • No DOL model notice

12. Target Date Fund – Role of Advisors • Provide meaningful TDF disclosures to participants as “best practice” right now • Explain key information • Glidepath • Landing point • Potential volatility • Facilitate sponsor’s prudent review of TDF • Assist in fiduciary review of glidepath, tiered funds structure, underlying funds & risk • Special review of TDFs with near-term (2015) target date

13. 1. Target Date Funds • 2. Lifetime Income Initiative • 3. Tax and Healthcare Reform

14. Goals of Policymakers • Help retirees take plan distributions without outliving them • Motivate retirees to annuitize accounts • Retirement paycheck for life • Encourage plan sponsors to voluntarily offer annuity options • Permit longevity annuities • Remove regulatory hurdles • Facilitate default annuities • Promote education and disclosures

15. Lifetime Income Solutions for DC Plans • Three Basic Approaches 1) External Solution (Outside of Plan) 2) Distribution Option Within Plan 3) Investment Vehicle Within Plan • External Solution • Participants purchase IRA Annuities. • Annuitization occurs outside of plan through rollovers. • Internet portals can improve participant access.

16. “In Plan” Lifetime Income Solutions • Distribution Option Within Plan • Plan purchases Distribution Annuities • Immediate annuity purchased at time of distribution • Annuity contract is distributed to participant • Investment Vehicle Within Plan • Plan invests in Group Annuity • Offers various investment and distribution options • Participant’s account converted to lifetime income

17. Comparison of Retirement Income Strategies Guaranteed Access to Cash Income?In Retirement? Systematic Withdrawals NoYes Managed Payout No Yes Distribution Annuities Yes No Group Annuity (Traditional) Yes No Longevity Insurance Partial Partial GLWB (Group Annuity) Yes Yes

18. Guaranteed Living Withdrawal Benefit (GLWB) • Guaranteed Withdrawal • Guaranteed percentage of “Benefit Base” may be withdrawn annually during retirement years. • Guarantee takes effect when account’s investment value is insufficient to cover guaranteed withdrawals. • Benefit Base • Initial value is based on contributions. • Future value may “roll up” by fixed percentage each year, or “step up” based on anniversary value of account.

19. Need for Additional Fiduciary Guidance • Selection of Annuity Provider and Annuities • Subject to ERISA fiduciary standards. • Must act in accordance with duty of prudence and loyalty. • Existing DOL Guidance • 1995 guidance on Distribution Annuities for DB plans. • 2008 safe harbor on Distribution Annuities for DC plans. • No clear guidance on other annuities for DC plans.

20. Current Fiduciary Standard for Annuities • DC Plans and Lifetime Income • Lack of clear guidance has not stopped DC plan sponsors (e.g., United Technologies adds GLWB annuity option) • Selection of Annuity Provider and Annuities • Subject to ERISA fiduciary standards. • Act in accordance with duties of prudence and loyalty • 2008 DOL safe harbor on Distribution Annuities for DC plans: 1. Procedural prudence 2. Insurer’s ability to pay 2. Cost 4. Draw appropriate conclusions 5. Seek expert advice

21. First Step in Annuity Selection(Procedural Prudence) • Engaging in Objective, Analytical Process • Prudence of fiduciary act is based on process • Must conduct appropriate investigation of annuity investment • Documentation of Selection Process • Maintain minutes of fiduciary reviews • Records for ongoing monitoring

22. 2nd Step for Annuity Selection(Insurer’s Ability to Pay) • Obtaining Sufficient Information • Insurer’s experience and expertise • Level of capital • Ratings • Contract’s structure and benefit guarantees • Protection through state guaranty associations • DOL Proposal • Proposed amendment to DOL safe harbor

23. 3rd & 4th Steps for Annuity Selection(Cost and Appropriate Conclusions) • Considering Annuity’s Cost • Cost considered in relation to benefits and services. • Evaluate fees, commissions and other charges. • No requirement to select cheapest annuity. • Drawing Informed Conclusions • Conclude insurer will be able to make future payments. • Conclude annuity’s cost is reasonable.

24. 5th Step for Annuity Selection(Seeking Expert Advice) • Necessity of Hiring Expert • Must hire expert if plan fiduciary cannot properly evaluate annuity providers, contracts and costs. • Procedure for Hiring Insurance Advisor • Investigate advisor’s qualifications. • Identify advisor’s compensation. • Provide complete information to advisor. • Ensure reliance on advisor’s advice is reasonable.

25. Removing Regulatory Obstacles to Annuity Distributions • Rollovers to DB Plans • Rev. Rul. 2012-4. • 401(k) accounts may be rolled over and converted to DB plan annuity benefits • Provides favorable annuity rates for participants • Relief for DC Plans With Deferred Annuities • Rev. Rul. 2012-3 • Ruling confirms 401(k) plans with deferred annuities can avoid onerous death benefit rules

26. Promoting Longevity Annuities • New IRS regulation relaxes required minimum distribution rules • RMD rules mandate start at age 70 ½ but longevity annuities provide income stream for later in life • Final Regulation provides: • RMD exception for investment in QLAC • Investment in QLAC capped at $125,000 or 25% of account • QLAC payments to start no later than age 85 • Applies to annuity purchases on/after July 2, 2014

27. Default Annuities • Should annuity option be default for plan? • Possible Approach: Amend QDIA Rules • Permit annuity option to qualify as QDIA. • Critics argue annuities not appropriate for all. • Default annuity investments not easily reversed. • Possible Approach: 2-Year Trial Period • Retirees receive annuity during trial period (unless opt out).

28. Education and Disclosures for Participants • GAO Recommendations • Update DOL’s “investment education” guidance to cover decumulation • But DOL is concerned about conflicts • Guidance likely to restrict sales pitches • Lifetime Income Disclosure Act • Plan to show account balances converted into guaranteed monthly amount • Encourages participants to think about retirement paycheck for life

29. DOL Proposal for Lifetime Income Disclosures • Advance Notice of Proposed Rulemaking • Lifetime income illustration in participant statements • Must provide estimated income streams based on (1) current account and (2) projected account at NRA • Safe Harbor for Projected Account • Assume 7% investment return • Assume current contribution level, with 3% increase • Use 3% discount rate to convert to current dollars

30. Lifetime Income Illustration • Illustration for 50-Year Old Participant Account Estimated Monthly Balance Lifetime Payment Current Account (2014) $125,000.00 $ 700.00 Projected Amount (2029) $500,000.00 Projected Account (Current Dollars) $321,000.00 $1,800.00 ● Required Disclosures/Disclaimers - Explanation of assumptions - Estimates are not benefit guarantees

31. 1. Target Date Funds • 2. Lifetime Income Initiative • 3. Tax and Healthcare Reform

32. Administration Initiatives to Increase Retirement Savings Through IRAs • Administration pushing automatic IRAs featuring: • 3% default contribution rate • Choice of traditional pre-tax IRA or after-tax Roth • Multiple alternatives for selecting IRA provider • Government designated default investments • MyRA Initiative • Starter program does not require legislative authorization • Contributions to Roth accounts • Permits small investments ($25 / $5) • Low rate of return from Treasury bonds • Maximum $15,000 balance

33. Limiting Tax Cost of Retirement Plans • Impact of retirement plans on federal deficit • DC / 401(k) • $61 billion (2015) • $414 billion (2015 – 2019) ◦ DB • $42 billion (2015) • 235 billion (2015 – 2019) • Tax reform • Pension system reform

34. Limiting Contributions & Benefits • 2014 Plan limitations that can be reduced to limit deficit: • Annual additions from all sources - $52,000 • Elective deferrals - $17,500 • Plan sponsor deduction - 25% participant compensation • Compensation limit to determine benefits/contributions - $260,000 • Proposed Tax Reform Act of 2014 − Freezes DC limits until 2024 ‒ $63.4 billion revenue gain over 10 years ‒ Additional $144 billion from treating half of 401(k) deferrals as Roth

35. Administration Tax Proposals • Obama FY 2015 proposed $3.2 million cap on aggregate lifetime contributions • Cap to vary based on age. • Double tax if prohibited amount not withdrawn • Obama proposal limiting tax deductions for plan contributions • 11.6% tax on employer & employee plan contributions - High earners only - Basis adjustment for extra tax

36. Pension System Reform - Federal LevelUSA Retirement Funds • USA Retirement Funds proposed by Sen. Tom Harkin in 2014 • Harkin “report” in July 2012 proposes new retirement system - Automatic/universal enrollment required by employers with no plan - Regular stream of income starting at retirement age - No lump sum withdrawals • Financed by employee payroll contributions & government credits • Privately managed investment by new entities: USA Retirement Funds - Limited employer involvement; no fiduciary responsibility - Unspecified level of required employer contributions. - Employees can increase/decrease contributions or opt out.

37. Pension System Reform – State Proposals • State-managed plans for private-sector workers • Intended to expand access to retirement saving • States would mange investments • California Secure Choice • Mandatory auto-IRA • Pooled investments managed by state and guaranteed returns • NCPERS Proposal • State managed investment and guaranteed returns • Exposure to lifetime benefit obligation • Backstopped by taxpayers

38. Summing Up • Significant Transformation of Private Retirement System Possible. • Tax Reform. • Reducing tax incentives will shrink system. ° Lower contributions at all income levels result if tax exclusions cut back. • Obama proposal for general limit on benefit from tax exclusions. ° Does not focus directly on 401(k) contributions. ° Provides political cover. ° Same effect on contributions as direct cutback on excludible amount

39. Summing Up (cont’d) − Systemic Changes • Intended to create access for low-wage employees • Government will replace private employers in system °Mandated benefits °Guaranteed benefits and/or investment results °Creation of new interest group to lobby for expansion of benefits °Government influence in choosing investment managers or control of investments could drive many out of the retirement industry. • State-level programs may cause breakdown in uniformity of pension laws, effective since enactment of ERISA • Inflection Point regarding the types of Retirement Schemes Nation wants and needs • Interesting Times ……

40. Effect of PPACA on Employees • Earlier plan distributions, because employees will not be tied to their jobs in order to maintain health insurance • New investment and liquidity strategies needed • Older generation of workers to be replaced more quickly by younger less experienced employees • Lower salaries will result in smaller plan contributions • Some industries could experience higher pay and larger contributions • New generation will be less vested making plans less expensive • Low-paid workers will choose health insurance over 401(k) contributions • ADP/ACP problems and issues with discrimination testing may result

41. Effect of PPACA on Employers • PPACA-mandated healthcare benefits likely to reduce level of employer support for 401(k) plans • Knock on effect of smaller match; smaller employee contributions • Shrinking employee contributions exacerbates discrimination issues • PPACA disincentive to maintain 401(k) plan • $3000 per head penalty for unaffordable health insurance avoided if cost of single-person coverage not in excess of 9.5% W-2 wages • 401(k) reduction of wages makes avoiding penalty harder • PPA 90-day rule for health plan availability can compromise overall plan administration • Delay greater than 90 days for entry into all benefit plans no longer possible • May necessitate enrollment at different times

42. PPACA Effect on Retirement Industry • Increased competition in healthcare marketplace • Government-regulated exchanges • Reduced brokers’ commissions • Potential expansion of healthcare brokers into retirement plan industry • New legislatively-mandated retirement plan models • Reduces/eliminates role of employer • Marketing focus redirected to employees

43. IMPORTANT PENSION CHANGES−WASHINGTON & REGULATORY UPDATE Marcia S. Wagner, Esq. 99 Summer Street, 13th Floor Boston, Massachusetts 02110 Tel: (617) 357-5200 Fax: (617) 357-5250 Website: www.wagnerlawgroup.com marcia@wagnerlawgroup.com A0128703.PPTX