Guest Article

(Reprinted from The 401(k) Handbook, published by Thompson Publishing Group, Inc.)

A Look Back at the Clinton Years: IRS and DOL Actions Helped Spur 401(k) Growth

by Martha Priddy Patterson

In the 1990s, a series of favorable government actions at a time of robust economic growth made 401(k) plans flourish.

The percentage of families with 401(k) accounts doubled, from 32 percent in 1992 to more than 65 percent in 1998. In 1996, the U.S. Department of Labor (DOL) counted 226,000 401(k)-type plans covering almost 35 million participants.

Many of these retirement accounts experienced tremendous returns, largely because of a U.S. economy that enjoyed its longest period of growth in history. And while unemployment and inflation were consistently low, investment markets grew steadily.

In addition, much of the growth and success of 401(k) plans from 1992 to 2000 can be attributed to actions by two Clinton administration agencies and Congress.

The Internal Revenue Service (IRS) and the DOL took regulatory steps to make it easier for employers to sponsor these plans and for employees to participate. Encouraged by plan sponsors' associations, these agencies simplified rules governing 401(k) plans, clarified enforcement policies and gave plan sponsors the means to correct plan mistakes. The agencies also instituted policies that encouraged the creation of new 401(k) plans and educated and encouraged employees to participate in those plans.

Not to be outdone, Congress repealed a number of burdensome requirements and installed clearer provisions, including safe harbors and simpler definitions.

Encouraging Plans to Correct Mistakes

Consider what the 401(k) regulatory landscape looked like in 1991. If the sponsor of a qualified retirement plan found mistakes in the operation of the plan, there was no official procedure for correcting those problems. Although disqualification of the plan seldom occurred, that was the only official mechanism for dealing with plan mistakes. As a result, plan sponsors faced a disincentive to correct any plan defects, for fear of calling attention to the problem. Plans that failed to file timely Form 5500s were subject to late fees of $1,000 per day. However, if the plan never filed a Form 5500, the DOL was not likely to catch the error. So never filing became the only apparent way to avoid a $365,000 penalty each year. Plans filed reams of summary plan descriptions and summaries of material modifications with the DOL, but when the DOL received a request for these documents, the agency sometimes called the employer for copies because it was impossible to retrieve the "filed" copies.

In late 1992, the IRS and DOL, encouraged by benefits groups, began a series of proactive steps to encourage plan sponsors to bring their plans into compliance without fear of disqualification or outrageous penalties and to alert the American public about their need to save and plan for retirement.

The DOL acted to encourage plan sponsors that had not filed Form 5500s to file back years' forms, knowing such filings would also encourage filing in the future. The DOL's late filing penalty grace period, originally scheduled to run from the spring of 1992 to the end of September of that year, was so successful that it was expanded immediately. The program evolved into the permanent Delinquent Filer Voluntary Compliance (DFVC) program in 1995. The DFVC program offers late filers significantly lower late penalties and enables the DOL to gather better data on the number and design of all ERISA plans, including 401(k) plans.

In late 1992, the IRS announced the Voluntary Compliance Resolution (VCR) program, which was slated to run through the end of 1993. Under the VCR program the plan sponsor voluntarily "confessed" to the IRS about mistakes in the plan, corrected those mistakes, paid a sanction fee (which was a fraction of the costs that would have been incurred if the plan had been disqualified), and agreed to keep the plan in compliance. For the first time, plan administrators could correct mistakes without fear that the plan would be "caught" and disqualified. The VCR program began slowly, but the number of users increased gradually. Over time, the IRS expanded the program into the current Employee Plans Compliance Resolution System (ECPRS), which is composed of several correction programs. One of those, the Administrative Policy Regarding Self-Correction (APRSC), permits plan sponsors that discover and correct problems within a year after the close of the plan year to avoid involving the IRS at all.

In 2000, the DOL established a Voluntary Fiduciary Correction (VFC) program that enables plans to correct specific nonegregious fiduciary breaches through voluntary means without incurring ERISA penalties. These breaches are limited to such transactions as below-market loans, purchases and sales involving parties-in-interest, and late contributions to plans.

Limiting Employer Liability for 401(k) Investment Education

As many plan sponsors offered more and more investment choices in their 401(k) plans, they became increasingly concerned about their liability for their employees' investment choices. Clearly, a high-return, high-risk fund, even though it may be a sound investment within its asset class, is not a prudent investment choice for 100 percent of a 64-year-old's 401(k) account. But in a 401(k) plan that offers such choices, the employer has no control over employees' decisions. ERISA §404(c) provides limited liability for employers if the employees have "control" over their investments. In 1992, the DOL issued final regulations outlining the requirements for investment choices, disclosure and operation that would constitute "control" in this context. These ERISA §404(c) regulations enable plan sponsors to give their employees a variety of investment choices that can be used to construct appropriate investment portfolios for employees of all ages and with very different retirement needs, while also protecting the sponsor from liability for an employee's choices. Of course, the plan fiduciaries remain liable for the soundness of the investment options they elect to offer under the plan.

Plan sponsors remained concerned that their employees were not familiar enough with basic financial principles to maximize the value of their 401(k) accounts. Many plan sponsors wanted to provide plan participants with financial and investment education, often through professional outside advisors, but did not want to take on the fiduciary liability for the employee's financial decisions or for the impact of the financial education advice.

To encourage plan sponsors to offer such financial education and to clarify sponsors' responsibilities for that advice and education, the DOL issued Interpretive Bulletin 1996-1. By following the guidelines in this bulletin, employers and financial advisors are better able to create financial education seminars and materials without becoming fiduciaries to the participants or the plans. The DOL also worked with the Securities and Exchange Commission (SEC), which regulates financial advisors, to obtain an SEC letter stating that employers would not become financial advisors subject to SEC regulation as a result of this kind of financial education.

Easing Plan Administration and Employee Communication

Both the DOL and the IRS took steps to help make 401(k) plan administration more efficient. In advisory opinions issued to Aetna and Frost Bank, the DOL essentially approved the use of "bundled services" under certain conditions. These letters enabled plan sponsors to enjoy the efficiencies of "one stop shopping" for all plan administrative and investment options, subject to ERISA's fiduciary duty requirements.

In 1994, the IRS began to consider clarifying the appropriate use of "paperless" plan communications and transactions. In response to prodding from Congress, the IRS issued final guidance on these forms of communications and the DOL issued proposed rules in this area. Both sets of regulations authorize the use of electronic communications for nearly all plan transactions, with the exception of those requiring notarization. And with the adoption of the Electronic Signatures in Global and National Commerce Act in 2000, even electronic notarizations may be possible soon.

Making Administrative Fees Less Painful

Concerned about the difficulty of determining the total amount of administrative fees imposed on 401(k) accounts, the DOL worked with the American Bankers Association, the American Council on Life Insurance and the Investment Companies Institute to create a series of 401(k) fee disclosure forms, which were released in the summer of 1999. These forms serve two important purposes. First, they enable plan sponsors to shop for vendors with ease and assurance - at least on the criterion of fees. Second, the use and retention of these forms should provide evidence of adequate fiduciary care in reviewing and evaluating the fees charged by service providers.

Increasing Enrollment

Both the federal government and 401(k) plan sponsors have long been concerned about the adequacy of retirement plan coverage and low participation rates. Many employers, recognizing that the same inertia that keeps employees from enrolling in a 401(k) plan in the first place can be used to keep employees in the plan once they do enroll, have long viewed automatic enrollment in the plan as an effective way to boost participation rates.

In June 1998, the IRS approved automatic enrollment (termed "negative election" by the IRS) in 401(k) plans. The IRS authorized the process of giving new employees enrollment forms with the various options, but with a notice that if the form was not returned, the employee would be automatically enrolled in the plan and a specified percentage of his or her salary would be invested in a conservative "blended" fund until the employee made an affirmative choice of investment vehicle. Later that year the IRS authorized a similar automatic enrollment process for existing employees. Early studies show that on average, 86 percent of employees who are "automatically enrolled" in a plan stay in it.

Simplify, Simplify, Simplify

The IRS took other steps to simplify 401(k) plan administration. The agency issued final rules permitting plans to eliminate various forms of alternative benefit payment options without violating the anti-cutback rule that forbids eliminating "other benefits, rights and features." This change enables plan sponsors to drop payment options that are rarely, if ever, used by participants, thereby simplifying both employee communications and plan administration. It also makes it easier to merge two or more plans by eliminating the need to adopt all payment forms that either plan had offered.

The IRS moved toward eliminating the "same desk rule" that prevented plans from distributing or rolling over 401(k) plan accounts when employees terminated because of a sale, merger or spin-off. This enables employees who go with a spin-off or buyer to shift their accounts to the new employer's plans even though the employee has the same job with the new employer.

Encouraging Retirement Saving and Planning

Perhaps the most important step taken by the Clinton administration was several actions the DOL took to help both employers and employees recognize the importance of basic retirement savings education and planning.

The DOL began its own retirement savings education campaign in 1995 under the title, "Save - Your Retirement Clock Is Ticking." The DOL then teamed with the American Savings Education Council (ASEC) and the Employee Benefits Research Institute on their "Choose to Save Campaign," to educate the public about the goal of saving for retirement and provide tips and help on how to achieve it.

ASEC, with the help of the DOL, pushed Congress to enact the Savings Are Vital to Everyone's Retirement (SAVER) Act, which provided for "national summits" on retirement savings in 1998, 2001 and 2005. The 1998 summit brought together a broad cross-section of individuals and organizations to exchange ideas on effective savings education techniques and generated considerable publicity on the need for retirement planning and saving.

In 2000, the DOL marked the fifth year of its retirement savings campaign by adopting a new campaign name, "Savings Matters," and by working with private companies and trade associations to develop a Web site describing the various retirement plans that are available to small businesses. These efforts supplemented the DOL's own "Small Business Retirement Savings Programs Employer Advisor," a Web site featuring an interactive program designed to help a small business find the type of retirement plan that best suits its needs.

Congressional Tinkering Helped Too

Over the course of the last eight years, Congress also acted to improve the efficiency and attractiveness of 401(k) plans by taking numerous actions:

• adding safe harbors to avoid nondiscrimination testing;
• allowing nondiscrimination tests to be based on deferrals by nonhighly compensated employees in the previous year instead of the current year;
• simplifying the definition of a highly compensated employee;
• providing that excess contributions to 401(k) plans may be returned based on the highest excess amounts, not on the highest percentages of compensation;
• including 401(k) and Section 132(f) deferrals as compensation when calculating the Section 415 limit annual contribution limit of 25 percent of compensation;
• repealing the family aggregation rules that made it impossible for all members of a family working for the same employer to contribute the maximum deferral to a 401(k) plan;
• repealing the combined plan limit rules that limited benefits from a defined contribution and a defined benefit plan offered by the same employer;
• allowing nonhighly compensated employees who are under 21 or have less than one year of service to be excluded when running the 401(k) nondiscrimination tests;
• increasing the involuntary cash-out limit from $3,500 to $5,000 (separately, the IRS eliminated the "lookback" rule that prevented involuntary cash-outs if the participant's benefit amount had ever exceeded the threshold, regardless of the current level of the account);
• repealing the requirement that SPDs and summaries of material modifications (SMMs) must be filed with DOL; and
• expanding the availability of 401(k) plans to nonprofits.

It Was a Very Good Decade

All of these changes made the 1990s a very good decade for 401(k) plans. While anyone who deals with 401(k) plans can still get exasperated with the numerous compliance requirements, much credit is due the IRS and the DOL for taking steps to ease plan administration and impress upon the public the need to save for retirement. Given the fast pace of change propelling us into a new millennium, the next 10 years are likely to see as much, if not more, change. Here's hoping those changes will be as positive as those of the last 10 years.

Martha Priddy Patterson is the director of employee benefits policy analysis with Deloitte & Touche LLP's Human Capital Advisory Services in Washington, D.C. Patterson is the contributing editor of The 401(k) Handbook.

Reprinted with permission from the February 2001 supplement to The 401(k) Handbook, ©Thompson Publishing Group, Inc., 2001. All rights reserved.

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