Q4 2017 Fiduciary Hot Topics

December 13, 2017

TIAA’s Public Image Takes a Hit

A whistleblower complaint filed with the Securities and Exchange Commission alleges that Teachers’ Insurance and Annuity Association (TIAA) engages in aggressive sales practices designed to steer plan participants, at retirement, into its own high-fee managed account products.

TIAA is one of the largest money managers with over a trillion dollars under management. It has long been the dominant provider for college, university and nonprofit organization retirement plans. Many of these institutions view TIAA as a trusted partner.

TIAA successfully maintained the public image of a nonprofit retirement plan provider that acts in the best interests of its customers, in contrast to its competitors that are driven by profit. The first hit to this image came in 1997 when Congress decided that TIAA’s tax exemption was unwarranted and enacted legislation revoking this status.

One of the challenges facing TIAA in recent years is that, at retirement, many participants in TIAA retirement plans elect to move their accounts to competitors such as Vanguard and Fidelity. To stem this tide, TIAA established a wealth management group. The whistleblower complaint filed with the Securities and Exchange Commission pertains to the sales practices of this group.

This complaint was obtained by the New York Times which interviewed a number of former TIAA employees. The New York Times article alleges:

  • TIAA’s wealth management group charges advisory fees that range from 0.75 percent to 1.15 percent. This advisory fee is on top of the, sometimes hefty, fees associated with TIAA’s investment products and annuities.
  • Quotas were imposed on employees to move plan participants from low-cost, self-managed accounts in TIAA’s retirement plans, to its high-cost managed account products. Employee compensation was dependent on moving plan participants into TIAA’s more expensive products.
  • Employees who resisted this pressure were “processed out” of the organization.

The New York Times article comes on the heels of a $5 million settlement TIAA paid to resolve a lawsuit brought by its employees claiming they had been overcharged in TIAA’s own retirement plan.

Tax Reform Proposals and the Art of the Possible

The markets are focused on the progress tax reform bills are making on Capitol Hill. Most significant to the markets is the proposed reduction in corporate tax rates, as this would have a positive impact on corporate earnings. Some experts predict a comprehensive bill will pass before year-end. However, at this point, it is difficult to ascertain what, if any provisions, Congress will ultimately enact.

Both the Senate and House bills contain provisions that will result in significant reductions in tax revenues. This is a concern for retirement plans which are viewed as a giant tax loophole by those at the Treasury Department responsible for tax policy. For this reason, retirement plans are often a target when the Treasury is looking for ways to make up for lost revenues. In the past, major tax bills have often included significant paring of tax benefits for retirement plans.

A proposal was introduced in the context of tax reform that would reduce the annual limit for employee deferrals from $18,000 to $2,400. President Trump tweeted against this and it does not appear to be going anywhere.

The most significant tax proposal is in the Senate bill. It reduces the corporate tax rate to 20 percent. While there is a consensus that a reduction in corporate tax rates is needed, this provision will result in a major reduction in revenue. For this reason, it will likely be subject to negotiation.

Some items seem fairly likely to pass as they appear in both the Senate and House bills. These include:

  • IRA Re-Characterization: Repeal the rule that currently allows individuals to reverse a Roth IRA re-characterization before the due date, including extensions, for filing the individual’s tax return.
  • Standard Deduction: Increase the standard deduction, which 70 percent of taxpayers take in lieu of itemizing. It will increase from $6,500 to $12,000 for singles and twice that for married couples filing jointly. It is predicted that this would reduce the number of tax payers who itemize to 10 percent. This appeals to the IRS as it simplifies enforcement.
  • Deduction for State and Local Taxes: Repeal the deduction for state and local income taxes. This will be a tough sell for members from blue states where the deduction is most valuable. Currently, the House version of the bill keeps the deduction for property taxes with a cap of $10,000.
  • Estate Tax: Increase the exemption from $5 million per individual to $11 million.
  • Alternative Minimum Tax: This is a complex surtax that rescinds or postpones the value of many tax breaks in order to guarantee that all taxpayers pay a certain minimum amount of tax. Enacted in 1982, it was aimed at only the wealthiest tax payers, but with inflation now impacts many taxpayers and for this reason has become controversial.

Rolling Over a Plan Account to a Roth IRA—A Few Quirky Rules

There are some little known rules that come into play when rolling over an account from a 401(k) or a 403(b) plan to a Roth IRA. Contributions may be made on an after-tax basis to Roth accounts in both retirement plans and IRAs. Once the five-year holding period is satisfied for such accounts, all amounts may be withdrawn tax-free, including the investment earnings.

Note the following:

  • Roth accounts in retirement plans may be rolled over to another retirement plan or to a Roth IRA. However, this can be accomplished only through a direct trustee-to-trustee rollover. If a plan participant takes a distribution from a Roth account in a plan, then only the investment earnings may be rolled over to another plan or an IRA within 60 days.
  • If a Roth account is rolled over from a retirement plan to a Roth IRA, the five-year holding period is calculated from the date of the first contribution to the IRA. Thus, if an IRA is established to accept a rollover from a retirement plan, the five-year holding period begins anew. On the other hand, where an individual has not satisfied the holding period in a retirement plan, it is possible to step up this period by rolling over to an existing Roth IRA.
  • There are two distinct advantages to rolling from a retirement plan to a Roth IRA. The minimum required distribution rules do not apply to Roth IRAs and 100 percent of any after-tax amounts may be withdrawn first from a Roth IRA.
  • Estate Tax: Increase the exemption from $5 million per individual to $11 million.

Another distinct feature of Roth IRAs is that the decision to re-characterize a traditional IRA as a Roth may be reversed. This must be done before the due date for filing the IRA holder’s tax return for the year in which the IRA was re-characterized. This option is not available for in-plan Roth conversions.

Litigation Update

A Victory for Plan Fiduciaries—Federal Court Dismisses Lawsuit against the University of Pennsylvania

Last year, lawsuits were brought against the fiduciaries of the 403(b) plans of a number of major colleges and universities. Among the defendants were some of the country’s most prestigious institutions, including Columbia, Johns Hopkins and Vanderbilt. Very generally, these lawsuits allege that the 403(b) plans of these institutions are paying fees that are too high, include underperforming investments and offer cumbersome investment menus that are confusing to participants.

One such suit was brought against the 403(b) plan sponsored by the University of Pennsylvania. This plan has about $4 billion in assets and 78 investment choices offered through TIAA and Vanguard.

This past September, the judge granted the University’s motion to dismiss, which means this case will not go to trial. A court will grant a defendant’s motion to dismiss only if it decides that the plaintiffs cannot prevail on their merits, even if they prove all the facts they are alleging.

Some brief highlights of the court’s lengthy opinion:

  • The judge rejected the argument that fees are too high by concluding that plan fiduciaries must balance the need to provide benefits to participants against defraying reasonable costs. The court noted that fiduciaries are not obligated under ERISA to always select the cheapest option.
  • • The court’s reasoning is slightly unclear regarding its decision to reject plaintiffs’ claims that fiduciaries failed to act prudently with regard to the investment offerings. This allegation was based on the fact that 60 percent of the funds in the plan’s lineup were underperforming their respective benchmarks. Curiously, the judge noted that underperformance does not create a claim under ERISA. The court concluded that the fiduciaries have fulfilled their duty to act prudently if the investments selected were reasonable based on the information available to the fiduciaries at the time the decisions were made. This seems to run contrary to the Supreme Court’s decision in Tibble which imposes on fiduciaries a continuous duty to monitor.
  • The court rejected the argument that revenue sharing paid to TIAA and Vanguard was a prohibited transaction under ERISA. Here, the judge noted that ERISA does not contain an explicit prohibition against revenue sharing.

Securities offered through Kestra Investment Services, LLC (Kestra IS), member FINRA/SIPC. Investment advisory services offered through Kestra Advisory Services, LLC (Kestra AS), an affiliate of Kestra IS. BHS Financial Services is not affiliated with Kestra IS or Kestra AS