DOL Issues Rules on State-Based Savings Programs

Practical Law Legal Update w-003-2454 (Approx. 8 pages)

DOL Issues Rules on State-Based Savings Programs

by Practical Law Employee Benefits & Executive Compensation

State-Based Savings Programs

California, Connecticut, Illinois, Maryland, and Oregon have established SSPs that essentially encourage employees to establish IRAs that are funded by payroll deductions. These SSPs require most employers that do not offer retirement savings arrangements to deduct specified amounts from employees' pay and remit those amounts to state-administered IRAs for the employees. SSPs with automatic enrollment typically require employers to deduct amounts on behalf of employees, unless an employee affirmatively elects not to participate.

As currently designed, these SSPs:

Do not require, provide for, or permit employers to make matching or other contributions to employees' accounts.
Require that employers act as a conduit for information regarding the SSP, including disclosures of employees' rights and program features. These disclosures are often based on state-prepared materials.

Some states and practitioners have expressed concern that SSPs of this type may:

Inadvertently cause employers to establish ERISA-governed plans. For a discussion of the criteria courts use to determine whether a retirement arrangement constitutes an ERISA-governed plan, see Practice Note, Severance Benefit Plans and Agreements: Overview: Severance Arrangements Subject to ERISA.
Be preempted by ERISA (see Practice Note, ERISA Litigation: Preemption of State Laws).

Current Guidance Addressing Payroll Deduction Arrangements Under ERISA

IRAs are governed by the Internal Revenue Code (Code) and are not generally covered under ERISA. ERISA coverage of IRAs is contingent on an employer (or employee organization) establishing or maintaining the arrangement (29 U.S.C. §§ 1002(1) – (2)). The DOL previously provided guidance that helps employers determine if their involvement in voluntary payroll deduction arrangements (such as sending employee contributions to IRAs), would amount to establishing or maintaining an ERISA-governed plan.

In 1975, the DOL issued a safe harbor regulation that clarifies the circumstances under which IRAs funded by payroll deductions would not be treated as ERISA plans (29 C.F.R. § 2510.3-2(d)). This regulation permits an employer to:

Allow a vendor to provide employees with information about an IRA product.
Facilitate payroll deductions for employees who voluntarily initiate action to sign up for the IRA. Automatic enrollment is not permitted under this regulation.

Under this regulation, the employer may not make contributions and must not endorse the product to employees.

The currently effective SSPs are similar to arrangements covered under the 1975 IRA safe harbor. However, the 1975 safe harbor does not envision state involvement in the IRA program or use of automatic enrollment.

In 2015, the DOL issued proposed regulations establishing a safe harbor providing that SSPs that satisfied certain conditions would not be considered an ERISA-governed pension plan by adding a new paragraph (h) to DOL Reg. Section 2510.3-2.

The safe harbor conditions generally required:

The SSP to be established by a state government pursuant to state law.
Voluntary participation by employees (including automatic enrollment programs with opt-outs).
Limited employer involvement.

For more information, see Legal Update, DOL Proposes Safe Harbor and Issues Interpretive Bulletin on State-Based Savings Programs.

Final Regulations

The final rule largely adopts the proposed rule's structure with certain modifications and clarifications. In response to public comments on the proposed rule, the final rule explains certain sections where the DOL:

Made changes based on public comment (see Changes Based on Public Comment).
Elected to adopt the proposed rule without change (see Comments Not Requiring Changes).

Changes Based on Public Comment

Final Rule Creates a Safe Harbor

In response to comments, the final regulations clarify that the conditions simply create a safe harbor and do not prohibit states from taking additional or different action or from experimenting with other programs or arrangements.

The DOL acknowledges that the safe harbor does not preclude the possibility that plans, funds, and programs that do not satisfy the safe harbor may also not qualify as pension plans within the meaning of ERISA.

Restrictions on Withdrawals

Commenters requested that the final rule remove the condition in the proposed rule that prohibited states from imposing any restrictions, direct or indirect, on employee withdrawals from their IRAs. Commenters expressed concern that this condition would:

Interfere with the states' ability to guard against leakage (the use of long-term savings for short-term purposes).
Restrict the ability to design programs with diversified investment strategies.

In response to these comments, the final rule removes the condition prohibiting states from imposing restrictions on employee withdrawals.

Employer Compensation

The proposed rule included a condition that would have prohibited employers from receiving more than their actual costs of complying with the SSPs.

In response to comments urging the DOL to provide more flexibility for states to determine the most effective ways to compensate employers for their role in the state program, the final rule:

Eliminates the requirement that employers' actual costs be calculated.
Provides that the maximum consideration that a state may provide to an employer is limited to a reasonable approximation of the employer's costs.
Allows consideration in the form of tax incentives or credits without regard to whether they equal the actual cost of the program to the employer.

The DOL notes, however, that the safe harbor requires that states ensure that their economic incentives are narrowly tailored to reimburse employers for their costs under the SSPs.

Employers That Do Not Offer Savings Arrangements

The proposed rule provided that SSPs may be directed toward employees who are not eligible for some other workplace savings arrangement. Commenters argued that this provision could potentially provide employers with an incentive not to offer a retirement plan for their employees.

The final rule shifts the focus of the provision from employees that are not eligible for workplace savings arrangements to employers that do not offer any workplace savings arrangement. The final rule modifies the proposal to provide that a program would not fail to qualify for the safe harbor merely because it is directed toward those employers that do not offer some other workplace savings arrangement.

Government Agencies May Implement and Administer State Programs

The final rule clarifies the role of government agencies and instrumentalities in implementing and administering SSPs. It provides that, as long as the SSP is specifically established pursuant to a state law, it is eligible for the safe harbor even if it delegates implementation and administrative authority to either a:

Board.
Committee.
Department.
Authority.
State Treasurer.
Office.
Other similar governmental agency or instrumentality.

Comments Not Requiring Changes

In the final rule, the DOL also addressed certain comments that it determined did not require changes to the proposed rule, including:

Application of prohibited transaction provisions in Code Section 4975. The final rule does not adopt any special provisions for, or provide any special treatment or exemptions to, IRAs established and maintained pursuant to SSPs. The prohibited transaction rules of Code Section 4975 (26 U.S.C. § 4975) apply to and protect the assets in in SSP IRAs to the same extent that they apply to traditional IRAs (see Practice Note, Prohibited Transactions and Exemptions Under ERISA and the Code). The DOL notes individual exemption requests are still available to SSPs.
Geographic or residential nexus between the state, employers, and employees not required. The final rule requires that the SSP be established pursuant to state law and that the employer's participation be required by state law. No geographic or residential nexus between the state, employers, and employees is required. The DOL explained that states are in the best position to determine the appropriate connection between employers and employees covered under the SSP and the states and to know the limits on their ability to regulate conduct outside of the state.
State responsibility for the security of payroll deductions. The final rule provides that a state must assume responsibility for the security of payroll deductions. The DOL explained that this condition does not:
- make states guarantors or hold them strictly liable for an employer's failure to transmit payroll deductions; or
- require the use of a single approach to satisfy the safe harbor.
Automatic employer participation. Employer participation must be required by state law in order for the safe harbor to apply. According to the DOL, an employer that voluntarily chooses to enroll its employees in a SSP has established a pension plan under ERISA and is not eligible for the safe harbor. However, the DOL noted that the 1975 safe harbor may be available to employers who voluntarily choose to facilitate employees' participation in a SSP.

Effective Date

The final regulations are effective 60 days after publication in the Federal Register.

Proposed Regulations

Some commenters on the 2015 proposed SSP regulation argued that the safe harbor should be extended to payroll deduction savings programs established by political subdivisions of the states. (For more information on the 2015 proposed regulation, see Legal Update, DOL Proposes Safe Harbor and Issues Interpretive Bulletin on State-Based Savings Programs.)

In response to these comments, on August 25, 2016, in conjunction with the DOL's final regulation on SSPs, the DOL issued a proposed regulation that would amend 29 C.F.R. Section 2510.3-2(h) (which was added by the final regulation), to cover the payroll deduction savings programs of qualified political subdivisions of states that otherwise comply with the requirements of the final regulation.

Specifically, the proposed regulation would extend the safe harbor of the final regulation to qualified political subdivisions that establish and operate payroll deduction savings programs with automatic enrollment. The safe harbor provisions of the final regulation would apply in the same manner to payroll deduction savings programs of qualified political subdivisions as they apply to SSPs. The proposed regulation would add a new paragraph (h)(4) to 29 C.F.R. Section 2510.3-2 to define a qualified political subdivision as any governmental unit of a state, including a city, county, or similar governmental body, that:

Has the implicit or explicit authority under state law to require employers' participation in the savings program.
Has a population equal to or greater than the population of the least populated State, (excluding the District of Columbia and US territories). As discussed in the preamble to the proposed regulation, Wyoming is currently the least populated state, with approximately 600,000 residents. Therefore, were the proposed regulation to be finalized and effective today, a savings program established by a political subdivision would be eligible for the safe harbor in the proposed regulation only if the subdivision has at least 600,000 residents. Smaller political subdivisions may establish payroll deduction savings programs, but they would not be eligible for the safe harbor under the proposed regulation.
Is not located in a state that, under state law, establishes an SSP for private-sector employees.

The preamble notes that the definition of qualified political subdivision in (h)(4) would not apply for other purposes under ERISA, such as for determining whether an entity is a political subdivision for purposes of the definition of a governmental plan under ERISA Section 3(32) (29 U.S.C. § 1002(32)).

There are 88 political subdivisions in the US that meet all three requirements of paragraph (h)(4). These would be eligible to establish a payroll deduction savings program under the proposed regulation. The DOL believes that a political subdivision that meets all three criteria would have the experience, capacity, and resources to oversee and establish a payroll deduction savings program. The DOL is also considering adding a fourth requirement that qualified political subdivisions must demonstrate a capacity to design and operate a payroll deduction savings program (such as by maintaining a pension plan for the employees of the political subdivision).

The DOL is seeking further comments on whether and how the safe harbor should be expanded to state political subdivisions. The DOL is especially interested in comments on the definition of "qualified political subdivision" in the proposed 29 C.F.R. Section 2510.3-2(h)(4). The DOL is also seeking comments on:

Whether the final regulation should contain a provision to address the consequences of a qualified political subdivision falling below the required population threshold after it has already established a payroll deduction savings program.
Whether the final regulation should discuss how a payroll deduction savings program of a qualified political subdivision is impacted legally if the state in which the subdivision is located establishes a state-wide retirement savings program after the subdivision has established and operates a payroll deduction savings program.
Whether the final regulation should cover situations in which a political subdivision, encompassed within the jurisdictional boundaries of a larger political subdivision that already maintains a retirement savings program, seeks to establish a payroll deduction savings program.
Possible criteria relating to a demonstrated capacity to design and operate a payroll deduction savings program.

The preamble to the proposed regulation explains in detail how members of the public may submit comments on the proposed regulation to the DOL.

The DOL also stated in a footnote in the preamble to the proposed regulation that, in the DOL's view, the principles articulated in the Interpretive Bulletin issued last year with the proposed regulation on SSPs also applies to laws of a political subdivision, if the requirements included in the bulletin can be and are satisfied by the political subdivision.

Practical Implications

The safe harbor the DOL created in the final regulations sets enforceability guidelines for employers operating in California, Connecticut, Illinois, Maryland, and Oregon that may be subject to the currently effective SSPs in those states and establishes a roadmap for states currently considering implementing SSPs. Companies in these states that do not offer retirement savings programs may be most directly impacted by SSPs, though some state programs exempt some of the smallest companies. Employers should take note of the modifications in the final regulations as compared to the proposed regulations.

Employers should also familiarize themselves with the proposed regulations which would extend the safe harbor to qualified political subdivisions. Interested parties should submit comments on the proposed regulations prior to the submission deadline.

DOL Issues Rules on State-Based Savings Programs | Practical Law