In recent years, a number of states have explored the idea of establishing state-run retirement plans for private sector employees who do not have access to employer-sponsored retirement plans. The preemption concerns under the Employee Retirement Income Security Act of 1974, as amended (ERISA), have proven to be significant for these programs, not only because of ERISA itself but also because of the reluctance of states to take on the ERISA responsibilities and liabilities of a plan administrator or other fiduciary. The Obama Administration, however, has made it clear that it supports state-run retirement programs, and the President directed the Department of Labor (DOL) to provide guidance to states to help them navigate around the ERISA constraints.
On November 16, 2015, the DOL issued two pieces of guidance in this regard. The first is a proposed regulation that would expand the current regulatory safe harbor under which certain payroll-deduction IRAs are carved out of the definition of “employee benefit plan” for purposes of ERISA coverage. The second is an interpretive bulletin that proposes an analysis under which certain other approaches could arguably survive an ERISA preemption challenge. The guidance admittedly is not determinative about whether any specific state program would be preempted by ERISA, particularly if the program, when combined with state sovereign immunity laws, would leave state-run plan participants without a remedy.
Proposed Regulation on Payroll-Deduction IRAs
ERISA regulations already provide a method for employers to assist employees in saving for retirement without sponsoring an ERISA-covered plan. The regulations provide a safe harbor exempting payroll-deduction IRAs from ERISA if:
- Employer involvement is limited to permitting IRA providers to publicize the program and to collect contributions and remit them to the providers. The employer cannot make contributions or endorse the plan, and may not receive consideration other than reasonable compensation for services actually rendered in setting up the payroll deduction program; and
- Participation by employees must be “completely voluntary.”
The proposed regulation would add a safe harbor for state-sponsored, auto-enrollment, payroll-deduction IRA programs, provided that employees are permitted to opt out of participation in the program. The new safe harbor has similar conditions as the current regulation, but replaces the “completely voluntary” participation requirement in favor of a “voluntary” requirement in order to distinguish the permissibility of auto-enrollment. To be eligible for the new safe harbor, the IRA program would have to meet the following additional criteria:
- The program must be established by a state pursuant to state law and be administered by the state or a state agency or instrumentality. The state or the agency would be responsible for investing the employee savings or for selecting investment alternatives for employees to choose. The proposal specifically permits the use of service and investment providers other than the state;
- The state assumes responsibility for the security of the payroll deductions;
- The program does not impose any restrictions on withdrawals or impose any cost or penalty on transfers or rollovers permitted under the Internal Revenue Code; and
- All rights under the program are enforceable only by the employee, former employee or beneficiary, an authorized representative of such a person, or by the state (or the designated governmental agency or instrumentality of the state).
Additional conditions apply to an employer that wishes to take advantage of the safe harbor. Significantly, an employer’s participation in the program must be mandated by state law. Accordingly, an employer that elects to participate in a voluntary state program, or that is not required to participate in a program but has the option to do so, would not be covered by the safe harbor. Presumably, by participating in such programs, an employer would be establishing an employee benefit plan subject to ERISA. Conditions limiting the extent of the employer’s involvement in the program, similar to the condition in the current payroll-deduction IRA safe harbor, also must be followed.
Interpretive Bulletin 2015-02
Interpretive Bulletin 2015-02 addresses certain specific program designs that are outside of the safe harbor, suggesting arguments that could be made against ERISA preemption challenges to state laws creating these programs. ERISA contains a broad preemption clause, which preempts any state law that relates to an employee benefit plan (subject to certain exceptions not relevant here), and the validity of any state program may ultimately turn on an ERISA preemption analysis. Three approaches, loosely based on existing state proposals, are addressed.
- Marketplace Approach. The state of Washington has adopted a program that would create a retirement plan marketplace to connect small employers with providers of savings and retirement plans. The state would determine the criteria for provider participation in the program and would select the providers. The DOL’s view is that this type of state marketplace program is not itself an employee benefit plan. The DOL noted that the marketplace could include both ERISA plans and non-ERISA savings programs, and that ERISA coverage would be determined based on the nature of the plan chosen and the employer’s involvement.
- Prototype Plan. Under this type of program, the state develops and administers a prototype plan similar to those traditionally developed by financial institutions. Small employers that adopt the plans will have established an ERISA-covered employee benefit plan. The interpretive bulletin contemplates that a state-run prototype would be beneficial to small employers because the state or a designated third party could assume responsibility for most administrative and asset management functions of the plan. Massachusetts has developed a prototype plan, to be made available to small non-profits, and is in the process of obtaining Internal Revenue Service (IRS) and regulatory approvals.
- Multiple Employer Plan Approach. Under this approach, the state would establish and maintain a multiple employer plan in which private employers could elect to participate. The state would be deemed the “employer” for ERISA purposes.
The DOL also presented an analysis arguing that state laws establishing these types of programs should not be preempted by ERISA, provided that they do not undermine ERISA’s exclusive regulation of employee benefit plans.
- The ERISA preemption analysis set forth in the Interpretive Bulletin seems strongest when applied to a state law that merely creates a marketplace. Provided that state criteria for provider participation do not impact the terms and conditions of the plans themselves, the marketplace in and of itself would not have the characteristics of an employee benefit plan. ERISA protections still apply to participants of ERISA-covered employee benefit plans that are established through the services of a marketplace provider. The preemption analysis becomes more strained under the prototype and multiple employer plan analyses because the plan terms and administration would necessarily seem to be dictated by state law to some extent.
- Most of the enacted legislation has included a proviso that the program will be effective only if it is determined that the program is not subject to ERISA and/or if the state has no potential for incurring liability as an ERISA fiduciary or otherwise. It is therefore unclear whether the DOL’s multiple employer plan approach, which contemplates the state assuming some financial responsibility for the plan, will be palatable to the states.
- The proposed safe harbor makes clear that any payroll-deduction IRAs must qualify as IRAs under the Code. Among other things, this would preclude the state from holding and managing the assets (unless the state is approved by the IRS as a non-bank custodian, which would seem improbable under current law).
- The DOL assumes, but admittedly is unable to quantify, that state-run proposals will be less costly for small employers than alternatives that are available in the marketplace. The state proposals often provide that the costs to the state of the program will be passed through to participants.
- Similarly, while the safe harbor for mandatory state payroll-deduction IRAs is intended to be helpful to employers by providing an exception from ERISA coverage, the costs to small businesses of state mandated programs remain unclear. System changes and compliance costs would likely be greater than those of the traditional, completely voluntary, payroll-deduction IRA. Principles of ERISA preemption would also suggest that any state mandated benefits program would be preempted, and the DOL acknowledges that it cannot issue assurances that this is not the case.
The DOL invites comments on the proposed regulation, which are due January 19, 2016. Interpretive Bulletin 2015-02 is not subject to public notice and comment rulemaking.