Overview
Law360, New York (January 22, 2015, 4:16 PM ET) -- On Dec. 3, 2014, the Illinois Legislature passed the Illinois Secure Choice Savings Program Act, but will not be effective for at least 24 months. The Act requires private sector employers that do not already maintain a retirement plan to enroll their employees in automatic “payroll deposit retirement savings arrangements” and to remit after-tax payroll deductions to a separate trust fund established by a state-run board (Act §15). Illinois thus joins the ranks of several states that have made varying attempts to require private sector employers to make contributions to payroll deduction individual retirement accounts. (See e.g., the California Secure Retirement Savings Trust Act, signed into law by Calif. Gov. Jerry Brown on Sept. 28, 2012.)
Outgoing Democratic Gov. Patrick Quinn signed the Act on Jan. 4, 2015, which becomes effective on June 1, 2015. The Act provides, however, that implementation must occur within 24 months of the effective date (Act §60), but only after the Illinois Secure Savings Board obtains adequate “start-up” funds for implementation (Act §93) and obtains a ruling from the U.S. Department of Labor as to whether the Employee Retirement Income Security Act applies to the Program (Act §95). The Act further provides that the program will not be implemented if “the IRA arrangements offered under the program fail to qualify for the favorable federal income tax treatment ordinarily accorded to IRAs under the Internal Revenue Code [(the Code)] or if it is determined that the program is an employee benefit plan and state or employer liability is established under [ERISA]” (Act §95). An IRA for this purpose is defined under the Act as “a Roth IRA under Section 408A” of the Code (Act §5).
The concept of a “payroll deduction IRA” has been around for a long time, and both the Internal Revenue Service and the DOL have previously expressed their views on the concept. In a recent information letter, the DOL expressed the view that that an employer whose employees participate in the federal myRA program would not be establishing or maintaining an “employee pension benefit plan” under ERISA § 3(2) based solely on the fact that the employer allows payroll deductions, submits contributions, distributes information, facilitates employee enrollment and otherwise encourages employees to make deposits to myRA accounts. See DOL information letter dated Dec. 15, 2014, from Joe Canary of the DOL to Mark Iwry of the U.S. Department of the Treasury (myRA Letter). As explained below, however, there are important differences between the federal myRA program and the Illinois program, and there is an open question whether a state law requiring employers to participate in a state-run payroll deduction IRA program is preempted by Section 514(a) of ERISA, which generally overrides state laws that “relate” to employee benefit plans.
Who Is Affected by the Act?
The Act applies to Illinois employers, including “any person or entity engaged in a business, industry, profession, trade, or other enterprise in Illinois, whether for profit or not for profit that (i) has at no time during the previous calendar year employed fewer than 25 in the state; (ii) has been in business at least 2 years; and (iii) has not offered a qualified retirement plan … in the preceding 2 years” (Act §5). An “employee” under the Act is broadly defined as “any individual who is 18 years of age or older, who is employed by an employer, and who has wages that are allocable to Illinois during a calendar year” under the Illinois Income Tax Act (Act §5). The Act does not specify that an employee must be employed for any length of time or must work a specified number of hours.
Under the Act, any employer who fails to enroll an employee will be subject to a penalty of $250 per employee who was neither enrolled nor elected to opt out of participation by the applicable deadline. The penalty increases to $500 per employee still unenrolled (without having opted out) for each calendar year after the initial penalty assessment (Act §85).
What Does the Act Require?
The Act requires that, unless an employee opts out of the program or elects to change the amount of the contribution, each employer will automatically deduct, by payroll deduction, 3 percent of the employee’s after-tax compensation (as defined for IRA purposes under Section 219(f)(1)) and contribute it to the state fund on the employee’s behalf (Act §60(c)). The state fund will maintain an IRA for each employee for whom the payroll deduction contribution was made. The Act does not require any employer to make employer contributions to the fund.
The Act permits employees to direct the investment of their individual accounts among investment funds approved by the board. The board will act as the trustee of the fund (Act §§ 45, 60(b)). The individual accounts are expected to work like Roth IRAs under Section 408A. Thus, the contributed amounts plus earnings, when paid, will not be subject to further tax. Illinois currently does not impose any state income tax on IRA distributions, and, if the program is determined to satisfy the requirements as a Roth IRA, federal income tax will not apply, either.
The Act specifies that an employer can always, in lieu of compliance, establish an employer-sponsored retirement plan, and lists as examples certain types of tax-qualified plans.
If an employee fails to opt out of the program (i.e., fails to elect a contribution of $0) or select a different contribution level, the employee’s contribution will be (and his or her wages will automatically be reduced by) 3 percent, provided that such contributions do not cause the employee’s total IRA contributions for the year to exceed the deductible amount for IRAs under Section 219(b)(1)(A) (currently $5,500 for individuals under age 50 and $6,500 for those who are older) (Act §60(c)). The Act does not specify any requirements as to how individual accounts are to be paid to enrollees upon retirement.
Who Pays the State Fund’s Administrative Costs?
The Act establishes an administrative fund to pay administrative expenses under the plan (Act §16). It is intended that the administrative fund will hold “any grants or other moneys designated for administrative purposes from the state, or any unit of federal or local government, or any other person, firm, partnership, or corporation” that may contribute. After the initial start-up, all of the fund’s administrative costs will be paid only out of the administrative fund (Act §§ 16, 45(m)). In any event, annual administrative expenses must be as low as possible and cannot exceed 0.75 percent of the total trust balance.
How Will the State Fund be Invested?
Employees may select investment options from the permitted investment options established by the board. The investment options will be managed by either the state treasurer’s office or pursuant to a contract with the State Board of Investment or private investment managers, or both, as selected by the board. The Act requires the board to establish as an investment option a lifecycle fund with a target date based upon the age of the employee that will also serve as the default investment option for enrollees who fail to elect an investment option (unless the board designates another default investment option) (Act §§45(a), 60(d)).
The Act also authorizes the board to establish any or all of four additional investment options consisting of a conservative principal protection fund; a growth fund; a secure return fund “whose primary objective is the preservation of the safety of principal and the provision of a stable and low-risk rate of return”; and an annuity fund. While the Act likely contemplates a money market or bond fund as a conservative investment option, the type of “secure return fund” intended is not fully explained. If the board elects to establish a “secure return fund,” the Act permits the board to purchase insurance to insure the value of individuals’ accounts and guarantee a rate of return, and the cost of that insurance would have to come from that fund (Act §45(c)). The board is required to review investment performance only once every four years (Act §30(e-5)).
Is the Program an “Employee Pension Benefit Plan” Covered by ERISA?
There is a substantial question whether the Act on its face requires employers to establish an “employee pension benefit plan” within the meaning of ERISA or whether the program in operation may result in employers being deemed to have established such a plan. Section 95 of the Act requires the board to request in writing an opinion or ruling from the DOL regarding the applicability of ERISA. The board may not implement the program “if it is determined that the Program is an employee benefit plan and state or employer liability is established under ERISA” (Act §95).
As a threshold matter, ERISA arguably would preempt a state law that requires employers to establish an employee benefit plan administered by the state. Cf. Golden Gate Restaurant Ass’n v. City and County of San Francisco, 546 F.3d 649, 654 (9th Cir. 2008) (rejecting the secretary of labor’s argument that San Francisco’s Healthcare Security Ordinance required employers to establish an employee welfare benefit plan administered by the city), rehearing en banc denied, 558 F.3d 1000 (9th Cir. 2009). Whether the Act would survive such an ERISA-preemption challenge is an open question.
Assuming that the Act would survive such a challenge, the question remains whether the program in operation may result in an employer being deemed to have established a “pension plan” within the meaning of ERISA. The application of ERISA would, among other things, impose ERISA fiduciary duties on persons who satisfy ERISA’s definition of “fiduciary” with respect to the program and prohibit such fiduciaries from engaging in certain categories of transactions in the absence of an exemption. ERISA §§ 404, 406. If applicable, these rules could subject the state or an employer to liability as an ERISA fiduciary or party in interest, thereby preventing the implementation of the program. Further, ERISA may impose additional reporting and disclosure requirements upon employers, in addition to the state tax reporting requirements imposed by the Act. The question, then, is whether ERISA applies to the program.
To be an “employee pension benefit plan” under ERISA, the program would have to be “a plan, fund, or program … established or maintained by an employer or by an employee organization, or by both.” ERISA §3(2)(A). IRAs under Section 408 generally are not subject to ERISA, unless they are established or maintained by an employer or employee organization. In contrast, both SIMPLE plans and SEPs are subject to ERISA because, by their terms, they can exist only if established and maintained by an employer.
The Act provides that the state-run board will establish the IRAs under the program. Although the Act does not explicitly prohibit employer contributions to IRAs established under the program (see Act §§15(a), 25(3)), there is certainly no requirement that employers make such contributions, nor do employers have any responsibility for selecting or entering into agreements with providers, making IRA investment decisions or preparing employee communications with respect to the program (see Act §75(b)). These functions are to be performed by the board or by vendors selected by the board. It is apparently contemplated under the Act that the employers’ only responsibilities are “enrolling” employees, figuring out either by default or from an employee election how much to deduct from the employee’s paycheck by payroll deduction and remitting the amount to the state fund.
Under these circumstances, payroll deduction IRAs established by employers under the program may fall under a regulatory safe harbor that applies to certain individual account plans in which an employer’s participation is minimal. These regulations provide that ERISA will not apply to an IRA described in Section 408(a) or 408(b) of the Code, provided that: (1) no contributions are made by the employer; (2) participation is completely voluntary for employees; (3) the sole involvement of the employer or employee organization is without endorsement to permit the sponsor to publicize the program to employees, collect contributions through payroll deductions, and to remit them to the IRA sponsor; and (4) the employer “receives no consideration in the form of cash or otherwise” although the employer may receive reasonable compensation for services actually rendered in connection with payroll deductions.
Safe Harbor
The DOL clarified the circumstances under which the Safe Harbor would apply to a payroll deduction IRA program established by an employer in Interpretive Bulletin 99-1, stating that, although the employer must remain neutral about an IRA sponsor in the employer’s communications with its employees, the employer may generally encourage employees to save by payroll deduction, answer questions about the mechanics of the payroll deduction IRA, provide materials written by the IRA sponsor and limit the number of IRA sponsors made available to employees. Labor Reg. § 2509.99-1. Additionally, the employer may pay administrative fees to the IRA sponsor and may collect reasonable compensation for the actual costs of services the employer renders in the payroll deduction program, provided that such payments do not include any profit to the employer.
There is a substantial question whether employers who establish payroll deduction IRAs in compliance with the Act can also satisfy the requirements of the Safe Harbor and thereby avoid the application of ERISA. Assuming that employers can both comply with the Act and satisfy the requirements of the Safe Harbor, it is difficult to see how there can be any assurance that every employer who establishes a payroll deduction IRA under the program will satisfy the Safe Harbor requirements in practice.
The DOL’s myRA Letter raises significant doubts about whether a payroll deduction IRA established in compliance with the Illinois Act would satisfy the requirements of the Safe Harbor. In concluding that an employer would not be establishing or maintaining an ERISA-covered pension plan simply by facilitating and encouraging employee participation in the myRA program, the DOL emphasized the “voluntary nature” of the program and the “absence of any employer funding.” The DOL stated specifically that: (1) “Treasury does not at this stage intend for employers to implement automatic contribution arrangements (also known as automatic enrollment) whereby a contribution equal to a default percentage of the employee’s pay is made to a myRA established for the employee unless the employee elects otherwise;” and (2) “[e]mployers would not make employer contributions to myRAs and would have no investment or other funding obligations, or have any custody or control over account assets.” Regarding the latter point, the DOL indicated that an employer would be treated as making contributions to a myRA if the employer “reimbursed employees for amounts they contributed to a myRA.”
The myRA Letter suggests that the Illinois program may not satisfy the Safe Harbor requirement that a payroll deduction IRA be “completely voluntary for employees.” DOL Reg. §2510.3-2(d)(ii). Unlike the myRA program, the Illinois program requires employers to automatically enroll each of their employees and to contribute by payroll deduction 3 percent of each employee’s after-tax compensation to the state fund, unless an employee opts out of the program or elects to change the contribution amount (Act §60(c)). These features may cause all payroll deduction IRAs under the program to be deemed ERISA-covered pension plans.
Further Analysis
The Act contains some internal inconsistencies and ambiguities. For example, the Act applies to employers who “have not offered a qualified retirement plan.” It is not clear whether the program must be offered to any employee not covered by such a plan, or whether the employer can avoid the Act by providing a retirement plan, regardless of its quality, to some but not all of its employees. This raises some of the same complicated and technical issues that many employers struggle with under the Affordable Care Act in dealing with part-time, temporary and seasonal employees.
The Act is unclear as to who will pay for the “start-up” of the program. The program cannot be implemented unless the state or federal government or private individuals contribute “start-up” money to an administrative fund (Act §90). The costs for implementing the program could be substantial. The drafters assumption that private individuals would contribute to the administrative fund is unexplained. Nonetheless, there is a hard cap on costs to the plan (0.75 percent of the total trust balance), and presumably implementation will not occur until the administrative fund has sufficient assets to permit the program to operate under that cap.
The Act’s implementation date is also uncertain. Although the stated effective date is June 1, 2015, implementation must occur within 24 months or by June 1, 2017. However, the program cannot be implemented until there are sufficient funds in the administrative fund to keep administrative costs under 0.75 percent and rulings are obtained from the DOL and IRS (Act §93 and 95). If implementation is delayed until there are sufficient funds in the administrative fund to keep administrative costs under the cap and the rulings are obtained from the DOL and IRS, the program may not be implemented for several years.
One of the more surprising provisions of the Act is that the board is required to review investment performance only once every four years. Qualified plan fiduciaries do not have such latitude under ERISA, and it is difficult to see how it is warranted in the state fund. Even if ERISA does not apply, this requirement is surprising in light of the Act’s prudent person rule (Act §25(2)).
—By Joni Andrioff and Eric G. Serron, Steptoe & Johnson LLP
Eric Serron is a partner in Steptoe & Johnson's Washington, D.C., office.
The opinions expressed are those of the author(s) and do not necessarily reflect the views of the firm, its clients, or Portfolio Media Inc., or any of its or their respective affiliates. This article is for general information purposes and is not intended to be and should not be taken as legal advice.
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