Compliance April 24, 2018

DOL Clarifies How ESG Investment Considerations Should Be Made Under ERISA

The new guidance addresses ESG investment considerations under investment policy statements and when choosing QDIAs.

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The Department of Labor (DOL) has issued Field Assistance Bulletin (FAB) No. 2018-01, which provides guidance to the Employee Benefits Security Administration’s (EBSA) national and regional offices to assist in addressing questions they may receive from plan fiduciaries and other interested stakeholders about the exercise of shareholder rights and written statements of investment policy and Interpretive Bulletin (IB) 2015-01 (relating to “economically targeted investments” (ETIs)).

In 2015, the DOL issued Interpretive Bulletin 2015-01, a piece of guidance it said will significantly expand the use of environmental, social and governance (ESG) investing principles under the Employee Retirement Income Security Act (ERISA).

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The Department had previously addressed issues relating to ETIs in Interpretative Bulletin 94-1. The publication “corrected a misperception that investments in ETIs are incompatible with ERISA’s fiduciary obligations” that existed beforehand, the Labor Secretary at the time said. The guidance also “contains much clearer discussion and explanation of how responsible fiduciaries should and should not use ESG/ETI factors while creating and managing portfolios under ERISA.”

Strictly speaking, under IB 94-1, as under the 2008 guidance, ESG investing factors can still only serve as a tiebreaker when considering economically similar investments. As the Secretary clearly reiterated, “Fiduciaries still may not accept lower expected returns or take on greater risks in order to secure collateral benefits.”

But under the 94-1 paradigm, unlike under 2008-1, the DOL directly acknowledged that ESG factors “may have a direct relationship to the economic and financial value of an investment. When they do, these factors are more than just tiebreakers, but rather are proper components of the fiduciary’s analysis of the economic and financial merits of competing investment choices.”

In the new FAB, the DOL says fiduciaries must not too readily treat ESG factors as economically relevant to the particular investment choices at issue when making a decision. “It does not ineluctably follow from the fact that an investment promotes ESG factors, or that it arguably promotes positive general market trends or industry growth, that the investment is a prudent choice for retirement or other investors. Rather, ERISA fiduciaries must always put first the economic interests of the plan in providing retirement benefits. A fiduciary’s evaluation of the economics of an investment should be focused on financial factors that have a material effect on the return and risk of an investment based on appropriate investment horizons consistent with the plan’s articulated funding and investment objectives,” the FAB says.

Disregarding IPS policies if imprudent

In addition, the DOL explains that in IB 2016-01, it noted that investment policy statements (IPS) are permitted to include policies concerning the use of ESG factors to evaluate investments, or on integrating ESG-related tools, metrics, or analyses to evaluate an investment’s risk or return. It says that discussion in the IB does not reflect a view that investment policy statements must contain guidelines on ESG investments or integrating ESG-related tools to comply with ERISA. Moreover, the IB does not imply that if an investment policy statement contains such guidelines then fiduciaries managing plan assets, including appointed ERISA section 3(38) investment managers, must always adhere to them.

A statement of investment policy is part of the “documents and instruments governing the plan” within the meaning of ERISA section 404(a)(1)(D),5 and an investment manager or other plan fiduciary to whom such an investment policy applies is required to comply with the policy, but only insofar as the policy is consistent with Titles I and IV of ERISA (including the core fiduciary obligations of prudence and loyalty). Thus, if it is imprudent to comply with the investment policy statement in a particular instance, the manager must disregard it.

ESG investments in QDIAs

The Department explained in the preamble to IB 2015-01 that the standards set forth in sections 403 and 404 of ERISA apply to a fiduciary’s selection of an investment fund as a plan investment or, in the case of an ERISA section 404(c) plan or other individual account plan, a designated investment alternative under the plan. In the case of an investment platform that allows participants and beneficiaries an opportunity to choose from a broad range of investment alternatives, adding one or more funds to a platform in response to participant requests for an investment alternative that reflects their personal values does not necessarily result in the plan forgoing the placement of one or more other non-ESG themed investment alternatives on the platform. Rather, in such a case, a prudently selected, well managed, and properly diversified ESG-themed investment alternative could be added to the available investment options on a defined contribution (DC) plan platform without requiring the plan to remove or forgo adding other non-ESG-themed investment options to the platform.

In the case of a qualified default investment alternative (QDIA), however, selection of an investment fund is not analogous to merely offering participants an additional investment alternative as part of a prudently constructed lineup of investment alternatives from which participants may choose. Nothing in the QDIA regulation suggests that fiduciaries should choose QDIAs based on collateral public policy goals. In the QDIA context, the decision to favor the fiduciary’s own policy preferences in selecting an ESG-themed investment option for a 401(k)-type plan without regard to possibly different or competing views of plan participants and beneficiaries would raise questions about the fiduciary’s compliance with ERISA’s duty of loyalty.

Even if consideration of such factors could be shown to be appropriate in the selection of a QDIA for a particular plan population, however, the plan’s fiduciaries would have to ensure compliance with the guidance in IB 2015-01. For example, the selection of an ESG-themed target-date fund as a QDIA would not be prudent if the fund would provide a lower expected rate of return than available non-ESG alternative target-date funds with commensurate degrees of risk, or if the fund would be riskier than non-ESG alternative available target-date funds with commensurate rates of return.
Client Service April 24, 2018

Tax Time Is Over, But It’s Still a Great Time to Talk Taxes

An analysis from the American Institute of CPAs shows how clients can use their recently filed tax returns to map out a more efficient budget and investing plan for 2018.

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Instead of “filing and forgetting it,” the American Institute of CPAs (AICPA) is encouraging Americans to use the information in their 2017 tax return to develop a plan that will put them on the path to securely reach their financial goals.

“The stress of the 2017 tax-year filing deadline has passed and, though many Americans may be eager to put away their financial records, now is the perfect time to plan for the future,” AICPA argues in new survey report, created in collaboration with Harris Poll. According to a survey of 507 affluent Americans—defined here as those with $250,000 in investable assets or more than $200,000 household income—nearly eight in 10 are likely to use the information on their tax return to guide their financial plan. 

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“This underscores the bridge between taxes and financial planning,” AICPA says. “A tax return can double as a roadmap to a more prosperous financial future. In it, Americans can find details of their cash flows, important investment information, insights to retirement and estate planning and identify overlooked strategies to help them achieve their financial goals.”

As AICPA and Harris Poll lay out, with the significant changes brought about by the Tax Cuts and Jobs Act now in effect for the 2018 tax-year, Americans should revisit their overall financial plan while all their documents are readily available.

“By not taking advantage of various tax planning strategies, Americans could be leaving money on the table every year that could have gone towards their children’s education, their family’s healthcare savings, or towards retirement,” says Andrea Millar, Raleigh-Durham, North Carolina-based director of financial planning for AICPA. “In today’s dynamic tax environment, taking some time after tax season to ensure your financial plan is in synch with the current law will allow you to feel more confident you’re on track to meet your financial goals.”

The survey data shows nearly a quarter of affluent adults (23%) overpaid taxes in at least one of the past 10 years and were owed a refund. In addition, 14% underpaid and owed the Internal Revenue Service (IRS) money in at least one year.

“Over or under withholding payroll tax can be a strategic move,” researchers note. “But winding up with a big tax bill or a large refund can also indicate that adjustments are in order. And with updated withholding tables from the new tax law in effect, now is a perfect time to do this.”

Tax data highlights potential strategy shifts

According to AICPA and Harris Poll, life events such as having a child, experiencing a divorce or purchasing a home can all have a major impact on an individual’s tax situation—and by extension on their budgeting and investing plans.

“Alarmingly, less than half of affluent adults said it is likely that a major life event would cause them to adjust their financial plan to be more tax efficient,” the analysis states. “Of those who would be likely to make changes, the leading causes cited were health issues, followed by retirement, becoming disabled, getting divorced and having children.”

The survey further shows that affluent adults appreciate the value of a financial planner with substantial tax expertise—and they also value non-CPA advisers who can make connections between clients and niche experts. But “financial planning is not just for the wealthy. Every American can benefit from knowing where their money is going and taking advantage of opportunities to incorporate planning strategies available to them in the tax law.”

With tax-filing season having just concluded, CPA financial planners suggest a few themes to think about for next year’s taxes. First, “make your 2018 contributions as early as possible.”

“Taxpayers should make their contributions to tax-advantaged accounts, such as IRAs, 529s, and workplace retirement plans, as early in the year as possible. By making these contributions earlier rather than later, taxpayers will benefit from additional tax-free compounding growth, which can be substantial over time,” the research points out. “For families with kids going to private elementary or high school, take advantage of the new 529 provision that allows you to pay $10,000 per year, per child, from a 529. If your state gives you a deduction for amounts contributed (check with your state’s plan to find out any limits on each year’s deduction), even if you don’t have a 529 established, it could make sense to deposit up to that deductible limit in the account first before paying education expenses, which can lower your state income taxes.”

Again, a tax expert can help advisory clients “work out the logistics.”

Another strategy suggested is to consider other benefits beyond the 401(k), and how these could impact tax burdens. “Tax time can be a good opportunity to review your employee benefits and determine if any changes need to be made during the next open enrollment period. Lots of companies are offering ways to save their employees money such as health savings accounts or pre-tax commuter benefits.”

Finally, AICPA urges investors to consider bunching medical expenses into 2018, according to the following logic: “If you have been putting off a procedure or visiting a medical specialist, now may be the best time to schedule that appointment. Under the new law, the 7.5% of income medical deduction threshold will be in place only for the 2017 and 2018 tax years. After that, the threshold reverts back to 10% of income. For what is and isn’t deductible, visit the IRS website.”

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