Hybrid retirement plans provides sponsors with options

October 2nd, 2014 No comments

By Javier Sanabria

Hybrid retirement plans are becoming more popular among employers seeking to offer the best features of both traditional defined benefit and defined contribution plans. A recent Employee Benefits Adviser article (subscription required) highlights variations of these hybrid plans and identifies some public and private sector sponsors that have shown interest in adopting them.

Here is an excerpt featuring some perspective from Milliman’s Mark Olleman and Kelly Coffing:

“I think we are going to see more hybrid arrangements and fewer defined contribution and traditional defined benefit plans [in the future],” says Mark Olleman, principal and consulting actuary at Milliman, Inc. in Seattle. “I think we really need more plans to provide people with a lifelong income, without providing employers unpredictable contributions.”

…Wisconsin’s plan looks more like a variable annuity pension plan. [Retiree benefits are based on a conservative assumption of] a 5% return. If the plan returns better than 5% over the long term, retirees get dividends. If it returns below 5%, the dividends will be taken away, Olleman says. Retirees receive a minimum amount [of their original benefit] regardless of how the market performs.

The big difference between public sector and private sector plans is that public sector plans need to get permission from the legislature to make changes, he said. Both sectors have shown an interest in hybrid options.

Kelly Coffing, a principal and consulting actuary for Milliman who works more closely with private sector employers, says that variable annuity pension plans have been around for a while but have not been popular with retirees. The reason? They don’t like it when their benefits go down, she said. In a VAPP, the monthly benefits move up and down based on the performance of the plan. If the assets go up, the benefits go up. If the assets go down, the benefits go down.

Despite the volatility, these types of plans always stay funded and have very predictable, rational employer costs, Coffing says. They also offer longevity pooling and inflation protection, which is something participants don’t get in a defined contribution plan.

…Milliman has attempted to smooth out some of that volatility for retirees in its latest version of the VAPP [that they call the stabilized VAPP].

“In years where returns are high, we don’t give the whole upside to participants. We [cap] the increases [to build] a reserve. When the market goes down, we can [use the reserve to] shore up the benefit to the high water mark,” she says. This way, participants don’t see a roller coaster of ups and downs in their retirement [benefits].

…Milliman’s experts say they hope the variable annuity pension plan will gain in popularity now that [final hybrid retirement regulations issued September 19, 2004 have confirmed that the stabilized VAPP is an acceptable plan design.]

To learn more about how VAPPs can provide lifelong retirement benefits, read Olleman and Kelly’s article entitled “Variable annuity pension plans: An emerging retirement plan design.”

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Hedge funds and investment alternatives

October 1st, 2014 No comments

By Matt Albano

Albano-MatthewOver the last week, a few large defined benefit (DB) programs announced they are migrating away from using hedge funds in their investment strategies, stating that fees, complexity, and changing investment approaches played a part in their decision. In the current environment, when investment managers are increasingly packaging hedge fund types of investment instruments into mutual funds, some of the largest DB programs are moving away from them.

According to Morningstar, their alternative mutual fund categories saw 17 new funds in the first quarter of 2014, following a record year for 2013 for both new funds and asset inflows from investors (70 new funds and $40.3 billion in net inflows). These include the Morningstar categories Market Neutral, Long-Short Equity, and Multialternative. Historically, managers of these types of strategies have locked up or limited investors’ access to their money in order to employ the complex investment tactics. This made the investment “illiquid” as the investor needed to give the manager some amount of lead time, three months or sometimes more, in order to withdraw the money from the fund. However, with these new mutual funds the investor has daily liquidity and can buy and sell the mutual fund just as they would an S&P 500 index fund—making them “liquid alternatives” or “liquid alts.”

One of the essential benefits these alternative strategies bring to a portfolio is additional diversification (lower correlation), which is not available from simply using stocks and bonds. As the portfolio’s core asset classes move up and down, the alternative strategies are intended to dampen those moves. Ideally this helps to preserve capital when the other asset classes are negatively performing, at the cost of lowering portfolio returns when the core assets are performing positively. Because of the introduction of daily liquidity, there is increased discussion over including these types of funds within the investment menu of defined contribution (DC) plans such as the 401(k) and giving those participants access to the additional diversification benefit.

Typical of any decision, plan fiduciaries need to weigh this additional diversification benefit against some of the adverse aspects, including participant mishandling as well as fees associated with these funds. As with the other investments in a plan’s line-up, these alternative strategies are intended to be used as a piece of the whole portfolio and not as a stand-alone investment. Additionally, because of the complexity of the investment strategies these alternative mutual funds can carry expense ratios of over 1.5% to well over 2%. In comparison, an S&P 500 index fund typically carries an expense ratio of around 0.1%.

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Milliman infographic: The boomerang generation’s retirement planning

September 30th, 2014 No comments

By Javier Sanabria

The Millennial generation has gotten a bad rap concerning their retirement planning habits – or lack thereof. Fortunately, there are several steps Millennials can take to secure a better retirement. The infographic below features 12 tips Millennials should consider when developing their retirement strategy. The tips are taken from Jinnie Olson’s article “Retirement planning: 12 practical tips for Millennials.” The infographic also highlights some of the generation’s retirement planning behaviors.

Millennials boomerang infographic_Milliman Inc_09-29-14

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Regulatory roundup

September 29th, 2014 No comments

By Employee Benefit Research Group

More retirement-related regulatory news for plan sponsors, including links to detailed information.

PBGC issues technical update on the effect of HATFA on PBGC premiums
The Pension Benefit Guaranty Corporation (PBGC) issued Technical Update 14-1 providing guidance on the effect of the Highway and Transportation Funding Act of 2014 (HATFA) on PBGC premiums.

The guidance supersedes any inconsistent guidance in PBGC’s 2014 premium instructions. It does not affect the guidance in PBGC Technical Update 12-1 (Effect of MAP-21 on PBGC Premiums), which continues to apply for plan years to which HATFA applies.

For more information, click here.

PBGC requests OMB approval of modification to its regulation on payment of premiums
The PBGC has issued a notice of intention to request approval from the Office of Management and Budget (OMB) to modify the collection of information under its regulation on payment of premiums. The notice informs the public of PBGC’s intent and solicits public comment on the collection of information.

To read the entire notice, click here.

IRS final rules on employee retirement benefit plan returns required on magnetic media
The IRS released final regulations related to the requirements for filing certain employee retirement benefit plan statements, returns, and reports on magnetic media. The term magnetic media includes electronic filing, as well as other magnetic media specifically permitted under applicable regulations, revenue procedures, publications, forms, instructions, or other guidance on the IRS.gov website.

The regulations apply to employee retirement benefit plan statements and notifications required to be filed under section 6057 for plan years that begin on or after January 1, 2014, but only for filings with a filing deadline (not taking into account extensions) on or after July 31, 2015.

For more information, click here.

IRS issues new edition of employee plans newsletter
The IRS has issued an updated edition of its newsletter Employee Plans News. This edition contains:

• Form 5498 reporting errors – IRA trustees, issuers and custodians should carefully complete IRA transactions
• Updated: Finding missing plan participants – Steps plan sponsors may take to locate missing participants
• DOL corner – Updates on brokerage windows and missing participants
• IRS and DOL guide for retirement plan reporting and disclosure issues – Chart summarizes plan sponsors responsibilities on Form 5500 annual reports, participant notices and other items.

To read the entire newsletter, click here.

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GASB 67/68: Substantively automatic plan provisions

September 25th, 2014 No comments

By Javier Sanabria

This PERiScope article authored by Michael Iacoboni discusses “substantively automatic” plan provisions and their inclusion in the determination of a plan’s total pension liability (TPL). For many plans, the concept of “substantively automatic” is critical to the treatment of cost of living adjustments (COLAs), which are often granted on a discretionary or ad hoc basis. In Statements 67 and 68, GASB neither objectively nor specifically defines the term “substantively automatic” and it does not prescribe a one-size-fits-all formula for determining if a plan’s COLA policies fall into this category.

To read Milliman’s PERiScope series on technical and implementation issues surrounding GASB 67 and 68, click here.

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Regulatory roundup

September 22nd, 2014 No comments

By Employee Benefit Research Group

More retirement-related regulatory news for plan sponsors, including links to detailed information.

IRS issues final and proposed regulations for hybrid retirement plans
The IRS has issued final regulations providing guidance for defined benefit plans that use a lump-sum-based benefit formula, including cash balance and pension equity plans, as well as other hybrid retirement plans that have a similar effect.

To read more about the final regulations concerning hybrid plans, click here.

The IRS has also proposed regulations on market rate of return. For more information, click here.

IRS issues proposed regulations to Roth distribution accounts
The IRS has issued proposed amendments to the regulations that address the tax treatment of distributions from designated Roth accounts under tax-favored retirement plans. The proposed regulations would limit the applicability of the rule regarding allocation of after-tax amounts when disbursements are made to multiple destinations so the allocation rule applies only to distributions made before the earlier of January 1, 2015 or a date chosen by the taxpayer that is on or after the date the regulation was published in the Federal Register (September 19, 2014).

To read more about the proposed regulations to Roth distribution accounts, click here.

IRS issues guidance on allocation of after-tax amounts to rollovers
The IRS has issued Notice 2014-54, providing rules for allocating pre-tax and after-tax amounts among distributions that are made to multiple destinations from a qualified plan described in Section 401(a). These rules also apply to disbursements from a 403(b) or 457(b) plan maintained by governmental employers.

To read Notice 2014-54, click here.

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PBGC variable rate premium: Should plans make the switch?

September 17th, 2014 No comments

By Maria Moliterno

Moliterno-MariaMany pension plan sponsors are facing a decision on the methodology of calculating the premiums payable to the Pension Benefit Guaranty Corporation (PBGC) that may result in significant savings. PBGC premiums are made up of variable rate and flat rate premiums. Variable rate premiums are based on unfunded vested benefits (UVB). In 2014, many plan sponsors are eligible to change the methodology used to calculate their plan’s UVB. The question is: should they make the switch?

The UVB is determined by the amount that the vested liability, called the premium funding target, exceeds the fair market value of plan assets. The required variable rate premium for 2014 is $14 per $1,000 of UVB and is scheduled to increase to $24 in 2015 and $29 in 2016. The PBGC allows plan sponsors to determine UVB for purposes of calculating the variable rate premium by either:

• Using the three spot segment rates for the month preceding the month in which the plan year begins (standard premium funding target)
• Using the 24-month average segment rates as of the plan’s previously elected look-back period (alternative premium funding target)

Many plan sponsors elected for 2009 to switch to using the alternative premium funding target to avoid the volatile and low spot interest rates basis for the standard premium funding target.

Plan sponsors making the switch are locked into it for five years. After five years, the plan sponsor can switch again. If the plan sponsor doesn’t make a switch, they can stay with the current method as long as they like.

Five years later, plan sponsors who elected in 2009 to switch to using the alternative premium funding target are eligible to switch back to using the standard premium funding target. For calendar year plans, plan sponsors would need to do this in time for the PBGC premium due date of October 15, 2014. With the rise in interest rates that occurred during 2013, plan sponsors are asking themselves if they should make the switch during 2014.

To answer this question, consultants can estimate the variable rate premium amounts under both options for both the 2014 and 2015 plans. Does the plan sponsor save over the course of two years by switching methods?

Let’s look at an example for a sample plan with a UVB of $14.90 million under the alternative method and $9.75 million under the standard method for 2014:

For a calendar year plan, rates used for the standard premium funding target in 2014 are generally higher than the rates used for the alternative premium funding target; therefore, in this example, the standard premium funding target results in a lower variable rate premium for the 2014 plan year by $72,000.

Although interest rates for determining the alternative and standard premium funding target for the 2015 plan year are not yet available, if we assume the rates currently in effect stay constant through the end of the year, rates used for the alternative premium funding target are generally higher than the rates used for the standard premium funding target for the 2015 plan year. Assuming these rates are still in effect for the 2015 plan year, most plans will have a smaller premium funding target under the alternative method for 2015, resulting in a lower variable rate premium. In our example, the alternative method election would produce a more favorable result in 2014 by an amount of $33,000.

Therefore switching in 2014 to the standard premium funding target would result in a projected net savings of $39,000 over the two-year period.

Just remember, the standard method uses volatile spot interest rates. If there is another dip in the market, the plans may face higher costs under the standard premium funding target method and won’t be able to switch back to the alternative premium funding target until 2019. However, they will be happy they switched if interest rates rise but that of course is anyone’s guess!

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Google+ Hangout: Pension Funding Index, September 2014

September 16th, 2014 No comments

By Javier Sanabria

The funded status of the 100 largest corporate defined benefit pension plans deteriorated by $22 billion during August as measured by the Milliman 100 Pension Funding Index (PFI). The deficit increased from $259 billion to $281 billion at the end of July, due to a drop in the benchmark corporate bond interest rates used to value pension liabilities. August’s robust investment gain was not enough to improve the Milliman 100 PFI’s funded status. As of August 31, the funded ratio dropped down from 84.8% to 84.0%.

PFI co-author Zorast Wadia discusses the index’s latest results on this Milliman Google+ Hangout.

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Regulatory roundup

September 15th, 2014 No comments

By Employee Benefit Research Group

More retirement-related regulatory news for plan sponsors, including links to detailed information.

IRS issues pension funding stabilization guidance under HATFA
The Internal Revenue Service (IRS) has released Notice 2014-53 providing guidance on the changes to the funding stabilization rules for single-employer pension plans under the Internal Revenue Code (Code) and the Employee Retirement Income Security Act of 1974 (ERISA) that were made by section 2003 of the Highway and Transportation Funding Act of 2014 (HATFA).

To read the entire notice, click here.

House Ways and Means announces hearing on private single-employer and multiemployer pension plans
The Committee on Ways and Means will be holding a hearing on defined benefit pension plans offered by private sector employers, including both multiemployer plans and single employer plans. The hearing will take place on Wednesday, September 17, at the 1100 Longworth House Office Building, beginning at 10:15 A.M.

For more information, click here.

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Retirement plan leakage and retirement readiness

September 10th, 2014 No comments

By Kara Tedesco

Tedesco-KaraThe title alone proves opposites don’t always attract. “Leakage” means outflow and outflows in retirement plans are not easily controlled. Worse yet, the impact on a participant’s retirement readiness is a big problem. Where money goes once it leaves a retirement plan is a question with many answers, some of which lead to plan sponsors feeling concerned about plan design and the choices available to participants.

In defined contribution (DC) plans such as the 401(k), participants defer money from their paychecks into the plan. The employer may make matching or other employer contributions. Most 401(k) plans are designed to allow participants to access these deferrals, as well as their other vested monies, while actively working. This access occurs through loans, hardship withdrawals, and other in-service distributions. When participants take a loan, they pay themselves back over time. In some instances, however, a participant defaults on the loan, which automatically reduces the account balance. In the case of in-service distributions, once the money is paid to the participant, it does not come back into the plan, similarly reducing the participant account balance.

Of greater concern may be the preretirement withdrawal of an account balance upon termination of employment. Participants terminate employment for a myriad of reasons, such as to start a new career path. In a defined benefit (DB) plan, it is not uncommon to see a lump-sum window option offered to participants. Plan sponsors benefit from participants choosing the lump-sum window option just as they do when terminated participants take their money from 401(k) plans. The plan sponsor’s administrative costs associated with either type of plan are reduced.

The problem? Participant account balances that are cashed out and not rolled over to an IRA or another qualified retirement plan are subject to immediate income tax and potentially burdensome tax penalties, depending upon their age. But many participants don’t know what to do with the money and will often use it right away to satisfy an immediate financial need rather than save it for retirement. An even greater, more glaring problem is that the participant’s total projected retirement savings has been compromised. Does this mean that a participant will not achieve the suggested 70% to 80% income replacement rate? Most likely, the answer is yes, especially if the participant has no other savings outside the former retirement plan.

There is no clear answer to the leakage problem in plans. A good retirement plan design can greatly influence the behavior of its participants. It has to include and encourage regular employer and employee contributions to help build retirement accounts. Withdrawal provisions and loans in plans don’t signify poor plan design, but tighter administrative controls around the plan provisions, such as allowing only one in-service withdrawal per year, helps keep money in the plan. In addition, increased participant education has to remain a focus for employers, with a special emphasis on the benefits of taking a rollover instead of a lump-sum cash distribution.

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