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Retirement plan enrollment considerations

July 31st, 2015 No comments

Employers are constantly seeking new ways to get employees enrolled in their retirement plans. This Plan Adviser article quotes Milliman’s Gerald Erickson and Jinnie Olson discussing how automatic plan designs and targeted communication strategies can affect the enrollment of participants especially Millennials.

Here is an excerpt:

When it comes to automatic plan design, says Gerald Erickson, a principal at Milliman Inc. in Minneapolis, the adviser community obviously supports these features. Still, it is important to acknowledge that while popular opinion claims auto plans are the next logical step in improving participant outcomes, “from a plan sponsor and an administrator/recordkeeper perspective, automatic plans are not easy to administrate.”

There’s a lot that goes on behind the scenes, he says, and that may include some mistakes. “I think it’s important for people to understand that it’s not as easy as just getting people to automatically go in the plan and think that’s the end of it. It does require a lot of work from the plan sponsor side, and it does require a lot of work from the recordkeeping/administrator side.”

Plan advisers should be wary of potential complications when designing their automatic features. Most retirement plan advisers are “looking at what makes the biggest impact in getting people in the plan,” Erickson says, which for Millennials may lead them to look at Roth options. “If you add a Roth feature to the plan,” he points out, Millennials that are in a lower tax bracket now can essentially “marginalize their tax hit by taking advantage of the tax-free distribution on the back end.”

Speaking for Millennials, Olson says, “We’re really the first generation that’s going to have to fund our own retirement, rather than relying on the typical defined benefit [DB] plan that’s losing popularity, and it can be really intimidating for people to hang onto enrollment packets for a year while you try to meet the eligibility requirements.”

…Advisers can help make an overwhelming amount of information more accessible for all participants, Olson says. “You want to be able to give that information to everybody but in a way that everyone has the opportunity to get through it and understand what it is,” she says. “Rather than a 15-page enrollment packet, maybe you pare it down to two pages, summarizing everything, but then give them the opportunity to look into it more later.”

Will the proposed overtime pay changes affect your retirement plan compensation?

July 30th, 2015 No comments

Smith-SuzanneThe Department of Labor (DOL) announced a proposed rule on July 6, 2015, that would change who qualifies for overtime pay.

Today, only 8% of salaried workers qualify for overtime pay ─ those workers who earn less than $23,660. The proposed rule will extend overtime pay to salaried workers who earn less than about $50,440 next year. The proposed change is estimated to cover 4.6 million workers, more than the current regulations.

What does this mean for the retirement plans of employers who will be affected by this proposed rule?

While many employers use gross compensation or total pay for retirement plan purposes, some employers provide retirement benefits only on base pay, excluding additional pay such as overtime, bonuses, or premiums for shift differentials.

Generally, excluding overtime pay for retirement plan purposes is okay if the plan’s definition of compensation passes nondiscrimination testing.

Nondiscrimination testing on compensation is done by comparing the average includible compensation for highly compensated employees (HCEs) to the average includible compensation for non-highly compensated employees (NHCEs). If the HCE average percentage exceeds the NHCE average percentage by more than a de minimis amount, the plan will fail the test. A de minimis amount is generally thought to be no more than 3%, but there is no formal guidance so plan counsel should be involved.

2015 Example: Plan excludes overtime pay and bonuses from plan compensation.

HCE Average Includible Compensation 95%
NHCE Average Includible Compensation 93%
PASS

Because the HCE average inclusion percentage exceeds the NHCE average inclusion percentage by no more than 3%, the plan passes the test.

But what happens next year if many of the NHCE participants are suddenly eligible for overtime pay? The increase in excludable overtime pay will cause the NHCE inclusion ratio to drop, and the disparity between HCE and NHCE includible compensation will exceed 3%– and thus fail the test.

2016 Example: Plan excludes overtime pay and bonuses from plan compensation.

HCE Includible Compensation 95%
NHCE Includible Compensation 86%
FAIL

Because the HCE average inclusion percentage exceeds the NHCE average inclusion percentage by more than 3%, the plan fails the test.

Failed testing is never good. More complex testing would have to be done, and the plan may have to take corrective action if the complex testing doesn’t pass.

Employers with salaried workers who would qualify for overtime under the proposed changes will want to check their retirement plan compensation definition and keep an eye on what happens with the proposed overtime regulations.

Interested parties can submit comments on the proposed rule at www.regulations.gov (RIN: 1235-AA11) on or before September 4, 2015. The department is expected to make a final rule next year.

IRS guidance on favorable determination letters for individually designed plans expected this summer

June 19th, 2015 No comments

Smith-SuzanneEvery summer we look forward to nice weather, vacations, picnics, and barbecue. And Internal Revenue Service (IRS) guidance.

Yes, this summer we are expecting IRS guidance relating to changes in the determination letter program. The IRS has informally communicated a possible halt, beginning in 2016, to the issuance of IRS determination letters for individually designed retirement plans except for new plans or terminating plans. A formal announcement with details and an opportunity for comment is expected this summer.

Initially, this may sound like a beneficial change for employers because it eliminates a burdensome and costly process that individually designed retirement plans must generally undertake every five years.

But the potential negative impact of such a change is very concerning. While there is no federally regulated requirement to have favorable determination letters for each retirement plan, there are many good reasons for employers to seek them:

Reliance on audit: By having a current determination letter, an employer has assurance that its plan language is tax-qualified. If a plan is audited, the employer can rely on the determination letter to prove the plan’s tax-qualified status.
Approval of amendments to plan: Most plans are amended from time to time to incorporate new laws and optional plan provisions. A determination letter is important to demonstrate that the amended plan language meets the tax-qualified rules.
Due diligence for corporate restructuring transactions: When corporate restructuring transactions such as mergers, acquisitions, or divestitures occur, it is prudent to obtain current determination letters to review the tax qualifications of the plans involved in the transaction.

Without the ability to secure a current determination letter, plan sponsors would not be able to confirm the tax-qualified status of their plans, thereby leaving them unprotected in the event the IRS finds the plan language to be noncompliant during a future audit. Such a finding could result in severe penalties.

Two types of plans that have been considered individually designed and for which an employer would generally seek a favorable determination letter are employee stock ownership plans (ESOPs) and cash balance plans.

Perhaps recognizing that it will be limiting the availability of determination letters for individually designed plans, the IRS has recently released guidance that would expand the preapproved plan document program to include ESOPs and cash balance plans. If an employer uses preapproved language without modifications, an employer would have reliance on the IRS opinion/advisory letter without the need for a favorable determination letter. Thus, employers with individually designed ESOPs and cash balance plans may want to consider converting their plans to preapproved plan documents in the future.

So, as we kick off summer, we are anxiously awaiting IRS guidance on the future of the determination letter program as well as watermelon, fireworks, and pool parties.

Employers helping former employees deal with rollover fees

June 11th, 2015 No comments

Many defined contribution plan participants are incurring excessive fees when they roll over their account balances into their IRAs. Sponsors can help former employees maintain their savings by retaining the account balances within their qualified plans. In this article, Milliman consultant Doug Conkel discusses what plan sponsors are doing to help their former employees make better decisions with their plan balances.

Here is an excerpt:

Plan design thoughts

Like other transformations within the defined contribution (DC) market, the genesis of these changes is linked to creating a defined contribution plan with some attributes passed down from the “pension plan era.” Participants and sponsors alike are considering changes that shift the plan design discussion from retirement accumulation topics to the “de-accumulation” or payout phase. So what plan design changes are they making?

Partial lump-sum distributions. Many sponsors have modified their plans such that former participants can request a partial lump-sum distribution of their account balances. This enables former participants to satisfy a one-time expense while leaving a portion of their account balances in the plan.

Installments. Years ago, many sponsors simplified their distribution options by removing installments, based on the conclusion that “a participant can set up installments outside the plan (usually an IRA or annuity).” However, now some sponsors have come to realize the issues noted above with outside accounts and some participants are requesting in-plan installments. Some sponsors are again electing to liberalize the distribution options by allowing former participants to elect installment payments from the plan, which gives participants flexibility and allows them to keep their accounts in the plan….

Education and communication

Guidance on comparing fees. A plan that is run in an unbiased environment is able to provide guidance to participants to help them understand the fees they pay under the current plan provisions and how they might compare those fees to individual retail arrangements. The participant fee disclosure rules introduced a few years ago provide participants with the information they need to access their current plan’s total fees. The plan’s annual notice provides the investment expense ratios from which participants can calculate a weighted expense ratio using their personal account. Plus, using their quarterly statements, a participant can also determine the amount of direct expenses (if any) being deducted from the account. These two key pieces of information yield the total cost of a participant’s account within the qualified plan. If participants can obtain the same information about proposed IRAs or new employers’ retirement plans, they should be able to perform an apples-to-apples comparison of the fees. A best practice in the future would be to provide some guidance to former plan participants to assist them in making this comparison so they can then make informed decisions.

Considerations: Is adding after-tax contributions in your 401(k) plan always a good idea?

May 5th, 2015 No comments

Cross-BrandySince the Internal Revenue Service (IRS) loosened the distribution restrictions on after-tax and pretax amounts when rolling over funds from a 401(k) plan, many advisors and consultants are encouraging participants to consider making additional traditional after-tax contributions to their 401(k) plans, and in turn, encouraging plan sponsors to add traditional after-tax back to their plans.

After the IRS Notice (2014-54), a participant can now specifically direct the pretax and after-tax amounts of any distributions or conversions without the limitation of having to take a proration of pretax and after-tax amounts.

Recent articles on the subject point out that a participant could potentially deposit substantial after-tax contributions above the individual deferral limit of $18,000 (for 2015). The after-tax contributions would be limited only by the Section 415 annual addition limit of $53,000 (or $59,000 for those over age 50). This 415 limit includes all contributions to the plan including pretax deferrals, Roth deferrals, after-tax contributions, and all employer contributions.

This could mean significant savings and future tax advantages for the participant. If the plan allows for in-service withdrawals or in-plan Roth distributions, employees could then choose to annually distribute the after-tax contributions to a Roth account, thus sheltering any earnings on the contribution from further taxation, instead of letting the earnings continue to grow inside the pretax account to be later subject to taxation upon withdrawal.

This sounds fantastic for the participant, but it feels too good to be true. What is missing? What isn’t being considered? How do these potentially large contributions affect the plan?

As a compliance manager, I believe that the largest missing component in this discussion is the nondiscrimination testing. Some articles I’ve seen on the topic mention nondiscrimination testing, and some don’t. But even when they do, it’s an afterthought. All 401(k) plans are subject to some form of testing.

Where might large after-tax contributions make testing difficult?

It stands to reason that the participants with the ability to take advantage and be most interested in making additional large after-tax contributions would be highly compensated employees (HCEs). Whether an HCE because of compensation or because of ownership and attribution (such as the spouse of an owner not needing the wages), this is the group most likely to be able to fund these contributions.

Many 401(k) plans need to be tested for nondiscrimination of the average deferral rate (ADR) and average contribution rate (ACR) of HCEs as compared with the ADR and ACR rates of non-highly compensated employees (NHCEs). They are referred to as the 401(k) ADP and 401(m) ACP tests. The 401(k) ADP test assesses pretax and Roth contributions, while the 401(m) ACP test looks at the employer matching contributions and employee after-tax contributions.

Let’s work an example. If it is true that the participants who will likely take advantage will be the HCEs, these larger after-tax contributions could negatively affect the results of the ACP test.

Read more…

A major change to correction procedures provides much needed relief for sponsors

April 20th, 2015 No comments

Jakobe-KariOn April 2, the Internal Revenue Service (IRS) rolled out major changes to the correction methods related to failure to implement automatic enrollment or to having missed participant-elected deferral changes.

Previously, the prescribed correction in the Employee Plans Compliance Resolution System (EPCRS) was for the employer to make up 50% of the missed deferrals and 100% of the match, plus earnings on both. This was often a windfall for participants and penalty for sponsors that deterred many from adopting auto-enroll provisions in their plans.

There are now two new safe harbor corrections: one for plans with auto-enroll provisions, another for faulty elective deferrals. The general guideline of the new correction methods are as follows:

For plans with auto-enroll features:
• If the failure is found within nine months of the plan year-end in which the auto-enroll should have begun:
o Start the deferral immediately
o Send a notice of the failure to the participant
o 100% of any missed match is made up and adjusted for earnings

• If the failure is found outside the nine-month window following the plan year-end, the old procedure remains in place.

For other elective deferral changes that are not completed as requested by the participant, if the failure is found within three months:
• Start the deferral immediately
• Send a notice of the failure to the participant
• 100% of any missed match is made up and adjusted for earnings

If found after three months from the date the change was to be effective:
• Start the deferral immediately
• Send a notice of the failure to the participant
• 100% of any missed match is made up and adjusted for earnings and the participant must receive a qualified nonelective contribution (QNEC) in the amount of 25% of the missed deferral, plus earnings

For a more detailed explanation on the new regulations, see the recent Client Action Bulletin published by Milliman.

March 15 alert: Ides of March is a 409A fateful day for employers’ bonus programs

March 11th, 2015 No comments

Pizzano-DominickJust as ignoring the seer’s warning to “Beware the Ides of March” led to Julius Caesar’s demise on that fateful March 15, employers with calendar fiscal years must be wary of this date. Otherwise, when they distribute their bonuses, they may find the payments falling victim to a similarly highly undesirable outcome—becoming subject to Internal Revenue Code Section 409A. It is true that 409A, the now infamous rule that so strictly regulates the time and form of payment of nonqualified deferred compensation, includes a helpful exemption for “short-term deferrals.” However, to qualify for this “get out of 409A free” card, a payment must be made on or prior to the 15th day of the third month (i.e., March 15 for calendar fiscal years) following the end of the employees’ (or, if later, the employer’s) taxable year in which the bonus amount is no longer subject to a “substantial risk of forfeiture” (SROF).

Payment of the bonus is considered subject to a SROF if the employees only earn the right to payment once they have completed a specified number of years of service and/or met certain performance goals. Once such conditions are met, employees are considered to be “vested” in the benefit (i.e., entitled to the payment when it is made regardless of their employment status on the payment date). Employers sometimes add an extra condition by attaching a noncompete restriction under which employees forfeit the bonus if they terminate employment and enter employment with one of the employer’s competitors prior to the payment date. However, the inclusion of such a restriction is not recognized by the 409A rules as sufficient to create a SROF.

The following two examples illustrate how these rules are applied to employers with calendar fiscal years. Under the first scenario, the employer awards annual bonuses based on both the employer’s financials and the employees’ individual performances. Payment of the bonus is scheduled to be made in the first quarter of 2015 as soon as administratively practicable following the determination of the amounts. Participants must actually be employed with the employer on the payment date to receive the bonus. Because of this “active employment on payment date” requirement, the employees never become vested in the benefit until the actual payment date. Therefore, employers with this design need not be concerned about missing the March 15 payment deadline.

In contrast, assume the same facts as the previous example except that in order to receive the bonus payment made in 2015, the employees must be employed on December 31, 2014, and must not violate a noncompete agreement prior to the payment being made. Because 409A does not recognize the noncompete condition, the vesting occurs in 2014. Consequently, in order to avoid 409A coverage, the bonus must be paid by no later than March 15, 2015, unless one of 409A’s limited late payment exceptions applies: (1) an unforeseen administrative delay, (2) the need to retain such funds because their disbursement would jeopardize the employer’s ability to continue as a going concern, or (3) the employer reasonably anticipating that its deduction of the bonus will be subject to the $1 million Internal Revenue Service (IRS) deduction limit (and the employer did not reasonably anticipate the application of Section 162[m] when the bonus award was originally made). Each of these three exemptions will only be considered valid if the employer promptly makes the delayed bonus payment as soon as the applicable cause for the delay no longer exists.

What happens in the case of a bonus plan where the amounts were vested in 2014, the March 15 payment deadline is missed, and none of the three exemptions are available? Does 409A coverage automatically spell doom in the form of noncompliance and the corresponding penalties? The good news is that it’s possible to structure bonus plans so that they comply with the 409A rules. So for any employer that currently has a bonus program that needs to meet the March 15 deadline (i.e., those programs that vest employees in the prior year), it’s crucial to examine their current bonus determinations and delivery processes. Does the employer have any intrinsic procedures (i.e., thereby eliminating the “unforeseen” exemption) that could cause the program to pay bonuses later than March 15 more than just on a one-time accidental basis? If the answer is “yes,” the employer should consult with its employee benefits specialist to review such bonus programs to make sure it is covered by a compliant 409A document so that even if the payment date is missed and the “short-term deferral exemption” blown, the bonus payment does not violate 409A, thereby risking the costly consequences of such noncompliance. One does not need to be a seer to know that to do otherwise would tempt the fates of the Ides of March, which history has shown never to be sound policy whether for emperors or employers.

Putting a stop to retirement plan leakage

March 3rd, 2015 No comments

Moen-AlexThe Center for Retirement Research at Boston College recently published a study that found in-service withdrawals (partial withdrawals and hardships) and cash-outs were the main reasons for leakage from 401(k) plans and IRAs. Leakage refers to the erosion of assets in retirement accounts—approximately 1.5% of retirement plan assets “leak” out every year. This can potentially lead to a reduction in total retirement assets of 20% to 25% over an employee’s working years. The phenomenon is the result of the gradual change in retirement funding vehicles over time from predominantly defined benefit plans to defined contribution plans and, in recent years, IRAs.

The impact of this 1.5% leakage is easier to grasp when the total dollar amount involved is known. The Investment Company Institute’s quarterly reports show the following numbers. Consider the total assets affected and the significance of that annual number.

U.S. assets in retirement plans

401(k) plans have three main sources of leakage:

In-service withdrawals: In-service encompasses one of two options: a hardship withdrawal or a withdrawal at age 59½. Hardships can be taken based on proof of an immediate financial need, but they are subject to an early 10% tax penalty (if applicable) on top of the required 20% federal tax and they force a participant to cease deferrals for six months. Hardships also require participants to use up their loan resources first. By the time a participant is eligible for a hardship, the account has been severely depleted. In-service withdrawals allow an active employee who has reached the age of 59½ to remove funds from the account without the 10% penalty. These age 59½ withdrawals are on the rise and the leakage arises when the funds are not rolled over. It is estimated that only about 70% are, in fact, rolled into an IRA.

Loans: Approximately 90% of actively working individuals enrolled in a retirement plan have access to some type of loan. While loans get a bad rap, they are not the leading offender in terms of leakage, but there is still some asset loss. If loans are repaid in a timely manner, the withdrawal is not taxed, but the employee no longer has the ability for gains on those assets during the repayment period. And while the participant has an obligation to repay, that does not always happen. When the loan has defaulted, it is deemed a distribution and is then subject to tax withholding.

Cash-outs: Cash-outs are the act of automatically paying out terminated participants below a certain threshold; for balances of $1,000 or less, checks are cut, whereas balances between $1,000 and $5,000 require a rollover to an IRA. And while plan sponsors do have a say in the dollar threshold and the timetable for cash-outs, virtually every 401(k) plan has this rule.

Looking at defined contribution plans only, withdrawal activity has increased slightly over the last three years, while hardships have remained steady. These numbers may seem small, but they do not include IRAs, which are considerably harder to track. And because IRAs lack the same rules as defined contribution plans, estimates suggest the percentages are much higher.

Source: Investment Company Institute

Source: Investment Company Institute

The Federal Reserve’s 2013 Survey of Consumer Finance presented some scary results—workers between the ages of 55 and 64 had average assets of only $111,000. What’s more, assets in IRAs have surpassed assets in defined contribution plans. Looking at the numbers above for third quarter 2013 and 2014, IRAs consistently have 2.5% more in assets than defined contribution plans. IRAs can be risky for long-term retirement funding, if not used correctly, which is due to the lower levels of regulations and the lack of education and promotion to “keep assets in.” A recent Department of Labor report expands on this concern that rolling funds to IRAs puts the worker at the mercy of the investment advisor and asks whether all investment advisors take their fiduciary duties seriously or not. The report discusses what they call “conflicting advice” and estimates the leakage due to this is as high as 12% of an account balance.

There is hope. Some proposals that have been suggested include:

• Raise the age requirement for early withdrawal from 59½ to 62 to match the earliest Social Security retirement age
• Limit balances for in-service withdrawals to only employee contributions
• Tighten hardship rules even more and only allow hardships in case of “unpredictable events,” for both 401(k) plans and IRAs
• Remove cash-outs altogether (this will mostly likely be met with resistance from plan sponsors because small balances can be expensive and burdensome to administer)

Plan sponsors can make many of these adjustments to their individual plans, but these proposals are working to ensure that the goal of preparing workers for retirement stays in sight.

New Year’s resolutions for retirement plan sponsors

January 8th, 2015 No comments

For many, a new year usually means a fresh start. With that thought in mind, Milliman’s Jinnie Olson provides 401(k) plan sponsors 10 ideas that can help them administer their plans more effectively in 2015. Below are her 10 ideas.

1. Create administrative procedures and internal controls—and follow them.
2. Make sure changes to your operating procedures are well documented.
3. Audit your data.
4. Transmit contributions in a timely manner.
5. Establish a retirement committee.
6. Understand plan fees.
7. Audit your service providers.
8. Conduct an annual plan review.
9. Establish success measures.
10. Establish a strategy for the upcoming year.

Read Jinnie’s article “Top 10 New Year’s resolutions for plan sponsors of retirement plans” for more perspective.

ERISA fee litigation: Is my plan at risk?

December 23rd, 2014 No comments

Skow-KevinSome plan sponsors may have wondered, upon reading about the recent $140 million settlement in the Haddock v. Nationwide case and the $1.3 billion settlement in the Lockheed Martin case, if their plans could be susceptible to an ERISA case over excessive fees. Here are a few things to consider in light of these recent settlement announcements:

Vendor transparency. Understanding fees should not be difficult—as long as you have a vendor or advisor that is transparent in the total revenue it expects to receive and as long as you know the expense of the investment products you have available for participants to invest in.

Service provider expenses. Think of anyone who may do work for you—an attorney, a contractor, a cleaning person. They bill you at an hourly rate. That comes to an annual amount. The same idea should be true within your retirement plan: You want to know who is working for you and what you are paying them, and you especially want to know whether it is a flat annual fee, a per-head fee, or a percentage of your plan’s assets. After all, you wouldn’t agree to hire attorneys and then give them access to your bank account to pay what they saw fit. And sometimes, with a better view of total revenue, it becomes evident that a “cheaper” provider may not mean a better provider when you are then able to evaluate the services and level of service you are receiving.

Investment expenses. Investment expenses must be included in your understanding of plan fees. Your investment products within the plan have fees that are required to be disclosed. For example: Fund A charges 76 bps and shares back 25 bps (or 0.76% with a 0.25% paid back to the plan). Do the math and apply their fee to the assets you have in their product—this is their projected revenue for the year—less any revenue sharing if they pay this.

Example Investment Expense Calculation:

Sample Investment Expense - Skow blog

Note, this fee is not deducted from your account balance—it is taken out of what would otherwise be your return. And if you lose money, you still pay this on top of it and so do all of your participants.

Revenue sharing. Revenue sharing should be easy to understand. It should be disclosed to you and should be going back to your plan in the form of an ERISA budget and used for the benefit of plan participants. We help our clients understand this by calculating the expenses for them and forecasting the fees and shared revenue, which may move the client to consider another share class that does not pay revenue sharing (or keeping a class that does because the net effect of the shared amount is financially advantageous). If revenue sharing exists, as it does in most plans to some extent, the discussion should then be about what to do with it. Should you allocate back to those participants in the plan that generated the revenue in the first place—or use it to pay hard-dollar expenses that are allowed under the plan? See my colleague’s recent series of articles with his insight on this issue.

Year-end balances. A note to the wise: Having expensive funds that generate large sums of revenue sharing to pay for these expenses in a given plan year—but that leave a balance carryover to the next plan year—is an issue that will come up in an audit (if it hasn’t already).

Total cost. After understanding the fees, plan sponsors should address how costs may be affected by participation, plan design, usage, or fund allocation.

Answers. Perhaps most importantly, if someone were to call you and ask what exactly he is paying for when participating in this plan, you would have an answer that could help him make an important decision when it becomes time to retire.

For example: In the chart above, this $30 million plan has a weighted expense ratio of 54 bps. Let’s assume the total administration expense (all service providers: recordkeeper, trust company, advisor, auditor) is $80,000 (or ~27 bps) and those fees are paid for on a pro rata basis by all plan participants.

This plan’s total annual expense would be estimated as follows:

Investment expense: .54%
+ Vendor expenses: .27%
(-) Revenue sharing: (.22%)
_____________________
Total: .59%

The size of the recent settlements lends perspective on how big of an issue fees can become for a plan sponsor. Sponsors that attend to the principles outlined in this blog—and work with their vendors to build transparency around these issues—can avoid becoming a statistic.