Archive for the ‘Defined contribution’ Category

Retirement plans and fees: Get some satisfaction

March 19th, 2014 No comments

Guanella-Jay-EThe balance between value and expense is often a large part of our daily considerations. As a consumer, when we look at the cost of a jar of peanut butter, we consider the quality of the product and the opportunity for satisfaction. The same rationale is true with retirement plans, though satisfaction as it relates to value in a retirement plan product is more difficult to define. At a base level, it could be as simple as answering the question, “Are the participants in the plan satisfied with their projected retirements?” At termination of employment, why does a participant feel the need to move their assets out of the retirement plan that they had previously relied on for several years?

With the new fee disclosure requirements, most plan sponsors are well aware of the costs involved to maintain their plans, including administration and trust/custody fees. These expenses are clearly defined in communications to the plan sponsor and participants. Also included is a listing of fund returns along with operating expense ratios (OERs) for the investments. The OER is the expense charged by the investment to the participant and can vary significantly, not only from fund family to fund family but by similar investments as well.

Savvy investors understand the important role of OER and how different share classes of the same investment can yield different results. Participants in a retirement plan are more likely to experience lower expense ratios than if they invest by themselves in an individual retirement account (IRA). To illustrate the expense, if a plan participant invests $10,000 in a fund with an expense ratio of 0.46%, the cost per year is $46. That same investment at a retail IRA level could have an expense ratio as high as 0.85% or $85 per year. That extra 0.39% in expense directly reduces the return on investment (or satisfaction) for participants. Which raises the question, why are participants so eager to leave the employer’s retirement plan for an IRA?

Perhaps having one investment advisor watch over your all of your retirement funds can be comforting to participants. The number of investment options increase when moving from a retirement plan to a retail product. And the termination of employment can lead to a feeling of separation with the company and retirement plan.

Providing participants detailed information on their post-employment options can help them make informed decisions to maintain retirement satisfaction. It is important for participants to know they may not be required to move their money out of their retirement plans. They may want to consider the expense and features of the plan compared to other investment vehicles and decide where they see the most value for their retirement dollars to maintain that level of satisfaction.

Rewriting retirement readiness: Will the USA Retirement Funds Act amend your plan?

February 21st, 2014 No comments

Copeland-MiraDuring the State of the Union address on January 28, President Obama announced his directive to create “My Retirement Account” (MyRA), a personal savings vehicle. On January 29, Senators Susan Collins and Bill Nelson introduced the Retirement Security Act of 2014, which includes moderate changes to the existing legislative framework for employer-sponsored plans to entice more small employers to sponsor plans. On January 30, Senator Tom Harkin, chair of the Senate Health, Education, Labor, and Pensions Committee, unveiled the Universal, Secure, and Adaptable (USA) Retirement Funds Act. This act would provide for the creation of a kind of “super” multiple-employer plan and would ensure that almost every worker is covered by a retirement plan with both automatic enrollment and annuitized distribution features.

MyRA provides for a supplement to the current retirement system; the Retirement Security Act would modify it; the USA Retirement Funds Act would profoundly alter it. How?

The USA Retirement Funds Act would have a significant impact because all employers with 10 or more employees would be required to offer a retirement plan with automatic enrollment and a lifetime income option. If Milliman’s recordkeeping clients can be used as a representative sample, a quick look would tell us that only 2% of plans currently offer both features, which indicates the substantial majority of plans would be required to be amended if this core provision is enacted.

It’s possible that some employers would choose to terminate their current plans and participate in a USA Retirement Fund rather than amend their current plans. Though automatic enrollment has been gaining popularity since the Pension Protection Act (PPA) codified it in 2006, with approximately 40% of plans now offering it, plans that have not yet adopted automatic enrollment tend to have good reasons for not doing so—participant populations with especially high turnover, for example. Annuitized payment options, however, have been declining. According to one recent survey, only 6% of plans offer a lifetime income distribution option. Of this group, 82% report that less than 5% of participants elect it.

The USA Retirement Funds Act could indeed dramatically alter retirement preparedness statistics: requiring a retirement plan for companies with 10 or more employees would allow access to a workplace retirement plan for many American workers who currently don’t have one; automatic enrollment for all plans would increase the number of people saving for retirement; and requiring annuitized distribution options would reduce the risk of people outliving their savings.

Senator Harkin has designed some intriguing new tires to get Americans moving toward retirement readiness … but will the rubber hit the road? If it does, plan sponsors would be advised to make sure their ERISA attorney is along for the ride.

MyRA versus USA Retirement Funds

February 13th, 2014 No comments

Bleick-TimDuring the State of the Union address, President Obama said, “Let’s do more to help Americans save for retirement. Today, most workers don’t have a pension. A Social Security check often isn’t enough on its own.” He then announced plans to create a new government-backed savings account called MyRA, and he asked Congress to offer every American access to an automatic IRA on the job.

Two days later, Senator Tom Harkin, chairman of the Senate Health, Education, Labor, and Pensions Committee, introduced new legislation: the Universal, Secure, and Adaptable (USA) Retirement Funds Act of 2014. Senator Harkin says the legislation would create a new type of privately run retirement plan that combines the advantages of traditional pensions and 401(k)s.

Numerous studies have shown that Americans are not saving nearly enough for retirement—it’s not even close. So anything that helps in this regard is a good thing. Let’s compare the two proposals.

MyRA is strictly an account balance. An individual contributes after tax dollars to the fund, and the distributions are tax-free at retirement. This is the same concept as a Roth IRA. The fund is backed by U.S. Treasury securities, and the principal is guaranteed not to lose value. When the balance grows to $15,000, the individual must roll the account over to a private Roth IRA. One big stumbling block to MyRA, though, is that employers are not required to set up the mechanism to allow their employees to contribute to the account via payroll deduction. The president does intend to include this provision in his budget for employers who do not offer an employer-sponsored savings plan—a process that would require Congressional approval.

USA Retirement Funds also starts out as an account balance. During working years, it operates just like a 401(k). The principal is not guaranteed, but the funds are pooled and professionally managed. The plan shifts to a traditional pension at retirement, when the fund is converted to a lifetime income distribution with spousal death protection. Employers with more than 10 employees who do not offer a plan with automatic enrollment and a lifetime income option would be required to select a USA Retirement Fund and automatically enroll all employees at a contribution rate of 6% of pay. Employees can opt to increase, decrease, or stop contributions anytime. Employers are allowed to make additional contributions on behalf of their employees. Because it’s an account balance during working years, the plan is completely portable upon a job change.

Could these proposals make a dent in the retirement savings gap of many Americans and increase their confidence level about a secure retirement? MyRA is essentially a new way to set up a Roth IRA, which is currently underutilized. But without requiring employers to automatically enroll their employees, can it make a significant impact? The automatic enrollment feature of USA Retirement Funds can be a powerful mechanism, and some people may like the built-in lifetime income aspect. In addition, USA Retirement Funds could be appealing to small employers who would like to provide a retirement plan but have been reluctant because of the plan administration hurdles.

It’s time to move our retirement savings crisis to the forefront. Maybe MyRA or USA Retirement Funds can get it kick-started.

Guidance issued on in-plan Roth rollovers to designated Roth accounts

January 13th, 2014 No comments

The Internal Revenue Service (IRS) has issued Notice 2013-74, providing guidance on the expanded types of amounts eligible for in-plan Roth rollovers within 401(k), 403(b), or 457(b) governmental retirement plans. These amounts, which became eligible for in-plan Roth rollover treatment in 2013 under the 2012 American Taxpayer Relief Act, include sums that are otherwise not distributable to participants under the terms of the plan, such as elective deferrals, matching contributions and nonelective contributions, and annual deferrals made to 457(b) governmental plans.

The IRS’s new guidance also includes deadlines for adopting plan amendments to provide for these in-plan Roth rollovers of such otherwise nondistributable amounts, as well as rules applicable to all in-plan Roth rollovers.

For more perspective on this new guidance, read this Client Action Bulletin.

Revenue sharing creates disparities in retirement plan fee allocations

December 9th, 2013 No comments

In his paper “Fees: What no one is talking about, round 2,” Milliman’s Doug Conkel revisits the question of “what is fair?” concerning retirement plan fees paid by participants. The paper focuses on the inequalities that revenue sharing produces in retirement plan fees paid at the participant level. Here is an excerpt:

At this point, I think it is blatantly clear that revenue sharing creates disparity in fees paid across participants. But how much disparity truly exists? From time to time, I hear sponsors comment that most of their funds have revenue sharing and the rates are pretty similar, so each participant should be paying a similar fee. To test this assumption, I pulled participant data across five industry segments and calculated the participant-level revenue sharing by multiplying each participant’s fund balance by the revenue sharing percentage for that fund. I then summed the total revenue sharing generated across all funds for that participant and divided the total revenue sharing amount by the total account balance for an individual revenue sharing percentage. Figure 2 illustrates the graphical and tabular results of my findings.


Conkel’s first article, “Fees: What everyone is NOT talking about!,” offers solutions for keeping fees at the participant and fund levels fair.

Judging tax implications of Roth 401(k) contributions

October 29th, 2013 No comments

Guanella-Jay-EContributing to a retirement plan is widely considered a no-brainer if the goal is to attain a meaningful retirement. But the decision on how to invest contributions within the plan can be daunting. Determining what type of contributions to make further complicates things. While tax-deferred contributions reduce taxable income in the year in which they are made, the taxes owed on those contributions as well as the investment earnings are deferred until a later time, possibly at retirement. Roth contributions don’t reduce current taxable income, but the tradeoff is no tax liability on the investment earnings when a distribution is taken (provided the individual is at least age 59½ and has held the account for at least five years).

The decision to contribute to a Roth 401(k) instead of deferring at a tax-deferred level is often based on an anticipation of changes to future tax rates. While this is a personal decision based on future income, several other factors should also be considered. The truth behind the decision is similar to other choices in life, more complicated than we’d like it. For example, the reduction in tax-deferred income can affect tax liability, possibly increasing refunds. If tax-deferred contributions increase a tax refund, how can the “newly found” money be taken advantage of? Depending on a person’s filing status, different advantages or disadvantages may exist.

None of us are fortune-tellers. It’s difficult to predict future income or tax brackets over a period of several years. It becomes even more complex when trying to anticipate things that are out of anyone’s control, such as politicians altering tax rates to address policy changes and deficits. Recent history underscores this fact with significant changes occurring at the top rate, ranging from 50% in 1982 to 38.5% in 1987, 28% in 1988, 31% in 1991, 39.6% in 1993, 35% in 2003, and settling at back at 39.6% starting in 2013 (with rates exceeding 90% at certain points in the last century). Accordingly, depending on when money is taken out of a retirement plan, the tax results can dramatically change over a period of years.

A diversified investment strategy has long been considered a way to optimize investment returns over time while reducing risk. A diversified tax strategy may be equally important. By utilizing tax-deferred and Roth savings options, tax liabilities may be mitigated, ultimately creating more flexibility to reduce individual tax burdens.

Crafting a well-considered loan policy

September 24th, 2013 No comments

Anderson-ChaseOver the past few months, several articles have weighed in on participant loans from defined contribution (DC) plans, nearly all with the same refrain: loans are bad. Some go a bit further: loans must be stopped. One piece, for example, opined that 401(k) loans “should not be allowed in any retirement plan other than for hardship reasons,” calling plan loans “the worst investment anyone could possibly make.”

Ultimately, for plan sponsors looking to help participants adequately prepare for retirement, one primary task is to craft plans that work best for each one’s workforce. Revisiting loan policies in pursuit of those goals—but with sufficient flexibility to encourage maximum participation in the first place—is a good way to start.

The IRS restricts loan amounts to no more than 50% of account balances (generally); repayment to up to five years (except for purchase of a primary residence); and the total borrowed over the past 12 months to a maximum of $50,000 (always). It also allows use of the funds for any purpose.

In addition to those required limits, a sponsor may craft a better-tailored loan policy for its workforce by considering:

• How much (and how often) its participants are borrowing
• Participants’ reasons for loans (if known, officially or anecdotally)
• Deferral rates and account balances
• Relative financial sophistication of plan participants
• Participant input and any other relevant factors

Here are some loan policy terms a sponsor may wish to consider:

Lower limits: Cap loan amounts to less than 50% of vested account balances. A cap of 20% of the vested balance, for example, will help ensure that a participant keeps at least $4,000 invested for retirement for every $1,000 borrowed. (The “help ensure” bit refers to the fact that participants often will qualify for hardship or other withdrawals after taking loans. On that note, plans should consider steps to cut down on hardship withdrawals; a well-crafted loan policy may be just the ticket.)

Faster repayment terms: Limit loan repayment to one year, for example, rather than five years, with a primary residence exception. Requiring faster repayment may also help reduce the instances and severity of loan defaults, under which the outstanding balance is treated as a taxable distribution.

Minimum payments: Require that scheduled loan payments not fall below a specified percentage of compensation—1%, for example.

Waiting periods: Require that any participant who pays off a loan (whether on schedule or with a full payoff) wait a certain specified time—say, 90 days or even a full year—before taking a new loan, to help minimize “revolving-door” loans.

Allow more than one loan out at a time: Although counterintuitive to retirement saving, it may reduce a participant’s urge to take more than his or her immediate need. To minimize the negative impact on retirement savings, this option may be best incorporated with other limits above.

Another approach might allow a participant more than one loan at a time, but restrict the additional loans to loans satisfying special financial-hardship criteria—either as defined by the IRS safe-harbor eligibility for hardship-based withdrawals, or as differently defined by the plan’s document or loan policy.

By taking steps to tailor the plan’s loan policy rather than doing away with loans altogether, a sponsor can strike a good balance between encouraging retirement savings and allowing participants some financial flexibility when they need it.

Tips for promoting a defined contribution plan to employees

September 19th, 2013 No comments

Employers who actively promote and communicate their retirement plans can demonstrate its importance to employees. In Jinnie Regli’s new article, she provides 10 ideas that plan sponsors may use to help employees get the most from their defined contribution (DC) plans. Here is an excerpt:

Get your employees in the plan.
Allow employees to enter the plan on day one. New employees are excited about the new opportunity so get them enrolled from the very start. Hook them in while it’s fresh on their minds so they will be used to seeing the deduction in pay right from their first check. Delayed entry dates tend to lead to employee inertia.

Consider adding an automatic contribution arrangement.
The most effective way for plan sponsors to encourage participation in their retirement plans is through plan design. An automatic contribution arrangement (ACA), more commonly known as automatic enrollment, is a feature that can be added to existing 401(k), 403(b), 457, SIMPLE IRAs, and SARSEP plans. This arrangement allows the employer to automatically enroll a newly eligible participant unless the participant makes an affirmative election not to participate.

When the arrangement is adopted, the plan sponsor selects a default contribution percentage, which is automatically reduced from employee’s wages upon meeting the eligibility and entry requirements of the plan. Participants may “opt out” of this automatic contribution. Studies show most employees will leave their contribution rate at the plan default or even increase their elections. There are alternative methods of automatic contribution arrangements; refer to your plan consultant for more information.

Offer an employer-matching contribution.
Would you walk past a $100 bill on the sidewalk? Would you turn down a work bonus? Most would answer no to these questions. Retirement in this day and age is largely going to be self-funded; offering an employer-matching contribution is like offering your employees a bonus. If your employees take saving for their retirement seriously and contribute, you’ll add free money to their accounts. As an employee it’s next to impossible to turn that down. A recent Wells Fargo survey indicated that 85% of those with a 401(k) offering a company match contributed enough to receive the maximum match. Matching is an effective way to work hand in hand with employees to fund their retirement. If high turnover/low employee retention has deterred you from implementing a match in the past, why not implement a vesting schedule?

A long hot summer for 401(k) loans

September 16th, 2013 No comments

Anderson-ChaseAs the weather heated up this summer, so too did the discussion on participant loans from defined contribution (DC) plans. At least a handful of financial news sites have published pieces critical of participant loans.

With information often comes misinformation and, accordingly, some clearing up is in order. Here are a few recently heard statements—in both pro-loan and anti-loan flavors, culled from participants and analysts alike—and the facts behind them.

“Since I’m borrowing from myself and paying interest to myself, taking a plan loan is actually good for my 401(k).”

Generally false. It is definitely true that, in and of itself, paying interest to yourself is better than paying it to another entity, such as a bank. Fees associated with plan loans also are often lower than those at commercial lending institutions (although those fees vary widely).

Other than the loan fee, the loan cost is the loss of the earnings of those funds if they had remained invested in the plan during the time of repayment. If by chance the market declines while the loan balance is out of the plan, the participant would have been fortunate to have taken a loan at that time. However, the reason participants choose to invest in the first place is that, on average, earnings are positive. Chances are, therefore, that the account will miss out on additional earnings during the time those funds are out as a loan rather than invested.

“Aren’t my loan payments double-taxed? The payments are taxed—and then I get taxed again when I cash out the account.”

Mostly false. This persistent (and sensible sounding) myth asserts that the participant makes loan payments with after-tax money, and the funds are taxed again upon eventual distribution. That assertion overlooks the fact that the loan funds were not taxed when disbursed. The net effect, therefore, is that “it all evens out”: with single taxation each on the funds received via loan disbursement, and on the tax-deferred contributions upon distribution of them. The interest payments, however, are double-taxed—unless distributed tax-free from a Roth account—because, unlike the loan proceeds, the participant never received the interest portion tax-free.

“You should take any other credit available to you before taking a 401(k) loan.”

Probably false, because there are a lot worse ways participants can borrow. When plan loans are offered, they must be at commercially reasonable rates of interest, and they must be the same for all plan participants. For participants without many options, therefore, plan loans might be the only accessible route to decent credit. Payday loans, credit cards, and high-interest personal loans, for example, all may be far more dangerous to long-term financial security than plan loans.

“Plans should get rid of loans, since they prevent participants from amassing retirement savings.”

Not necessarily. Plan sponsors should consider more than whether, all else being equal, participants will have less in their retirement accounts if they take a couple plan loans over the course of employment. While the answer to that is almost certainly yes, in reality all else is rarely equal. Participants may turn to withdrawals if loans are not available. Many may be more reluctant to participate at all—or may make very conservative estimates on how much they can afford to save—if they know the funds are firmly off-limits until termination or attainment of a certain age. The fear of saving in the first place may impact retirement readiness just as easily as tapping into what’s already there.

Sponsors (in collaboration with their consultants or service providers) should consider turning first to participant education and certain loan conditions that may make sense for their participant groups, before making hasty decisions to end or curtail their loan programs.

Don’t assume you are average!

September 11th, 2013 No comments

Haynes,-Roscoe_mugShotThe U.S. Department of Labor is considering issuing rules requiring plan sponsors to illustrate retirement income projections for participants in 401(k) plans. Many plan sponsors are beginning to provide retirement income projections, and financial planning websites with projections are cropping up. While the goal is admirable, some of these projections may provide a false sense of security.

Defined contribution (DC) plans place a significant level of personal responsibility on individual participants. These plans expose participants to significant risk in regard to a number of issues. One of these risks is longevity. Although the average life expectancy at retirement is approximately age 85, a significant percentage of current employees can be expected to survive until age 90, 95, or even 100. Should they determine after retirement that their survival past age 85 is likely or certain, most of these individuals will not be able physically or mentally to return to the workforce.

When discussing retirement readiness, it is not unusual to hear that a life expectancy of age 85 is assumed, because this is approximately the “average” life expectancy. This is a serious flaw. This approach leads to a false sense of security among participants who perceive that they are expected to have income until age 85 at a level they deem to be sufficient. To the contrary, they actually have a probability of approximately 50% that they will find themselves alive but without sufficient income after age 85. As they approach age 85, they and their families are likely to experience anxiety and concern over their deteriorating financial position. The goal of ERISA is to provide retirement income security; this approach leads to retirement income insecurity.

For married people the risk of underestimating the likelihood of surviving past age 85 is even greater. The probability of at least one partner in a marriage living many years past age 85 is very high. Ascribing adequacy to an income stream ending at age 85 for a married couple will be a serious impediment to the goal of providing for their retirement income security.

More and more people are living to very old ages, many to 100 and beyond. But not everyone will live that long; anyone who reads the obituaries will note that many survive only a few years after retirement. There is no easy answer to the question of “how much do I need to retire?” However, those who retire with enough to survive for an average life expectancy will face an above-average level of anxiety. Setting a 401(k) goal of having enough to last at least until an age in the late 90s will go a long way toward encouraging realistic retirement income expectations.