Monthly Archives: August 2011

A basic guide to nondiscrimination testing (part 1)


Forbes,-David_mugShotEmployers who sponsor qualified defined benefit (DB) and defined contribution (DC) plans are responsible for making sure that their plans remain in compliance with IRS requirements, as failure to do so can result in excessive costs, penalties, or even plan disqualification. These requirements include the nondiscrimination rules, which are complex and can cause problems for plan sponsors that are unfamiliar with the details.  Part 1 of this series outlines the framework for the testing.  Parts 2 and 3 will explain the basic requirements of the testing and describe common pitfalls to be avoided. UPDATE: Part 2 is available here and Part 3 is available here.

Part 1

What is nondiscrimination testing?

Certain benefit plans may be deemed qualified by the IRS and therefore eligible for favorable tax treatment, as long as they do not provide excessive benefits to upper management at the expense of the lower-paid employees. The nondiscrimination rules were established to give plan sponsors a framework for demonstrating that their plans do not provide benefits that discriminate in favor of the highly compensated employees (HCEs).

HCEs are generally those employees with total compensation in excess of a specified limit. For example, if an employee earns more than $110,000 in 2011, the employee would be considered to be an HCE in 2012. (There is an alternative “top 20%” definition that applies for some plans.) Employees who own more than 5% of the organization are also considered to be HCEs. The remainder of the employees would be non-highly compensated employees (NHCEs).

Continue reading

Retirement Town Hall rewind

Even before the recent earthquakes in Colorado and Virginia, the past couple of weeks would have fallen into the category of “strange days.” We’ll take a look back at Retirement Town Hall’s coverage of the ups and downs in this rewind of a rather odd stretch of time called August 2011.

Question and answer time

The beginning of the August was marked by the fallout from the debt ceiling crisis. Jeff Marzinsky noted that The United States has been “downgraded”: What can investors do now? Shortly thereafter, Charles Clark posed a simple question to our readers: How did you respond to recent volatility? The results may surprise you. Similarly, earlier this week Clark posted another poll looking at how 401(k) contributions may be affected by a second recession in Double dipping into your savings.

Have pension, will travel

In a two-part series, Bart Pushaw looked at defined benefit (DB) plans and The question of portability (part 1) and (part 2). Looking at the question from the employee perspective (in part 1) and the employer perspective (in part 2), Pushaw dispels myths about defined contribution (DC) 401(k) plan portability and the portability of pensions.

Dog days of summer

This August may not be as hot and humid as other recent years but people who keep an eye on corporate pension funding may be sweating it out nonetheless. Early in the month John Ehrhardt posted his monthly Pension Funding Index. To be blunt, it wasn’t pretty: Corporate pensions experienced the largest funded status decline of the year. As we noted in Inside August’s $97 billion erosion, Bloomberg offered some explanations for why things got so far off track.

On the topic of reports from pensions, we also covered some new and upcoming rules that plan sponsors should know about. First, the Employee Benefit Research Group explained the latest in Reporting of hospital pension costs under Medicare rules. Then Tim Connor brought us up to speed on Multiemployer pension disclosures and the coming compliance changes.

For more timely, useful information on retirement issues be sure to check back in to Retirement Town Hall regularly or follow us on Twitter.

Double dipping into your savings?

The stock market’s volatility may be the precursor to a “double-dip” recession.  In the previous official recession, many employers sponsoring savings plans chose to eliminate all employer contributions. There is evidence to confirm that many (but not all) employers restored the matches or other contributions that did not rely on the employee’s contributions.

Some speculate that a suspension of employer contributions, voluntary or otherwise, could occur again because the economy is struggling with anemic growth.

The question of portability (part 2)

I recently wrote, in The question of portability (part 1), about how portable defined contribution (DC) retirement plans, such as the 401(k), aren’t always the best option for employees. Now let’s look at how the urge to create a portable benefit by converting to a 401(k) may not necessarily always be working in the best interests of employers.

The chicken or the portable nest egg

Since the idea of portability entered the retirement plan arena, academics have looked closely at the question of employee mobility. One study stated the question very directly: Which came first—mobile employees or plans that encouraged employee mobility? Did the plans altruistically provide a solution to a changing demographic, or did the mobility solution actually open a door to problematic mobile employees?

The research indicated that employee mobility picked up only after 401(k) plans became widespread. Aside from the business reasons for retaining good employees, the portable 401(k) also raises questions about unintended consequences for the plan itself.

Spreading the wealth

More monies tend to be accumulated by the young and recently hired employees in 401(k) plans than in pension plans. This is balanced out in later careers as long-service employees eventually tend to receive more annually from pension plans compared to 401(k) plans.

The irony for some employers is that even if a career-average structure is adopted for portability’s sake, the benefit often could have been delivered much less expensively in a defined benefit (DB) pension plan than via a DC plan. Even if benefit levels established under the benefit policy are kept constant in order to maintain competitive and adequate income levels, a DB plan could cost the company less and increase shareholder returns.

There’s no doubt that the 401(k) plan has a place in tomorrow’s retirement landscape, as long as people understand the real intrinsic differences of DC and DB plans. It’s fair to say that portability is not actually one of those differences. Plan sponsors are in a position to reverse this misconception, and should not be swayed from pursuing an effective DB strategy only in the name of portability.

Multiemployer pension disclosures

We blogged in June about how the Financial Accounting Standards Board (FASB) is wrestling with questions over what information investors would benefit most from when it comes to an employer’s participation in a multiemployer defined benefit (DB) plan. Following the most recent round of board meetings, the FASB has directed its staff to draft a final accounting standard to be issued by September.

While final details remain to be seen, the expected disclosure requirements for each plan deemed “individually material” for an employer will include:

  • Basic plan information: name and employer ID number (EIN) of plan
  • Most recent zone status as required by the Pension Protection Act (PPA)
  • Whether or not a PPA rehabilitation plan or funding improvement plan applies
    Contributions made to the plan for each annual period that an income statement is presented
  • Whether a PPA surcharge applies
  • A range of collective bargaining agreement (CBA) expiration dates with significant CBAs noted
  • Whether or not the employer’s contribution represents more than 5% of all contributions to the plan
  • Any minimum funding arrangements with the plan

If zone status were unavailable, an employer would need to disclose whether or not the plan is:

  • Less than 65% funded
  • Between 65% and 80% funded
  • Greater than 80% funded

As noted above, these disclosures will be required for each plan deemed to be individually material to the employer’s overall financial statement. For all plans that don’t meet that distinction, disclosure requirements entail a summation of contributions to all plans in the aggregate. Additionally, an employer will be expected to disclose a general narrative describing each affected plan and a description of the nature and effect of any changes that could affect comparability of income statements for each period presented. This could include changes in contribution rates or covered populations.

The final standard is expected to require compliance for public entities for annual periods ending after December 15, 2011, with nonpublic entity compliance deferred one year later. With much of the information for 2011 likely already available, public companies should begin efforts to collect the necessary information now.

The question of portability (part 1)

In the late 1980s defined benefit (DB) pension plans were firmly entrenched as the foundation for an employee’s retirement security planning. But 401(k) plans had just been awarded long-overdue IRS regulations and were gaining in popularity as a differentiator for companies in their quest for talent.

Among the key selling points for employers reviewing 401(k) plans was that employees were more likely to change jobs than they had been previously and because of this they were served well by benefit portability. It was a feature most pension plans were not positioned to provide as well.

You can take it with you

The portable 401(k) plan looked, to some, to be the best solution. Yet, in some cases, it may be a mistake to assume that portability in and of itself is necessarily the best option for employees or employers.

Continue reading

How did you respond to recent volatility?

When the financial markets closed on Aug 15th, the stock market had recouped all of its losses from the previous horrific week of volcanic volatility.  Three-year and five-year Dow Jones and S&P500 returns were either flat or negative.

The Investment Company Institute reported that over $50 billion moved into money market funds in the week ended August 10, but the cumulative change in the prior three weeks was a $130 billion outflow from money market funds.

The Wall Street Journal reported that the wealthy no longer have an appetite for the risk of equities and are “hunkering down with cash, gold, farmland and other safe-haven investments.”

Many financial advisors recommend staying the course with a diverse portfolio including, among other investment options, target date funds.

The United States has been “downgraded”: What can investors do now?

Jeff_MarzinskyThe S&P downgrade is no doubt one of the most historic valuations in recent memory. What should a plan sponsor or investor do in light of the recent downgrade?

  • U.S. debt: In light of the S&P downgrade, both Fitch and Moody’s have noted that they will keep the AAA and Aaa ratings for the time being.  On August 9, the Federal Reserve auctioned around $32 billion in debt to the public without a blink. Seems the rating downgrade has not led to investors shying away from U.S. debt.
  • Interest rates: With the downgrade, the rates may go up in light of the presumed risk related to the rating. Adjustments in rates will affect bonds, as well as pension plans. Moving interest rates will have more of an effect on longer durations. Review the duration of bond holdings and consider diversification across short, intermediate, and long durations to lessen the impact of changing rates.
  • Investment policy: With the S&P downgrade, investors should review their investment policy statements (IPS) to see if there are terms that require bond holdings to maintain AAA or Aaa ratings. If this is the case, the IPS may need to be adjusted; alternatively, liquidations of bond investments not meeting this requirement may be necessary.
  • Diversification: We have already seen a great deal of volatility since the downgrade, and going forward we may see continued discomfort in the markets, both bond and stocks. As has always been the case, diversification is key. A mixed portfolio of U.S. stocks, bonds, and international stocks and bonds are key in managing some of the volatility we’re seeing in the U.S. markets.
  • Stay the course: Invest for the long term. Don’t make rash decisions, in particular after dramatic stock market fluctuations. Set a policy, adjust it as necessary, and think before making knee-jerk reactions to market declines.

One thing is certain: There will be many debates over the right course of action, as much will unfold over the coming months.

Reporting of hospital pension costs under Medicare rules

Hospitals covered by Medicare rules that sponsor defined benefit (DB) retirement plans will be subject to new pension-cost calculation requirements for cost reports, beginning October 1, 2011. Under the final rule of the Centers for Medicare and Medicaid Services (CMS), the agency’s policy for determining maximum allowable pension costs has been revised for both the cost-based reimbursement and the Medicare wage index.

Under the final rule, a hospital’s reportable pension cost eligible for reimbursement must be amounts funded in cash, limited to 150% of the hospital’s average cash contributions over the highest three of the last five years. The rule allows hospitals to include “carry forward contributions” from prior periods, subject to the 150% limitation. Carry-forward amounts are those cash contributions not reflected as pension costs in prior periods. In addition, certain cash contributions in excess of the 150% limitation may be considered as current period pension costs if the hospital can demonstrate that the additional amounts are “reasonable and necessary.”

Continue reading

Inside August’s $97 billion erosion

We’ve already blogged about the results of the latest Pension Funding Index—and in particular the major hit to pension funding status so far in August. This Bloomberg article takes you inside the $97 billion increase in the pension funding status deficit during the first six business days of August. Excerpting from the article:

Company pensions are a casualty of record low bond yields, a benchmark in determining future liabilities, that have been driven down by mounting concern that the U.S. economy is stalling. Pension plan assets fell $6 billion in July, while liabilities increased $62 billion, according to Seattle-based Milliman. Assets declined $64 billion and liabilities increased $33 billion between Aug. 1 and Aug. 8.

“We had a nice bounce on the assets since the financial crisis until the last month or so,” Ehrhardt said in a telephone interview. “The interest rates have been a tremendous drag on the pension plan funding.”

U.S. gross domestic product grew at a 1.3 percent pace from April through June, less than forecast, after almost stalling in the first quarter as consumers retrenched, government data showed on July 29. Standard & Poor’s lowered the U.S. long-term rating one level to AA+ after markets closed on Aug. 5, while keeping the outlook at “negative” as the firm becomes less confident that Congress will end Bush-era tax cuts or tackle entitlements.

Treasury yields fell to 1.27 percent yesterday, the lowest ever, according to Bank of America Merrill Lynch index data.