Tag Archives: 401(k)

A “Sign O’ the Times” for 401(k) plans?

Laursen DarleneTimes have changed since 401(k) plans were started back in the ’80s, just like hair styles and rock bands. Where most 401(k) plans only offered a lump-sum distribution option, the new trend in retirement plans may have you facing a decision. Could additional options, such as installments and ad hoc distributions, be the new featured value to plan participants? Could a lack of more distribution options be affecting participants’ distribution behaviors? Let’s look at the options and effects for the participants.

A 401(k) retirement plan that offers only a lump-sum distribution option requires participants to move the full account balance before they can even access one dollar from their accounts. While this may seem like no big deal, let’s turn this soup can around and read more about this lump sum on the label. It may provide greater insight into the lump-sum option.

If the need for cash at retirement is immediate, a participant may be forced to distribute the full account balance when the investment market is down. Participants would be locking in the investment loss on their entire account. This effect of the lump-sum distribution option affects participants whether rolling over their account or taking a distribution in cash.

These same lump-sum distributions can also adversely affect the plan as a whole. You may be scratching your head at this point and asking what do you mean? How can only having the lump-sum distribution option adversely affect the plan? Consider the scenario of a large population of plan participants retiring or terminating within a similar time period and possibly carrying away the larger balances in the plan. A tsunami of lump-sum distributions may trigger a significant drop in the total plan assets. This drop in assets may adversely affect the asset pricing structure for the remaining population of participants in the plan, creating a higher asset expense. Not to be a downer on lump-sum distributions, as they certainly have their place in retirement plans, but it may be time to consider offering additional options.

Installment payments can be a second option for a retirement plan. I like to call them the “Pac-Man” of the payment structures. This stream of same bite-size payments works like the Pac-Man arcade game. Pac-Man just kept munching his way around the board, eating until every bite was gone. The upside to installment payments is that participants can have a steady stream of income from the retirement plan and still remain invested. The participant continues to glean the benefit of lower investment pricing by remaining a participant in the plan. What participants should be considering, however, is the effect of these steady Pac-Man installment payments, which continue to happen in a downward investment market. Those installment payments can result in a larger reduction or faster depletion of a participant’s account than planned. For plan sponsors who offer the installment payment option, it is one way of potentially slowing down abrupt changes to the assets in the plan.

The third option, ad hoc distributions, may be considered the most flexible option in retirement plans. Let’s unpack how the ad hoc option can provide an ongoing investment benefit as well as distribution flexibility through retirement. Participants can leave their retirement accounts in the plan and remain invested in the plan’s institutional fund options. The ability to request a distribution when needed, or at the peak of a market upswing, can provide the ability to manage retirement drawdown. For participants who can afford to retire on other sources of income but may incur an unexpected medical cost during retirement, the ad hoc option provides a financial source to tap into only when needed.

Each distribution option has something to offer plan participants. Is it time to offer all three?

DOL issues final rule on fiduciary/conflicts of interest

The Department of Labor (DOL) has released a final rule redefining “fiduciary” under ERISA, focusing on individuals who provide investment advice or recommendations to retirement plan savers for a fee. The rule requires investment advisers to adhere to a fiduciary standard—that is, they must act in a client’s best interest—when advising retirement plan participants, such as on whether to roll over funds from an employer-sponsored 401(k) plan or on what funds to invest in for IRAs. The agency concurrently published related guidance to exempt certain activities from the conflict-of-interest rule, allowing advisers to continue to receive fees or compensation if they comply with the fiduciary standard. The final rule generally applies beginning April 10, 2017, although portions become effective January 1, 2018.

The package of the final rule and related guidance on class exemptions and prohibited transaction exemption amendments is lengthy and complex; this Client Action Bulletin highlights the key areas covered for retirement plan sponsors. The rule applies to tax-qualified plans under ERISA; it does not affect 457 governmental plans or 403(b) tax-sheltered annuities under a governmental plan or a nonelecting church plan.

Goodbye rollovers, hello “stay-overs”

Moen-AlexNo surprise here—Baby Boomers are retiring. But as they retire, there is a new trend in town, the “stay-over.” The stay-over approach represents a shift in thinking about how employees will handle their retirement savings investments. Instead of rolling money out of employer plans into IRAs, the stay-over approach encourages retirees to keep their money in their current company-sponsored plans.

Plan sponsors, and their plan advisors, are now competing to keep retirees’ money in employer plans. The reason? As that extremely large workforce exits, sponsors are worried about their ability to negotiate fees with their outside fund managers and maintain lower overall fees for plan participants. Plan sponsors are now forced to weigh traditional concerns related to administration and compliance costs against fee negotiations. A recent Wall Street Journal article says, “Workers pay about 0.45% of assets in fees to outside money managers when they remain in the firm’s 401(k) plan; by comparison, experts estimate they would pay fees of more than 1.5% in IRAs.” Increased plan assets create economies of scale, which in turn reduces the level of fees for all participants in the plan. This movement is also in line with the overarching goal of encouraging retirees’ savings, focusing on keeping money in the plan, and educating employees about their options. Baby Boomer assets in defined contribution/401(k) plans currently total $4 trillion dollars, according to the same Wall Street Journal article, and 2013 was the first year that plan level withdrawals exceeded contributions. This rollover versus stay-over debate is just beginning to launch.

Employees benefit by keeping their balances in the plan as well. Fees paid by participants have a huge impact on the growth of investments over time, thus participants can benefit from the lower fees. Retirees face pressure from outside financial advisors who will try to convince them that keeping money in employer plans adds a layer of difficulty to investment changes and accessing funds. On the contrary, though, investing can be easier for ex-employees to manage because they are more familiar with the fund offerings and fewer choices are less overwhelming. Usually plan investment options are selected and monitored by independent investment advisors who work with the plan fiduciaries—this translates into professional unbiased advisory services, which benefits all participants. A plan feature to consider, which will aid and encourage workers to keep money in the plan, is ad hoc withdrawals for retirees, allowing participants to access their accounts the same way they would in an IRA, and take money as needed. This is a balancing act, however, as the retiree still needs to be aware of the risks of removing money and should have a financial plan in place for retirement.

Employers and plan sponsors should think big. Rather than designing retirement savings plans for the length of time the employee is with the company, plans should represent a tool for lifetime retirement savings for all workers.

Celebrating National 401(k) Day can generate enthusiasm for retirement plan

Many employers hold benefits fairs during open enrollment, providing employees an opportunity to review all benefits offered to them. Focusing on the 401(k) plan only during open enrollment events can give employees the false impression that they must make their 401(k) decisions only during the open enrollment period. This article explains how Milliman helped one employer highlight its 401(k) benefits by engaging employees in the process more effectively.

Weighing income options can prepare individuals for retirement

Pushaw-BartPension plans are providing an ever-decreasing portion of retirement wealth as wave after wave of Baby Boomers reach retirement. In and of itself, this is neither surprising nor remarkable. What is remarkable, though, are two typical characteristics of what we are being left with regarding retirement wealth.

First, the jettison of pension plans means relying on defined contribution plans as the provider of principal retirement wealth. This is suboptimal inasmuch as these plans are typically 401(k) savings plans, originally introduced as a sideline fringe benefit scaled for purposes less than what they’re now required to deliver on. This is mostly a benefit-level issue of which we have seen recent hints of amelioration—namely, the industry recognizing that in an all-account-based retirement world, saving 16% of annual pay is in the ballpark, not the historical mode of 6% employee deferral (plus maybe 6% employer match totaling 12%). This relates to the second endangered characteristic, which needs to be brought into brighter focus: an in-plan solution for generating guaranteed retirement income.

Pension plans are wonderful for participants in that everyone is automatically a participant, automatically earning benefits on a meaningful trajectory, and automatically having the ultimate retirement wealth delivered on a lifetime guaranteed basis. Yes, 401(k) plans are trending this way on the first two, and the third is quickly emerging as another area where we need more pension-like alternatives.

One may generalize by saying that retirees take their 401(k) balances and roll them over when they retire. An economic conundrum baffling academics is that none or very few of these folks take advantage of insured annuities even in the midst of robust studies identifying them as an optimal solution for retirement income in face of investment uncertainty and longevity risks. This raises two subtle yet important points.

Continue reading

Automatic savings increase tool enhances 401(k) plan

Milliman’s automatic savings increase tool helped one bank transition to a defined contribution-focused retirement program. In this article, Noah Buck discusses how the organization’s 401(k) plan achieved higher employee participation as well as greater savings rates two years after plan modifications.

Here’s an excerpt:

Separate from providing guidance and strategy on plan design, Milliman helped the client roll out a secret weapon: Milliman’s voluntary automatic savings increase tool. To be clear, the plan design changes mandated a 1% annual increase up to 10% for any participant who is automatically enrolled. The voluntary automatic savings increase tool is a feature of Milliman’s website that allows participants to elect their own automatic increase schedule. It is a convenient mechanism to help participants update or confirm their current savings rate and choose an annual increase date, the annual incremental increase, and the maximum savings rate. For example, a participant may elect to save at 5% with an annual 1% increase every September 1 until the savings rate reaches 12%. Participants can provide their email address in order to receive a reminder a few weeks before the scheduled annual increase.

The voluntary automatic savings increase tool was not expected to have a major impact. Instead, it was considered something useful to help chip away at the lost 11.5% of annual DB benefits. It was also considered a means for those participants on a tight budget who were not automatically enrolled to increase their savings rates at their own pace.

… As seen in the table below, the average expected total increase in the savings rate for the 35 participants who elected auto-increase is 5.9%, which will roughly double the current average savings rate for this group. This increase, combined with the expanded profit-sharing contribution, is projected to close the 11.5% gap for many employees.

Auto savings increase tool_image

You heard it before, American workers still aren’t saving

Moen-AlexA recent survey shows that Americans are saving more overall, but less in employer-sponsored retirement plans. So how can sponsors and administrators of defined contribution plans solve this? Easy:

1. Use an auto-enrollment design with a default of no less than 6%.
2. If you provide a match, stretch the match to at least 7% or 8% of pay.
3. Consider adding a nonelective (i.e., profit-sharing) contribution.
4. Reenroll all non-savers every six years at the default rate.

Some experts suggest that automatic plan features are the best way to change behavior. This is most likely true, but a New York University (NYU) study suggests that while auto-enrollment gets people into the plan, it is not ensuring that they build secure retirements. All too often employers select the default rate of 3%, which, according to researchers, reduces long-term retirement savings for those who would have enrolled at a higher rate. As consultants, we see this example frequently—a young employee enters the plan automatically and three years later is still at 3%, even though the plan is matching deferral rates up to 6%. Out of sight and out of mind can be dangerous for young employees. The NYU study states that 80% of retirement plans include an employer match contribution, and of those plans, almost half of employees are not maximizing the match. That means that at least half of workers do get it; at the right deferral rate, there is free money on the table. With this in mind, consider an example to illustrate the savings impact of a new match contribution formula: currently, the match is 50% of the first 6% (or maximum of 3% of pay). Why not match 100% of the first 1%, then 25% of the next 8%? In this scenario, we could argue that half of the employee population would defer 9% of pay to get the 3% match. This would produce a total annual contribution of 12% of pay per year, without the employer matching anymore compensation than it did in the current formula.

Figure 1: Match Formulas

Figure 1

To emphasize the impact of different deferral rates on an employee’s account balance at retirement, using the proposed new match formula, see the chart below:

Figure 2: Potential Savings

Figure 2

A recent Employee Benefits Research Institute Retirement Confidence Survey asked workers what action they would take if they were automatically enrolled into their retirement plans, deferring 6%. Nearly three-quarters, 74%, responded that they would stay at that rate or increase their contribution rates. This survey addressing employee behavior offers strong incentive for a 6% auto-enrollment rate. In my opinion, plan sponsors should incorporate this type of employee behavioral analysis into the plan design process. A current client has maintained participation rates near 90%, with a 6% auto-enrollment rate. And of those deferring, 84% defer at a rate greater than or equal to 6%.

While matching contributions are an important feature, the researchers argue a more beneficial tool for a plan is a general (i.e., nonelective) contribution. And if the employer can afford to, and the plan is designed for the population correctly, the nonelective contribution can provide a more substantial retirement benefit. There are, of course, trade-offs, and with nonelective contributions comes stricter annual testing.

Something else to think about—reenrolling all current employees when the plan adds the auto-enrollment design. I have witnessed firsthand the success of such an endeavor with another Milliman client who did this 18 months ago. The plan went from 63% participation to 97%—and has maintained that level.

As an administrator of defined contribution plans, I know automatic arrangements can be difficult to administer, but the recent relaxation by the Internal Revenue Service (IRS) of correction rules (Revenue Procedure 2015-28), and the evidence provided by the surveys mentioned above, simplify the decision. If employers enroll new employees in plans automatically, they are clearly likely to stay, and the automatic arrangement often becomes the obvious choice. But the rate needs to be high enough to be worthwhile. Plan sponsors must evaluate the goals of their plans. Is the objective to simply have higher participation, satisfy tax incentive rules, and ensure that workers save something toward retirement? Or is it to truly build a serious retirement benefit for employees? In that likely case, additional studies of the employee population and their saving behavior must be incorporated into plan designs.

Employers helping former employees deal with rollover fees

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.

U.S. Supreme Court ruling calls attention to the fiduciary duty to monitor 401(k) plan investments

The U.S. Supreme Court unanimously held that, although the initial selection of plan investments occurred beyond ERISA’s six-year statute of limitations, a lawsuit by participants in a 401(k) savings plan may proceed on whether the plan fiduciaries breached their continuing duty to monitor and remove imprudent trust investments (Tibble v. Edison Int’l [No. 13-550, 5/18/2015]). In so ruling, the Court found that a lawsuit against plan fiduciaries is filed in timely fashion if the participants’ claim alleging a breach of the continuing duty to monitor occurred within six years. The Court’s ruling may spur lawsuits by participants over plan fees. This Client Action Bulletin provides more perspective.

DOL provides flexibility in timing of annual defined contribution plan disclosures

Sponsors of 401(k) and other participant-directed defined contribution retirement plans will have more flexibility in the timing of providing annual plan and investment disclosures to participants, under a direct final rule from the U.S. Department of Labor (DOL). Instead of disclosing the required information “at least annually,” which the agency had interpreted to mean no more than 365 days after the sponsor provided the prior annual disclosure, sponsors will have up to 14 months to do so. The modification will require disclosures to be made “at least once in any 14-month period, without regard to whether the plan operates on a calendar year or fiscal year basis.”

The change to the timing requirement will ease the administrative burdens faced by many plan sponsors and administrators.

The flexibility provided by the direct final rule is slated to be effective June 17, 2015, and will apply to disclosures made on or after that date, unless the DOL withdraws the rule before then, which would be due to adverse comments received.

The DOL’s direct final rule also announces an immediate, temporary enforcement policy (until June 17), so that plan sponsors and administrators may take advantage of the two-month grace period before the June 17 effective date, as long as they reasonably determine that doing so will benefit participants and beneficiaries. The relief granted by the enforcement policy is in addition to the one-time, 18-month “re-set” opportunity provided by the DOL’s Field Assistance Bulletin 2013-02.

For more information about the DOL’s direct final rule or a related proposed rule, please contact your Milliman consultant.