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AdvisorNews - December, 2011

IMHO: Five Plan Trends

October 5, 2011 ( - A few weeks back, I offered some notions about what the next five years will bring in terms of industry trends.

However, in preparing for our recent PLANADVISER National Conference, I came up with five more (For that initial list, see "IMHO: Fifth 'Avenues'").

  1. Everybody isn't going to do automatic enrollment.

Without question, automatic enrollment has done much to shore up the retirement savings rates of American workers. For plan sponsors and participants alike, the efficacy of an approach that doesn't require participants to complete an enrollment form, deliberate over investment choices, set upon a desired rate of savings, or even darken the door of an education meeting has done much to get tens of thousands of workers off on the right retirement savings foot. And, for the vast majority of workers, the ability to do the right thing without doing anything at all has not only been well-received, but much appreciated as well.

Not that automatic enrollment as outlined by the Pension Protection Act (PPA) doesn't have its shortcomings. Arguably, the 3% starting deferral rate outlined in the PPA---and still adopted by the vast majority of plans---is better suited to avoid creating a financial burden on workers than to ensuring an adequate level of retirement savings; and some workers, in taking the "easy" path cleared by automatic enrollment, wind up saving at lower rates than they would likely choose for themselves had they only taken the time to actually fill out an enrollment form (see "IMHO: 'Starting' Points" ).

But at some level, automatic enrollment requires that the plan sponsor "impose" a savings decision on a participant, and even though workers can choose to opt out, many plan sponsors are simply disinclined to set aside the purely voluntary approach. Many smaller programs that might once have been willing to go down that route as a means of avoiding trouble with the nondiscrimination tests have since found the solace required in adopting a safe harbor design. But for many, perhaps most these days, it's all about economics; simply said, the more participants, the more matching dollars---and considering the potential number of additional participants, those matching dollars could be significant, or significant "enough" in the current economic environment.

PLANSPONSOR 's annual Defined Contribution Survey has, for the past several years, shown a flat or flattening adoption rate for automatic enrollment. There's no reason to think this will change in the short term.

  1. Everybody who does automatic enrollment isn't going to do it for everybody.

Among the PPA's provisions is a safe harbor for those adopting automatic enrollment---a safe harbor that effectively provides plan sponsors with protection identical to that afforded under ERISA 404(c ), so long as certain conditions are met. Among those conditions is that all eligible participants be automatically enrolled and/or given the chance to opt out.

And yet, PLANSPONSOR's annual Defined Contribution Survey has found, for several years running, that two-thirds of plan sponsors that have embraced automatic enrollment have done so only for newer hires (see "IMHO: A Prospective Perspective" ). Anecdotally, plan sponsors are reluctant to "disturb" workers who, at least in theory, have previously been afforded the opportunity to participate and decided not to. Some are hesitant to "insult their intelligence" by doing so, and for others, it's just the economic dilemma posed above. The PPA doesn't mandate going back to older workers, of course---but plan sponsors desirous of those safe harbor protections either have to, or have to be able to establish that they have. There is also, of course, the issue of a plan design that, at least on the surface, is more attentive to the financial security of shorter-tenured workers.

Still, the current---and apparently persistent trend---is to adopt this feature prospectively, and it will likely take an improved economy---or perhaps litigation---to change that dynamic.

  1. Roth 401(k)s are going to continue to gain ground.

The advantages of tax-deferred savings have long been part-and-parcel of the pitch behind 401(k) plans. The notion is simple: defer paying taxes on your savings now, and they'll add up faster, further fueled by the tax-deferred accumulation of earnings on those balances. And then, the logic goes, you pay taxes on those monies as you withdraw them---years from now---and at rates that, post-retirement, will be lower.

Plan sponsors have long been reluctant to push Roth 401(k)s; their pay-it-now concept on taxes at odds with the traditional tax deferral mantra, and their benefits often seen as skewed toward more highly compensated workers.

However, these days, it's hard to find someone willing to predict lower taxes in the future, even post-retirement. Moreover, today's younger (and not-so-highly compensated) workers may very well be paying the lowest tax rates they will ever experience.

To date, most surveys indicate that the participant take-up rate on Roth 401(k)s remains modest, something on the order of what self-directed brokerage accounts have garnered (and in many cases, appealing to the same audience). However, the preliminary results of PLANSPONSOR's annual Defined Contribution Survey suggest that Roth 401(k)s are cropping up on a surprising number of plan menus. It's a trend that, IMHO, bears watching.

  1. Plan sponsors will (continue to) measure plan success on things (they think) they can control.

Plan sponsors have long measured the success of their defined contribution plans by the rate of participation in the plan. More than just providing a sense of interest and/or the success of inspiring enrollment meetings, the rate of participation, certainly by non-highly compensated workers, has a significant impact on the plan's ability not only to pass nondiscrimination tests, but to allow highly compensated workers to defer at meaningful rates. However, in an era of automatic enrollment and safe harbor plan designs, the value of this metric has been muted or, in many cases, eliminated.

There is, however, a growing discussion among providers that plan sponsors should begin---and in some cases, are beginning---to consider other metrics: things like rates of deferral, diversity of asset allocation, and even adequacy of retirement income. That they are now able to consider such a shift in focus is a testament to a new and exciting generation of tools now available from the provider community, and they may well foreshadow a time in the not-too-distant future where those perspectives are shared with participants who may, for example, increase their current rate of deferral to ensure a higher level of retirement income, or adjust their asset allocation to preserve portfolio gains as they near retirement.

However, it's not clear to me that plan sponsors will choose to benchmark their plans on criteria that is so individualized and so far outside their control to influence. Consider that about two-thirds of plan sponsors today still benchmark based on participation, and half that number examine deferral rates within various employee groups. These measures may not provide a picture of what the plan will yield in terms of its ultimate goal, but they are indicative of things a plan sponsor can control or influence with plan design, and---for the foreseeable future, anyway---I'm guessing they will continue to be the measures of choice.

  1. Plan sponsors want good retirement outcomes for participants---but don't feel it is their responsibility to ensure them.

Under the auspices of "best practices" and armed with some of the aforementioned benchmarking measures, some claim that fulfilling the plan fiduciary's responsibility to act in the interests of plan participants extends to ensuring a good result. Of course, some plan sponsors are reluctant to know the results of that benchmarking for just that reason: that, once apprised of those results, they will one day be held to account for them.

Unlikely as that seems to me, one should never underestimate the creativity of the plaintiff's bar. The reality is that a voluntary savings system needs goals, and I think participants would save better if they understood more. It also seems to me that plan sponsors who know more about what is going on in their plan might do a better job as well.

Value for service

October 5, 2011 By James Douglas

The majority of the focus on the recent disclosure regulations issued by the U.S. Department of Labor (DOL) has been on the fees and other forms of compensation that must be disclosed to retirement plan fiduciaries and participants.

However, an important aspect of the regulations that is often overlooked is the requirement that service providers must justify compensation by describing the services they provide. Keep in mind that the overriding concept behind the regulations is to ensure that arrangements made in connection with qualified retirement plans are "reasonable." In order to do so, fiduciaries and participants alike must know what services they are receiving in exchange for the fees paid.

This requirement presents an opportunity for broker/dealers and financial advisors to document their value proposition to qualified retirement plan clients. Establishing value for service is important both at plan inception and once the plan is up and running, especially when ongoing compensation is earned for providing services to the plan.

Obviously, there are add-on services that broker/dealers and financial advisors can and do provide to retirement plans on an ongoing basis. They can choose to assist plan sponsors by conducting enrollment meetings and other participant-related tasks, such as education. They can provide the plan's fiduciaries with materials and consultation on investment monitoring, which could include participation in regular investment committee meetings.

Broker/dealers and financial advisors can also assist their clients with advice regarding plan design.

The question remains, however, whether the compensation is reasonable. As with so many questions under ERISA, there is no clear answer. Sponsors (and potentially even the DOL) will need to determine if the value provided to the retirement plan is "reasonable" in light of compensation received.

Interestingly, another set of DOL regulations may present an opportunity for broker/dealers and financial advisors. As you know, the DOL recently proposed changes to the definition of "fiduciary" for purposes of providing investment advice. The proposed regulations would change the current narrow definition and replace it with a broader definition, under which many financial advisors in the retirement plan market would be considered fiduciaries.

Although the DOL recently withdrew the regulations for reconsideration, it's likely that the final regulations, if and when they are issued, will follow a similar approach.

Briefly, under the proposed rules, a "fiduciary" will include anyone who provides investment advice for a fee to a retirement plan fiduciary or participant pursuant to an understanding that such advice may be considered in connection with the investments in the retirement plan. This rule, if finalized, could potentially make an advisor a fiduciary for providing a single piece of advice, whether or not it is followed by the recipient. In my next post, I will go into more detail on these regulations and their potential impact.

Understandably, some in the broker/dealer community have recommended narrowing the guidelines. Although it's unclear what the final result will be, it's entirely possible that the final regulations will be far less inclusive than the proposal.

That said, financial advisors may find that being a fiduciary investment advisor is a possible solution to the "reasonable compensation" issue. Many financial advisors are already providing the type of advice that would, if the proposed regulations were finalized, make them plan fiduciaries. The existing business model would not need to be changed in any significant way.

Obviously, this is an oversimplification of the issue, and the increase in potential liability that a financial advisor would be taking on could be exponential if the new proposed rules were to take effect. Financial advisors who don't want to be deemed "fiduciaries" would need to successfully operate in the retirement plan market without providing "fiduciary" types of services.

The provision of fiduciary investment advisory services would likely be sufficient to justify most existing levels of compensation. With the increased scrutiny on fees and services that will surely follow the effective date of the disclosure regulations, those financial advisors and broker/dealers willing to act as a fiduciary may be well positioned, both in the competitive marketplace as well as in regulatory compliance.

One caveat is that once a financial advisor takes on a fiduciary role, the advisor will need to review the manner in which he or she is compensated. The manner in which a fiduciary may be compensated for providing services to a plan is closely regulated by ERISA. For example, if an investment advisor causes a plan to invest in a certain investment that results in additional compensation to the advisor, he or she may be found to have engaged in a prohibited transaction. As such, some investment advisors and broker/dealers who decide to take on a fiduciary role may want to consider changing to a flat fee compensation structure. As always, it is important to discuss these matters with your attorney before making any changes so that you can make a fully informed decision.


Meet the "ERISA Account", the newcomer to the small 401(k) plan scene

10 | 3 | 2011 Posted By Jerry Kalish

Let me introduce you to the "ERISA Account", a relative newcomer to the small 401(k) plan market. It's been part of the large and medium plan market for some time. Only recently has it migrated down stream because of (yes, you guessed it) the increased regulatory emphasis and fiduciary attention to fee disclosure.


ERISA Accounts are sometimes referred to as "ERISA Budget Accounts", "ERISA Expense Accounts, "Expense Recapture Account", or "Revenue Sharing Account". We use the term ERISA Account because it succinctly describes the essence of what it is:

A plan level account that captures excess income collected by the recordkeeper that can be used to pay eligible plan expenses or even allocated to participants.

Let's separate this discussion into its elements: 1) where the income comes from, and 2) how it can be used.

Where the Income Comes From

A mutual fund charges a fee that encompasses all the various fees that a participant is charged to invest in the particular fund. It's usually referred to as the Expense Ratio. In addition to the management fee charged by the fund manager to manage the fund assets, the Expense Ratio may include:

  • 12(b)(1) Fee: the fee paid by the mutual fund to a 401(k) provider or broker for including in it in the plan and servicing it after the sale.
  • Sub Transfer Agent (Sub-TA) Fees: the fee paid by the fund when it subcontracts the participant accounting to transfer agents, e.g., bank or trust company, to execute, clear, and settle trades, and maintain shareholder ownership records. These organizations are called Sub-Transfer Agents.
  • Provider Compensation: the fee paid by the fund to the service provider, sometimes referred to as Revenue Sharing, for administrative or contract owner or participant services provided on behalf of the fund.

The Expense Ration is usually stated as a percentage of assets under management, and is netted from mutual fund performance rather than being paid directly by the plan.

How the Income Can Be Used

At some point, the income received by the recordkeeper becomes excessive, i.e., more revenue that is needed to run the plan, and can be used to pay plan level expenses or reallocated to participants.

Plan Expenses

The expenses that can be paid by the plan are part of that ERISA basic: a fiduciary must "act for the exclusive purpose of providing benefits to plan participants and defraying reasonable expenses of administering the plan."

The Department of Labor says that reasonable administrative expenses could include:

  • Plan amendments required by change in law
  • Plan amendments necessary to maintain tax qualified status
  • Nondiscrimination testing
  • Recordkeeping
  • Plan accounting
  • Preparation of Form 5500

Plan assets, however, cannot be used for "Settlor Functions", i.e., those expenses that are for the benefit of the employer. Settlor Expense could include:

  • Studies of options for amending plan to maintain tax qualified status or for meeting new legal requirements
  • Terminating plan
  • Testing to explore plan design
  • Union negotiations about plan provisions

The Department of Labor also permits participants to be charged for the reasonable cost of transactions attributable to individual participants, e.g., loans, QDROs, hardship withdrawals, calculations to determine benefits under various distribution alternatives, and benefit distributions.

Allocation to Participants

In addition to paying for reasonable plan expenses, funds in an ERISA Account may be reallocated to participant accounts pro-rata based on their account balances at the end of the year, or on a per capita basis. Note, however, that funds must be used by the end of the plan year. They cannot be rolled over to another plan year, or returned to the employer.

Plan Documentation

As with all things ERISA, there has to be proper documentation. Best practices would be to specifically state in the plan document that the plan may pay reasonable operating expenses, reflect that in the Summary Plan Description or Material Modification thereof, and have a written Expense Policy.


Not all 401(k) plans will see excess income that can be used in an ERISA Account. However, as we move more into the "Age of Transparency", expect to see ERISA Accounts more prevalent in the small plan market. And what's a "small plan'? We've seen $1 million plans with ERISA Accounts.


Deferred comp plans:

when they're a great choice, and when they're not

Nonqualified deferred compensation plans are a common feature of executive pay packages. They're a great choice in the right conditions, i.e. when:

  • The executive's share of company profits is very small, and
  • The executive is willing to shoulder the employer's credit risk, and
  • Providing the benefits through a qualified plan would be too expensive.

But they're not so great when any of these conditions are missing. Let's examine each in turn.

Small share of company profits: Nonqualified deferred compensation isn't deductible for the company until it becomes taxable for the executive. If the executive is a substantial owner in a profitable enterprise, e.g. a law firm or medical group partner, any deferred income boomerangs right back as taxable profit. In contrast, qualified retirement plan contributions are deductible for the company when they're made, and not taxable to the employee until they're received in cash.

Willing to shoulder the employer's credit risk: Funding vehicles like rabbi trusts can protect the executive from the employer's unwillingness to pay, but not against its inability to pay. In today's economic environment where even large companies are struggling, this risk may be unacceptable. Protection from both of these risks - and even from the executive's personal creditors - is provided by a qualified plan.

Qualified plan too expensive: This is usually the main reason for setting up a deferred compensation plan. Qualified plans have many requirements that don't apply to most nonqualified plans: coverage, nondiscrimination, government filings etc. But they're more flexible than most people realize. In a cross-tested profit sharing/401(k) plan, top executives can often reach the annual $49,000 defined contribution limit with a 5% staff contribution. And if that's not enough, a cash balance or other defined benefit plan can allow much higher deductions: up to an additional $100k-200k per year.

So, are we biased toward qualified plans? Oh, absolutely. Nonqualified plans can be a great choice, but make sure you've maximized your qualified plans first.



IRS Announces Pension Plan Limitations for 2012

According the the IRS website,

  • The elective deferral (contribution) limit for employees has increased from $16,500 to $17,000.
  • The catch-up contribution limit for those aged 50 and over remains unchanged at $5,500.
  • Effective January 1, 2012, the limitation on the annual benefit under a defined benefit plan under section 415(b)(1)(A) is increased from $195,000 to $200,000.
  • The limitation for defined contribution plans under Section 415(c)(1)(A) is increased in 2012 from $49,000 to $50,000.
  • The annual compensation limit under Sections 401(a)(17), 404(l), 408(k)(3)(C), and 408(k)(6)(D)(ii) is increased from $245,000 to $250,000.
  • The dollar limitation under Section 416(i)(1)(A)(i) concerning the definition of key employee in a top-heavy plan is increased from $160,000 to $165,000.
  • The limitation used in the definition of highly compensated employee under Section 414(q)(1)(B) is increased from $110,000 to $115,000.