More Participants Understand TDFs

The retirement plan industry is approaching the 10-year anniversary of the Pension Protection Act, a law that has clearly impacted participant investing knowledge and behavior.

A short series of papers published by Vanguard shows knowledge of investing principles and fund features directly impacts the likelihood of investing success, even in product categories designed to put most decisionmaking in the hands of professionals.

The quintessential example of this product category, at least within the workplace retirement investing domain, remains target-date funds (TDFs). According to Vanguard, TDFs are currently offered by 88% of plan sponsors and utilized by upwards of 64% of participants, due largely to the Pension Protection Act’s (PPA) sanctioning of TDFs as a qualified default investment alternative. It’s not just the PPA driving TDF success, though; about half of individual target-date investors report having proactively chosen to invest their TDF holdings.

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Generally, TDF investors understand how their investments work and say they are familiar with the “outwardly simple, inwardly sophisticated” messaging product providers have stressed in the last year. A strong majority (64%) say they understand the glide path concept of the investment mix getting more conservative over time, while 57% understand TDFs hold both equity and fixed income in a ratio that is rebalanced over time.

These are positive signs, Vanguard says, but the industry is still a long way away from ensuring all participants are picking the right TDF vintage, for example, or that all participants grasp the distinction between to- versus through-retirement funds. A significant number (19%) reported the incorrect perception that TDFs will provide guaranteed retirement income, while 14% said a TDF generally has a guaranteed rate of return/guaranteed growth. Another 12% identified a TDF as “having the same asset mix over time,” while 11% said TDFs become “risk free” after the retirement date.

The Vanguard paper warns the helpful features of TDFs—automatic asset allocation and regular rebalancing, in particular—are not enough to overcome poor investor decisionmaking in these areas. Even participants using TDFs need to understand the pitfalls of too-small salary deferral percentages, overactive trading, loans/leakage, etc. 

NEXT: Risk understanding improves among participants

Another interesting trend reported by Vanguard is a strong acknowledgement by investors that TDFs carry potentially significant risk. Nearly eight in 10 (78%) agreed that TDFs carry at least “some investment risk,” with about half of this group suggesting TDFs carry moderate or significant investment risk. 

Also encouraging is that participants increasingly understand that specific TDF providers will vary on their glide path recommendations, but that in general equity exposure should be reduced over time to prevent dramatic portfolio losses immediately prior to retirement. In other words, they are coming to understand the connection between TDFs' glide path approach and the importance of addressing sequence of returns risk within an individual's retirement portfolio.

Looking to the back-end of the glide path, there is an ongoing need for education and innovation. TDF investors broadly expect employer-sponsored retirement plans to be their primary source of retirement income—including a majority of investors planning “to take systematic withdrawals or spend their savings as needed in retirement.” The last several years have brought significant innovations in the area of in-plan income, Vanguard notes, but most plans are still simply not prepared to help participants effectively control their retirement spending. 

Vanguard concludes plan participants are, in effect, seeking “through-retirement” products, something for plan sponsors and advisers to keep in mind when selecting or reviewing products in the new year.

Vanguard partnered with Greenwich Associates to conduct the underlying participant survey and associated TDF reports, which cover both proprietary and non-propriety funds. 

Church Plan Legislation Finally Gets Passed

Lawmakers’ repeated efforts to clarify the application of certain tax and retirement laws and regulations to the church retirement plans have come to fruition.

Section 336 of the Protecting Americans from Tax Hikes (PATH) Act (S. 2029), which was passed as part of the recent budget deal signed into law by President Obama on December 18, 2015, contains a number of significant provisions affecting church plans, according to a Groom Law Group Benefits Brief.  

The measure addresses each of the five issues in bills previously introduced to Congress by lawmakers, including controlled group rules, grandfathered defined benefit (DB) plans, automatic enrollment in church defined contribution (DC) plans, transfers between 403(b) and 401(a) plans, and investing in collective trusts.

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Previously, the controlled group rules for tax-exempt employers may have required certain church-affiliated employers to be included in one controlled group (i.e., treated as a single employer), even though they have little relation to one another. Groom Law Group explains that the PATH Act adds further clarification in the form of a general rule that an organization that is otherwise eligible to participate in a church plan shall not be aggregated with another such organization and treated as a single employer with such other organization for a plan year beginning in a taxable year unless (i) one such organization provides (directly or indirectly) at least 80% of the operating funds for the other organization during the preceding taxable year of the recipient organization, and (ii) there is a degree of common management or supervision between the organizations such that the organization providing the operating funds is directly involved in the day-to-day operations of the other organization. There are two exceptions to this rule, explained in the Benefits Brief.

Groom notes that the legislative history of the act includes commentary that none of the new legislation is intended to have, or appears to have, any impact on the ongoing litigation against church-related hospitals over the church plan definition. 

NEXT: More new legislation for church plans

Changing the current provision of the Internal Revenue Code Section 415 regulations, the act provides that grandfathered defined benefit church retirement income accounts under section 403(b)(9) will be subject to the defined benefit limitations of code section 415(b), and not the defined contribution limitations of code section 415(c). This applies to years beginning before, on, or after the date of the enactment of the legislation.

According to Groom Law Group, a new Code section 414(z) has been added by the act which will permit tax-deferred transfers of all or a portion of the accrued benefit of a participant or beneficiary, whether or not vested, from a church plan that is a plan described in section 401(a) or an annuity contract described in section 403(b) (which includes 403(b)(7) custodial accounts and 403(b)(9) retirement income accounts) to an annuity contract described in section 403(b), if such plan and annuity contract are both maintained by the same church or convention or association of churches, and similarly from an annuity contract described in section 403(b) to a church plan that is a plan described in section 401(a), again if such plan and annuity contract are both maintained by the same church or convention or association of churches. The provision also permits a merger of a church plan that is a plan described in section 401(a), or an annuity contract described in section 403(b), with an annuity contract described in section 403(b), if such plan and annuity contract are both maintained by the same church or convention or association of churches.

The act provides availability of automatic enrollment for church DC retirement plans by preempting any state laws that may be inconsistent with including auto-enrollment features in church DC retirement plans.

Finally, the act has added a provision that church plan investment boards may invest assets in a group trust described in Internal Revenue Service Revenue Ruling 81–100 (often called “collective trusts”), without adversely affecting the tax status of the group trust, the plan, account, investment board organization, or any other plan or trust that invests in the group trust. This provision applies to investments made after the date of enactment of the new legislation.

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