Retirement Plan Features to Consider Pruning

Sometimes retirement plan sponsors get ideas or suggestions for plan features that probably shouldn’t be in the plan, says Mike Webb, vice president at Cammack Retirement.

He suggests simplifying or getting rid of features that make administration harder or could hinder participants’ retirement readiness. In his writeup, “Five Features that Retirement Plans Can Do Without,” Webb explains why plan sponsors should consider kicking certain features to the curb.

Webb considers revenue sharing, a practice that allows investment companies to share a portion of revenue from fund expenses with third-parties or recordkeepers, as the least-favored contender. Aside from its complicated process, Webb adds that most participants fail to understand the term.

“It makes the issue of transparency almost impossible,” he says. “If you talk about revenue sharing to participants, they’re going to roll their eyes. Revenue sharing does not keep things simple.”

Webb describes how specific features may toughen administration on employers. 403(b) plans, for example, allow certain participants to elect what is called 15-year catch-up contributions to contribute above the statutory limit for retirement plan deferrals. Webb says it is one of the trickiest features to manage since it involves accumulating data throughout a worker’s career.

Not only are 15-year catch-up contributions complex, they are one of the primary issues identified in IRS audits, and lack of compliance appears to be widespread. Webb suggests plan sponsors consider eliminating the feature.

An issue that comes up in regulatory audits is the use of the wrong definition of compensation. Non-W-2 and other total compensation definitions can be difficult to administer, since employers can have thousands of pay codes, each of which must be separately coded, Webb explains.

While atypical definitions of compensation are not unheard of, Edward Hammond, an attorney for employee benefits and executive compensation at Clark Hill in Michigan, says employers must ensure they use the correct definition for nondiscrimination testing. Otherwise, plan sponsors may subject themselves to audits or penalties if the IRS finds operational failures. “If they’re not careful, those definitions can get them into trouble,” he adds. 

Participant loans can be burdensome to administer as well, but could also hinder employees’ retirement savings, especially if one terminates without paying off an outstanding loan. Loans are discretionary plan features that plan sponsors do not have to offer.

However, both Hammond and Webb note the high value in offering loans and considering this, plan sponsors may not want to eliminate the feature entirely. “The employer should consider that [making plan loans available] will make it competitive,” says Hammond.

Webb argues the significance among participants should outweigh management when it comes to offering loans from the plan. A plan sponsor should not get rid of plan features solely because it is administratively cumbersome, its value towards the employer and employee should be taken into consideration as well, he claims.

There are ways to discourage participants from taking loans from their retirement plan accounts without eliminating the loan feature entirely. The plan could provide for only one outstanding loan at a time and could include a waiting period between loans.

Hardship distributions is another plan feature that can hinder participants’ retirement savings. Webb says plan sponsors can look into other options to help participants, including emergency fund assistance programs and student loan debt support. Or, they can discourage hardship distributions by requiring participants to exhaust their loan options before taking a hardship. However, incorporating the latter could fail to address deeper financial wellness issues that led the employee to take out a hardship distribution in the first place, he notes.

“If your plan has a lot of hardship distributions, it most likely a cry for help from participants who are suffering financially,” Webb observes. “Initiatives such as emergency fund assistance and student loan debt support will likely reduce both loan and hardship distribution utilization by addressing the causes of it.”