Benefits March 14, 2014

DC Plans Ended 2013 Strong

March 14, 2014 (PLANSPONSOR.com) – Defined contribution (DC) plans outperformed defined benefit plans significantly during the fourth quarter of 2013 and during the whole year, according to a recent analysis.
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The Callan DC Index, which tracks the cash flows and performance of over 80 DC plans, indicates that DC plans ended 2013 strongly, advancing 6.23% in the fourth quarter. This contributed to a very impressive calendar year return for the index of 20.15%, making 2013 the index’s best year since the 2009 rebound, when it was up 22.22%.

DC plans tend to have much less exposure to longer-term fixed income than defined benefit (DB) plans, say the authors of the index, which accounts for much of the difference in performance. However, DB plans’ greater diversification also tended to work against them in 2013.

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While the typical corporate DB plan has nearly 2.5% in hedge funds and another 4% in other alternatives, the index shows that the typical DC plan has just a tiny fraction of a percent of such exposure. With domestic equities bringing in such blockbuster performance in 2013, the index indicates that it was difficult for alternatives to compete.

By the end of 2013, DC plans outperformed DB plans by an average of 7.59%, according to the index. This, in turn, significantly narrowed the performance advantage that corporate DB plans have demonstrated since the index’s 2006 inception. Between 2006 and 2012, corporate DB plans outperformed DC plans by 1.8% (average, annualized). Through year-end 2013, DB plans’ performance advantage had been squeezed by recent DC strength to less than half a percentage point annually.

The index also finds that the trend in target-date funds (TDFs) also experienced a bit of a reversal during the year. Normally, TDFs have tended to outperform DC plans in rising markets, say the authors of the index. But in 2013, TDFs lagged slightly with the average 2035 target date fund advancing just under 20% for the year.

For the year ending December 31, 2013, the index shows that DC plan balances soared 22%, driven almost exclusively by market returns. Plan sponsor and participant contributions (net flows) added 1.85% to growth during the year, or less than 10% of the total growth in balances. The index shows that over time, plan sponsor and participant contributions have tended to do more of the heavy lifting; accounting for one-third of the total growth in balances (2.84% annualized) since the index’s 2006 inception.

The index shows that target-date funds remained the recipient of much of the money that flowed in DC plans during the quarter and the year. Nearly 80 cents of every dollar that moved within DC plans headed for TDFs in fourth quarter 2013, and more than 70 cents of every dollar did so during the year. In contrast, more than half of the asset classes tracked in the index experienced net outflows during the quarter. This includes two of its best recent performers, company stock and domestic large cap equity. Domestic fixed income and stable value both suffered significant outflows. Overall turnover (also known as net transfer activity levels within DC plans), was below average for the quarter and for the year at 0.64% and 2.09%, respectively.

Target-date funds took another step forward during fourth quarter 2013 to becoming the single-largest holding in the typical DC plan, accounting for more than one-fifth of total assets (21.1%) within the index. Only domestic large cap equity allocations are higher, at 23.7%, followed by domestic small/mid cap equities at 11.9%. While TDFs have never experienced a quarter of net outflows since the index’s 2006 inception, domestic large cap equity has seen outflows more than two-thirds of the time, including the fourth quarter.

Overall, the index’s total equity allocation has increased to over two-thirds (66.8%) of DC plans’ assets. This allocation has been trending slightly upward since the end of 2012. However, it is below the index’s historic high of more than 70%, reached prior to March 2008.

The Callan DC Index, which is produced by the San Francisco-based Callan Associates Inc., is an equally weighted index, representing more than 800,000 defined contribution participants and over $100 billion in assets. The index is updated eight to 10 weeks after the end of the quarter and reflects 401(k) plans, as well as other types of DC plans.

Opinions March 14, 2014

IRS Linking 403(b) Plans to Former 501(c)(3) Organizations

March 14, 2014 (PLANSPONSOR.com) - The Internal Revenue Service (IRS) has rolled out its next 403(b) Compliance Check questionnaire.
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The questionnaire focuses on whether employers that had their 501(c)(3) nonprofit status revoked still offer a 403(b) tax deferred annuity plan to employees.

By way of background, the Pension Protection Act of 2006 requires that, effective with the 2007 annual period, a nonprofit organization file the appropriate Form 990 series (“Return of Organization Exempt from Income Tax”) at least once within a consecutive three-year period.  Failure to do so results in the IRS’ automatically revoking the employer’s tax-exempt status. An impacted employer could regain federal tax-exempt status by submitting an application to the IRS, and to the extent that the employer can demonstrate reasonable cause for not timely filing the Form 990 series, request that the reinstatement be retroactive to the date of revocation. 

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The latest Employee Plans Compliance Unit (EPCU) project—known as “Ineligible Employer – 403(b) Project Compliance Check”—targets employers that have received a notification of revocation of tax-exempt status from the IRS (known as a Notice CP120A) in 2010 (the first year following the new Pension Protection Act filing requirements that an organization’s tax-exempt status could be revoked). 

The Compliance Check consists of five areas of inquiry:

1.    Determination of whether the organization’s employees are participating in a 403(b) plan;

2.    Eligibility to sponsor a 403(b) plan; recognizing the impact of an automatic revocation of tax exempt status, one of the options is “A Previously Exempt Organization under Code Section 501(c)(3);”

3.    Confirmation of whether deferrals reported on employees’ IRS Form W-2 (“Wage and Tax Statement”) for the 2010 year were coded as contributions to a 403(b) plan;

4.    Identification of deferrals made to the 403(b) plan after the organization’s tax-exempt status was revoked (according to a footnote in the Compliance Check questionnaire, typically the automatic revocation occurring in 2010 would be May 17, 2010, 5½ months after the end of the 2007-2009 consecutive year period in which the Form 990 series was not filed); and   

5.    Determination of whether the organization has submitted Form 1023 (“Application for Recognition of Exemption Under Section 501(c)(3) of the Internal Revenue Code”) to the IRS to regain nonprofit status.

The accompanying cover letter seeks the return of the completed Request for Information by mail or fax within 30 days of the date of the letter.  If an employer does not respond to the Compliance Check, the IRS reserves the right to audit the 403(b) plan.

If the employer is no longer considered a 501(c)(3) organization and does not meet any other Internal Revenue Code criteria to sponsor a 403(b) plan, the IRS will notify the employer within 30 days of receipt of the completed Compliance Check to address any corrective measures needed with respect to the 403(b) plan.

It is not clear whether the EPCU would consider the correction method to be under the Employee Plans Compliance Resolution System’s Voluntary Correction Program (VCP) (with an IRS user fee accompanying the application) or under an Audit Closing Agreement Program (where a monetary sanction would be assessed as part of the closing agreement process). In either event, the correction method would be the same—participants could preserve the tax-deferred status of the contributions under the plan, provided that (1) the plan is frozen, and (2) participants can only access their accounts when they have a distributable event as described in the plan (such as terminating employment, becoming disabled, reaching age 59½, or dying).

Additional information about the latest Compliance Check can be found at http://www.irs.gov/Retirement-Plans/Employee-Plans-Compliance-Unit-EPCU-Current-Projects-Ineligible-Employer-403(b)-Project.

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Linda Segal Blinn, J.D.*, is vice president of Technical Services for ING U.S. Retirement Solutions’ Tax-Exempt Markets.  In this capacity, Blinn leverages her nearly 25 years of experience administering and designing defined contribution plans to provide general legislative and regulatory information to assist public and non-profit employers in operating their retirement plans. 

This material was created to provide accurate information on the subjects covered.  It is not intended to provide specific legal, tax or other professional advice.  The services of an appropriate professional should be sought regarding your individual situation.  These materials are not intended to be used to avoid tax penalties, and were prepared to support the promotion or marketing of the matters addressed in this document.  The taxpayer should seek advice from an independent tax advisor.

* Linda is not a practicing attorney.

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