Compliance June 14, 2022

PSNC 2022: Washington Update

From shifting compliance deadlines to growing debate on ambitious retirement reform legislation, there is a lot happening in the nation’s capital for retirement plan fiduciaries to be aware of.

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During the 2022 PLANSPONSOR National Conference in Orlando, a pair of experts shared their perspectives on the legislative and regulatory outlook for the retirement plan industry, suggesting there is significant room for optimism about the passage of helpful reforms.

The speakers included Jodi Epstein, partner at Ivins, Phillips & Barker; and David Levine, principal and co-chair of the plan sponsor practice at Groom Law Group. In addition to discussing the legislative outlook, the attorneys addressed the evolving regulatory picture and the emergence of key trends in retirement plan litigation.

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Overall, they said, it is a challenging time to be a retirement plan fiduciary, but opportunities to improve the retirement plan system—concerning both inclusivity and outcomes—abound.

Still Waiting for Regulations

As the panel spelled out, the retirement industry is still working to interpret and put into practice prior reforms that were established under the Setting Every Community Up for Retirement Enhancement Act, affectionately known as the SECURE Act. One of the main regulations the industry is watching for, Epstein said, involves the SECURE Act’s requirement that certain part-time workers be made eligible for retirement benefits.

As of the start of 2021, the SECURE Act defines these workers as employees who in each of the past three consecutive years worked between 500 and 999 hours. As such, the first year that any long-term, part-time employee may enjoy mandatory eligibility is 2024, although plans can allow entry earlier.

According to Epstein and Levine, it is important for plan sponsors to track the hours worked by their part-time staffers, so that they can be in a good position for compliance with the part-time eligibility rules by the time 2024 arrives. This is particularly important in cases where a plan sponsor is moving between recordkeepers, making an acquisition or experiencing another potentially disruptive business event.

Employees who are required to be covered by the SECURE Act’s expansion may receive, but are not required to receive, matching employer contributions. Furthermore, they can be excluded for nondiscrimination testing purposes.  

“There are still some places where we hope to get clarifying guidance, but, for now, the bottom line for employers is to prepare for 2024 by starting in 2021 to track part-time employees’ hours,” Levine said.

SECURE 2.0 Raises Questions

As Epstein and Levine explained, there are provisions in a new legislative framework, the Securing a Strong Retirement Act, which is referred to by some in the industry as SECURE 2.0, that could impact the part-time eligibility rules. Namely, the proposal currently envisions reducing the eligibility window from three years to two, which could further complicate plan sponsors’ efforts to comply with any forthcoming regulations. There is also the possibility that the rules around required minimum distributions could again be modified, with the expectation being that the RMD age could be pushed back to 75, though this is far from given at this stage in the legislative process.

“There is a whole lot in SECURE 2.0 and all the related bills floating around,” Levine said. “In English, the legislative package is about making things better by creating new plan features and new levels of access to the retirement plan system. It is also important to note that the House has passed its version of the legislation by a wide margin, but the Senate is continuing to work on two parallel pieces of legislation. All is yet to be cobbled together, and so we are in a wait-and-see posture with our clients.”

Other features of the legislation package would provide support to workers with student loans by allowing employers to match their loan repayments with retirement account contributions, and there are provisions aimed at simplifying the fiduciary process involved in the provision of guaranteed lifetime income options within DC plans.

Epstein explained that many of the provisions in the legislative package enjoy substantial bipartisan appeal. More challenging is the fact that some parts of the bill will “cost revenue,” meaning they are not budget neutral and may require new tax revenues, which always makes legislation more difficult to pass in a closely divided Congress.

The Regulatory Front

Levine and Epstein said retirement plan fiduciaries should expect a busy year in terms of the development of regulations that impact institutional investors and retirement plans.

For example, in May, the Securities and Exchange Commission extended the comment period for its proposal to make key rule amendments that would require domestic or foreign registrants to include certain climate-related information in its registration statements and periodic reports, such as on the Form 10-K. Examples of the information to be disclosed by securities issuers include climate-related risks and their actual or likely material impacts on the registrant’s business, strategy and outlook. Other information to be disclosed includes the registrant’s governance of climate-related risks and relevant risk management processes, as well as the registrant’s greenhouse gas emissions.

Levine and Epstein said they expect the final version of the regulation to closely resemble the proposal.

According to the attorneys, the SEC’s leadership has clearly signaled its intention to work to improve ESG-related disclosures, and they can be expected to factor ESG themes into multiple rulemaking actions. Since its original proposal, the SEC has already followed up on the broad ESG disclosure package with two additional regulations, one aimed at mandating similar types of disclosures on the part of registered investment advisers and fund managers and the other restricting and regulating the use of the ESG label in fund names.

Investing June 14, 2022

PSNC 2022: The Evolving DC Plan Investment Menu

Customization and, more recently, inflation hedging are considerations for defined contribution plan investment lineups.

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At the 2022 PLANSPONSOR National Conference in Orlando, Kathleen Kelly, managing partner, Compass Financial Partners LLC, told attendees of a session about defined contribution plan investment menus that her firm’s plan sponsor clients are increasingly “looking to us to enhance their retirement plan benefit to address needs related to the Great Resignation.”

Plan sponsors are asking what they can do to improve their retirement benefits to retain employees, she said. Among the solutions are fee compression, options to help do-it-yourself participants to build their own investment portfolios and good target-date funds for do-it-for-me investors.

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Kelly said plan sponsors also often bring up decumulation solutions. “Sponsors are interested in how they can do better in letting employees know they care about them today and in the future,” she said. “Sponsors are thinking maybe they should be using their retirement plan as a tool to help long-tenured employees, and structure it to be a cradle-to-the-grave benefit.”

Kelly was among a panel of experts who spoke about trends in DC plan investment menus. Two trends discussed were the increasing use of collective investment trusts and the use of customized solutions.

CITs

Gene Huxhold, head of DCIO at John Hancock Investment Management, told conference attendees that asset managers expect that in the next five years, 50% of DC plan asset flows will be into CITs. He added that the No. 1 reason is price, as CITs are normally less expensive than similar mutual funds.

Lucian Marinescu, portfolio manager, head of target-date strategies, Morningstar Investment Management LLC, said CIT popularity is growing, especially in TDFs.

Another advantage of CITs, according to Huxhold, is they are not subject to retail investor reaction. “A number of years ago, a well-known investment manager, who had headed a fund for many years, retired, and when he did, the performance of the retail version of the fund dropped, but the CIT version didn’t,” he explained.

Huxhold noted that previously, onboarding with a CIT was complex and highly customized, so they were mainly adopted by mega plans. However, providers have found ways to simplify and investment minimums have come down, so smaller plan sponsors are able to adopt CITs. He added that they are still not permissible investments for 403(b) plans.

Huxhold warned that there is sometimes a deviation between a CIT and its comparable mutual fund performance, so when selecting CITs, plan sponsors want to check with the provider that returns are in line.

In addition to making sure CIT returns track similarly to their comparable mutual fund returns, plan sponsors should ask what oversight the CIT trustee has and look at whether the CIT is following the same strategy as its corresponding mutual fund and not deviating far from it, Kelly said.

Kelly said smaller plans should keep an eye on the threshold for when they will be able to switch to the CIT version of a fund. And plan sponsors shouldn’t necessarily assume a CIT is cheaper than the mutual fund version if the mutual fund version has revenue sharing that gets rebated, she added.

Customized Investments

According to Huxhold, there is not a high demand for customized TDFs, although asset managers and plan sponsors are interested in how to provide a more customized benefit. “There are tools now that will take a handful of data points about participants to customize investment portfolios, but they are usually used for managed accounts—asset managers haven’t yet figured out how to translate them to TDFs,” he said.

Marinescu said custom TDFs make sense for large plan sponsors with their own investment committees and perhaps for plan sponsors that offer defined benefit plans, which would mean allocations should be different for their participants than the allocations in off-the-shelf funds.

Morningstar believes in the value of personalized advice, Marinescu said. He told conference attendees that available data from recordkeepers show that participants who are using managed accounts save 2% more on average for retirement.

“Plan sponsors need to do more than regular due diligence on managed account performance; they should look at the overall advice participants are getting,” Marinescu added. “For individuals with complicated financial situations or assets in other accounts, advice has value.”

Kelly said Compass Financial Partners believes managed accounts could be a valuable option alongside a TDF, but participants should not be defaulted into managed accounts because of their higher fees. “The benefit of managed accounts is realized when participants are willing to input data for full customization of investment allocations,” she said.

Some recordkeepers have just a single managed account option on their platform, but others have multiple solutions available, and “in the latter case, we do an RFI to select” the managed account, Kelly added. She said if a recordkeeper just puts a managed account on the lineup when a plan sponsor onboards with it, that is not a defendable reason to offer a managed account. Plan sponsors need to consider the usage by participants and whether fees are reasonable when they consider the benefits, not just the advice component.

“We do feel some people have complex situations and managed accounts would be a viable solution,” Kelly said. “We track what percentage of users of managed accounts that are paying these additional fees are optimizing customization.”

A Note About Inflation

On a final note, Kelly said that when Compass Financial Partners looks at the overall DC plan investment menu construction, it goes through a solid TDF selection process and includes a solid core lineup of actively managed funds and a suite of indexed strategies. “Beyond that, about seven or eight years ago, we started implementing real asset strategies with clients,” she said. “With TIPS [Treasury inflation-protected securities], REITs [real estate investment trusts] and commodities, we use a single fund-of-funds approach. The objective is inflation hedging. Many TDFs have real assets in their underlying strategies, so with this approach, participants have options to create their own strategy.”

Marinescu said that as inflation stays high, participants will reconsider their portfolios to hedge inflation. They’ll consider TIPS but also which asset classes will perform better in an inflationary environment. He said commodities are good for hedging inflation.

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