Benefits June 9, 2017

A Closer Look at Plan Health

Diagnosing key components of plan health and embracing proactive administration are crucial in ensuring retirement readiness for all participants. 

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As defined benefit (DB) plans shrink in number and the future of Social Security benefits dips further into uncertainty, defined contribution (DC) plans and individual retirement accounts (IRAs) are becoming the primary tools driving America’s retirement security.

However, many Americans are behind on retirement readiness. More than half (52%) of households are at risk of not being able to maintain their standard of living in retirement, according to a recent study by Prudential and the Center for Retirement Research at Boston College (CRR).

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And with a heightened scrutiny on fees and fiduciary responsibility, it’s becoming increasingly important for plan sponsors to ensure their participants’ retirement readiness and maintain a healthy plan.

Sean McLaughlin, senior vice president, head of client relations and business development, Prudential Retirement, tells PLANSPONSOR that a major component to any healthy plan is “the right plan design for your participants.”

Features such as auto-enrollment have been among the biggest drivers of higher participation, according to Wells Fargo’s study “Driving Plan Health 2016.” Still, the Plan Sponsor Council of America (PSCA) found that the most common auto-enrollment salary deferral rate is 3% of pay. “We recommend closer to 6%,” says McLaughlin.

While some sponsors may fear this would reduce participation rates, volumes of evidence suggests otherwise.

Wells Fargo’s data indicates that plans which have auto-enrolled participants at a deferral rate of 6% averaged 87% participation rates. The figure is 83% for those that auto-enrolled at 3%. The firm also notes that opt-out rates “do not vary substantially from lower to higher default deferral rates,” and that plans with lower default deferral rates naturally have overall lower average deferral rates.

NEXT: Plan design and plan health 

Furthermore, the PSCA found only 65% of plans with auto-enrollment utilize auto-escalation. McLaughlin suggests auto-escalation of 1% annually up to 10%, “or more if the employee population can save more.”

Auto features are so important to a healthy plan because otherwise a whole lot of people will never take the necessary action to enroll themselves, even if they like the idea of saving, warns Zane Dalal, executive vice president at Benefit Programs Administration (BPA). “Let’s say you get into a 401(k) in your 20s, and by the time you’re ready to retire, you can have $1 million. If you were not clear about this in your 20s and decide to start contributing in your 30s, you’d only have about $630,000. It’s a huge disadvantage.”

McLaughlin suggests plan sponsors “auto-enroll until people give up and they’re in the plan. Do it on an annual basis, reenrolling the entire eligible population.”

A company match can also go a long way, even without auto-enrollment. The Wells Fargo’s data indicates that for plans without auto-enrollment, the average participation rates were higher for those with the larger matches. Plans with matches up to 3% averaged 48.7% participation. Plans with matches between 6% and 9% averaged 64.6% participation.

But regardless of how much money employees defer, what matters most is where that money goes.

NEXT: choosing the right investments

Alleged excessive fees have been central to plenty of the current litigation surrounding the DC space. Thus, to have a healthy plan, sponsors have to maintain a cautious eye when selecting investments for their qualified default invest alternatives (QDIAs), and understand the different share classes available across the entire core menu.

This decision can and should rely heavily on employee demographics. Target-date funds (TDFs) and managed accounts offer the advantage of letting participants hand over investment management to professionals. And while TDFs currently dominate the DC space, they can vary widely based on provider.

Prudential’s paper notes that “sponsors should consider how well a target-date fund’s characteristics align with the demographics of the plan. The glide path design should address the right risks at the right time—target date funds need to be aggressive enough to address longevity challenges while not over-exposing participants to market risk near retirement.”

And while basic demographics tell a sponsor a lot about participants’ risk tolerance, other factors should also be used to dig deeper. The job itself can play a significant role in how an employee saves.

“Different industries have different expected return and profit levels, which makes more or less money available to invest in a retirement program for employees,” says McLaughlin. “Industry matters a lot, and it has to be factored into plan design. Sponsors need to speak specifically with advisers, providers and stakeholders to discuss their needs as an organization and where they are in their lifecycle, whether it be a start up with limited cash or a large and very successful firm.”

This, along with fund performance and costs, are some of the main points to consider when selecting a fund lineup. Choosing the right options could not only attract and retain the best talent, but also provide the right amount of turnover.

NEXT: Helping participants retire on time

“One of the challenges that has been much more common since the financial crisis has been workers not retiring at a ‘normal’ retirement age, and sticking out longer than employers may have planned,” explains McLaughlin. Research sponsored by Prudential notes that a one-year delay in retirement may result in incremental workforce costs of 1% to 1.5% annually.

McLaughlin suggests that one way to address this issue, along with the fear among participants of outliving their assets, is to incorporate an in-plan guaranteed lifetime income (GLI) product.

He alludes that even if a participant has enough assets to feel retirement ready by the time he reaches that milestone, the drawdown phase poses another challenge. “How does he take that money as income? Most folks don’t have expertise around that. So, having an in-plan income option is really helpful.”

Prudential also notes that GLI may serve as a backdrop for participants in the event that a severe market downturn impedes retirement readiness. One of the firm’s recent surveys finds that 53% of financial executives believe participants will engage in less risky behavior—like getting out of investments at the wrong time—if they are invested in some kind of GLI product.

“The biggest mistake you can make is jumping in and out of the market,” says BPA’s Dalal. “It’s the biggest killer in the investment world.”

Choosing the best fund lineup would help plan sponsors meet their fiduciary responsibilities and comply with various regulators in the DC space. In this realm, it’s also important to leverage support from all parties involved in the plan.

“Consultative regulatory services can help plan sponsors navigate the complexity of having a DC plan,” McLaughlin concludes. “They can look at plan documents, plan design and all of the different elements that tie back to regulation before making a set of recommendations.”

But even solid plan design and a strong investment lineup will fail to reach the plans’ full potential if participants aren’t utilizing the plan properly. Education is key to driving engagement. Many tools can boost engagement and help participants think of retirement as a piece to overall financial wellness. And these can be integrated with the existing benefits package to control costs. 

The “Driving Plan Health – 2016” report can be found at WellsFargoMedia.com.

“The Power of Plan Wellness” document can be found at Prudential.com. 

Compliance June 9, 2017

PSNC 2017: Fixing Your Mistakes—Correcting the Most Common Plan Errors

What errors do plan sponsors make most often, and what programs are available to fix them?
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No one is perfect, not even plan sponsors. Mistakes will be made.

Speaking at the 2017 PLANSPONSOR National Conference, in Washington, D.C., Tami Guimelli, assistant vice president, Employee Retirement Income Security Act (ERISA) attorney, benefits consulting group at John Hancock Retirement Plan Services, discussed common plan mistakes and how to navigate the regulators’ various correction programs.

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Guimelli explained that the self-correction program (SCP) is part of the Internal Revenue Service (IRS)’ Employee Plans Compliance Resolution System (EPCRS) and allows plan sponsors to correct operational plan failures. The voluntary correction program (VCP) covers operational failures, but also demographic failures and plan document failures.

There is a fee involved with the VCP. Plan sponsors file a formal submission process and pay a per-participant fee. Guimelli said the IRS will review the plan sponsor’s proposed correction and, hopefully, approve it and send the sponsor a compliance letter. The sponsor will have 150 days to fix the error.

The closing agreement program (CAP) is the most expensive IRS correction program, but sometimes the fee can be negotiated down. An error that would require the CAP could be one the IRS finds during an examination of the plan; it would disqualify the plan and make it and participant contributions subject to taxation.

Guimelli noted it is easier to fix a problem before the IRS finds it.

There is a difference between a significant and insignificant failure. Guimelli explained that the determination is based on facts and circumstances—whether it is a one-time or recurring error, how many participants it affects, how much in plan assets is affected, and how long the error has existed. She said, if the error has been going on for two years or less, it could be considered insignificant. If it is insignificant, it can be fixed at any time, even if the plan is under audit.

If the error is significant, though, the plan sponsor must correct it no later than the end of the second plan year following the failure. For example, Guimelli said, if a plan failed actual deferral percentage and actual contribution percentage (ADP/ACP) testing and didn’t fix the testing failure by the end of the following year, that’s when the two-year-period correction program under the IRS EPCRS would start.

NEXT: Common plan errors

Elective deferral failures are common in defined contribution (DC) plans, Guimelli told conference attendees. For instance, a participant’s deferrals weren’t started, a participant wasn’t informed of eligibility to defer, or deferrals started at the wrong rate. She said, under new guidance, if the plan is an automatic enrollment plan and a participant’s deferral was missed or started at the wrong amount, and if the error was discovered within 9½ months after the year of failure, the plan sponsor may correct it under the VSP.

Guimelli explained that, before, the plan sponsor would have had to restore missed contributions to the participant’s account, but under the new guidance the sponsor has to restore only the missed employer match on deferrals plus earnings, and it can use the return ratio of the default investment in the plan to calculate earnings. If the error is discovered after 9½ months, the employer may correct within a two-year period, but the plan sponsor needs to make a 25%-of-salary qualified nonelective contribution (QNEC) to compensate for the missed deferral. If the error isn’t corrected within the two-year period, the QNEC becomes 50%.

For plans not using auto-enrollment, the error can be corrected within three months by contributing the missed match plus earnings. If after three months, but within two years, the plan sponsor must also make a 25% QNEC. If after two years, the QNEC rises to 50%.

The plan sponsor must provide a notice to participants affected by such errors, saying the correct deferral wasn’t implemented on time but the plan sponsor has restored the missed match with earnings to the account and started elective deferrals, Guimelli said. The notice must also provide the participant with the phone number of someone to contact, with any questions.

“The goal of all corrections is to put participants in the position they would have been in if the error wasn’t made at all,” Guimelli said.

Other than enrollment errors, Guimelli said, other common errors are:

  • The vesting was wrong on a participant’s account, and it wasn’t discovered until after a distribution was made;
  • The matching contribution changed, but it wasn’t communicated, so the wrong match was made. If the error is that the plan sponsor failed to make an employer contribution, the VCP should be used, and if the wrong amount was applied to a participant’s account, the SCP should be used; and
  • The wrong definition of compensation was used, resulting in an excess deferral by the participant. In that case, the plan sponsor should return the excess to the participant and forfeit the match.

According to Guimelli, a less frequent error is allowing an employee to defer before he is eligible. In that case, the plan sponsor may make a retroactive plan amendment to allow the employee to participate. “The same can be true if the plan sponsor permitted a hardship withdrawal or loan and didn’t have a hardship or loan provision in the plan,” she said.

NEXT: Errors under the DOL correction program and helpful tips

According to Guimelli, the late deposit of contributions or loan repayments falls under the Department of Labor (DOL)’s voluntary fiduciary correction program (VFCP) because it is a fiduciary breach. Anything that is a fiduciary breach, such as misuse of plan assets, falls under this program.

One common error the DOL focuses on is remittance of contributions and loan repayments within a less than reasonable time period. Guimelli warns that if you have always remitted within five days, you may not switch to seven days.

Sometimes this is outside the plan sponsor’s control, so she suggests that plan sponsors have good procedures and open communication, also that they check with the payroll provider to see when contributions and loan repayments will be deposited.

Guimelli offered these additional helpful suggestions:

  • Identify what type of mistake was made and which program can be used to correct it;
  • Review the plan document and procedures on an annual basis. Make sure you are operating correctly per the document, and check to see if there was an amendment and whether it was circulated to everyone, including your payroll provider and recordkeeper; and
  • Have formal procedures in place.

Guimelli stresses that set procedures are important if someone else needs to take on the job and must get up to speed quickly. Also, if a plan sponsor uses a correction program or if the sponsor is audited, it must show there are procedures in place. If a significant failure has occurred and the plan sponsor is involved in an IRS audit, such procedures will help, she said.

“Don’t be afraid to find mistakes and correct them. The IRS really wants people to correct their plans and not have to disqualify the plan. The Revenue Procedure regarding corrections is long, but you will be able to find your particular error and correct it,” Guimelli concluded.

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