Compliance April 16, 2014

Amending Retirement Plans for New 'Spouse' Definition

April 16, 2014 (PLANSPONSOR.com) – Sponsors of both defined benefit (DB) and defined contribution (DC) retirement plans will need to review plan documents to ensure the definition of “spouse” conforms to current federal law.
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The recent release of Internal Revenue Service (IRS) Notice 2014-19 gives plan sponsors guidance for making sure language relating to spouses includes same-gender spouses as per the June 2013 Supreme Court decision in United States v. Windsor (see “Not All Retirement Plans Must Be Amended for Windsor”).

IRS Notice 2014-19 provides that retirement plans must recognize the marriages of same-gender couples as of June 26, 2013, the date of the Windsor decision. Plans are not required to change operations for events prior to that date, but retroactive application is permitted, if applicable qualification requirements are not jeopardized.

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Anne Waidmann, director of PwC’s Human Resource Services, tells PLANSPONSOR, “It’s very helpful to DC plan sponsors in that it didn’t retroactively disqualify plans, since these plans were acting in compliance with then-current federal law. If retroactive disqualification had been enacted, it would’ve been extremely costly and difficult to recover payouts, especially since most employers would not have maintained plan-related records on same-sex spouses or domestic partners.”

As to the impact of the limited retroactive application on defined benefit plans, Joanne Jacobson, a principal with Buck Consultants tells PLANSPONSOR, “The limited retroactive application of the Windsor decision makes it easier for plan sponsors to achieve document compliance and ensure operational compliance.”

Notice 2014-19 calls for a retirement plan to be amended if its plan provisions are inconsistent with the Windsor decision—if it defines “spouse” by reference to Section 3 of the Defense of Marriage Act (DOMA) or only as between people of opposite genders.

Waidmann says, “Plan sponsors need to look at their plan documents and specifically at how they have the term ‘spouse’ defined. If a definition still makes reference to DOMA, then it definitely needs to be amended. However, if the language defines the term as ‘a spouse under federal law,’ that’s fine, and no amendment is required.” She says the deadline of December 31 should give plan sponsors enough time to carry out the process.

Jacobson adds: “Others also believe that even plans with only the word ‘spouse’ should be amended to clarify that spouse must include same-sex spouses. Many suggest amending the plan to read ‘spouse under federal law’ or ‘spouse, including same-sex spouses.’” She recommends plan sponsors have their legal counsel review Notice 2014-19 and have them specify and approve the final language to be used for the definitions.

The Washington, D.C.-based Waidmann says if defined contribution plan sponsors do need to amend their plans, the plan documents usually specify the methods by which this is achieved, be it through a plan committee or other means. Regardless of the plan-specific procedures for amendments, says Waidmann, plan sponsors need to remember to not only notify their recordkeepers of these changes to the plan, but also to communicate them clearly to participants. PwC published an analysis of the IRS notice— “Same-Sex Marriage Recognition Has Limited Retroactive Impact on Qualified Retirement Plans.”

Jacobson, also based in Washington, says, “In terms of amendments, the notice will affect defined benefit plans more than defined contribution plans, since defined benefit plans are more likely to require amendments to reflect a plans sponsor’s choice to apply the rules under the Windsor decision, prior to June 26, 2013, with respect to survivor annuities.” Buck Consultants released an analysis on the topic, “IRS Windsor Guidance Limits Retroactivity for Retirement Plans,” which Jacobson co-authored.

She clarifies, “Many plans do not define the terms ‘spouse’ or ‘legally married spouse’ any further and do not require amendments in this regard. Plans with choice of law provisions in states that do not recognize same-sex marriages, however, may need to be amended so as not to conflict with Windsor.”

Typically, she says, plan amendments are made by plan sponsors or their delegates, such as a benefits committee. “Plan sponsors should review their plan terms for compliance with the Windsor decision. If an amendment is required, it can be adopted by the committee at the next quarterly meeting or by consent resolution. Similarly, if a plan sponsor chooses to apply the rules prior to June 26, 2013, then it must also adopt conforming amendments. In that case, the sponsor must determine the effective date of the elective amendment and work with the recordkeeper in preparing communications with the participants and in determining who is affected by the amendment.”

Jacobson adds that plan operations must be reviewed to make sure they are consistent with the retroactive amendment. For example, if the plan sponsor decides to apply the rules prior to June 26, then if a participant in a same-sex marriage elected a single life annuity, the plan sponsor may provide the participant with the option to revise his or her election to a joint and survivor annuity. If the participant does not revise his or her election, then the plan sponsor must ensure that consent of the spouse to the life annuity is received.

Products April 16, 2014

Schwab Makes the Case for Open-Architecture TDFs

April 16, 2014 (PLANSPONSOR.com) – Charles Schwab Investment Management introduced a new unit class for its Schwab Managed Retirement Trust Funds (SMRT Funds) with a lower 35-basis-point operating expense ratio.
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Jake Gilliam, managing director and senior portfolio manager at Charles Schwab Investment Management, tells PLANSPONSOR the SMRT Funds are collective investment trust (CIT) arrangements offered exclusively to qualified retirement plans. Beginning July 1, the new unit class will be available to retirement plans with $300 million or more in SMRT Fund assets.

Gilliam says Schwab uses the SMRT collective trust vehicles to deliver more customized and cost-effective target-date solutions to large retirement plans—especially those looking to break away from proprietary approaches to target-date investing. He explains target-date funds (TDFs) built through the SMRT Fund trusts feature an open-architecture approach and a wide array of choices in investment funds and strategies, all at a good value for participants.

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“If you look at the average target-date product, it’s about 70 basis points to 90 basis points in expenses depending on the different class of fund you’re looking at and what the target date actually is,” Gilliam says. “So we feel the expense ratio of the SMRT Funds is obviously a strong differentiator.”

But it’s the open-architecture approach that really sets the SMRT Fund methodology apart, Gilliam says.

“We go out and hire best-in-class asset managers and pair them together to really build an institutional-type product that is looking across the whole investment universe to build a target-date portfolio,” he explains. “Like a DC consultant would construct a core menu working with a large plan, we do the same thing for our TDFs. It’s purely unbiased and constructed according to the best interest of the end investor.”

Gilliam contrasts the open-architecture approach with the “proprietary method,” through which investment shops build TDFs only using their own funds and managers. The open approach allows for freer choice for which particular funds will fulfill specific roles in the TDF—reducing the potential impact of commissions and other fees and ultimately driving down expense ratios compared with proprietary products, Gilliam says.

The open-architecture approach to TDF portfolio-building also helps prevent “groupthink,” Gilliam says.

“We’re looking to find best-in-class managers in each asset class, and then we pair them together in a way that diversifies the return stream and doesn’t overly rely on one shop or one method of thinking to run the TDF,” he explains. “So the appeal here is diversification not only of asset classes but also diversity of thought, which means better diversification in the holdings the end-participants will have. That should lead to a smoother ride and a better volatility pattern for the investor.”

Gilliam says the open-architecture approach also allows for more sophisticated glide paths. Asked whether the SMRT Fund trust TDFs should be thought of as an active or passive investment product, Gilliam says the answer is “none of the above.”

“They’re actually both active and passive,” he says. “We’ve learned that people view risks in TDFs according to a couple different common dimensions. They want to know if it’s active or passive, and they want to know about the glide path and the equity versus fixed-income exposures through time. But the real matter of analyzing a target-date fund’s investment philosophy is much more complex than those two factors.”

He says the SMRT Fund TDFs are tailored to not just change their equity and fixed-income exposures over time, but also to shift the levels of active management and passive indexing included in the portfolio depending on market considerations and evolving participant needs.

“To us, an 85-year-old investor who has long been in retirement should not have the same level of active management in the portfolio as a 25-year-old just starting out, so we build our funds to address that,” Gilliam explains. “It’s a more sophisticated way to approach risk than a lot of the off-the-shelf products that you see.”

When it comes to the other most common method of categorizing TDFs—“to-retirement” versus “through-retirement”—Gilliams says the SMRT Funds are probably best classified as “through-funds,” but he says the label is imperfect.

“To versus through is a really simple way to structure the argument, but it misses what a to-fund actually means in terms of volatility in the asset class exposure,” Gilliam says. “When someone hears ‘to-fund,’ they are probably going to assume it’s a more conservative approach because it’s not going to continue to roll down on equities over time. But that’s not always the case.”

Gilliam says it’s not uncommon to see a to-fund glide path land with 40% or 50% in equities—even if it’s designed to be held by retirees late into their life (see “An Argument for To-Retirement TDFs”). On the other hand, it’s also not unheard of to see TDFs that convert entirely or almost entirely to fixed income at the target date.  

“We just don’t agree with either outlook,” Gilliam says. “We know that investors' needs and expectations evolve and life continues to change after retirement. So you have to maintain a balanced approach that benefits the end investor on both longevity risk and investment risk, which is what we strive to do through the more sophisticated approach.”

Like others closely involved in TDF product development and delivery work, Gilliam predicts huge growth for the strategies in coming years and agrees with industry research showing as much as 50% of all 401(k) assets could be held in TDFs by 2020.

Part of making sure the trend is positive for retirement plan participants, Gilliam says, is building better and less costly TDF products.

“We expect that, regardless of how TDFs grow in the coming years, there will be big demand for advice and packaged solutions,” Gilliam says. “For a time we were swinging towards much more employee responsibility for retirement savings, but now I think you’ll see the pendulum is again swinging towards employer stewardship. These TDFs and packaged solutions can be a great middle ground.”

More information about the SMRT Funds is available at https://www.csimfunds.com/.

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