(b)lines Ask the Experts – Mandatory Contributions vs. Automatic Enrollment
November 12, 2013
(PLANSPONSOR (b)lines) – “I hear all of this discussion regarding
automatic enrollment, but our 403(b) plan already has a mandatory contribution
that is a condition of plan participation.
“If the participant
fails to make the mandatory contribution at time of initial eligibility, he/she
may never participate in the plan and receive the plan’s employer contribution.
Isn’t this just another form of automatic enrollment?”
Michael A. Webb, Vice President, Retirement Plan Services, Cammack LaRhette
Consulting,
answers:
Mandatory
contributions, which have been in place for some 403(b) plans for many years,
particularly in the higher education sector, require employees to contribute as
either a) a condition of employment, or b) pursuant to a one-time irrevocable
election as to whether to participate in the plan (the scenario you describe in
your question). Automatic enrollment, on the other hand, is neither a condition
of employment nor is a condition of plan participation. Though employees are
automatically enrolled in the plan with a certain percentage of employee
contribution, the employee may opt out of the arrangement, and this ability to
opt out does not affect the employee’s ability to participate in the plan in
the future. The employee can simply resume salary deferrals at a later date,
with no impact on employer contributions (except of course, if there is a
matching contribution, such contributions would only be made for the period
that employee deferrals are made to the plan).
Another
key difference between automatic enrollment and a mandatory contribution
formula is the tax treatment of contributions that are made by the employee.
Under a mandatory contribution formula, the employee contribution is NOT
treated as an elective deferral that is subject to the 402(g) limit. Thus, if
an employee is required to make a 5% employee contribution, such an employee
may make the 5% mandatory contribution AND contribute up to the 402(g) limit
($17,500 in 2013, $23,000 if age 50 or older). The 5% contribution does not
reduce the employee’s elective deferral limit in any way; it is a contribution
that may be made in addition to the elective deferral limit. It should be
noted, however, that although the contributions are not considered to be
elective deferrals for 402(g) limit purposes, they remain subject to FICA
withholding.
However,
contributions under an automatic enrollment scenario, though required under the
plan, do count toward the 402(g) elective deferral limit, so automatic
enrollment does not provide the opportunity for employee contributions in
excess of the 402(g) limit.
The
Experts hope this response will provide clarification of the distinction
between mandatory contributions and contributions under an automatic enrollment
scenario. We thank you and all of our other readers for their continued
thought-provoking questions!
NOTE:
This feature is to provide general information only, does not constitute
legal advice, and cannot be used or substituted for legal or tax advice.
November
11, 2013 (PLANSPONSOR.com) – Canadian plan sponsors
are taking steps to address challenges facing their defined benefit (DB)
retirement plans.
Aon Hewitt, a provider of human resource solutions, has released
the Canadian findings of its 2013 Global Pension Risk Survey, which found a majority of Canadian plan sponsors
are:
Managing risk in their DB plans with strategies
increasingly grounded in long-term planning;
Establishing clear, long-term goals that are monitored
and measured as standard practice;
Paying closer attention to plan funding and viewing
performance as critical; and
Actively managing investment strategies with a focus on
liabilities and are paying increased attention to diversification and
alternative investments such as real estate.
“For most plan sponsors, the pain of the last few years has
led to a greater awareness of the risks faced by their DB pension plans. There
is heightened interest in how these risks should be managed and possibly
de-risked regardless of an organization’s long term commitment to a DB plan,”
said Will da Silva, senior partner, Canadian Retirement Consulting at Aon
Hewitt, Toronto. “Simply following the herd in setting investment and funding
policy is no longer the standard. To survive, pension plans must be affordable
for their sponsors, and appropriate risk management is one way to manage this
goal.”
Plans in different sectors are using different approaches
when they see a need to change benefits.
The private sector plans are more likely to make
fundamental changes to participant benefits. Many Canadian plan sponsors have
already closed or intend to close plans to new participants, freeze accruals
for existing participants and/or switch to a pension structure where more of
the risks are borne by plan participants. Seventy-five percent of plans where
the plan sponsor is publicly traded have already closed at least one plan to
new participants, and 15% are looking to freeze their plan in the near future.
On the other hand, there is a strong commitment to DB plans
in the public sector. Plan sponsors are more likely to look for adjustments to
benefits or cost structures that maintain the form of the benefit, but at a
level that is more manageable for plan sponsors. Many plan sponsors are looking
at ways to make the underlying benefit less costly and the vast majority are
contemplating further cost sharing with participants. Specifically, 71% of
public sector plans are considering additional participant contributions, while
about one-third are looking to reducing ancillary/discretionary benefits or
reduce/eliminate indexing.
The survey results indicate there is considerable
interest by plan sponsors (43%) in finding out more about the “target benefit
plan” concept, although it is a relatively new way to manage many of the risks
inherent in traditional DB plans and defined contribution plans and legislation
is still outstanding in most jurisdictions.
Solvency and Funding
Survey results show most DB plan sponsors are employing
a cautious combination of passive and active measures to meet funding
obligations. There is an encouraging trend toward investment diversification
and de-risking practice, though many continue to rely on passive measures such
as interest rate increases to boost their funding position.
Letters of credit continue to be underutilized, despite
being useful in some cases for managing short-term contribution volatility.
Letters of credit can be used to satisfy solvency funding requirements by
securing funding obligations rather than making cash contributions. Specifically,
19% have already posted a letter of credit, and 22% intend to do so in the
future.
Annuities and Longevity
As well as having choices in managing benefits, survey
results indicate plan sponsors have an increasing array of tools that
can be used to manage plan liabilities. Annuity options are increasingly
marketed by insurance providers and are popular in other parts of the world.
The popularity of annuities in Canada can be expected to grow given the private
sector trend toward plan closures and freezes. Annuity purchases can reduce
pension liability by transferring some or all of a plan's benefit obligations
to an insurance carrier. They can be used by plan sponsors wanting to exit the
DB business, and also by those wanting to de-leverage an ongoing plan.
Similarly, insuring the “longevity risk” of a
plan is becoming of interest to sponsors in Canada. Sixteen percent of plan
sponsors are very or somewhat likely to consider a buy-in, and another 11% are considering
a buy-out. Sixty-five percent of organizations are now concerned with longevity
risk in their plans, and 28% are open to exploring ways to hedge longevity
risk.
De-Risking and Alternative Investments
The survey results reveal a growing awareness of the risk
pension plans face and the steps that are required by plan sponsors to mitigate
that risk. Specifically, 37% of plan sponsors say low-risk targets are part of
their long-term strategy, while 40% are interested in hedging risk related to
interest rates, and 22% are planning to increase allocation to long bonds to
better match their plan’s liabilities.
Investment strategy continues to be targeted towards greater
diversification of portfolios. Diversifying out of Canadian equities and into
alternative asset categories and foreign equities has been a trend for several
years now, according to the survey results.
Last year, 33% of plan sponsors reduced Canadian
equity holdings and 30% will continue this trend into next year. Also, more
than 30% of plans are already increasing or planning to increase allocations to
alternatives.
Monitoring Risk and Thinking Long Term
The growing focus on risk may well be the catalyst for the
dramatic growth in monitoring practices as years of discussion are finally
transformed into actionable strategy, according to the survey results.
Recognition of the need for pension plan sustainability, supported by long-term
goals and strategic planning to support robust, reduced-risk plans, is gaining
momentum. Plan sponsors are not only mindful of the need for long-term
planning, but that plans are also focused on achieving established and
measurable goals.
To that end, 78% of DB plan sponsors are monitoring pension
plan assets and liabilities on a regular basis, and 84% of plan sponsors say
they have a long-term plan in place.
“Successful plan management can no longer be considered a
passive exercise. It requires careful attention to long-term funding and
investment strategy and a disciplined focus on adapting the strategy to take
advantage of opportunities that may arise,” da Silva said. “Active pension plan
management, with a focus on how the assets and liabilities interact, is key
with individualized strategies, including de-risking practices, becoming ‘the
new normal’ for Canadian plan sponsors.”
One hundred and thirty-nine Canadian pension plans participated in the 2013 Aon Hewitt Global Pension Risk Survey - Canada, representing more than $250 billion of assets and two million participants,
from a broad cross-section of organizations.