September 3, 2014 (PLANSPONSOR.com) - The aggregate funded ratio for U.S. corporate pension plans fell to 85.5% for the month of August 2014, according to Wilshire Consulting.
The
decrease in funding was the result of lower corporate bond yields increasing
the liability value versus a smaller increase in the asset value. “We estimate
that overall, the asset value increased by 2.2% due to positive returns for
most asset classes, while the liability value increased by 2.9% during the
month,” says Jeff Leonard, managing director of Wilshire Associates and head of
the Actuarial Services Group of Wilshire Consulting.
“Year-to-date,
the funded ratio for the sample plan has decreased by 4.3%, from 89.8 percent to
85.5%. This decrease was driven by the larger increase in liability value of
12.4% versus the 6.9% increase in asset value,” Leonard notes.
The aggregate figures
represent an estimate of the combined assets and liabilities of corporate
pension plans sponsored by S&P 500 companies with a duration in-line with
the Citi Group Pension Liability Index (CPLI) – Intermediate. The funded ratio developed in the analysis is
based on the CPLI – Intermediate liability, plus service costs, benefit payments
and contributions in-line with Wilshire’s 2014 corporate funding study. The
most current month-end liability growth is estimated using the Barclays Long
Aa+ U.S. Corporate Index. The assumed asset allocation is: U.S. Equity-33%; Non-U.S.
Equity-22%; Core Fixed Income-17%; Long Duration Fixed Income-26%; and Real
Estate-2%.
September 3, 2014 (PLANSPONSOR.com) – The rule for who is eligible to diversify company stock holdings in a retirement plan is simple, but examining the criteria for eligibility can be complicated, says a white paper from the Principal Financial Group.
Every
year, an employee stock ownership plan (ESOP) must offer eligible participants a
chance to diversify, or sell off some of the stock. A qualified participant is
an employee age 55 who has completed at least 10 years of participation in the
ESOP, or who has met other requirements.
Overall,
plans with an ESOP are in the minority (4%), but that percentage grows with the
size of plan assets. According to PLANSPONSOR’s 2014 Plan Benchmarking Report, about 13% of plans with more than $1 billion in assets offer an ESOP.
“ESOP Diversification Requirements,” a white paper from the
Principal Financial Group, gives an overview of eligibility and what is
required of plan sponsors.
Eligible
participants have the right to elect to diversify up to 25% of the company
stock in their accounts for five years after meeting the eligibility
requirements, says John Prodoehl, vice president of consulting at
Principal Financial Group in Kaukauna, Wisconsin, and one of the paper’s
authors. “In
the final election, the sixth year, they may elect to diversify up to 50% of their
company stock,” he tells PLANSPONSOR.
A
key issue is how to measure years of participation, Prodoehl says. Do
years of plan participation include all plan years in which a participant had
an account balance, or does it only refer to plan years in which a participant
is eligible for contributions and forfeitures? What if an employee was
terminated and has deferred, vested benefits under the ESOP?
The Tax Reform Act of 1986 instituted the requirement for diversification.
In a 2009 memorandum from the internal Revenue Service (IRS), the definition
for a year of participation has a few options. It can mean a year in which a participant
has an account balance in the ESOP. It does not mean the participant must be
employed, or complete a stated number of hours of service, or be eligible for a
contribution to be credited with that year of participation.
Some plans can have more restrictive language that defines
participation for the purpose of ESOP diversification, and the plan sponsor may also choose to amend the language to be
less restrictive. However, the opposite is not true. A less-restrictive plan
cannot put in language to make the definition more
restrictive.
Instead of years of participation, a plan can measure
eligibility by years of service: but not more than 1,000 hours, according to
the IRS guidance. A participant who leaves employment after 10 years of participation
but before age 55, will be eligible for diversification upon reaching age 55.
One
way to measure years of participation for the purpose of ESOP diversification is to mirror the plan’s definition of
vesting years of service, Prodoehl says. When the documents are drafted, he
recommends, attorneys should specify exactly what is meant by “year of
participation” so the plan can be precise about how participation years are
being tracked. “It helps the plan sponsor to avoid missing someone who should
have been eligible [to diversify company stock], and not operating the plan according to its terms,” he
explains.
Another key point is how plan sponsors can satisfy the
requirements for diversification without incurring a lot of additional costs, Prodoehl
says. A common best practice
is using the company’s 401(k) plan to accept the funds that are elected to be
diversified. “The plan sponsor can use the 401(k) chassis to offer up the
various investment options,” he explains, “versus having to establish that
investment lineup and recordkeeping platform within the ESOP which is not a
participant-directed plan.”
In
other words, the plan sponsor that chooses to build this part into the ESOP
would find it cumbersome and costly, he says. “Why not use the 401(k)?” Prodoehl
says. “It’s legal." According to Prodoehl, the law also states that the plan sponsor can distribute the money directly to
participants, who can pay taxes. Or, he says, participants can roll the
distribution into their own individual retirement account (IRA).
But, the plan can also outline a process to
establish these investments as an automated plan-to-plan transfer. “It depends
on the plan sponsor’s attitude toward retirement planning,” Prodoehl says, “If they
want to protect that money as much as possible they will transfer to 401(k) plan.”
This option would spare the participant having to pay taxes.
“Typically,
the plan sponsor will notify the eligible participants by mailing a notice to
them explaining their right to diversify and explaining the rules, the timing
and how to make their elections,” Prodoehl says. “They must be offered at least three
different investment alternatives with three different levels of risk. If they’re
transferring into a 401(k) plan, odds are most plans have that criteria already
satisfied.
Another
advantage to using the 401(k): those participants who want to diversify but do
not pick new investments can be placed in the plan’s qualified default
investment alternative (QDIA), Prodoehl adds. “The 401(k) plan’s QDIA will come into
play just as it would for any other monies in the 401(k) plan where the
participant fails to direct the investment,” he explains.
Imposing an early withdrawal penalty on participants that take a distribution seems odd to Prodoehl. “The IRS requires the
plan sponsor to offer this to participants at age 55, but if it is processed as
a distribution and the person doesn’t roll it over, they’re going to have pay a
penalty,” he says. “There is no exclusion for [ESOP] diversification from [the early withdrawal penalty] rule.”
The only way around it is to roll the distribution into a 401(k) or IRA until
the participant is 59-1/2. “It couldcatch people. They think it’s a right they have, and
they shouldn’t be penalized for early withdrawal—but they could be.”
No
matter which option the plan sponsor chooses, the company is going to have to
come up with the cash to liquidate those shares, Prodoehl points out. The
best plan is for the company to look forward a couple of years to determine
their list of eligible employees, and what its maximum exposure would be from a
cash standpoint. “This way, it’s not a surprise when they have to offer it, and
it’s a big number and they haven’t planned for it,” he says. “You don’t know
what people are going to elect to do, but you know when it will happen and what
the maximum amount could be, so you can prepare for it.”
More
information, such as diversification examples and different compliance time
frames, are detailed in “ESOP Diversification Requirements,” which can be
downloaded from The
Principal’s site.