Benefits August 13, 2020

Are Employer-Sponsored DC Plans the Best Retirement Savings Vehicles?

The coronavirus pandemic and other factors have called into question the value of DC plans, but experts say they’re still good savings vehicles.
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Started with the passage of the Revenue Act of 1978, employer-sponsored 401(k) plans have been celebrated among those in the retirement industry for their tax advantages. However, in an op-ed for Bloomberg, Aaron Brown, a former managing director and head of financial market research at AQR Capital Management, contends that the four factors on which the tax advantages of a 401(k) depend have changed dramatically since 1980, to the detriment of 401(k)s. He argues that the tax incentive to save in 401(k)s is diminished.

Brown also suggests in his op-ed that fees eat into 401(k) participants’ returns. And there have been an increasing number of excessive fee lawsuits, against both 401(k) and 403(b) plans, that argue just that.

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In addition, a working paper issued by the Pension Research Council of The Wharton School at the University of Pennsylvania found that investment returns in the coming decades may continue to fall. One researcher the paper cited, who looked into the effects of past European pandemics, predicted that after-effects from the coronavirus outbreak will persist for roughly 40 years.

A 2018 report by the Stanford Center on Longevity found that if workers expect to retire by age 65, they must aim to allocate 10% to 17% of their salary to a retirement account annually, beginning at 25 years old. As the average employer match stretched to 4.7% last year, according to Fidelity, that leaves anywhere between 5% to 12% for the employee to cover. Effects of the coronavirus pandemic have revealed the precarious financial situation many employees are in and calls into question whether this amount of savings is feasible for them.

Provisions in the Coronavirus Aid, Relief and Economic Security (CARES) Act grant employees access to their defined contribution (DC) plan accounts to address financial needs. Many say this shows employees need to build emergency savings before saving for retirement.

The employer match, if provided, is a great value to DC plan participants. However, during the 2008/2009 financial crisis and the coronavirus pandemic, some plan sponsors reduced or cut their matching contributions due to their own financial troubles.

Still There’s Current and Potential Value in DC Plans

Steve Vernon, a consulting research scholar in the Financial Security Division at the Stanford Center on Longevity says 401(k) and 403(b) plans are still important, if not for their payroll deduction basis, then for many of the features included in these plans. Accessibility to investment advice, recordkeepers and financial wellness education are likely included in most employer-sponsored plans, but not in other retirement savings vehicles, such as individual retirement accounts (IRAs).

IRAs allow participants to fund their retirement on their own accord, providing a tailored solution for those looking to manage their own accounts. Participants can shop around for investment funds and decide fee options. While they provide a soluble alternative for sophisticated individuals, IRAs are a complex tool for the average investor, Vernon says. “An individual will need to shop on their own, and, while that’s not a bad problem, a lot of people don’t know how to shop financially,” he says. Additionally, while 401(k)s are automatically deduced from a paycheck, those with an IRA have to write and send monthly checks to their account.

Robyn Credico, defined contribution consulting leader, North America, Willis Towers Watson, says contribution levels are higher in employer-sponsored plans, such as 401(k)s and 403(b)s, than in IRAs. While limits on traditional and Roth IRAs are capped at $6,000, 401(k) and 403(b) limits are $19,500. “You can actually save more in a 401(k) or a 403(b) than in an IRA,” Credico says.

In its report, “Is your defined contribution plan ready for 2020 and beyond?” Willis Towers Watson notes that DC plan sponsors can address the problem of emergency savings within their plans. “For example, employers can set up after-tax accounts or in-plan Roth sidecar accounts that employees can use to fund emergency savings up to a target threshold (e.g., three months of salary). Employees can then withdraw after-tax dollars to address financial emergencies instead of taking a loan or hardship withdrawal, both of which come with associated repayment requirements and/or unfavorable tax ramifications,” the report says.

The report also suggests that plan sponsors can examine their DC plan investment options and increase diversification to make plan investments work harder and smarter for participants. In addition, it says, “the need for plan sponsors to offer appropriate and flexible spend-down solutions for retirees is now more important than ever.” Willis Towers Watson encourages plan sponsors to look at available retirement income solutions that can help participants balance income needs with growth potential.

On the subject of tax advantages, Vernon recommends employers look at health savings accounts (HSAs) as retirement savings vehicles. If an employer has a high-deductible health plan (HDHP), its employees can contribute to an HSA.

“That actually has better tax advantages than a [DC plan] account, because the money that you put in isn’t taxed, and the money you take out is not taxed. If you’re an employee that is eligible to contribute to an HSA, what you do is contribute to the DC plan first [up to the amount] the employer matches,” he recommends. “Once you max out on those savings, then you switch over to an HSA.”

Compliance August 10, 2020

Recent Acts Will Require Plan Amendments

Retirement plan sponsors will need to be aware of select modifications depending on their plan type, as well as key deadlines to follow.
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Plan modifications brought on by the Coronavirus Aid, Relief and Economic Security (CARES) Act and the Setting Every Community Up for Retirement Enhancement (SECURE) Act mean there could be select changes to plan documents that require amendments.

However, changes differ depending on what type of plan an employer has. There are pre-approved plans that, in the past, have been referred to as either master and prototype (M&P) or volume submitter (VS) plans. According to the IRS, an M&P plan consists of a basic plan document containing non-elective provisions, an adoption agreement with elective provisions that an adopting employer selects, or a trust or custodial account. M&Ps may also be standardized or nonstandardized.

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A VS plan is administered by a VS practitioner—or what’s more commonly called a provider now by the IRS—and may have a sample plan document that offers choices over plan terms, a trust or custodial account, or an adoption agreement with elective provisions.

Typically, the IRS now refers to both M&P and VS plans as “pre-approved plans,” which can be either standardized or nonstandardized.

Tom Meagher, a senior partner and practice leader of Aon’s Legal Consulting & Compliance team, notes that employers using these pre-approved plan types may see an update to their programs, to restate current adoption agreements and plan documents on their systems, in accordance with new regulations brought on by the CARES Act and SECURE Act. Until then, plan recordkeepers are responsible for properly, and timely, administering the provisions intended to apply to the pre-approved plan, he adds.

“Pre-approved plan providers may dictate which changes will apply to their pre-approved documents, or they may provide a choice for adopting employers to consider,” he continues. As an example, Meagher notes that most sponsors of pre-approved defined contribution (DC) plan documents may require adopting employers to incorporate the extension of the required minimum distribution (RMD) date to the April 1 following attainment of age 72 for participants who had not reached 70.5 before 2020.

Providers of the prototype plan will generate an amendment automatically, and then roll it out to adopting employers and other third parties for review, says Rachel Smith, an attorney at Goodwin Law. “The document provider answers any questions they may have—and usually recommends an attorney review it—and then they give the plan sponsor a deadline by which the document needs to be returned,” she says.

Due to these changes, the IRS has issued pre-approved plan language relating to RMDs specifically for pre-approved DC plans. This includes language designed for basic plan documents or for an adoption agreement to allow employers to select among options related to the application of the basic plan document provision, Meagher says.

Individually Drafted Plans

Individually designed documents are for retirement plans drafted specifically for one employer and are crafted exclusively for the plan. Companies will implement these plans if they have a unique employee population with a distinctive benefit or composition structure, explains Smith. With such a plan, employers may work with an adviser or an ERISA [Employee Retirement Income Security Act] attorney to keep informed on current law, and to make changes necessary and appropriate to preserve qualification status. An ERISA attorney would work with clients to implement the deadline and understand the client’s approval process, especially with end-of-year deadlines and constricted schedules, she adds.

“For example, the lawyer will tell the client there is a deadline at the end of the year, will generate a draft of the amendment according to the plan terms and will need to get information about when board meetings are coming up and what vacation and holiday schedules are, to make sure the right people are around to sign the document at the right time,” Smith says. “Most required amendments are required to be adopted by the last day of the plan year, which in most cases is December 31, which creates timing constraints because people break for the holidays.”

If qualified plan provisions of the SECURE Act or CARES Act apply to these specific plan types, then amendments are generally not required until the end of the 2022 plan year, and not until 2024 for governmental plans, Meagher says. However, if CARES Act provisions apply, the plan is required to operate in accordance to requirements under the act and will need confirmation from a recordkeeper to ensure the plan is being properly administered, he states.

Determination Letters

For DC and defined benefit (DB) plans, there is little to no ability to obtain a determination letter indicating the plan’s qualified status, since the IRS announced an end to the determination letter program, unless it’s for a plan’s initial qualification or for terminating plans, says Meagher.

In IRS Revenue Procedure (Rev. Pro.) 2019-20, the IRS opened a determination letter window for hybrid plans, including cash balance plans, and for plan mergers, which closes on August 31. For employers that would like to update their determination letter and obtain IRS approval of changes that may have been enacted since their last determination letter—whether those changes are statutory, regulatory or design, this hybrid/cash balance opportunity should be pursued before it closes, Meagher adds.

However, for determination letters relating to plan mergers, the determination letter application period applies to both DB and DC plans. “A ‘plan merger’ for this purpose means a merger or consolidation that combines two or more plans maintained by previously unrelated entities into a single individually designed plan,” he explains. “The plan merger must occur in connection with a corporate merger, acquisition or other similar business transaction among unrelated entities that each maintained its own plan or plans prior to the plan merger.”

Plan sponsors will need to look out for certain timing requirements that must be satisfied before submitting a determination letter request. For example, the plan merger has to occur no later than the last day of the first plan year that begins after the plan year that includes the corporate merger. The application must be submitted within a period beginning on the date of the plan merger and ending on the last day of the first plan year following the date of the plan merger, he says.

Key Deadlines

According to Smith, the only amendment required to be made in 2020 relates to hardship distribution rules. For example, employers can no longer require participants to suspend contributions for six months after a hardship distribution.

Important dates concerning CARES Act operational changes can vary depending on whether an employer chooses to apply some or all of the CARES Act plan provisions to its plans; the date by which the employer’s recordkeeper is in position to administer CARES Act changes; and various features of the plan, such as plan loans or in-service withdrawals, that may be impacted by the CARES Act’s changes, Meagher says. Additionally, many SECURE Act changes are required and are effective presently, but plan amendments may not need to be adopted before the last day of the first plan year beginning on or after January 1, 2022, or, again, 2024 for governmental and collectively bargained plans.

Relaxed deadlines are likely meant to assist workers affected by the pandemic, Smith says. “Plan documents don’t have to be updated in most cases before 2022, which is a nice accommodation by the IRS to let us take the time needed to get those changes into plan documents while still accommodating the needs that the COVID pandemic has produced for plan participants,” she explains.

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