Administration October 22, 2019

Mechanics of Implementing a Sidecar Savings Account

Keeping retirement plan contributions rolling in while also allowing employees to save for emergencies.
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Art by Katherine Streeter

Implementing sidecar savings accounts would allow employees to contribute towards both their emergency and retirement savings.

Linked to a participating worker’s retirement account, the tool would help workers fund a short-term savings account with after-tax contributions (The Employee Retirement Income Security Act [ERISA] does not allow pre-tax savings for emergency accounts). Once employees accrue their desired amount for emergency savings, the remaining contributions would be allocated to their defined contribution (DC) plan account, thus permitting employees to save for both short-term and long-term financial needs.

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Since participants are likely to withdraw dollars from their retirement accounts when emergency expenses arise, incorporating a sidecar account may prevent workers from tapping into their DC plans.

A bipartisan Senate bill introduced in 2018 mentioned sidecar savings accounts to increase access to workplace saving while avoiding retirement account leakage. Though the bill has not passed the Senate since its announcement, firms are currently implementing after-tax approaches to increase emergency savings. In 2018, Prudential Financial, along with nonprofit organization Prosperity Now, presented an emergency savings solution utilizing payroll deductions for after-tax contributions.

To integrate such a solution, plan sponsors may be required to amend their DC plan documents, and/or update their DC plan payroll files, says Harry Dalessio, head of Institutional Retirement Plan Services at Prudential Retirement. Certain recordkeeping systems, such as Prudential’s, immediately permit participants to view emergency savings from their retirement account.

“Plan Sponsors could re-purpose an existing after-tax source or they may want to add a new after-tax source specifically for emergency savings,” he adds. “Prudential’s recordkeeping system, participant website, statements, etc. already have the after-tax source integrated so participants will be able to see their emergency savings within their [retirement plan] account.”

Setting up a sidecar—or emergency—savings account isn’t difficult for plan sponsors, it’s compliance issues behind the mechanics that can be confusing. Obscurity with these savings tools concerns employers, contends Karen Andres, director of Policy & Market Solutions and project director of the Retirement Savings Institute at The Aspen Institute.

“There’s this lack of clarity that really prevents the proliferation of experimentation,” she explains. “Employers are now just trying to feel their way into [sidecar savings], because no one wants to run afoul.”

This trepidation is mostly seen when it comes to directing money from a participant’s paycheck to the savings account. “Plan sponsors are looking to check the boxes with compliance,” says Andres. “We have multiple banking and ERISA laws on the books that just don’t really make it easy to provide this solution.”

Other employers, however, are implementing a manual route to paycheck withdrawals for emergency savings by setting up accounts with banking institutions that allow for manual withdrawals. Others are discovering automatic Fintech solutions in the workplace, and some recordkeepers are offering both the after-tax savings approach and DC plan, side-by-side. 

According to Dalessio, at Prudential, employers update their DC plan payroll files to include the after-tax source. Once the plan sponsor adopts the feature, participants can change their contributions via Prudential’s mobile app or online. Dependent on the plan, set up for sidecar accounts may be simple.

“It’s very minimal because it’s part of the DC plan, so depending on how the plan is set up, the plan sponsor may only need to update its plan documents and/or payroll files,” Dalessio says. 

Since sidecar and emergency savings accounts remain relatively new features in the workplace benefits space, the industry continues to navigate these tools and the regulatory issues that follow. It’s why employers have yet to see many case studies or models of the savings vehicles, according to Andres.

“Plan sponsors are still trying to figure out how to solve for multiple needs at once, and doing so in the context of regulatory and legal lack of clarity,” she says. 

As the industry filters through these models and employers add sidecar savings and emergency savings accounts to their plans, Dalessio asks plan sponsors to consider certain prerequisites to offering such features. First, by adding an after-tax source, plans will be subject to Actual Contribution Percentage (ACP) testing, an annual nondiscrimination test needed to maintain qualified status under ERISA. Because ACP testing ensures highly compensated employees are not being favored by their DC plan, a sidecar savings solution can help plan sponsors pass the test since the sidecar account is geared towards the non-highly compensated employee (NHCE) population.

“However, we recommend reviewing a plan’s testing results to assess any potential impact,” Dalessio proposes. 

Second, employers have the option to provide a company match on after-tax contributions. Plan sponsors should keep in mind that after-tax contributions are still subject to the IRS 415 limit, capping total DC plan contributions to $56,000 in 2019.

Lastly, and in common with any plan design changes is consulting a professional if considering a sidecar savings or emergency savings model. Dalessio concludes: “It’s up to the plan sponsor to work with appropriate ERISA counsel or a plan design consultant to ensure its plan is designed appropriately.”

Administration October 17, 2019

Breaking Free From Interest Rate Bind on DB Funding

The long-running low interest rate environment has created DB plan funding challenges, but plan sponsors can take steps to mitigate them.
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Art by Andrea D'Aquino

Defined benefit (DB) plans are facing funding challenges, but there are actions that they can take to mitigate them.

The main problem is that the equity markets have been volatile and interest rates declined sharply in the late summer, says Gordon Young, senior director, retirement, at Willis Towers Watson in Milwaukee. Through the end of July, interest rates for both Treasury and high-quality corporate bond yields decreased to their lowest levels since the global financial crisis of 2008, Young notes. Then, in August, the 30-year Treasury yield dropped below 2% and the Merrill Lynch AA-AAA 10+ index dropped below 3%—both historically low levels.

Both public and corporate DB plan funding has suffered as a result. Goldman Sachs Asset Management estimates that the aggregate funded status of the U.S. corporate defined benefit (DB) system fell to 86% at the end of August, from 87% at the beginning of the year and a recent high of 91% in the second half of 2018. And while pension plans returned, on average, more than 15% through the end of August, actuarial losses due to the fall in interest rates reduced funded levels by a similar amount, says Mike Moran, senior pension strategist at Goldman Sachs Asset Management, based in New York.

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Extrapolating forward rates from the current environment, Willis Towers Watson expects “rates will remain low for a while, and the yield curve might flatten even further,” Young says.

In addition, “with the aging population in the U.S. and around the world, this is causing an insatiable demand for fixed income,” which is pressuring interest rates, according to Moran. This is going to cause challenges for pension plans, he says.

“Of course, it depends on how well a plan is funded and the degree of liability hedging in the portfolio, but for most pension plan sponsors, lower interest rates are bad news,” Young says. “As interest rates continue to decrease, their liabilities are going to increase and they will face higher profit and loss and cash funding costs. For pensions that are open, the liabilities are greater because they are more exposed to volatility in the markets. For plans that are frozen and gradually shrinking their liabilities,” the exposure is less.

Mitigating funding challenges

The first thing a pension plan sponsor should do in this environment is to revise their forecast of costs to their plan, Young says. “Then they should reevaluate management policies that oversee their risks and costs, their settlement and valuation policies, to see whether or not they should change these in light of continued low interest rates.”

Goldman Sachs believes that plans with deficits “should earn their way out. Even though rates are low, we think they should continue to buy fixed income because they are under hedged,” Moran says. “Also, in an environment where many asset classes are at high levels, they should diversify their portfolios into alternative, non-core fixed income, hedge funds and liquid alternatives that are more defensive. We view rebalancing to your appropriate strategic targets as a prudent risk management exercise. Whether it is done quarterly, monthly or when there is a deviation from your targets doesn’t matter as long as you do something.”

DB plan sponsors will inevitably also have to increase their contributions, Moran adds. “On the corporate DB side, many plans have enjoyed funding relief from Congress, enabling them to contribute less than they otherwise would have had to,” he notes. “Many of these rules sunset in 2021, and if interest rates are still low then, their contributions will need to go up.”

Alternatively, pension plan sponsors could decrease benefits to other plans, such as a 401(k), Young says. If they have multiple pension plans, some overfunded and some underfunded, they could also combine them, he adds.

Pension plans can also better manage their Pension Benefit Guaranty Corporation (PBGC) premiums, Moran says. “There are two such premiums: a flat rate based on the number of participants in their plan and a variable rate of 4.3% based on a plan’s deficit,” he says. “With interest rates going down, the cost to borrow is below that 4.3%. Plans could use that money to pay the premium. That is effective arbitrage. Caterpillar, UPS and FedEx have done this, and we expect more plans to do the same.

“And on the flat rate side, we see a number of organizations looking for ways to get out of the plan through a lump-sum payment to participants or by buying an annuity through an insurance company,” Moran continues. “In fact, many large-scale organizations, including FedEx and Bristol Meyers have done just that.”

Finally, Moran says, interest rate impacts don’t “hit” plans until their measurement date: “In other words, for a company that operates on a calendar year basis, any adjustment to the discount rate from the fall in interest rates would not occur until the end of December of this year, [meaning that] any balance sheet adjustment due to a change in funded status would not occur until that time, and any potential increase in recognized pension expense from an increase in the projected benefit obligation would not occur until 2020.”

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