Compliance May 31, 2018

Non-Electing Church Plans Subject to Some Pre-ERISA Requirements

Non-electing church plans are exempt from the Employee Retirement Income Security Act (ERISA) provisions pertaining to participation, coverage, and vesting; however, these plans are subject to the requirements for participation, coverage and vesting that were in effect on September 1, 1974, prior to the enactment of ERISA.

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In a recent Employee Plans (EP) Issue Snapshot, the Internal Revenue Service (IRS) identifies sections of the Internal Revenue Code (IRC) that a non-electing church plan must satisfy in order to be a qualified plan under IRC Section 401(a).

As the Snapshot notes, a plan that meets the definition of a church plan in IRC Section 414(e) is exempt from certain requirements imposed on other tax-qualified retirement plans under the IRC. However, a church plan sponsor can elect under IRC Section 410(d) to have the plan treated as though it were not an exempt church plan. Plans for which no IRC Section 410(d) election was made are known as “non-electing church plans.”

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Non-electing church plans are exempt from the Employee Retirement Income Security Act (ERISA) provisions pertaining to participation, coverage, and vesting; however, these plans are subject to the requirements for participation, coverage and vesting that were in effect on September 1, 1974, prior to the enactment of ERISA. The pre-ERISA vesting requirements are set forth in IRC Sections 401(a)(4) and 401(a)(7) as in effect on September 1, 1974.

Section 401(a)(4) stated that a trust constitutes a qualified trust “if the contributions or benefits provided under the plan do not discriminate in favor of employees who are officers, shareholders, persons whose principal duties consist in supervising the work of other employees, or highly compensated employees.” In addition, regarding vesting, Section 401(a)(7) stated that “upon its termination or complete discontinuance of contributions under the plan, the rights of all employees to benefits accrued to the date of such termination or discontinuance, to the extent funded, or the amounts credited to the employees’ accounts are nonforfeitable.”

According to the Issue Snapshot, the pre-ERISA participation and coverage requirements are set forth in IRC Sections 401(a)(3) and 401(a)(5) as in effect on September 1, 1974.

Section 401(a)(3) provided that a plan could satisfy one of two alternative percentage tests:

  • 70% or more of all employees must be covered under the plan; or
  • 70% or more of all employees must be eligible under the plan, and if so, at least 80% of all eligible employees must be covered.

The percentages above are applied after excluding employees:

  • who worked less than a period stated in the plan, not to exceed 5 years;
  • who do not customarily work for more than 20 hours in any one week; and
  • whose customary employment is not more than 5 months in any calendar year.

The IRS notes that in lieu of meeting one of the percentage tests, the plan may cover a classification of employees which does not discriminate in favor of officers, shareholders, persons whose principal duties consist of supervising the work of other employees, or highly compensated employees. Section 401(a)(5) provided that a classification shall not be considered discriminatory within the meaning of IRC Section 401(a)(3)(B) merely because it is limited to salaried or clerical employees.

Investing May 30, 2018

Many TDFs Need to Be Adjusted for Risk

According to Jake Tshudy at SEI, “An actuarial valuation approach akin to a DB plan is the best strategy to determine if a TDF series has the appropriate level of risk based on a plan’s demographics.”

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Target-date funds (TDFs) have been steadily growing in popularity, quadrupling as a portion of mutual fund assets in defined contribution (DC) plans in just over a decade, notes investment services provider SEI.

 

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However, the firm observes, many TDFs are riding the wave of the bull market and pursuing generic—meaning just stock and bond—investment strategies that are overall too risky: The average TDF for the year 2020 still has 54% of its assets allocated to equities. Jake Tshudy, director of DC investment strategies at SEI in Oaks, Pennsylvania, says his firm looks at equity beta. “Five years out from retirement, we’re roughly 10% less in equity exposure [than the average target-date fund],” he says. SEI’s analysis looks at major providers of off-the-shelf TDFs, not at custom funds.

 

Tshudy tells PLANSPONSOR some of SEI’s funds are strategy funds; a multi-asset-class portfolio uses Treasury inflation protected securities (TIPS) and nominal bonds, as well as equities. SEI makes an effort to seek out risk premia, using investments other than stocks and bonds, so its TDFs are not riding the market cycle. “If a plan participant hits retirement during a market low with significant equity risk, it is not a good thing,” he says.

 

SEI also employs high yield investments and emerging market debts to manage downside risk. “They don’t fall as far as equities but approach equity-like returns and offer return enhancing performance,” Tshudy explains. He adds that SEI’s approach might look less advantageous because there is a lower allocation to equities, but this tends to create better returns on the market downside. SEI has been talking to TDF managers about deploying strategies within their investment lineup that mitigate the potential downside.

 

For plan sponsors and advisers to help determine whether a retirement plan’s TDFs are too risky, an analysis should be run, Tshudy says and adds that he is also a believer in custom TDFs. Plan sponsors and advisers should consider employees’ expected retirement age, investing patterns and estimated Social Security benefits. “We believe an actuarial valuation approach akin to a DB [defined benefit] plan is the best strategy to determine if a TDF series has the appropriate level of risk based on a plan’s demographics. For example, if participants are retiring on average at age 55, that will affect which TDFs to use,” he says. SEI’s approach to making recommendations to plan sponsors about TDFs grew out of its history in liability-driven investing (LDI) in DB plans. “We employ the same practices in the DC space.”

 

Tshudy says his advice to DC plans is to consider their TDF’s underlying allocations, determine if it is likely the market will continue its run-up, and consider diversifying so as to keep from chasing equity returns. By diversifying, he is not saying, get out of TDFs—but to consider changing to one with a more long-term allocation.

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