Administration June 19, 2015

Non-ERISA 403(b)s Off the Radar

Non-ERISA 403(b)s are not under regulatory scrutiny. Is that a good thing or bad thing?
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Until regulations passed in 2007, 403(b) plans didn’t fall under the same Employee Retirement Income Security Act (ERISA) regulatory oversight to which 401(k) plans were subjected.

In fact, says Ellie Lowder, tax-exempt and governmental plan consultant at TSA Consulting and Training Services, before the regulations changed, most 403(b) plans were not treated like plans, but simply “arrangements,” in which an employer provided a payroll slot to a provider and then remitted contributions to the provider. Plan sponsors were only required to play a very limited role in plan oversight and administration, she tells PLANSPONSOR.

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However, with the 2007 regulations only three types of 403(b)s are exempted from ERISA scrutiny—church plans (which can elect to be ERISA plans), governmental plans and plans with limited employer involvement (those that fell under the ERISA “safe harbor” for 403(b) plans)—a plus or a minus for plan sponsors, depending on your view.

If anyone is harmed by the absence of new regulations for non-ERISA 403(b)s over such a long time frame, says Carol A. Idone, vice president of business development at Strategic Benefit Services, it’s the participants themselves, and fees are the reason. If the plans were subject to ERISA, she tells PLANSPONSOR, “participants might be able to get better pricing, if it’s a true group plan. [There are] more providers in the market willing to [take on] ERISA plans.” 

NEXT: The risk of becoming an ERISA plan.

Church plans that do not elect to be governed by ERISA and governmental plans will never be ERISA plans, but private-sector plans with limited employer involvement risk becoming ERISA plans. Idone contends some non-ERISA 403(b)s are getting very close to edge of becoming ERISA plans. The Department of Labor (DOL) could well point to some practices in these plans and say, “Based on what you’re doing, this plan should fall under ERISA.” She says she has seen plans take action that are in the best interests of the participants, the very thing that will trip them up. 

The lack of clear-cut guidance to clearly mark the difference between 403(b) plans that do or do not fall under ERISA can make life difficult for plan sponsors, who are told it will be decided on a case-by-case basis. “It comes down to facts and circumstances,” Idone says. “It’s based on what the plan sponsor is doing, how much control the employer is exerting—too much, and it’s an ERISA plan.”

While the guidelines may seem unclear, Idone explains, generally they are: plan sponsors cannot monitor investments or be involved in the hardship and loan approval process. They can provide data on loans, but cannot actively approve the loans or hardship withdrawals. Plan sponsors cannot be involved in fee reviews. They can look at the fees but cannot say that fees are too high: “That is a murky area they have to be aware of,” Idone says.

And when it comes to the vendor arrangements for the plans, she says debate is ongoing: if the plan has just one vendor, does that make it an ERISA plan? Or, if it is an open-architecture investment platform, is it a non-ERISA 403(b)? There are equal opinions to support either side.

NEXT: Confusion when offering both types of 403(b)s.

One particularly thorny situation can arise when a single organization has side-by-side plans: a 403(b) that falls under ERISA and a non-ERISA 403(b). Each plan contains different products—mutual funds in the ERISA-governed plan, and an annuity product in the non-ERISA plan—but both plans use the same recordkeeper.

Since non-ERISA 403(b) plans are prohibited from performing investment reviews, Idone observes, the employer may not exert control over the non-ERISA plan, such as conducting an investment review and deciding to remove an investment. Her firm recommends eliminating the non-ERISA plan, but if the plan sponsor is going to keep it, the firm advises keeping a hands-off approach.

“It’s confusing for everyone,” Idone says, “because they have their eyes closed with the non-ERISA plan and full involvement on the ERISA plan.” During meetings of the plan committee, she says, any discussion of the non-ERISA 403(b) must be held to a strictly general level, lest the plan become subject to ERISA.

When the organization uses the same recordkeeper for both plans, Idone says, nine out of ten participants would be unlikely to know the difference between the two plans, and often participants think of the two plans as one, with the same products.

NEXT: When a non-ERISA 403(b) is the right plan.

One reasonable explanation for offering both an ERISA and non-ERISA plan Idone says she’s heard from an organization’s chief financial officer is that side-by-side offerings give employees a choice. “[But] is it a good choice?” she asks. “There’s no fee disclosure, no independent review of investments. On a plan committee with six or seven members, the members often don’t know the difference.”

Idone, whose business is largely nonprofits and 403(b) plans, concedes that many small to medium-size nonprofits benefit by offering a non-ERISA 403(b) without a match. “It’s not uncommon to have 200 employees eligible for a voluntary-only plan, but only 50 employees participating,” she says. ERISA requires organizations with more than 100 eligibles to conduct a plan audit each year at a cost ranging from $5,000 to $15,000—a significant expense for some plan sponsors.

But, in general, Idone believes the current regulations that govern non-ERISA 403(b)s don’t go far enough, and the plans should have been eliminated. “I can’t imagine the government is going to go too much longer with no reporting being done on these non-ERISA plans,” she says.

However, Lowder believes the plans are useful for some nonprofits, especially with an administrative burden eased by industry support. “Generally speaking, public school districts don’t have HR departments or staff members in these plans with plan expertise,” she points out. “When the regulations first changed, it created some angst and some employers tried to terminate their plans, but the industry worked to put together compliance support for these employers to help them.”

Administration June 19, 2015

Plan Sponsors Should Be Encouraged to Use Auto Features

A recent survey looked at the reasons retirement plan sponsors do not use automatic plan features.
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The use of automatic enrollment is expanding, a survey from the Defined Contribution Institutional Investment Association (DCIIA) finds.

Plan sponsors of the larger plans surveyed (greater than $200 million in assets – 185 plans) continue to adopt automatic enrollment, with 62% of survey respondents indicating that they utilize this feature, compared to 56% in 2012 and just 44% in 2010. Among plans with $50 million to $200 million in assets, 59% use auto enrollment, with $5 million to $50 million in assets, 38% use it, and with less than $5 million in assets, 24% do.

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During a webinar about the research, Catherine Peterson, global head of insights programs at J.P. Morgan Asset Management, said the vast majority of plans say the participant opt-out rate for auto enrollment is less than 10%; around 70% report it’s less than 5%.

A 3% default deferral rate is used by 37% of plans, down from 55% in 2010 and 47% in 2012. Meanwhile, the proportion of plans using a default rate of 6% or more increased to 27% in 2014, up from 20% in 2010 and 24% in 2012. Peterson said this is one area plan sponsors need to be encouraged to do—move to a higher default rate.

Since 2010, the level of automatic deferral escalation used by large plans has leveled off (46% in 2010, and 48% in both 2012 and 2014). “There is a risk of having participants defaulted and remaining at low contribution rates,” Peterson noted.

Use of plan re-enrollment, whereby participants’ assets are reset into the plan’s default investment option unless the participant opts out, has increased from 6% in 2010 to 13% in 2012 and 19% in 2014, but it remains an underused practice to improve participant asset allocation (see also “Re-enrollments Remain a Poorly Leveraged Plan Booster”).

“We haven’t seen nearly enough use of re-enrollments, considering the huge benefit of getting people into a proper investment allocation over time,” Peterson said. “Other research shows individuals in target-date funds (TDFs) have better returns than do-it-yourself investors over time.”

NEXT: What is the impact of using auto features?

The DCIIA Plan Sponsor Survey on Auto Features reveals the positive impact of using automatic plan features. A before-and-after picture of participation rates shows nearly 50% of plans had 75% or less participation before using auto enrollment. After auto enrollment, only 20% had 75% or less participation rates. Plans with greater than 90% participation moved from 18% to 45%. “Many plans still only use auto enrollment for new hires, so it will take more effort to get more plans above 90% participation,” noted Lori Lucas, executive vice president and defined contribution practice leader at Callan Associates in Chicago.

A picture of average contribution rates before and after using auto escalation shows 66% of plan had average deferral rates of 6% or less before using the feature; 41% had average deferral rates of 6% or less after using it. Lucas noted that the survey showed the economic theory of cognitive dissonance among plan sponsors; 50% of employers say the optimal savings rate is between 5% and 10%, 34% say it is between 11% and 15%, yet 66% of plan sponsors surveyed are defaulting participants at a less than 5% deferral rate.

The reported reasons for not closing the savings gap: For plans with $200 million to more than $1 billion in assets, it was that they already felt they were doing what they should; for smaller plans, it was that they felt employees preferred their wages be paid to them.

Are the larger plans really doing enough to close the savings gap? Lucas feels they could be doing more.

NEXT: Barriers to adopting auto features.

The primary barrier to adopting auto enrollment cited by plans in the DCIIA survey is the additional cost from matching contributions (30% of large plans cited this). Fifteen percent think their plan participation is already high enough, 22% say it’s not necessary because their defined contribution (DC) plan is supplemental to a defined benefit (DB) plan, and 15% feel auto enrollment is too paternalistic.

By plan size, the barriers can be quite different, noted Joshua Dietch, managing director at Chatham Partners. That it is too costly is more likely the barrier to adopting auto enrollment for plans with $200 million or more in assets. Thirty percent of plans with less than $50 million say it is too paternalistic. More than one-quarter of small plans have not even considered it; “maybe they didn’t even know it was an available option,” Dietch speculated.

For large plans, the feeling that auto escalation is too costly from a match perspective has dropped. Dietch thinks this may be because of the trend of using a stretched match formula. For small plans, 31% have never considered auto escalation, and they are two times more likely than large plans to think participants will complain. Fifteen percent of small plans feel their average deferral rate is already high enough.

As for barriers to engaging in a reenrollment, 18% of plan sponsors said they are comfortable with participant allocation, but Dietch noted this has dropped from 36% in 2010 and 35% in 2012. Thirteen percent feel there is too much risk in doing a reenrollment.

NEXT: Recommendations for plan sponsors.

Catherine Collinson, president of the Transamerica Center for Retirement Studies, shared with webinar attendees the DCIIA’s recommendations for automatic plan features:

  • Automatically enroll all new and existing employees;
  • Set the initial default deferral to no less than 6%;
  • Use auto escalation with a default increase of 1% to 2% up to a maximum of 15%;
  • Investigate the use of a stretched match formula to encourage higher rates of deferral in a cost-effective way. Collinson shared the example of switching from a match of 100% up to 3% of deferrals to 50% of up to 6%, and she warned that plan sponsors should not stretch the match so far that participants will think they can’t save enough;
  • Consider reenrollment to help participants invest their retirement savings in a risk-appropriate manner using the default investment option; and
  • Providers should offer decision tools that can help plan sponsors optimize these benefits.

Collinson noted that in the survey, plan sponsors expressed a desire for more information to help in plan design decisions. There is a reported lack of understanding among survey respondents of the risks and unintended consequences of implementing or optimizing automatic plan features. Very few plans reported that they modeled potential outcomes when considering implementing or modifying automatic plan features. There is a perceived lack of effective plan sponsor tools to analyze alternatives appropriate for each plan’s unique characteristics and objectives.

The survey report may be downloaded from the DCIIA’s website.

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