Benefits November 20, 2012

Reenrollment in QDIA Helps Diversification

November 20, 2012 (PLANSPONSOR.com) – Reenrollment in a QDIA can help improve plan diversification, according to a Vanguard research paper.
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The Vanguard report, “Improving plan diversification through reenrollment in a QDIA,” notes that even though most defined contribution (DC) plans offer a broad range of prudent investment offerings, plan sponsors find that some participants make portfolio construction errors, concentrating their investments in employer stock, in specific asset classes or styles, or holding overly conservative or aggressive portfolios. Reenrollment through which the plan sponsor defaults participants’ assets and future contributions into the plan’s designated qualified default investment alternative (QDIA) can fix these errors. 

Vanguard researched the effect of reenrollment on a large DC plan in 2008 and found that reenrollment immediately improved the portfolio diversification in the plan. Immediately following the initial reenrollment effort, 92% of the participants maintained either a full (74%) or partial (18%) position in the age-based target-date fund. This result was particularly striking in that the communications program strongly encouraged participants to take proactive action on their own. One year later, 87% of participants still maintained either a partial or full position in the target-date approach. It was their sole investment (61%) or part of their portfolio (26%).

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The day after reenrollment, the stable value exposure fell from 26% to 3% and the average company stock exposure fell from 20% to 2%. Reducing these exposures was one of the goals of the reenrollment. Assets in these options flowed (through the default target-date funds) to domestic equities, bonds and international equities.  

Plan sponsors need to weigh a variety of issues before proceeding with a reenrollment strategy. They should consider the effect of reenrollment on diversification and return potential, and also on risk levels. For some participants, improving portfolio diversification can mean improving long-term expected returns and increasing risk levels; for others, it can mean a reduction in both.

A plan sponsor’s decision to reenroll participants into the QDIA may relate to a specific investment option, a subgroup of participants, or the entire plan. In these instances, the sponsor implements such a change to enhance participant portfolio diversification and improve expected long-term retirement outcomes for participants.

A sponsor changing service providers may also make substantial changes in its investment menu. In lieu of attempting to map participant holdings from one set of investment options to another reasonably similar set of options, the sponsor can choose to default participants into the QDIA during the conversion process. Under certain circumstances, a sponsor may decide to make substantial changes to the plan’s investment lineup or eliminate a number of options. Rather than attempting to map those participants in the options being eliminated to similar new options, the sponsor may instead default the participants into a QDIA.

Under reenrollment, as long as participants are given proper advance notice and are provided an opportunity to make an alternative election, sponsors enjoy fiduciary protection in connection with participant investments—either because participants are transferred into the QDIA, or because they exercise control by opting out of the reenrollment. In addition to this fiduciary protection, the plan sponsor has taken affirmative steps to ensure proper diversification of participant accounts.

The research paper is available here.

Benefits November 20, 2012

LASERS to Ask for Delay of Cash Balance Plan

November 20, 2012 (PLANSPONSOR.com) – The Louisiana State Employees Retirement System (LASERS) board voted to ask the Legislature to delay implementation of a cash balance plan for new hires.
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The board took the action because members voiced concern that federal issues involving the IRS and Social Security status of the cash balance plan would not be resolved before the new law was to take effect, said Maris LeBlanc, deputy director of the system, according to The Advocate.   

The Social Security Administration needs to be asked whether the plan would provide an equivalent benefit to Social Security; otherwise, affected state employees would have to be enrolled in Social Security with required employee and employer contributions. Also, a determination letter from the IRS must be received for the plan to be qualified for favorable tax treatment (see “Louisiana Cash Balance Plan Faces Hurdles”).   

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An adverse decision from the IRS could cause contributions employees put into the system to become subjected to taxes beginning July 1. LeBlanc said the IRS determination period does not begin until February, and it is unclear how long it will take to get an answer. She added that the Social Security equivalency letter, which must be sought by the Jindal administration, has not been submitted “to our knowledge.”

The Advocate reports that Jindal administration spokesman Michael DiResto said there is no reason for delay. “We are confident that the plan meets all IRS requirements,” he said.  

Under the new plan for future nonhazardous-duty employees, an employee would contribute 8% of pay and the state would contribute 4% with all but 1% of the investment earnings going toward an individual’s pension. The 1% would act as a reserve to guard against investment losses.  

The Louisiana Retired State Employees Association has filed a lawsuit alleging that the cash balance plan did not get the required two-thirds vote in the State House to win approval (see “Association Challenges Louisiana Cash Balance Plan”). 

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