Compliance December 7, 2023

SECURE 2.0 Corrections Drafted by Congress

The bill will likely have to be added to a budget bill early in 2024 to pass.

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Members of the House of Representatives and the Senate Thursday issued a “discussion draft” for the much-anticipated bill applying technical corrections to the SECURE 2.0 Act of 2022.

Restoring Catch-Ups

The bill would make corrections to several mistakes made in the hallmark retirement law. First and foremost, it corrects the most egregious error of SECURE 2.0: accidentally removing catch-up contributions, starting in 2024. The drafters of SECURE 2.0 originally intended to create a higher catch-up limit for those aged 60 to 63, sometimes called super-catch-ups, and in the rush to pass a budget in December 2022, they made this now-infamous error. The corrections bill would make the original intent effective without removing catch-up contributions.

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In light of their original intent, the IRS announced in August it will permit catch-up contributions to be made into 2024, even though SECURE 2.0 technically removes the concept from the code. This means catch-ups would be safe, even if the corrections bill is passed after December 31.

Though not a technical error, strictly speaking, and more an error in judgment, the IRS announced in the same guidance that it would extend to January 1, 2026, from January 1, 2024, the effective date for employees making $145,000 or more to make catch-up contribution on a Roth, or after-tax, basis. The corrections bill does not speak to this issue, presumably because the IRS has already addressed it through guidance.

Matching Starter 401(k) Limits to IRAs

The corrections bill would also explicitly tie the maximum contribution amount for Starter 401(k) plans to the annual maximum for individual retirement accounts. SECURE 2.0 previously set the maximum for Starter plans at $6,000 indexed, which was the IRA limit in 2022, but that provision was not set to take effect until 2024, when the IRA limit is set to become $7,000, effectively making the Starter limit both less than and divorced from the IRA limit. The correction effectively says that the Starter limit will match the IRA limit.

Additionally, the provision in SECURE 2.0 changing required mandatory distributions would also be corrected to reflect the intent of the drafters, which was to increase the age to 73 starting on January 1, 2023, and age 75 starting on January 1, 2033.

Further, the legislation would change the effective date for the 15% ceiling on automatic escalation found in Section 101 of SECURE 2.0. Plans started since SECURE 2.0’s passage must adopt auto-enrollment at 3% to 10%, then escalate by 1% to an end range between 10% and 15%, unless the participant elects otherwise. The corrections bill would move the date for the 15% ceiling on escalation to January 1, 2026, instead of 2025, leaving the ceiling at 10% in the meantime.

Other provisions in SECURE 2.0 received minor clerical corrections, including the Saver’s Match and plan lost and found.

Timing Dependent on Budget—Again

Michael Kreps, a principal in and chair of Groom Law Group’s retirement services group, says, “There was some hope from industry that there would be a more comprehensive ‘fix-it’ package, but there does not appear to be an appetite on Capitol Hill to relitigate substantive issues.”

Substantive issues, such as the decision to permit 403(b) plans to use collective investment trusts, are not part of the bill because their omission was not technical in character. The Retirement Fairness for Charities and Educational Institutions Act would address it, but no action has been taken since it passed the House Committee on Financial Services in May.

Assuming the corrections bill is attached to a budget bill, it will have two opportunities to pass, given the staggered nature of the expirations of the November continuing resolutions that extended federal spending to January 19 and February 2.

Data and Research December 7, 2023

How Higher Interest Rates Are Changing Focus of Fully Funded Pension Funds

Many corporate pension fund leaders are re-evaluating their liability-driven managers and allocations.

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Fully funded due to higher discount rates and investment performance, many corporate defined benefit pension funds are shifting their investment goals to maintaining that funding progress, from their prior focus of maximizing investment returns.

While many have had significant assets dedicated to liability-driven investing in recent years, they are finding it is time to acknowledge the higher-yield, better-funding environment. As a result, a common approach among the cohort is to examine “overlap in plan holdings, inadequate hedging of liabilities and insufficient downside protection in their LDI manager lineup” to secure their funded status gains, according to a paper authored by Todd Glickson, head of North America investment management at Coalition Greenwich, a division of CRISIL, an S&P Global company.  

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“These pension plans that are now more than fully funded have to think about managing the plans a bit differently than they did X, Y years ago,” Glickson says. “[Funded] DB plans [are] moving to a different phase in that life cycle.”

Rising interest rates have driven 70% of corporate pensions plan sponsors to review their liability-driven investment manager selections, because of their gains in funded status, to ensure they can reach plan goals, found the study, “Corporate DBs Move to Secure Funded Status Gains and Begin Endgame,” based on a report commissioned by Franklin Templeton.

Almost three-quarters of the 30 institutional investors at corporate DB plans taking part in the study reported funding ratios of 100% or greater, 23% of plans reported funding ratios greater than 110% and only 27% of plans reported funding less than 100%.

According to the Milliman 100 Pension Funding Index, which tracks the average funded status of the 100 largest U.S. corporate pension plans, funded ratios surpassed 103% in September, as compared with just 88% at the end of 2020.

Funded pension plans “[are] more focused on things like risk management or downside protection, where before they were trying to get to the [funded status] goal,” Glickson says. “You’ve reached the promised land, so to speak; how do you stay there?”

Consequently, DB plan managers are “contemplating changes,” he adds.

Corporate DB plans that have moved from “underfunded to fully funded” may seize on this time to change course and re-evaluate their current LDI manager lineups because there may be allocations that overlap or allocations with “higher correlation among those LDI managers,” advises Glickson.

“The changes they’re contemplating are about adjusting the duration to more closely match liabilities, improving downside risk protection, increasing manager diversification, [and] all of those things to really go from one stage to another stage,” he adds.

The survey asked respondents what changes they are contemplating—if the institutional investors answered “yes” to the question, “Have you/are you contemplating changes within your LDI program?” according to a Coalition Greenwich spokesperson. From a list of options, respondents were asked to select all options that apply, and the changes investors said they are contemplating included:  

  • Adjusting duration to match liabilities more closely (56%);
  • Improving downside risk protection (44%);
  • Entering into either a hibernation or pre-PRT mode (22%);
  • Increasing manager diversification (11%);
  • Lowering fees (11%);
  • Hiring an LDI completion manager (11%); and
  • Other changes (22%).

The qualities DB plans are examining when selecting LDI managers for the next phase of their pension investment focus included:

  • Risk management (96%);
  • Fees (70%);
  • Knowledge and understanding of key pension risk management elements (70%);
  • Diversifying current lineup (33%);
  • No, or limited, style drift (26%); and
  • High alpha (15%).

Fully funded pensions are “evaluating if they need to diversify their portfolios by adding new managers with investment philosophies and styles less reliant on credit beta,” Glickson wrote in his paper. “For example, integrating advanced portfolio construction techniques as a primary source of alpha can provide both enhanced diversification and downside risk mitigation to an existing multi-manager liability-hedging portfolio.”

The risks most cited for the current LDI manager lineup included:

  • Substantial overlap in holdings among managers (43%);
  • High correlation between fixed-income LDI managers (29%);
  • Inadequate hedging of liability due to off-benchmark exposures such as high-yield, emerging market debt and others (29%);
  • Inadequate downside protection when markets sell off (29%);
  • Portfolios not sufficiently seeking alpha (19%); and
  • Most managers tend to be “risk on” at all times (10%).

Coalition Greenwich conducted 30 interviews with institutional investors targeting key decisionmakers at corporate DB plans based in the U.S. from August through October to understand how they manage diversification and plan/funding risk, select an LDI manager and navigate overall risks on the economic horizon. As part of the study, Coalition Greenwich also held in-depth discussions with investment consultants. The study is based on a report commissioned by Franklin Templeton in August.

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