Updates
December 2008
New Year’s Resolutions
The start of a new year is a good time to set goals for improving your participant-directed retirement plan. Here are some ideas:
Improve Participation. The first step is to benchmark your participation levels against those of your industry. For example, a law firm may find it relatively easy to have a 90% participation rate, while a retail chain may have a hard time reaching 50% participation. Once you find out if you are better or worse than your industry average, set goals for improvement. If you already are doing better than the industry, set a goal for incremental improvement and go to work on that.
Consultants tell me that a 5% improvement in participation often can be achieved just by requiring that every participant turn in an enrollment form. Quick or easy enrollment can produce an improvement of 10% or more in participation levels. With quick enrollment, eligible employees who do not enroll are given a pre-addressed and pre-stamped postcard that automatically enrolls them if they sign and return it. For example, the postcard might authorize a 3% deferral rate and an age-appropriate lifecycle investment. As a "best practice," the card also might authorize escalator deferrals. Automatic enrollment also should be considered. With the changes in the Pension Protection Act (PPA), automatic enrollment is now convenient and without risk. Surveys show that automatic enrollment usually increases participation by 15% to 25%.
Qualified Default Investment Alternative (QDIA). The PPA created a form of "safe harbor" investment for default accounts (technically, it's a 404(c) defense, but it works much the same as a fiduciary safe harbor). The fiduciary protections apply if a plan offers age-based lifecycle funds, risk-based lifestyle or balanced funds, or managed accounts—and if certain other requirements are met. From my perspective as an attorney, there is no greater fiduciary protection for investments than QDIAs.
Participant Investing. The quality of participant investing (as opposed to the quality of the investments) is a subject of great attention by the government, academics, and the media. As a result, it also should be on your radar screen. The easiest way to achieve results is to use QDIA-type investments. However, some providers are finding that only 15% to 20% of the money is going into the QDIA-type investments. What is the experience of your plan and your provider? If you don't know, ask.
I realize that I am assuming that a high level of deposits into lifestyle and lifecycle funds and managed accounts is the equivalent of quality participant investing. In fact, from a legal perspective, I believe that it is. I cannot imagine a successful legal challenge to the quality of participant investing when those vehicles are being used, though it may be possible to achieve broad-based high-quality participant investing in other ways, such as through investment education and investment advice. However, to my knowledge, the only way that plan sponsors have been able to get more than 50% of the participants to build true "portfolios" in their accounts has been through the use of lifecycle funds, lifestyle funds, and managed accounts.
Deferral Escalators. The PPA formally introduced into the law the concept of escalator, or step-up, deferrals. For automatically enrolled safe harbor plans, the Internal Revenue Code requires that employees be enrolled with at least a 3% automatic deferral, which increases to at least 4% in the second year, 5% in the third, and 6% in the fourth and thereafter. While some plan sponsors were already using escalator deferrals, this is the first time that the concept has appeared in the law.
This concept is particularly important because there is growing evidence that most employees are deferring significantly less than is required to have an adequate retirement income. For example, a common rule of thumb is that employee deferrals and employer contributions need to average at least 15% of pay during a participant's working career in order to fund adequate replacement income for retirement. Based on industry studies, it appears that the average participant is deferring between 6% and 8%.
This is just a partial list. The key is for you to set goals for improving your plan, evaluate the steps needed to reach those goals, and implement the steps. Look to your adviser and provider for ideas. Good luck!
Improve Participation. The first step is to benchmark your participation levels against those of your industry. For example, a law firm may find it relatively easy to have a 90% participation rate, while a retail chain may have a hard time reaching 50% participation. Once you find out if you are better or worse than your industry average, set goals for improvement. If you already are doing better than the industry, set a goal for incremental improvement and go to work on that.
Consultants tell me that a 5% improvement in participation often can be achieved just by requiring that every participant turn in an enrollment form. Quick or easy enrollment can produce an improvement of 10% or more in participation levels. With quick enrollment, eligible employees who do not enroll are given a pre-addressed and pre-stamped postcard that automatically enrolls them if they sign and return it. For example, the postcard might authorize a 3% deferral rate and an age-appropriate lifecycle investment. As a "best practice," the card also might authorize escalator deferrals. Automatic enrollment also should be considered. With the changes in the Pension Protection Act (PPA), automatic enrollment is now convenient and without risk. Surveys show that automatic enrollment usually increases participation by 15% to 25%.
Qualified Default Investment Alternative (QDIA). The PPA created a form of "safe harbor" investment for default accounts (technically, it's a 404(c) defense, but it works much the same as a fiduciary safe harbor). The fiduciary protections apply if a plan offers age-based lifecycle funds, risk-based lifestyle or balanced funds, or managed accounts—and if certain other requirements are met. From my perspective as an attorney, there is no greater fiduciary protection for investments than QDIAs.
Participant Investing. The quality of participant investing (as opposed to the quality of the investments) is a subject of great attention by the government, academics, and the media. As a result, it also should be on your radar screen. The easiest way to achieve results is to use QDIA-type investments. However, some providers are finding that only 15% to 20% of the money is going into the QDIA-type investments. What is the experience of your plan and your provider? If you don't know, ask.
I realize that I am assuming that a high level of deposits into lifestyle and lifecycle funds and managed accounts is the equivalent of quality participant investing. In fact, from a legal perspective, I believe that it is. I cannot imagine a successful legal challenge to the quality of participant investing when those vehicles are being used, though it may be possible to achieve broad-based high-quality participant investing in other ways, such as through investment education and investment advice. However, to my knowledge, the only way that plan sponsors have been able to get more than 50% of the participants to build true "portfolios" in their accounts has been through the use of lifecycle funds, lifestyle funds, and managed accounts.
Deferral Escalators. The PPA formally introduced into the law the concept of escalator, or step-up, deferrals. For automatically enrolled safe harbor plans, the Internal Revenue Code requires that employees be enrolled with at least a 3% automatic deferral, which increases to at least 4% in the second year, 5% in the third, and 6% in the fourth and thereafter. While some plan sponsors were already using escalator deferrals, this is the first time that the concept has appeared in the law.
This concept is particularly important because there is growing evidence that most employees are deferring significantly less than is required to have an adequate retirement income. For example, a common rule of thumb is that employee deferrals and employer contributions need to average at least 15% of pay during a participant's working career in order to fund adequate replacement income for retirement. Based on industry studies, it appears that the average participant is deferring between 6% and 8%.
This is just a partial list. The key is for you to set goals for improving your plan, evaluate the steps needed to reach those goals, and implement the steps. Look to your adviser and provider for ideas. Good luck!
The material contained in this communication is informational, general in nature and does not constitute legal advice. The material contained in this communication should not be relied upon or used without consulting a lawyer to consider your specific circumstances. This communication was published on the date specified and may not include any changes in the topics, laws, rules or regulations covered. Receipt of this communication does not establish an attorney-client relationship. In some jurisdictions, this communication may be considered attorney advertising.
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