DC Retirement Plans In Need of Non-Traditional Investments

On Wall Street:

BY: MARGARIDA CORREIA

THURSDAY, JUNE 6, 2013

Defined contribution retirement plans need the non-traditional investment solutions that traditional pension plans offer.

English: Emerging Markets without China and India (Photo credit: Wikipedia)

That’s the gist of BNY Mellon’s latest white paper. The report argues that DC retirement plans could improve their risk-adjusted returns, reduce volatility and provide better protection against inflation by broadening their investment options to include real assets, emerging market equities and debt, and liquid alternatives.

English: Study on alternative investments by institutional investors. (Photo credit: Wikipedia)

"Traditional DC plans do not provide the level of diversification and risk balance that plan participants require to achieve their retirement goals,” Robert Capone, executive vice president of the BNY Mellon Retirement Group and author of the report, said in a statement.

English: Investment Process Focused on Risk Measurement & Management (Photo credit: Wikipedia)

The limited range of investment options is the primary reason the plans are unable to match the performance of traditional pension or defined-benefit plans, which tend to incorporate a range of non-traditional assets, according to the report.

“We believe that applying the best DB practices to DC plans would reduce equity risk and home country risk as well as thoughtfully incorporating alternative investments to increase diversification, return potential and downside risk management,” Capone said.

If DC plans were constructed more similarly to DB plans, approximately 20% of the DC plan assets would be allocated to non-traditional strategies, such as real assets, total emerging markets and liquid alternatives, according to the report.

'via Blog this'

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For Performance, 401(k) Plans Can’t Touch Pensions

A new analysis shows that the performance gap in 2011, the most recent year for which research is complete, was the most in almost 20 years.

CFO.com:
Retirement Plans | May 28, 2013
David McCann

Pension plans have almost always outperformed 401(k) plans, but the gap in 2011 was the greatest it’s been since the mid-1990s, according to a new report from consulting firm Towers Watson. ...

... “Our research shows that over the last 17 years, at least, DB plans have consistently outperformed DC plans,” says Dave Such
sland, senior retirement consultant for Towers Watson. “DB plans are actually a less-costly way to provide the same benefit, because the better investment returns mean a company would need to contribute fewer dollars to offer that benefit. But generally when a company moves from DB to DC, it doesn’t provide the same benefit.”

WellPoint (Photo credit: Wikipedia)

The shift from DB plans to 401(k) plans has been ongoing since 1981. Companies have given different rationales for making the switch: to stay cost-competitive with others in their industry or to pay for rising health-care costs, for example.

English: This is the main office building of Hanover Insurance Group in Worcester, Massachussets, USA (Photo credit: Wikipedia)

Some even suggested that their employees didn’t value the pension plan, preferring a 401(k) or other savings vehicle instead. WellPoint, for example, said employees wanted to decide for themselves how to invest their retirement funds, according to a 2006 article in the Indianapolis Business Journal. At Hanover Insurance Group that same year, the company said its workers “liked the ability to borrow or take withdrawals from 401(k) plans,” according to the Worcester Telegram & Gazette.

English: Telegram and Gazette Building, Worcester, Massachusetts, USA. (Photo credit: Wikipedia)

Assuming those were accurate representations of employee sentiment, the workers probably changed their minds after the recent recession hammered their 401(k) balances. While the value of most accounts has since recovered, a sense of trust in 401(k) plans likely has not, and there is great yearning within American society for the guaranteed monthly benefit for life that a pension plan brings.

Not that DB plans are a picture of stability. “A DB plan may be even more volatile than a 401(k),” says Suchsland. “But it will typically provide a better benefit than a comparable contribution to a DC plan would provide, because of the advantages of greater diversification, lower fees, and access to investment professionals.”

Towers Watson’s analysis of more than 2,000 employer-sponsored retirement plans found that DB plans had median investment returns of 2.74 percent in 2011, compared to 0.22 percent loss for DC plans. ...

In fact, over the past five years that gap has been narrower than it was historically. Since 1995, DB plans have outperformed DC plans by an average of 76 basis points annually. But in the 2007-2011 period the difference shrank by roughly half, to an average of 39 basis points, driven almost entirely by strong stock-market performance in 2009, when DC plans returned 20.9 percent while DB plans gained 15.5 percent.

Judging by the stock market’s recent stellar performance, when the analysis for 2013 becomes available it likely will show that DC plans once again did better than DB plans, at least for a year’s time.

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Protection from the Storm

PLANSPONSOR.com

Thinking about investment-management outsourcing? Here are seven of the biggest myths and realities
“If it is raining, you are looking for the best umbrella,” says Joshua Dietch, Managing Director at Waltham, Massachusetts-based Chatham Partners, a market research and consulting company. Some employers—who sponsor underfunded defined benefit (DB) plans that need better risk management or defined contribution (DC) plans that need less-costly, more-customized investment options, for example—have looked to the expertise of investment-management outsourcers as that protection from the current storm.

However, this complex field is ripe for confusion among employers considering it. Sources talked about several of the most common investment-outsourcing myths:

1. It is just for mid-size sponsors. “The real sweet spot for outsourcing is mid-size companies,” says Seth Masters, CIO of AllianceBernstein Blend Strategies and Defined Contribution, and most of the first wave of deals did, in fact, happen with these plans. These employers often do not have the in-house resources to do all the work effectively, but have enough in assets to make deals scalable for an outsourcer.

Image via WikipediaWhile the mid-size market remains active, “we also see much more of a trend at the larger end,” says Joseph Gelly, Russell Investments Investment Outsourcing Practice Leader. “It is less around ‘I do not have buying power’ or ‘I do not have the resources or the technical competence’ and more around ‘I need to focus on running my company,’” he says, adding that many of those larger employers have frozen DB plans and want to devote their time and resources to core parts of their business rather than legacy benefits.

2. It is just about managing managers. Many sponsors traditionally see outsourcing in terms of investment oversight, says Clint Cary, Senior Vice President at Aon Investment Consulting. “It is not just managing assets; it is managing the funded status,” he says. Sponsors of active DB plans “are migrating to a risk-management approach, where they are trying to improve the funded status of the plan and de-risking the plan as they get better funded,” he says, “and they do not have the risk managers internally.”…

Image via Wikipedia3. Only defined benefit plans get outsourced. These plans have used outsourcing the most, but defined contribution (DC) sponsors increasingly consider it, says Jennifer Tretheway, a Senior Vice President and Managing Director at Northern Trust Global Advisors. “The most common thing we see from DC plans is an interest in having some type of oversight done, anything from overseeing the mutual fund options on a recordkeeper’s platform to something more proactive, in terms of having discretion on which investment-management firms to utilize,” she says.

DC plans may need outsourcers’ expertise even more than DB plans, Masters says. “Historically, DC plans did a kind of outsourcing by hiring recordkeepers that provided a bunch of options, mostly in mutual fund form and often, frankly, at a fairly high cost,” he says. However, DC plans have become most Americans’ primary retirement-savings vehicle, leading employers to want to limit the cost to participants as much as reasonably possible.
“The single biggest thing that people will get help with is customizing target-date funds,” Masters predicts. “In the next 10 years, virtually all growth in DC assets will be in target-date assets. So, as that unfolds, it becomes increasingly important for plan sponsors to get the target-date decision right.” Designing and implementing a customized target-date structure so that it comes as close to the cost of a DB plan as possible “is a fairly specialized task,” he says, and many employers lack that in-house expertise.
4. It costs a lot, or saves a lot. “Another primary misconception is that outsourcing is more expensive than doing it in-house,” Tretheway says. “The majority of our clients do recognize some savings, in the form of hard-dollar expenses for investment management, custody, and performance measurement. On average, clients might recognize a savings of around 10%.”…
“[Sponsors] do not go in thinking the overall fees are lower; they go in thinking they will get a more comprehensive service set,” Cary says. “They see it as a cost-neutral solution. Cost is not a main driver, and is also not a hindrance.”
Remember that the cost of administration for a DB plan pales compared with the cost of funding the plan, Dietch says. The argument for outsourcing a pension plan is “you reduce your cost of funding if you generate higher returns and less volatility, and reduce tracking error,” he explains.
5. Sponsors can offload their fiduciary responsibility. Dietch wonders if most employers realize that they retain significant fiduciary obligations if they outsource. Even if they think they can transfer that responsibility legally, Masters says, “I think you cannot morally: The reputational risks are too great.”
Yet, the desire to forgo as much fiduciary responsibility as possible “is a big motivator” to outsource, Dietch says. “It is certainly being aggressively marketed.” However, an ERISA plan sponsor remains a fiduciary, he adds, and has to operate with that standard in selecting and monitoring an outsourcer.
“That fiduciary role does not go away,” Gelly says. “The responsibility shifts from day-to-day to more strategic. Their involvement is extremely critical, but it is more at the strategic level,” such as approving the investment policy. The employer also still needs to evaluate the investment outsourcer’s performance regularly, Tretheway says, and most clients look at quarterly committee meetings as a good time to cover that.
6. It means giving up all control. “One thing I hear a lot is that people feel like, ‘Oh, I am giving up control,’” Gelly says of employers thinking about outsourcing. In reality, Tretheway says, clients’ ongoing involvement level really ranges. For instance, some clients delegate to Northern Trust the authority to hire and fire investment managers but, in other cases, it does not have complete discretion. For those with less day-to-day involvement, she believes, they ultimately have more control because they can track progress more closely to meet their goals.
There is no one right answer on how involved in day-to-day workings a sponsor should stay after outsourcing, Masters says. …
7. Outsourcers only sell pre-packaged solutions. “There is a little bit of a myth out there around, ‘This is a black box,’” Gelly says. “Unfortunately, some people think that everybody is treated the same.” Sometimes yes and sometimes no. For instance, Gelly says that Russell highly customizes the weighting among plan clients’ asset classes based on factors such as a plan’s liabilities.
Outsourcing has a lot of different permutations in the marketplace, Dietch says, but to do this business profitably, outsourcers have to create something scalable. As for customizing to specific clients, he says, “a lot of it comes down to what the contractual terms say.” Some outsourcing providers take a more-standard approach: “They have one fund, and everybody goes into that fund,” Tretheway says, “but all of our clients have a unique asset allocation, and a unique investment policy statement. We really have a hard time believing that any two organizations have identical needs.”
Judy Ward
editors@plansponsor.com

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Vanguard - Cash balance plans can hold hidden risks for plan sponsors

Vanguard

Vanguard | 08/31/2010

Legislative and accounting changes that require faster funding and balance-sheet pension cost disclosure—not to mention a 2008 market that devastated funding ratios—have given rise to a new respect for risk and volatility on the part of defined-benefit (DB) plan sponsors.

Plan sponsors who move to a cash balance plan from a traditional defined benefit (DB) plan may not always realize they are trading interest rate risk for investment risk, Vanguard’s chief actuary maintains.

“Generally, cash balance plan sponsors have the same goals and desires as any other plan,” said R. Evan Inglis, a principal in Vanguard Strategic Retirement Consulting and the chief actuary supporting Vanguard’s clients. “They are looking into ways that they can reduce risk. But reducing investment risk is actually easier with a traditional plan.”

That’s because while cash balance plans are technically DB plans since they provide a guaranteed level of benefit payable to a participant, the benefit is expressed as a lump-sum amount.  However, a traditional pension plan expresses its benefit as an annuity, payable over the participant’s lifetime.

As a result, it is more difficult to invest in assets that match the liability of the cash balance plan than it is to invest in assets that match the liability of a traditional pension plan, Mr. Inglis said. A traditional plan’s liability acts as a long-term bond, which means long bonds can be used to hedge the risk inherent in pension funding levels, he said. This can be a powerful risk-management tool because pension liabilities and bonds both change in value the same way when interest rates change. Investing in long-term bonds minimizes risk, but also allows for potentially a relatively high return.

On the other hand, the liability for a typical cash balance plan is not very sensitive to interest rates, Mr. Inglis said. The liability itself is more stable and predictable, especially because final average pay and early retirement provisions add volatility to a traditional plan. However, because there are no specific assets that will match the liability, the funded status of a cash balance plan is difficult to control, he said.

The original concept for cash balance plans was to credit a relatively low rate of interest to participant accounts and invest in a balanced portfolio that would generate investment earnings higher than the interest crediting rate, he said. That is likely (but not certain) to work fine over a very long time frame, but doesn’t allow for substantially eliminating uncertainty and volatility, Mr. Inglis said.  The reason is that most cash balance plans invest in a traditional balanced portfolio and cannot take advantage of liability-driven strategies that effectively reduce risk, he said.

Cash balance plan features
There are different ways, however, that cash balance plans can be structured, affecting the level of risk and ability to minimize risk.
Most cash balance plans credit a market rate of interest, which changes each year. The most common interest crediting rate is the 30-year Treasury rate. … For a cash balance plan that credits the 30-year Treasury rate to participant accounts, however, investing in 30-year Treasuries doesn’t match the liability, Mr. Inglis said. Each year when the interest crediting rate changes, there would be a gain or loss on the 30-year Treasury assets that’s not matched to the accounts, he said.
Other common interest crediting rates are the 10-year or 1-year Treasury rates. Plans that use the 1-year Treasury rate to credit interest on participant accounts can match the liability pretty well by investing in 1-year Treasuries, Mr. Inglis said. Doing so, however, sacrifices quite a bit of return relative to a traditional portfolio made up of 60% stocks and 40% bonds, he said.
Cash balance plans that use a fixed rate of interest for participant accounts are interest rate sensitive and allow for somewhat easier risk mitigation at higher rates of return, he said. Other plans have interest rate floors. “For example they may credit the 10-year Treasury rate with a minimum of 5%,” Mr. Inglis said. “When you do that you’ve introduced some interest rate sensitivity.” It’s hard, however, to actually invest in anything that matches the liability, he said. There may be some complex derivative strategies that match such a structure, Mr. Inglis said.  But it’s unlikely that most sponsors of cash balance plans are interested in such complicated approaches….
Accepting the efficient frontier

Image via Wikipedia

Beyond such strategies, however, there is little cash balance plan sponsors can do but accept that managing a cash balance plan means taking on investment risk they wouldn’t have to face managing a traditional DB plan.

“There’s just really no reasonable strategy you could adopt to minimize that risk other than to invest in cash or short bonds,” Mr. Inglis said. “That’s kind of the traditional efficient frontier approach.”
It’s a distinction that often goes unnoticed by many plan sponsors, he said.
“Plan sponsors with a traditional pension plan think: ‘Well, there’s a lot of volatility in this plan. We want to get rid of that and replace it with this cash balance plan because it is less risky, less volatile,’” he said. That’s true, however, only if both a cash balance and traditional DB plan invest in the same mix of stocks and bonds, Mr. Inglis said. Sponsors of traditional DB plans are more and more moving to a strategy when it can match its liability with long bonds.
It’s understandable that some employers have moved to cash balance plans. Many employees seem to understand the account balance concept offered in cash balance plans and appreciate the value of an account balance more than the value of a promised annuity. Also, younger participants may appreciate that the value of their benefit increases faster than in a traditional pension plan where much of the value accrues after age 45.
However, the potential to reduce risk and make costs predictable has to be considered alongside potential advantages.

Transforming 401(k) plans into DB plans

Employee Benefit News

By Lydell C. Bridgeford

April 5, 2010In the quest to make 401(k) plans look more like defined benefit plans, government officials are reaching out to employers and other stakeholders in the retirement plan industry for advice on offering annuities through defined contribution plans.

In February, the Departments of Labor and Treasury issued a request for information (RFI) to help federal regulators map out a course of action to improve Americans' retirement savings by purchasing lifetime income options, which include annuities. ...

The RFI hopes to solicit comments on topics that include:

* The advantages and disadvantages of distributing benefits as a lifetime stream of income both for workers and employers, and why lump sum distributions are chosen more often than a lifetime income option.

* Developments in the marketplace that relate to annuities and other lifetime income options.

"[The RFI] initiative is particularly important given the shift from defined benefit plans that offer employees lifetime annuities to 401(k) and other defined contribution plans that typically distribute retirement savings in a lump sum payment," says Phyllis C. Borzi, assistant secretary for the DOL's Employee Benefits Security Administration. Some retirement-income experts also contend that large swings in the stock market also have forced policymakers to rethink how the nation saves for retirement.

'Clearing the air'

The outcome of the government's request for public comments on lifetime income options will probably find some low-hanging fruit of the regulatory side to providing annuities within DC plans, says Edward Ferrigno, vice president of Washington affairs at the Profit Sharing/401(k) Council of America.

PSCA's latest research shows that about 20% of DC plan and profit-sharing sponsors offer an annuity option.

Still, retirement-income analysts observe that some employers are reluctant to offer annuities within their DC plans because of a lack of demand among participants and the complexity of the product in plan administration. …

A new landscape

Americans are living longer, and many will outlive their retirement assets. Annuities, in part, offer retirees the opportunity to exchange accumulated wealth for a lifetime stream of guaranteed income.

DC plans gradually are becoming the primary source for retirement income for many U.S. workers, given that traditional pension plans are slowly fading away, explains Charlie Nelson, president of Great-West Retirement Services. …

DOL hopes to figure out ways in which people don't run out of money while they are in retirement, says Karen Friedman, executive vice president and policy director of the Pension Rights Center, a Washington, D.C.-based advocacy group for workers and retirees.

Providing lifetime income options is a good idea, considering that "we are facing a retirement-income crisis in this country where people are not saving enough for retirement and millions of people are not going to have enough retirement income," Friedman says.

… "Even before the recession, the median account balance in a 401(k) plan was $25,000 and $40,000 for those nearing retirement, which is really not a lot of money," [Friedman notes].

Therefore, individuals with low 401(k) account balances will be reluctant to hand over those funds to a financial institution for an annuity, Friedman asserts. …

Think again

Jane White, president of Retirement Solutions, LLC, sees federal regulators call for a national discussion on lifetime income options as the brainchild of some key players in the Obama Administration.

The concept of "automatic annuitization is the product of the Retirement Security Project, launched by the Hamilton Project, which is part of the Brookings Institution. That project was run by Peter Orszag, who now runs Obama's Office of Management and Budget and Mark Iwry, who is now deputy assistant at the Department of Treasury," explains White.

"In the same fashion that automatically enrolling employees in 401(k) plans is seen a way of combating inertia, automatically annuitizing their account balances at retirement age is viewed as a paternalistic way of preventing them from shooting themselves in the foot by cashing out of vested balances and spending the money foolishly," White adds.

Many Americans are unable to retire because they only have a 401(k) plan. "Because of the puny 3% employer match, the only Americans who can afford to retire are ones that started saving at age 25," White notes. The rule of thumb for retirement readiness, created by pension actuaries, is that you need to have saved the equivalent of 10 times your final pay - or your salary right before retirement - in order to be able to afford to retire.

"The typical 65-year-old has a median income of $64,000 and savings of only $110,000. Therefore, retirement is not possible and it is irresponsible to sell someone an annuity when it can't make an empty nest egg full," White explains. For example, a 65-year-old with a $100,000 annuity who withdraws 4% a year will get $8,000 a year, or about $650 a month.

White asserts that such an amount will not adequately cover the living expenses for most Boomers, especially those who are still paying off their mortgages and footing the college tuition their children.

More importantly, annuities are expensive ways to create retirement income. White notes that "mutual fund industry has 'managed payout' funds that accomplish the same thing as an annuity at a lower cost." Besides, the only guarantee that the annuity purchaser receives is that the individual gets back the money he or she puts into it, plus any returns that you earned, White asserts. "You will very likely get this promise from a mutual fund as well at a lower cost."

Current hurdles

Employers with DC plans will certainly drill down on the fiduciary liability attached to providing an annuity in a DC plan, says Jan Jacobson, senior counsel of retirement policy at the American Benefits Council, a business association that represents private-sector employers.

"If you look at it from the point of view that you pay out a lump-sum, then whatever liability the employer has is over. The money is removed from the plan and it goes to the plan participant," Jacobson explains. Yet with an annuity, "it's conceivable that participants might come back 20 years later if the annuity provider goes under."

Jacobson also hopes the RFI process will yield clearer and straightforward guidance on some current practices on annuities in DC plans. Presently, DC plan sponsors "are a little bit confused on what the criteria is in selecting annuities to the plan, especially on how to determine the safest available annuities," Jacobson says. … L.C.B.

The shape of things to come for 401(k) plans

Employee Benefit News

By Jerry Kalish
January 1, 2010
…Despite the continuing recession, 401(k) providers will still be … offering more and more features to plan sponsors. …
Here are three more plan features that you are likely to see more of in 2010 and beyond:
Individually managed accounts
This is a plan option through which a 401(k) participant can elect to have his or her account professionally managed. A new survey by Hewitt Associates shows that more midsized-to-large employers are increasing their efforts to help employees meet their retirement income needs by adding outside investment advisory services. Approximately 50% of employees use such services (including advice, guidance and/or managed accounts), an increase from 40% in 2007, and 37% in 2005.
… A DALBAR study showed that while the S&P 500 earned an average return of 8.41% from 1988 to 2008, the average equity investor earned a mere 1.87%.
Regardless of the reason, more employers - particularly smaller employers - will be adding a managed account option that has two components. The first is personalized one-time investment recommendations. After that, participants are responsible for ongoing account monitoring, rebalancing and management.
…The second component of a managed account is ongoing discretionary investment management for a fee, paid for by the individual participant.
401(k) interfaced with payroll
The second 401(k) trend is employers interfacing their plans with their outside payroll provider. …
The appeal should be obvious. It allows employers to reduce their administrative involvement with both payroll and 401(k) plans. An interface allows employee and 401(k) participant data to be shared and updated in the course of the employer's normal payroll processing function. How this translates into cost-savings is an analysis that has to be done on an individual basis.
Distribution planning help
The third trend is employers putting programs in place to encourage terminating employees not to cash out.
While the good news is that the cash-out rate hasn't changed much since 2005 despite job losses, according to a recent Hewitt study, the bad news is that almost 50% of terminated participants take cash distributions.
It's a costly decision in terms of ultimate retirement income, particularly for those in their 20s. Terminated employees who cash out will miss out on years of tax-deferred growth in their account. …
Helping employees make better decisions is more important now than ever before. It's a 401(k) world now for employer-sponsored retirement plans, and the majority of future retirees will never participate in a defined benefit plan that provides a guaranteed income for life. For them, it will be a defined contribution plan, personal savings and Social Security. …

---

Contributing Editor Jerry Kalish is the founder of The Retirement Plan Blog and president of National Benefit Services, Inc., a Chicago-based employee benefit consulting and administrative firm.

Achieving Sustainable Retirement Withdrawals: A Combined Equity and Annuity Approach

Journal for Financial Planning
by Craig Lemoine, CFP®; David M. Cordell, Ph.D., CFA, CFP®, CLU; and A. William Gustafson, Ph.D.

Executive Summary

• This article contrasts sustainable retirement withdrawals from strategies with annuity components and strategies without annuity components.
• The authors discuss today's market environment as it affects retirement planning strategies with and without annuity components.
• This study evaluates common retirement planning strategies by analyzing the withdrawal stability for portfolios consisting of equity, fixed income, variable annuity, and fixed annuity assets.
• This article uses replacement Monte Carlo methodology to determine retirement success over investor accumulation and withdrawal phases. The goal of each trial was to secure calculated retirement funding rather than to maximize wealth.
• Five retirement portfolio strategies are evaluated: (1) 50 percent in equities and 50 percent in bonds, (2) 100 percent in equities, (3) a combination of equities and bonds in which the equities percentage is calculated as 128-minus-attained-age, (4) a variable annuity with a 5 percent withdrawal rate, and (5) 100 percent equities with a fixed annuity lock.
• Different rebalancing strategies were modeled to capture any variances between frequency. Portfolios composed of a higher portion of equities outperformed those with a higher portion of bonds. The trials using 50 percent equities and 50 percent bonds yielded the lowest chance of success. Attempting to reduce portfolio risk by reallocating to fixed-income assets annually is less likely to provide long-term success than an allocation that remains fully invested in equities.
• The results indicate that using an equity portfolio with a fixed annuity component provides a higher chance of maintaining retirement distributions than other alternatives.

Craig Lemoine, CFP^®, is an assistant professor of financial planning at the American College. He also works with retirees and is completing a doctoral dissertation at Texas Tech University.
David M. Cordell, Ph.D., CFA, CFP^®, CLU, is director of finance programs at the University of Texas at Dallas.
A. William Gustafson, Ph.D., is an associate professor at Texas Tech University.

Analysis Suggests Participants Don’t Understand Value of Annuities

PLANSPONSOR.com

December 28, 2009 (PLANSPONSOR.com) – An analysis of retiring participants from one public pension plan suggests they do not understand the value of life annuity payments.

John Chalmers from the Lundquist College of Business, University of Oregon, and Jonathan Reuter from the Carroll School of Management, Boston College, analyzed data on Oregon Public Employees Retirement System (PERS) retirees who must choose between receiving all of their retirement benefits as life annuity payments or receiving lower life annuity payments coupled with a partial lump sum payout… [Looking] at variation in the value of the incremental life annuity payments arising from how PERS calculates retirement benefits, the researchers found evidence that demand for lump sum payouts is higher when the forgone life annuity payments are more valuable. 
Chalmers and Reuter also found that demand for lump sum payouts is higher when the lump sum payout is "large," and when equity market returns over the prior 12 months are higher.
"Collectively, these findings suggest that retirees value incremental life annuity payments at less than their expected present value, either because they do not know how to accurately value life annuities or because they have strong demand for large lump sum payouts," the researchers wrote in a working paper for the National Bureau of Economic Research (NBER).
The researchers did find that those with poor health at retirement more consistently utilized "value-maximizing decision-making."
According to the NBER working paper, the Oregon PERS data showed that the higher the money’s worth of the incremental life annuity payments, the more likely the retiree is to choose the partial lump sum option over the full life annuity option. "This (robust) finding suggests that retirees facing more valuable incremental life annuity payments either attach greater value to the lump sum payout or … underestimate the value of the incremental life annuity payments," the researchers wrote. …
The research findings suggest that the fraction of retirees demanding a lump sum is associated with the returns on the prior 12-month returns to the S&P 500 index. …

The researchers also found that demand for the partial lump sum option is lower for retirees earning high salaries, and speculate that this is because these retirees are less financially constrained or more financially literate.
To order a copy of HOW DO RETIREES VALUE LIFE ANNUITIES? EVIDENCE FROM PUBLIC EMPLOYEES, go to http://www.nber.org/.
Rebecca Moore
editors@plansponsor.com

Will the DB(k) Plan Replace the 401k?

eRollover Blog
 By Mike Rowan, 11/18/2009

Meet the DB(k) Retirement Plan

… One retirement plan that will become available in 2010 offers a 401k alongside a guaranteed pension-like retirement benefit.
This new plan is called the DB(k) and it has its beginning in tax code from 2006. The tax law allows companies with fewer than 500 workers to start the DB(k) after Jan. 1, 2010, and many advocates would like to see it available to everyone. …

Questions and answers about details of the new DB(k) Plan:

Q: What are the features of the DB(k) Plan?

A: There are two parts to the new plan:
Employers will be required to establish a pension fund sufficient to pay  up to 20 percent of that individual’s average annual salary received during the last few years in the workforce. Once the employee has spent three years with a company, their benefits will become fully vested.
… The balance in this retirement account would be paid at retirement like a traditional type of pension plan. …
At the same time, the employer will be required to take 4 percent of a worker’s salary and put it in a 401k plan. The company must match at least 50 percent of the contribution, and would be immediately vested. Upon reaching retirement, the worker could withdraw additional funds from their 401k account as needed.
Employees can opt out of their contribution or they could chose to set aside less.
Q: Why create a hybrid type of pension/401k plan?
A: More companies are dropping traditional pension plans and employees with a 401k often do not save enough, leaving workers woefully unprepared financially for retirement.
The concept behind the DB(k) allows employers to provide the benefits of a combined plan without the paperwork, regulatory requirements, and elevated costs that would come with operating a pension and 401k plan separately. As a result, in theory employees get a more secure retirement with a guaranteed pension alongside their own 401k savings.
Q: What types of companies would be a good fit for a DB(k) and why?
A: Companies must have at least two and no more than 500 workers to implement a DB(k) plan. It is anticipated that DB(k) retirement plans will be offered by companies looking for professional workers in competitive fields. The Employer completely funds the pension and provides matching contributions in the 401k plan
Q: When will we start seeing DB(k) plans in the marketplace?
A: The DB(k) plan is authorized by the Pension Protection Act of 2006, which gives permission for companies to begin offering the plans starting on Jan. 1 of 2010. However, the IRS and the U.S. Treasury Department only recently began developing rules for the DB(k), so it may be delayed until later in the year. …

Retirement income – the axiomatic case for annuities

J.P. Morgan Compensation and Benefit Strategies

Nov 12, 2009

… In this article we lay out the axiomatic case for annuities as the investment instrument for providing retirement income. Summarizing: where, over any particular period, the objectives are to maximize lifetime income without risking the possibility that you will outlive your assets, an annuity (vs. self insurance alternatives) will always provide the greatest income. …

Longevity risk – the unpleasant choices for those blessed with long life

… Longevity "risk" … is the risk of being old and poor. Not, say, age 70 and poor … . Instead, we're talking about being, say, 85 or 90 and poor. … [Poor] because the individual lived longer than he or she expected. The retirement savings have been spent, and the individual now has nothing.

What are the choices?

We are going to consider three different general strategies for dealing with longevity risk:

• "ignoring" it, that is, depending on someone else (family, Social Security, state welfare systems) to finance it;

• self-insuring;

• or buying an annuity.

…

Ignoring longevity risk

If an individual is old and doesn't have any assets, one (or more) of three things happen. Either he or she: (1) moves in with his or her children or other family; (2) lives off of Social Security; and/or (3) lives on some combination of state welfare programs (e.g., a state-provided nursing home). Let's consider each of these alternatives in turn.

1. Living with family. The retiree may have a large and strong family, with a tradition, for instance, of grandparents living with parents and children. … [He] or she is also likely to have a positive motive in favor of preserving retirement assets for a legacy. If the individual does not have family members he or she can realistically live with, then alternative 1 is not a solution to longevity risk.

2. Living off Social Security. … In 2009 [the maximum] benefit is about $2,300 per month. If the individual lives in a low cost-of-living community and is prepared to get by on "very little," then alternative 2 may work.

3. State welfare. Finally, some states and municipalities have quite livable publicly funded "old age" homes. … At least at this time, in this country, there is still a safety net.

Realistically, if the individual is going to ignore longevity risk, i.e., not insure (either with an insurance company or self-insure) against outliving personal retirement resources, he or she is probably counting on some combination of alternatives (2) and (3) and perhaps, depending on family circumstances, alternative (1). …

What is self-insurance?

… Let's assume that you are primarily concerned about the risk of living to age 95. If you live past 95, then somebody is just going to have to take you in. … In that case, self-insuring simply means spending your resources at a rate that (more or less) insures that you will have income through age 95. …

… For purposes of this article we're going to assume that the typical individual, at 65, assumes that he or she is going to live into his or her 80s and is prepared to consider, at least, self-insuring for that period – say, 20 years. So that the individual will spend his or her resources at such a rate that they will last at least until age 85.

What is an annuity?

As we use the term in this article, an "annuity" is a guarantee by some other entity (e.g., a pension plan or an insurance company) of a specific income "for life," that is, with payments beginning on some date and continuing until you die.

Rate of return

… For purposes of this article we're going to assume the same investment return (generally 5% per year) for all purposes: whether you're ignoring longevity risk, self-insuring or buying an annuity. …

… This is not the place to discuss alternative return strategies. Suffice it to say, identical alternative return strategies can be pursued either via self-insurance or an annuity vehicle, that is, in a variable annuity. Thus, the return strategy itself should not affect the relative efficiency of self-insurance and annuities. As a general matter, our conclusions hold whatever rate of return you assume, provided it is the same for whatever longevity risk strategy you pursue.

Comparing alternatives

Let's now quantify the financial alternatives available for mitigating longevity risk – self-insurance vs. annuity.

Let's assume you have $1 million, are age 65 and in average good health. … Let's consider four alternatives: (1) you self-insure for the period age 65 to 85 and disregard longevity risk thereafter; (2) you self-insure through age 95; (3) you self-insure for the period age 65 to 85 and buy an annuity for the period after age 85; or (4) you buy an annuity beginning at age 65 (the number provided here is for a DB plan, not a retail annuity).

The following table summarizes the results for each alternative.

Alternative--Income per month

Self-insurance age 65 to 85--$6,512

Self-insurance age 65 to 95--$5,279

Self-insurance age 65 to 85 + annuity 85-death--$6,091

Immediate annuity beginning at age 65 DB plan--$6,945

Explaining these results

…Self-insurance age 65 to 85 – means you spend all your money, at a rate of $6,512 per month, to age 85. If you live past that age, someone else has to pay your living expenses.

Self-insurance age 65 to 95 – means you spend all your money, at a rate of $5,279 per month, to age 95. As discussed, this is more or less the equivalent of fully self-insuring longevity risk, that is, survival past age 95 can be realistically ignored.

Self-insurance age 65 to 85 + annuity 85-death – means you take some of your $1 million (about 6-7% to be precise) and buy, at age 65, an annuity that is payable for life beginning at age 85. This annuity is relatively cheap, because it doesn't pay anything unless you at least survive to age 85. You then take what's left over and spend it, at a rate of $6,091 per month, to age 85.

Immediate annuity beginning at age 65 – means just a regular old garden variety life annuity. As indicated, our immediate annuity number is based on what you would get out of a DB pension plan using current "standard" actuarial assumptions. Insurance company and regulatory overhead will add costs to annuities and bring the annuity income number down somewhat.

Tax effects

In our analysis we have generally disregarded tax effects. And, assuming our $1 million starts out in a qualified plan or IRA, taxation under self-insurance or an annuity will be, for the most part, identical. We say, "for the most part," because we have ignored two elements of the tax code that, in fact, further skew results in favor of annuities.

First, money held in a qualified plan or IRA, unless it's rolled into an annuity, must be distributed at a specific minimum rate (with a lot of oversimplifications, over the participant's life expectancy). At a stretch, those minimum distribution rules would permit a distribution over 20 years, i.e., allowing self-insurance over the period age 65 to 85. They would generally not permit distribution … under an age 95 self-insurance strategy, some tax-advantaged money would have to be distributed early and held in a taxable account.

Second, the after-tax rate of return on a taxable account (e.g., a garden variety bank or brokerage account) will be lower than the after-tax rate of return on a retail annuity. That's because the "inside build-up" on retail annuities is untaxed. …

When you put these two rules together, the annuity approach enjoys a tax advantage vis a vis self-insurance. Nevertheless, we regard that advantage as relatively marginal and have not taken it into account in our analysis.

Why are annuities such a better choice?

…Given those two objectives, maximizing retirement income and minimizing the chance of outliving your savings, annuities are the most efficient investment because – all other things being equal – they share the risk of outliving savings within the annuity pool. …

*     *     *

… Reviewing it, you would think that everyone would buy one. But the fact is, very few individuals do. Consider – only 2% of the income of current retirees comes from private annuities. (Increasing Annuitization in 401(k) Plans with Automatic Trial Income; Gale, Iwry, John and Walker; 2008.)…

Compromised longevity

The foregoing, "axiomatic" case for annuities holds for someone in average good health. Clearly, if you realistically expect not to live to an average life expectancy – that is, your longevity risk is, for some reason, compromised – then you should generally not buy an annuity. …

Solvency risk

If you take the annuity approach, then a third party will be paying you an income for life. Generally that third party is either an insurance company or an employer-sponsored pension plan. Both insurance companies and (corporate) pension plans are subject to solvency rules – requiring them to fund benefits at certain minimum levels. Moreover, many states provide insolvency funds for insurance companies that go "bankrupt," and the Pension Benefit Guaranty Corporation generally insures corporate pension benefits up to certain minimum levels.

…Suffice it to say, if you are taking an annuity option, you will want to evaluate the possibility that, under some circumstances, the third party annuity provider might not be able to make payments.

Explanations focusing on aspects participant behavior

Concerns about compromised longevity and carrier insolvency risk cannot, however, explain the overwhelming rejection of annuities by participants. …

In recent years, the field of “behavioral economics” has provided insights as to why individuals do not always act in accordance with “rational” principles. … While we recognize the fruitfulness of this perspective, we are resistant to the idea that low uptake on annuities is simply a result of irrational decision-making. …

Individuals view early death as "losing" in an annuity system

If you look at the actuarial tables, over 15% of a typical age 65 annuity cohort will die in the first ten years. They will "lose" – by dying early – a significant portion of the value of their benefit. We put "lose" in quotes because the axiomatic argument does not regard this as a loss. The participant is dead and so does not need any more income. And the participant could have had no fixed legacy intention with respect to the "lost" money – if (as was in fact more likely) he or she had lived to a normal life expectancy, there would have been no money "left over" to leave to heirs and beneficiaries.

Our guess, however, is that people don't think like that. …[Human] beings are reluctant to take a substantial risk that money they worked hard for will simply go to strangers, even after they're dead. … Humans retain, and act on, a proprietary view of their money, even after their (anticipated) death. …

Annuities limit flexibility

Simply, if money is "locked up" in an annuity, there is no (or, at least, less) money available for emergencies or, for that matter, for something special.

Individuals place a lower value on life after 85

… More nuanced: a 65 year old does not regard the financial challenge presented by living past 85 as a particularly high priority. Perhaps an analog to this is the reluctance of young people (say, individuals in their 20s) to buy health insurance. In both cases, the likelihood of catastrophe – a health catastrophe for a young person or a longevity catastrophe for an old person – is small enough that the individual feels comfortable ignoring it. (This argument reflects the behavioral economics notion of “hyperbolic discounting.”)…

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This is a publication of J.P. Morgan Compensation and Benefit Strategies. J.P. Morgan Compensation and Benefit Strategies is a part of JPMorgan Chase & Co. If you have any comments or questions, please contact your J.P. Morgan Consultant or Insight Editorial.

This material has been prepared for informational and educational purposes only. It is not intended to provide, and should not be relied upon for investment, accounting, legal or tax advice. J.P. Morgan Compensation and Benefit Strategies is wholly owned by J.P. Morgan Retirement Plan Services LLC, an affiliate of JPMorgan Chase & Co.

IRS Circular 230 Disclosure: JPMorgan Chase & Co. and its affiliates do not provide tax advice. Accordingly, any discussion of U.S. tax matters contained herein (including any attachments) is not intended or written to be used, and cannot be used, in connection with the promotion, marketing or recommendation by anyone unaffiliated with JPMorgan Chase & Co. of any of the matters addressed herein or for the purpose of avoiding U.S. tax-related penalties.

 

Leading the Horse to Water

 Legislation may nudge plan sponsors to reconsider annuities—but what about participants?

Plansponsor.com

Judy Ward editors@plansponsor.com

 

Illustration By Marco Wagner

 

The market's recent plunge likely frightened more Americans into a willingness to consider putting at least some of their 401(k) assets in a retirement-income product at retirement. Now, Congress may give them a nudge to go ahead with it.

Support for tax advantages for annuities, previously proposed in 2005 by Rep. Earl Pomeroy (D-North Dakota), seems low this year… However, several other ideas appear to have potential traction, and they speak to the logistical and psychological reasons that many see at the heart of 401(k) participants' continued aversion to retirement-income products—the overall inertia, concerns about the complexity and cost of choosing an annuity on the open market, the fear of losing money to unstable financial institutions, and the impression that a series of small payments made over time has less value than one big lump-sum payment.

"As we bring more people into the system, we will need to address the longevity risk," says David Certner, AARP's Director of Legislative Policy in Washington, pointing to the Obama Administration's auto-IRA push. "Having a better-functioning annuities market would be very helpful."

Three Possible Solutions

These three possibilities seem the most discussed currently:

Auto-enrollment in annuities: Nonprofit public-policy researcher The Brookings Institution has proposed a "test drive" that would automatically enroll defined contribution participants in an annuity for two years after they retire. …

A government mandate to purchase annuities "would be a step in the wrong direction," [William Gale, a Brookings Vice President and Director of the Retirement Security Project] stresses. An annuity does not work best for everyone, he says, and, even when it does work well, a bunch of variables mean no one annuity setup is right for everyone. "It is very important that these things remain voluntary," he says. If people get the wrong annuity, he says, they "have made a big, permanent mistake."…

From an employer perspective, sources agree, auto-enrollment succeeds in giving many more participants access to a retirement-income vehicle. With opt-out rates low for automatic enrollment in 401(k) plans, "it is not likely that they will opt out" of auto-enrollment in an annuity, says Robyn Credico, Arlington, Virginia-based National Director, Defined Contribution Consulting, at Watson Wyatt Worldwide. …

The concept has its challenges, though. "The problem is the pricing," says Dallas Salisbury, President and CEO of the Employee Benefit Research Institute (EBRI) in Washington. "You could do it—but it would be a very expensive option, because any annuity that can be terminated at the end of two years becomes very expensive to underwrite." …

Edward Ferrigno, Vice President, Washington Affairs, at the Profit Sharing/401k Council of America, also worries about any sort of annuity mandate. "We … fully support … a tremendous amount of innovation [by annuity­ providers], he says, but it would kill that innovation if they mandated something. "For insurance companies, that is a jackpot: 'We have your money, and you cannot get it back.'"

A federal guarantee: Some believe that automatic enrollment in annuities makes little sense without setting up a federal-guarantee structure for annuities, similar to the Federal Deposit Insurance Corp. (FDIC) guarantee of bank deposits. …

On the other hand, "One thing employers might be ­concerned about is that the whole arrangement would be ­subject to future changes by Congress," says Jan Jacobson, Senior Counsel, Retirement Policy, at the Washington-based American Benefits Council, "and it would be a fairly expensive proposition." Adds Salisbury, "Given the current fiscal situation, even if people said it was a good idea, it would take a long time to do."

Channeling employer contributions: Brookings' Gale also talks about using legislation to funnel employer contributions to an annuity. "It would be a default," he says. "[The idea is that] the employer has to offer it, but it is voluntary for the individual."…

Ferrigno does not favor the idea at all. "We would fight that to the death," he says, again mentioning a dislike of plan-design mandates. "If there was a demand for ­annuity products in a plan, they would be there.” …

"There is a lot of interest. The Administration is in favor of it, and I think Congress gets it," Gale says. "…The sea change coming is going to be to think of a 401(k) not as an asset-accumulation device, but a retirement-income-provision device."

Jacobson also sees interest in annuities in Washington, but does not expect a stand-alone bill. … U.S. Rep. George Miller (D-California), Chairman of the House Education and Labor Committee, was said at press time to be "in the middle of drafting a retirement bill that might or might not include annuities," Salisbury says. "Everything at the moment is dominated by the health-care discussion. The probability of that [retirement] bill getting enacted this year is probably zero," he predicts. "The question becomes, does it become a priority in 2010 and 2011, assuming they get health care done this year?"…

— Judy Ward

Legislation provides incentives for annuitizing distributions

Bipartisan legislation has been introduced to give workers a new incentive to annuitize, rather than spend, their retirement savings. U.S. Representatives Earl Pomeroy (D-North Dakota) and Ginny Brown-Waite (R-Florida) have introduced The Retirement Security Needs Lifetime Pay Act, H.R. 2748, which would encourage workers to annuitize some of their retirement savings by providing a 50% tax exclusion for up to $10,000 of lifetime annuity payments annually.

Other Provisions

The bill also will exclude from taxes 25% of lifetime income payments from individual retirement accounts (IRAs), qualified plans, and similar employer-sponsored retirement savings plans other than defined benefit plans. …

"For years, the federal government has recognized its duty to assist American families in building a retirement nest egg," Pomeroy said in a press release. "Saving and investing for the long term is extremely important, especially in these challenging times. A greater retirement challenge lies ahead: managing assets to make sure that your retirement savings last a lifetime. The Retirement Security Needs Lifetime Pay Act will provide families with incentives to plan for a secure lifelong retirement."

— Alison Cooke

Best of both worlds? Combined pension/401k plan

The Associated Press via Google Hosted News

By DAVID PITT (AP) – November 7, 2009

DES MOINES, Iowa — Over the last year it's become abundantly clear that the stock market can devastate even seemingly healthy retirement accounts. …

The vulnerabilities of the 401(k) plan have cast doubt on whether a voluntary savings plan is the best way for workers to prepare for retirement. There are some possible alternatives coming, however, that might just catch on. One that may become available in January offers a guaranteed pension-like retirement benefit alongside a 401(k).

It's called the DB(k) and it was created in the tax code in 2006. The law allows companies with fewer than 500 workers to start the hybrid plan after Jan. 1, 2010 … 

Here are some questions and answers that explain details of the DB(k):

Q: What are the basic features of the DB(k)?

A: There are two components to the plan:

Companies will be required to establish a pension fund sufficient to pay a worker in retirement up to 20 percent of that individual's average annual pay received during the last few years of work. After three years with a company, a new employee's benefits will be vested. … Their balance in this account would be paid out at retirement in monthly checks like a traditional pension plan. …

Alongside that benefit, the company will automatically take 4 percent of a worker's pay and put it in a 401(k) plan. The company must match 50 percent of that amount, which would be immediately vested. At retirement, the worker could withdraw additional funds from their 401(k) account to supplement the pension payments. Workers can opt out of their contribution or chose to set aside less.

Q: What's the reason for creating a hybrid pension/401(k) plan?

A: … More companies are dropping pension plans and workers with a 401(k) often do not save enough, leaving U.S. workers woefully unprepared financially for retirement. A recent study by The Center for Retirement Research at Boston College concluded that 51 percent of households likely will not have enough money in retirement to maintain their lifestyle, up from 44 percent in 2007.

The DB(k) idea allows companies to provide the benefits of a combined plan without onerous paperwork, regulatory requirements and costs that would come with operating the two plans separately, said Chris Mayer, a Principal Financial Group vice president. Workers get a more secure retirement with the guaranteed pension alongside their own savings.

Q: What types of companies would want to offer a DB(k) and why?

A: Companies must have at least two employees and cannot have more than 500 workers to implement a DB(k) plan. These plans are most likely to be offered by companies looking for professional workers in competitive fields — those who feel they need to offer this enhanced retirement plan to attract the best in their field or keep workers from going to a competitor, said Jan Jacobson, a spokeswoman for the American Benefits Council. …

Employers must completely fund the pension and provide matching contributions in the 401(k) plan. As a result, those adopting this plan need adequate cash to pay the cost, which Principal Financial's Mayer estimates to be about 6 to 8 percent of payroll. … [Companies] currently managing both a pension and a 401(k) might consider the new plans to reduce costs and paperwork.

Q: How soon are we likely to see DB(k) plans launched?

A: The DB(k) is authorized by the Pension Protection Act of 2006, which authorizes companies to begin offering the plans starting on Jan. 1. However, the Internal Revenue Service and the U.S. Treasury only recently began developing rules for the plans, so adoption may be delayed until later next year. …

Q: How can I find out more?

A: … If you want to do further research, you can find information by searching "DB(k) plan." The government frequently refers to the plans as "eligible combined plans" in its documents. You may also find some information under the IRS designation 414(x), which is the section of the tax code relating to the retirement accounts. The IRS details the plan in a document at: http://www.irs.gov.

Many details about the practical operations of DB(k) plans will not be known until the IRS and Treasury officials complete and publish the final rules, which could affect the number of interested companies.

Copyright © 2009 The Associated Press. All rights reserved.

What Sponsors and Advisors Should Know About Retirement Plans

BusinessWeek

October 28.2009

According to a 2007 U.S. Labor Dept. survey, 68% of small business owners feel unprepared for retirement and just 42% maintain a retirement plan. Here are four frequently overlooked tips about retirement plans for plan sponsors and their advisors.

1. Understand the "controlled group" opportunity. If you or your spouse own and/or control several businesses, the IRS may require you to treat all of your businesses as one for certain retirement plan purposes. The controlled-group rules can affect retirement plan selection and operation and could mean higher deductible contributions.
2. Determine your contribution budget. … For example, if your goal is to contribute more than $49,000, you will need to consider a defined benefit plan; a lesser figure can be served by such options as a simplified employee pension (SEP), savings incentive match plan for employees (SIMPLE) IRA, or 401(k)/profit sharing plan.
3. Shop around. Fees for establishing and maintaining plans vary enormously. … [You]can …evaluate how much you are paying for such things as plan investments and record keeping. In fact, it is your fiduciary duty to do so.
4. Keep good records. … Having an investment policy statement and documenting your activities for reviewing and evaluating your plan investments are good ways to start.

John Carl

President

Retirement Learning Center

Brainerd, Minn.

Defined Benefit 401ks set to make their debut

AccountingWEB.com

Posted by gailperry in on 10/29/2009 - 12:19

Small business owners have plenty of options to choose from when it comes to a qualified retirement plan for the company. It can range from a Savings Incentive Match Plan for Employees (SIMPLE) to a Simplified Employee Pension (SEP) to a 401(k). But now there’s a new kid on the block.

Strategy: Consider the defined benefit 401(k) plan (called the “DB/401(k)” for short) for small business clients. This hybrid plan combines some of the advantages of a traditional pension plan with a regular 401(k).
…The authority for this new plan, which becomes available on Jan. 1, 2010, was buried deep within the massive Pension Protection Act of 2006. But interest in DB/401(k)s is expected to heat up during the coming year. …
… It is available for the 2010 plan year to employers with at least two employees and no more than 500 employees.
The DB/401(k) combines a defined benefit plan based on final average pay with a safe-harbor 401(k). Two requirements:
1. The defined benefit part of the plan must provide a benefit equal to 1% of the final average pay times years of service up to a maximum of 20% of final pay. …
2. The 401(k) part of the plan requires automatic enrollment with an employee deferral of 4% of compensation. …

  Advisory: If these requirements are met, the company has to file only one document for the plan and one Form 5500, Annual Return/Report of Employee Benefit Plan, each year. Best of all, employers don’t have to undergo the rigorous testing procedures for 401(k)s. Simply make the allowable contributions, file the paperwork and you’re set.
Requirements for automatic-enrollment 401(k)s

Elective Deferrals By Employees     
Automatic deferral must equal between 3% and 10% of compensation with:
• At least 3% in the first year of participation
• At least 4% in the second year of participation
• At least 5% in the third year of participation
• At least 6%, but not more than 10%, in any subsequent year of participation
Employer Contributions
100% vesting after no more than two years under either of the following two options:

Option 1: Matching contributions for nonhighly compensated employees (non-HCEs)* must equal 100% of elective deferrals up to 1% of compensation + 50% of elective deferrals of more than 1% up to 6% of compensation.

Option 2: Automatic employer contribution must equal 3% of compensation.
*Matching contribution rate for highly compensated employees (HCEs) can’t exceed matching contribution rate for automatically enrolled non-HCEs.
Reprinted with permission from The Tax Strategist, October 2009. For continuing advice on this and numerous other tax strategies, go to http://www.taxstrategist.net/. Receive 2 FREE Bonus reports and a 40% discount on The Tax Strategist when you use Promo Code WN0013. …