Time to Rethink Your 401(k) Plan? Pension Protection Act Allows Employers to Redesign Retirement Plans
Oates, Nancy E., Brown, Cynthia B., Journal of Accountancy
* The PPA has made it easier for plan sponsors to automatically enroll employees in a retirement plan by eliminating the worry over state withholding laws. It delineates a new safe harbor automatic enrollment provision that starts the automatic deferral at 3%, raising it by 10/0 of salary per year until it reaches 6%.
* Investment education programs have long been allowed under the Employee Retirement Income Security Act of 1974 (ERISA). but to what degree employers would have liability for that education remained a concern. As a result, employers often provided general education but not specific investment advice.
* Section 404(c) was added to ERISA in October 1992 with the intent of relieving the employer from responsibility for the employee's asset allocation decision, but employers found it difficult to comply with all of the requirements. The PPA takes this implied protection a step further by providing an actual exemption from the prohibited transaction rules for fiduciary investment advisers.
* The PPA also allows employers to use computer models to deliver unbiased investment advice and reduce liability. Some companies were already using such models before the PPA passed, but the PPA formally amended ERISA to add an exemption that allows fiduciaries to use such models. This provision, ERISA section 408(b)(14), became effective Jan. 1.
* The PPA also has allowed the DOL to propose regulations for default investment options. Some investment advisers are concerned because proposed new DOL rules do not indicate that a fixed income or money market account would be an appropriate default investment option. Others believe sophisticated models based on the employees' profile are more suitable than defaulting to the most conservative investments.
Nearly 50% of the U.S. work force will become eligible for retirement by 2012, according to the Bureau of Labor Statistics. And rapidly rising costs of traditional defined benefit plans have led many employers to abandon traditional plans in favor of defined contribution plans such as 401(k)s. But the new responsibility to fund and direct their own retirement investments has left many employees angry, confused and in some cases seeking legal action against their employers.
The Pension Protection Act of 2006 (PPA) strengthened employers' options to bolster their 401(k) plans. Here we look at some of these new options and other strategies to strengthen and promote your 401(k) plan.
By superseding conflicting state wage and garnishment laws, the PPA has made it easier for plan sponsors to automatically enroll employees in a retirement plan by eliminating the worry over state withholding laws.
"The goal is to get people saving more," says Karen S. Sanchez, CPA, who heads up human resources and benefits consulting for Chicago-based accounting firm Sikich LLP. "401(k) plans weren't built to be the sole retirement system, yet the reality is, they are now."
Beginning in 2008, the PPA has delineated a new safe harbor automatic enrollment provision that starts the automatic deferral at 3%, raising it by 1% of salary per year until it reaches 6%. "We like to put things on autopilot as much as we can," says Sanchez. "It is easier for employees to do nothing than to do something."
Sue Scott, HR manager of Jacob & Hefner Associates PC, hired Sikich to conduct its benefits-education program when the Illinois-based survey and engineering firm added automatic enrollment after the PPA was signed into law. Scott made the benefits-education presentation mandatory and arranged a Webcast for field employees not able to come into the office for the in-person seminar.
"We've gone from a 78% participation rate to about 95%," Scott said. "That says the education program really worked for us. A good 30% of our employees increased their deferral amounts. That wouldn't have happened with me just sending out the enrollment forms."
To protect their employees from making uninformed decisions about how much money will be needed at retirement, and to protect themselves against liability should those decisions lead to inadequate retirement funds and employee lawsuits, employers are turning to formal investment education programs.
Ninety-one percent of large companies provided investment education to 401(k) plan participants in 2005, according to a survey by Hewitt Associates. Thirty-seven percent offered participants access to outside investment advisers.
Under the Employee Retirement Income Security Act of 1974 (ERISA), retirement plan sponsors have a fiduciary responsibility to plan participants. Those who provide investment advice to plan participants also are fiduciaries. ERISA prohibits fiduciaries from engaging in certain transactions that could create a conflict of interest, and fiduciaries are held personally liable for violations.
Plan sponsors are allowed to provide education, but to what degree they would have liability for that education remained an issue of concern. As a result, employers often provided general education but not specific investment advice.
Section 404(c) was added to ERISA in October 1992 with the intent of relieving the employer from responsibility for the employee's asset allocation decision. Plans that comply with a laundry list of provisions benefit from the 404(c) protection. CPAs can assist their companies (or clients) in determining the extent of their compliance with 404(c).
In 2005, the SEC published Staff Report Concerning Examinations of Select Pension Consultants, which outlines certain conditions under which an investment adviser providing advice to retirement plan participants may not result in a prohibited transaction.
The PPA takes this implied protection a step further by providing an actual exemption from the prohibited transaction rules for fiduciary investment advisers. The conditions for such an exemption are defined as an "eligible investment advice arrangement."
Under such an arrangement, the PPA allows investment advisers to offer personally tailored investment advice by charging a flat fee that does not vary depending on the participant's investment option. According to Department of Labor Field Assistance Bulletin no. 2007-01, "a plan sponsor or other fiduciary that prudently selects and monitors an investment advice provider will not he liable for the advice furnished by such provider to the plan's participants and beneficiaries."
The PPA's "eligible investment advice arrangement" also allows employers to use computer models to deliver unbiased investment advice and reduce liability. Some companies were already using such models before the PPA passed, but the PPA formally amended ERISA to add an exemption that allows fiduciaries to use such models. This provision, ERISA section 408(b)(14), became effective Jan. 1.
To comply with the PPA, computer models must be certified by an independent investment expert and meet audit requirements. CPAs should ensure that any computer model used to advise plan participants meets the requirements of section 601 of the PPA and subsequent DOL rules.
DEFAULT INVESTMENT OPTIONS
The PPA also has allowed the DOL to propose regulations for default investment options, should the employee not select one. Some investment advisers are concerned because proposed new DOL rules do not indicate that a fixed income or money market account would be an appropriate default investment option, says Sally Church, a partner in the Pittsburgh law firm of Thorp Reed & Armstrong LLP.
But Steve Patterson, vice president of the corporate and retirement services group at Charles Schwab & Co., approves of computer models that, depending on inputs, may not recommend the most conservative investment options. Some models recommend target-date retirement funds that reallocate assets into less volatile investment options as the employee's retirement date nears.
"Previously, the guidance was that the prudent thing to do was to put money into a money market or stable value fund, which, while safe, doesn't deal with the issue of outpacing inflation to any degree," Patterson said. "You were saving money, but you weren't growing that balance."
Target-date models are different from lifestyle funds, which are sorted by risk into conservative, moderate or aggressive investment options and require the plan participant to decide when to rebalance the asset allocation.
"Inertia is a very powerful force," Patterson said. "Target funds are very appealing, because you make one decision to invest, and that's it." Participants will be saving money, and it will be invested in the right funds, selected by professionals, he said.
DON'T WALK AWAY
But Church cautions that employers can't just set up retirement plans and walk away "Anytime you select anyone to do anything for your plan, you are on the hook," she said. "You have to go through due diligence to make sure that whatever investment adviser you bring in is doing its job and that the fees are reasonable. You have to monitor anyone you put in, and you definitely have to document your decisions."
One of the biggest risks to plan sponsors is giving reformation that is false, misleading or incomplete. Employees of Enron and WorldCom were encouraged by their employers to invest retirement savings in company stock, but the employers did not disclose their precarious financial situations. Under the PPA, publicly traded employer stock is subject to new diversification requirements. Companies are required to let employees diversify out of employer stock.
* AICPA National Conference on Employee Benefit Plans, May 21-23 New Orleans.
For more information or to register, go to www.cpa2biz.com or call 888-777-7077,
* Perform due diligence to make sure you have the best funds and investment advisers,
* Document all decisions about hiring or firing an adviser, or selecting or eliminating an investment option,
* Team up with an investment fund provider for guidance on how to select the investment funds and an attorney to advise on due diligence and the myriad rules.
* Evaluate how well the plan serves employees by looking beyond participation rates to the percentage people are deferring. Are your employees saving enough for retirement? Are they using the available tools?
* Encourage employee participation by using automatic enrollment, rebalancing and progressive savings features.
PPA Computer Model Requirements
The computer model must:
* Apply generally accepted investment theories that take into account the historic returns of different asset classes over defined periods of time.
* Utilize relevant information about the participant, which may include age, life expectancy, retirement age, risk tolerance, other assets or sources of income and preferences as to certain types of investments.
* Utilize prescribed objective criteria to provide asset allocation portfolios comprised of investment options available under the plan.
* Operate in a manner that is not biased in favor of investments offered by the fiduciary adviser or a person with a material affiliation or contractual
* relationship with the fiduciary adviser.
* Take into account all investment options under the plan in specifying how a participant's account balance should be invested and appropriately weighted with respect to any investment option.
Source: Pension Protection Act of 2006, section 601.
Nancy E. Oates is a freelance business writer and Cynthia B. Brown, CPA, CEBS, is an employee benefits consultant in Raleigh, N.C. Their e-mail addresses are email@example.com and firstname.lastname@example.org, respectively,
Percentage of Non-Government Workers Participating in Defined Contribution Plans Year Annual % 1999 36 2000 36 2003 40 2004 42 2005 42 2006 43 Source: U.S. Department of Labor, Bureau of Labor Statistics Note: Table made from bar graph.…
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Publication information: Article title: Time to Rethink Your 401(k) Plan? Pension Protection Act Allows Employers to Redesign Retirement Plans. Contributors: Oates, Nancy E. - Author, Brown, Cynthia B. - Author. Journal title: Journal of Accountancy. Volume: 203. Issue: 5 Publication date: May 2007. Page number: 50+. © 2009 American Institute of CPA's. COPYRIGHT 2007 Gale Group.
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