Data & Research February 8, 2016

Leakage Is a Serious Problem for 401(k) Plans

Millennials and those with balances lower than $20,000 are at the greatest risk for cashing out.
Reported by

Roughly one fourth of Baby Boomers cashed out their retirement savings at least once when changing jobs, and this rises to one third of Millennials and Gen X, the Defined Contribution Institutional Investment Association (DCIIA) found in a survey of 5,000 retirement plan participants.

Leakage is a serious problem for the nation’s retirement savings, as 40 cents of every dollar contributed to defined contribution (DC) accounts by savers under age 55 eventually leaks from the retirement system, DCIIA says, citing a study by the Federal Reserve Board.

About 75% of the cash-outs involved accounts with less than $20,000, suggesting that participants consider small amounts of savings not worth the effort. Among workers with more than $150,000 in retirement savings, only 23% have cashed out at least once in their lifetime.

DCIIA also found that cash-outs occur at all income levels. Among those earning more than $150,000 a year, 33% have cashed out at least once during their career. Wealth levels also affect cash-outs: 40% of workers with less than $25,000 in household retirement savings have cashed out at least once in their career.

For more stories like this, sign up for the PLANADVISERdash daily newsletter.

NEXT: Many workers leave assets in a former employer’s plan

Approximately half the survey respondents leave their retirement assets in their former employer’s plan, and this is consistent across generational groups. Only 20% expressed a well-thought-out reason for leaving their money in their previous employer’s plan, however, such as preferring the investment menu or customer service.

Not knowing how to roll assets over, not having the time or not considering it a priority were each mentioned by about 20% of all generations as the barriers to moving retirement assets to a new employer’s plan. “This suggests that there is an opportunity for employers to educate new and existing employees about the ability to consolidate their prior retirement plan assets into their new plan in an effort to enhance their retirement preparedness,” DCIIA says. “Eliminating the barriers present in the rollover process would be a viable solution to plugging the leak from retirement plans.”

Cerulli recently issued a report contending that participants can be dissuaded from cashing out of their retirement plan if they receive a phone call from an adviser or are shown an illustration of lost future value. To prevent hardship loans and withdrawals, Cerulli recommends showing participants net take-home amounts after the steep fees and taxes for pre-retirement withdrawals.

As well, participants who work with an adviser are more likely to have discussed the advantages and disadvantages of a rollover (60% vs. 30%), according to the LIMRA Secure Retirement Institute.

Compliance February 8, 2016

Problems Clients May Encounter with No Determination Letters

With the IRS planning to end its determination letter program, retirement plan sponsors will need guidance about what to do.
Reported by

The Internal Revenue Service (IRS) announced in July 2015 its intent to eliminate the staggered five-year determination letter remedial amendment cycles for individually designed retirement plans. The IRS also said it would limit the scope of the determination letter program to initial plan qualification and qualification upon plan termination.

In a comment letter, the ERISA Industry Committee (ERIC) asked the IRS to reconsider. ERIC argues that most large employers do not use predetermined or “off the shelf” retirement plans, instead choosing to individually design plans that best benefit their workforces.

Never miss a story — sign up for PLANADVISER newsletters to keep up on the latest retirement plan adviser news.

Annette Guarisco Fildes, ERIC’s president and CEO, tells PLANSPONSOR she has no data to back up that argument, but says, “I believe most large employers do not use prototypes, especially those that have been involved in mergers and acquisitions, and have complicated benefit designs and change them. It is easier to make changes with individually designed plans; prototypes do not keep up with changes.” She adds that prototypes do not support all that goes into offering company stock in a defined contribution (DC) plan lineup.

Todd Castleton, senior counsel with employee benefits compensation and Employee Retirement Income Security Act (ERISA) benefit practice centers with Proskauer in Washington, D.C., agrees that most large employers do not use prototype plan documents. “Some are using prototypes, but that’s the exception, not the rule,” he tells PLANSPONSOR.

NEXT: The problem with no determination letters

According to Castleton, prototypes take a lot of document control away from plan sponsors. If using a company’s prototype, the plan sponsor is locked in to the design of the master plan and what amendments are allowed. “Most large employers don’t want to do that,” he says.

In addition, Castleton notes that using a prototype could make plan administration difficult and lead to operational errors. Prototype documents comprise a master plan document and an adoption agreement with which plan sponsors can select provisions such as vesting schedules, the definition of compensation, matching contribution schedules, and so on. To ensure proper administration and operation of the plan, one must look at the adoption agreement, then look to the section related to it in the master plan document to see what rules apply based on the provision selected.

Also, the company providing the prototype could amend the master plan document. Castleton contends that plan sponsors and administrators often don’t look at master plan provisions, and this can result in operational errors.

Castleton says prototypes are not a viable option for merged plans or those that want to do something outside a prototype. Plan sponsors can adopt amendments, and Castleton believes they can still get a determination letter for an amendment, but without a determination letter for the whole document, they don’t have the guarantee that the document conforms to IRS rules as they would if they had a prototype.

There are two important circumstances in which IRS determination letters are relied on, Castleton says: M&As and audits surrounding Form 5500 filing. During M&As, a standard due diligence request is to get determination letters for all plans. But as time passes, the letters will get stale; the plans will have to be reviewed more carefully to see if any amendments disqualify them.

A more troublesome issue, according to Castleton, relates to plan financial audits that must be done during the Form 5500 filing process. Auditors request determination letters in plan audits and provide opinion letters saying that all amendments made since the letter keep the plan qualified. It will be difficult to provide opinion letters without an effective determination letter. “No one wants to be the insurer of a plan’s qualified status. Letters will be heavily caveated as to what they are actually representing as true,” Castleton says.

NEXT: What options are there?

By eliminating the determination letter program, Castleton says, the IRS hopes more plan sponsors will move to prototypes because they’ll need reliance that the document conforms to IRS rules, but he doesn’t think it will have that intended effect.

According to Castleton, a trend in the last five to 10 years has been for companies that offer prototype documents to switch to offering volume submitter plans. These allowed for more plan changes than prototypes; volume submitter plans would take care of some issues for plan sponsors, but not all. Time will tell if more plan sponsors take this route.

One reason the IRS is trying to eliminate the determination letter program is that the agency is short on resources to review them all.

Guarisco Fildes says ERIC has asked for a series of changes the IRS can make to narrow the scope of the program. For example, ERIC recommends that the IRS allow certain large plans to continue to apply for a favorable determination letter, similar to the approach currently in effect, but limiting the burden on the IRS by substantially reducing the pool of qualified applicants. “By limiting the determination letter approval program to extremely large employers, those with 15,000 or more participants, the IRS will not only ensure the smooth administration of large employer plans, but will also guarantee that it uses its limited resources efficiently,” said Guarisco Fildes in the letter.

For now, Castleton says plan sponsors need to get a determination letter to the extent they don’t already have one for existing plans. The IRS’ recent guidance removes the expiration dates on determination letters. Currently, determination letters expire at the plan’s next remedial amendment cycle. “So getting a determination letter is obviously a first step,” he says.

For plan sponsors merging or acquiring, Castleton advises them to look closely at all qualified plans, or the trend will become terminating plans before deals close.

«