Data & Research June 24, 2014

States With the Most Corrective Distributions

A new study of 401(k) plans shows that more than 50,000 of them failed nondiscrimination testing for the 2012 plan year.
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The study by Judy Diamond Associates, a 401(k) plan intelligence provider, reveals that a total of 57,277 401(k) plans failed their 2012 nondiscrimination tests. These plans were then required to return $794 million in 401(k) contributions to highly compensated employees (i.e., corrective distributions), resulting in increased income taxes and lower retirement savings for those participants.

The top five states for issuing corrective distributions for the 2012 plan year were:

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  • Kansas (with 13.03% of plans issuing corrective distributions);
  • Texas (12.79%);
  • New Jersey (12.49%);
  • Georgia (12.12%); and
  • Alabama (11.95%).

The states that had the lowest percentage of plan issuing corrective distributions include:

  • Montana (6.18%);
  • Hawaii (7.24%);
  • Wyoming (7.61%);
  • West Virginia (7.93%); and
  • Idaho (8.01%).

The Internal Revenue Service requires 401(k) plans to undergo nondiscrimination testing to ensure that both highly compensated participants and rank-and-file participants contribute to the plan at similar rates. When owners and managers of a company contribute at far higher rates than their employees during the year, the plan must return some of the highly compensated participants’ employee contributions, also known as corrective distributions, which then become subject to normal income taxes (see “The Tests You Don’t Want to Fail”).

Employers can use a number of options to improve their chances of passing nondiscrimination testing. One such approach is the use of a QNEC, or qualified nonelective contribution, on behalf of non-highly compensated employees in the plan. A QNEC is an employer contribution that can be used by 401(k) plans to ensure that testing requirements are satisfied without having to refund contributions to highly compensated employees. Other options include using a different form of compensation for nondiscrimination testing, the use of permissive disaggregation, or switching from prior year to current year testing (see “Improving Nondiscrimination Test Results”).

“The issuance of corrective distributions should serve as a red flag to plan sponsors. It means that the plan has highly compensated employees who were unable to save as much for their retirements with pre-tax income as they would like. It may also mean that the plan is not designed to encourage workers to contribute sufficiently. Plan sponsors can utilize this information by introducing retirement education programs and suggesting better 401(k) savings methods to participants,” says Eric Ryles, managing director of Judy Diamond Associates, based in Washington D.C.

Plans that issue corrective distributions may have other issues with their design, says Ryles, which may include inadequate fidelity bonds, incorrect calculation of vesting schedules or failure to amend plans in a timely period to conform with current laws and regulatory changes.

The study also shows that:

  • Nationwide, 12% of 401(k) plans issued corrective distributions in 2012;
  • Corrective distribution issuance was down about 2% from the previous year; and
  • Small states, proportionally, had fewer plans that issued corrective distributions than big states, which most likely reflects the locations of highly compensated workers.

Judy Diamond Associates based this research on the most recently available complete set of 401(k) plan disclosure documents released by the Department of Labor, in combination with the firm’s Retirement Plan Prospector database and plan analysis tool.

More information about this research can be requested at www.judydiamond.com/about/contact.

Data & Research June 24, 2014

How PBGC Premium Increases Would Impact DB System

A new report finds that Pension Benefit Guaranty Corporation (PBGC) premium increases would negatively impact the defined benefit (DB) pension system.
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“Further PBGC Premium Increases Pose Greatest Threat to Pension System,” recently released by the American Benefits Council, finds that PBGC premiums are disproportionately high already and that further increases could force employers out of the DB plan system and erode the PBGC’s premium base.

The report’s authors point out that premiums have increased substantially over the past decade or so. Specifically, between 2005 and 2016, the flat rate or per-participant premium is expected to more than triple, from $19 to $64 per participant. In addition, the variable rate premium is expected to more than triple, from $9 per participant per $1,000 of unfunded vested benefits to at least $29 per participant, during the 2012 to 2016 time period.

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The increases translate to “real and significant liabilities for employers and ultimately for employees,” according to the report. While the rationale given for these premium increases, by Congress, is to avoid short-run liquidity problems, the report finds that the PBGC holds enough assets to pay all benefits to participants in terminated single-employer defined benefit pension plans for many years into the future.

In addition, the report finds that proposed premium increases would impose an estimated $2 billion per year of additional costs on employers in the single-employer DB plan system by fiscal year 2024. Over the short run, employers may address these costs by reducing capital investments or reducing dividends paid to shareholders.

“All available data refutes the notion that the PBGC’s single-employer guarantee program needs additional premium revenue,” contends American Benefits Council President James A. Klein, based in Washington, D.C. “The agency’s self-reported deficit belies the fact that PBGC’s assets and income far exceed its foreseeable payouts.”

The report also finds that:

  • Artificially low interest rates inflate purported underfunding of pension plans and the PBGC’s self-reported deficit. More than 96% of PBGC’s own reported deficit estimates relate to plans that have already exited the DB plan system. So, current sponsors of plans that pose no risk to the PBGC are forced to pay for the actions of employers who long ago terminated their plans.
  • Double counting of PBGC premium increases perpetuates long-term deficit spending. Policymakers perpetuate long-term deficit spending by, in effect, “double counting” premium increases (which can legally only be used by the PBGC) for general revenue purposes, thereby offsetting spending for completely unrelated matters.
  • The mandatory nature of the PBGC program effectively gives employers only one choice to avoid burdensome premiums, which is to exit the system by de-risking. Employers lack a competitive market for the service provided by the PBGC. The only options available to plan sponsors to reduce the burden of PBGC premiums are to reduce risk through buyouts and other measures, or exit the DB plan system completely.
  • The PBGC premiums represent taxes on employees. While employers face the statutory incidence of these taxes, the impact is ultimately felt by employees if the result is to compel employers to freeze or terminate the DB plan.

Klein adds, “The same abnormally and artificially low interest rates that are inadvertently punishing pension plan sponsors are also distorting the true financial position of the PBGC. We urge lawmakers to avoid a third consecutive year of premium hikes and focus instead on making it easier for employers to stay in the system.”

Revised figures about participant longevity, when combined with potential premium increases, could also negatively affect the DB plan system, according to the report. New mortality tables generated by the Society of Actuaries show that plan participants are living longer. Once the Internal Revenue Service approves these new tables, pension liabilities will significantly increase. As a result, the funding levels of DB plans will decrease, resulting in substantially increased funding requirements and higher PBGC variable rate premiums.

The full text of the report can be downloaded here. The American Benefits Council is a national trade association for companies concerned about federal legislation and regulations affecting all aspects of the employee benefits system.

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