Automatic Enrollment & QDIA: Practical or Not?

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Automatic Enrollment & QDIA: Practical or Not?

  1. 1. Automatic Contributions and Qualified Default Investments – Practical or Not?<br />Adam C. Pozek, ERPA, QPA, QPFC<br />Partner<br />DWC ERISA Consultants, LLC<br />
  2. 2. Qualified Default Investment Alternatives(QDIAs)<br />
  3. 3. Overview<br />
  4. 4. Pre-PPA<br />“…the Department of Labor has taken the position that a participant or beneficiary will not be considered to have exercised control when the participant or beneficiary is merely apprised of investments that will be made on his or her behalf in the absence of instructions to the contrary.”<br />--IRS Revenue Ruling 2000-8, footnote 1<br />4<br />
  5. 5. Qualified Default Investment Alternative<br />Effective January 1, 2007<br />Guidance<br />Pension Protection Act of 2006<br />Proposed regulations issued September 27, 2006<br />Final regulations effective December 24, 2007<br />DOL Field Assistance Bulletin 2008-3 issued April 29, 2008<br />Worker, Retiree & Employer Recovery Act of 2008 passed by Congress in December 2008<br />5<br />
  6. 6. The Basics<br />Provides for limited fiduciary relief<br />Available options<br />Life-cycle/target-retirement-date funds<br />Balanced funds<br />Professionally managed accounts<br />Limited availability of capital preservation-type funds during first 120 days<br />Restricts fees for transfers out during the first 90 days<br />6<br />
  7. 7. Another Notice<br />Timing<br />30 days prior to initial investment<br />30 days prior to the start of each subsequent year<br />Content<br />Right to designate how contributions and earnings will be invested<br />Explanation that, in absence of election, contributions and earnings will be invested in default fund<br />Description of QDIA including risk/return characteristics and fees/expenses<br />7<br />
  8. 8. Practical Or Not?<br />
  9. 9. It’s Not Just for Auto Enrollment…<br />May be appropriate for any participant-directed plan…<br />Safe-harbor plan using non-elective contribution<br />Top heavy plan<br />Any plan with a non-elective contribution<br />9<br />
  10. 10. What Are People Doing?<br />According to Fidelity survey<br />63% use target-date fund<br />According to PlanSponsor.com survey<br />44.3% use target-date fund<br />15.6% use balanced fund<br />10<br />
  11. 11. Optional Provision<br />Fiduciary safe-harbor<br />Must still exercise prudence in selection and monitoring<br />Can select non-QDIA as default investment<br />Subject to normal rules requiring fiduciary prudence<br />11<br />
  12. 12. QDIA vs. Mapping<br />Change in vendors<br />Which is the better choice?<br />Can it be split – map some participants and use QDIA for others?<br />12<br />
  13. 13. Trustee Direction of Investments<br />DB plans (trustee-directed) vs. 401(k) plans (participant directed<br />DB outperformed DC almost every year from 1995 to 2008<br />Average outperformance = 1%<br />Lower volatility of returns<br />Source: www.watsonwyatt.com/us/pubs/insider/showarticle.asp?ArticleID=22909<br />13<br />
  14. 14. Automatic Contribution Arrangements<br />
  15. 15. Overview<br />
  16. 16. Slide Title (should be no more than two lines)<br />First Topic<br />Second Topic<br />Sub-Topic A<br />Secondary Sub-Topic 1<br />Secondary Sub-Topic 2<br />Sub-Topic B<br />Sub-Topic C<br />Third Topic<br />Fourth Topic<br />
  17. 17. Statutory Guidance<br />Pension Protection Act<br />Section 902<br />Internal Revenue Code<br />Section 414(w)<br />Worker, Retiree & Employee Recovery Act<br />Section 109(b)<br />17<br />
  18. 18. Regulatory Guidance<br />Proposed regs published November 8, 2007<br />Final regs published February 24, 2009<br />1.401(k)-2 and 3<br />1.401(m)-2 and 3<br />1.402(c)-2<br />1.411(a)-4<br />1.414(w)-1<br />54.4979-1<br />18<br />
  19. 19. Types of ACAs<br />Eligible Automatic Contribution Arrangements (EACA)<br />Qualified Automatic Contribution Arrangements (QACA)<br />Pre-PPA automatic enrollment plans<br />Not covered by final regs<br />19<br />
  20. 20. EACA<br />Automatic enrollment of covered employees with no affirmative election in effect<br />Subject to uniformity requirement<br />Allowed to offer permissible withdrawals<br />Allows refund of excess contributions by end of the 6th month following close of plan year without excise tax<br />20<br />
  21. 21. QACA<br />Automatic enrollment/escalation of covered employees with no affirmative election in effect<br />Subject to uniformity requirement<br />Subject to mandatory employer contribution<br />Provides ADP safe-harbor<br />21<br />
  22. 22. QACA Escalation Schedule<br />Automatic enrollment at minimum, increasing levels<br />Initial Period – 3%<br />Year #2 – 4%<br />Year #3 – 5%<br />Year #4 – 6%<br />Cannot exceed 10% in any year<br />Initial Period runs through end of the year following year of first automatic withholding<br />22<br />
  23. 23. QACA Employer Contributions<br />Employer contribution options<br />Match of <br />100% of the first 1%, plus<br />50% of the next 5%<br />3% NEC<br />Full vesting after 2 years<br />23<br />
  24. 24. Existing Safe Harbor Rule Apply<br />Full 12-month plan year<br />Initial and ongoing notices<br />Match not based on deferrals exceeding 6%<br />Discretionary supplemental match cannot exceed 4%<br />24<br />
  25. 25. Other<br />Vesting on conversion from “traditional” safe-harbor to QACA<br />Not addressed in final regulations<br />Deemed affirmative election for non-deferring participants on effective date of EACA<br />Not permitted<br />25<br />
  26. 26. Practical or Not?<br />
  27. 27. Why Auto Enrollment?<br />Prevent ADP testing failures<br />Maximize benefits for HCEs<br />Encourage retirement income adequacy<br />27<br />
  28. 28. Is 401(k) The Right Solution?<br />
  29. 29. Is 401(k) The Right Solution?<br />
  30. 30. Goal – Pass ADP Test<br />ABC Company – Considering Auto Enrollment<br />8 HCEs<br />100% participation<br />Average deferral of 6.53%<br />395 NHCEs<br />57% participation<br />Average deferral of 2.52%<br />Auto enrollment<br />4% of pay<br />0% opt-out rate<br />30<br />
  31. 31. Goal – Pass ADP Test<br />XYZ Company – Already Has Auto Enrollment<br />51 HCEs<br />94.1% participation<br />Average deferral of 6.59%<br />128 NHCEs<br />94.5% participation<br />Average deferral of 3.61%<br />Auto enrollment<br />48 new NHCEs enrolled at 3% of pay<br />0% opt-out rate<br />NHCE average deferral of 3.55%<br />31<br />
  32. 32. Goal – Pass ADP Test<br />Other options<br />Safe Harbor 401(k)<br />QNEC<br />Pro rata<br />Targeted<br />32<br />
  33. 33. I Love Rock N Roll, Inc. - HCEs<br />33<br />
  34. 34. I Love Rock N Roll, Inc. – NHCEs<br />34<br />
  35. 35. I Love Rock N Roll, Inc. – NHCEs (cont.)<br />35<br />
  36. 36. I Love Rock N Roll, Inc.<br />Test results<br />6 HCEs = 10%<br />35 NHCEs = 4%<br />Fail!!!<br />HCE Refunds = $34,020<br />36<br />
  37. 37. I Love Rock N Roll, Inc. – Auto Enrollment<br />3% Default Rate<br />NHCE Average of 5.20% - Still Fails<br />5% Default Rate<br />NHCE Average of 6.00% - Still Fails<br />10% Default Rate<br />NHCE Average of 8.00% - Finally Passes<br />37<br />
  38. 38. I Love Rock N Roll, Inc. – Match<br />“Regular” Match to Encourage Deferrals<br />50% of the 6% deferred<br />$31,380<br />Not guaranteed to pass<br />Up to 6-year graded vesting<br />Safe Harbor Match<br />Traditional (100% of the first 3% + 50% of the next 2%)<br />$47,580<br />Guaranteed pass<br />Immediate vesting<br />QACA (100% of the first 1% + 50% of the next 5%)<br />$38,205<br />Guaranteed pass<br />Up to 2-year cliff vesting<br />38<br />
  39. 39. I Love Rock N Roll, Inc. – QNEC<br />Salary proportional<br />NHCE average 4%  8%<br />4% QNEC x NHCE comp of $1,883,000<br />$75,320<br />Targeted<br />Determining representative contribution rate<br />35 NHCEs x 50% = 17.5  18<br />Total targeted QNEC = $38,310<br />QNEC range from 5.5% to 11% of compensation<br />39<br />
  40. 40. I Love Rock N Roll, Inc. – Summary<br />Refunds to HCEs = $34,020<br />Auto enrollment at 10% with no opt-out<br />Standard match = $31,380<br />Traditional safe harbor match = $47,580<br />QACA safe harbor match = $38,205<br />Pro rata QNEC = $75,320<br />Targeted QNEC = $38,310<br />40<br />
  41. 41. Goal – Retirement Adequacy<br />30-year old participant, earning $50,000/year with annual COLAs of 3%<br />Required replacement ratio = 69%*<br />Retirement age = 65<br />Average annual investment return of 8%<br />*Replacement Ratio Study: A Measurement Tool For Retirement Planning, Aon Consulting, May 2004.<br />41<br />
  42. 42. Goal – Retirement Adequacy<br />Default deferral of 3% of pay<br />Runs out of money by age 70<br />Escalating default deferral from 3% to 6% of pay<br />Runs out of money by age 78<br />42<br />
  43. 43. Practical or Not?<br />
  44. 44.
  45. 45. Caveats & Disclaimers<br />The content of this presentation is for informational purposes only. The applicability of the concepts and designs described herein is contingent upon numerous factors including the demographic composition and turnover of workforce as well as financial and cash flow stability of employer. Employers should consult their tax and/or legal advisors to determine whether one or more of these designs are appropriate based on all relevant facts and circumstances.<br />To ensure compliance with the requirements imposed on us by IRS Circular 230, we inform you that any tax advice contained in this communication (including any attachments) is not intended and cannot be used for the purpose of: (i) avoiding tax-related penalties under the Internal Revenue Code, or (ii) promoting, marketing or recommending to another party any tax-related matter(s) addressed herein.<br />
  46. 46. Thank you for attending!<br />Please remember to <br />complete the online evaluation<br />after the conference.<br />

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