Compliance July 14, 2016

DB Determination Letters Must Include Risk Transfer Info

The IRS is asking DB plan sponsors to identify whether their plan has lump-sum risk transfer language.
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The Internal Revenue Service (IRS) has said applicants requesting determination letters for their defined benefit (DB) plans should identify whether the plan has lump-sum risk transfer language in either the cover letter to their application or an attachment.

For plans that do, they must also identify the appropriate plan section and whether the plan satisfies one of the conditions in Notice 2015-49. In Notice 2015-49, the IRS announced its intent “to amend the required minimum distribution regulations under § 401(a)(9) of the Internal Revenue Code to address the use of lump-sum payments to replace annuity payments being paid by a qualified defined benefit pension plan.” Effective July 9, 2015, DB plan sponsors may no longer offer a lump-sum window to participants who have begun receiving installments.

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On its website, the IRS says if the plan sponsor advises that the plan has risk transfer language and satisfies one of the four conditions in Notice 2015-49, the agency will review the plan document to verify that it satisfies the qualification requirements of the Code. The plan’s determination letter will contain a favorable caveat providing reliance on the risk transfer language.

Plans with risk transfer language that do not meet one of the conditions in Notice 2015-49 won’t receive a determination letter unless the risk transfer language is removed.

For all other DB plans, the determination letter will contain a caveat that the plan has no reliance that any risk transfer language satisfies the requirements of the Code. This approach will be used if the plan sponsor:

  • Doesn’t include the information on a cover letter or attachment;
  • Doesn’t respond to the request; or
  • Responds that the plan doesn’t have risk transfer provisions.

For DB plan determination letter applications the IRS has already received, it will request the plan sponsor provide this information.

Client Service July 14, 2016

The Catch 22 of Aging, Savings and Investing Knowledge

Nobody really likes to think about the negative aspects of aging, but advisers have a legal obligation to pursue the long-term financial good of their clients.
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“All too often, investors are uninformed or in denial about the realities of how cognitive abilities decline as we age,” warns a new report from State Street Global Advisors. “That can lead to a Catch-22 for advisers who face legal and business risks whenclients are experiencing cognitive decline but it’s too late to implement a plan because of their diminished state.”

The title of the report says it all, “The Impact of Aging on Financial Decisions: The One Risk You Can’t Afford Not To Hedge.” According to State Street researchers, broaching the topic of cognitive decline can be “difficult for an investor as well as their adviser,” but it’s an absolutely critical part of building a truly sound financial plan.

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“Age is simply a number,” State Street says. “It shouldn’t represent a constraint or limitation. Advisers who are mindful of the challenges we all face as we age can apply a strengths-based approach to the conversation, building on the client’s own experiences, wisdom, patience, family support and other resources.”

The research argues there are two steps for advisers and their clients to take to formally address the potential of future cognitive decline. First, investors and advisers should “understand how cognitive decline and the aging process relate to investing attitudes and behaviors.” Once this step is taken, advisers and their clients must “identify proactive measures for advisers to help protect the client and better understand the connection between money mistakes and cognitive decline to minimize age-associated financial vulnerability.”

While the subject of the conversation is clearly a difficult one, advisers may be surprised by how willing their clients are to discuss and take proactive steps to prepare for this kind of contingency. Practically everyone has seen a parent, grandparent or other family member or friend go through the challenges of cognitive decline. 

“As our population continues to age, cognitive decline is set to become one of the most challenging intergenerational issues facing the investment industry,” State Street explains. “Since the financial crisis, the focus of financial advice has been squarely on saving for retirement; little attention has been paid to how cognitive decline could impact investors and their families … We gained nearly three decades of longevity in the 20th century, mostly through biomedical advances. Are we prepared for what this could bring in terms of extra years of age-associated financial vulnerability?”

NEXT: Taking cues from neurological science 

“Neuropsychology can help us address these questions by shedding light on how aging impacts our cognitive abilities, including how we make financial decisions,” State Street argues. At a very high level, the research argues, there are two forms of intelligence that play into this conversation—fluid and crystalized.

“Cognitive performance consists of these two neural systems. Fluid intelligence, which generally peaks at around age 20, describes the ability to learn and process information, and to solve abstract problems quickly. Crystalized intelligence, which is defined as wisdom, experiential knowledge and learning by doing, usually continues to improve before leveling off in a person’s late 60s,” State Street says. “This is around the time that the first signs of cognitive decline typically arise. They become more commonplace in the 70s and even more prevalent in the late 80s.”

This is a simplistic model, of course, but it's useful for thinking about how financial decisionmaking skills can change and, unfortunately, deteriorate over time. 

“Financial decision-making peaks for most people in their early-to-mid 50s,” State Street says. “Investing skills can start to decline sharply in one’s 60s and 70s. Regrettably, even as financial literacy and numeracy scores start to go down, self-assessment remains intact.”

The result is a relative increase in overconfidence, which “makes investors doubly vulnerable to adverse financial decisions as they age because their skills diminish but they are not cognizant of the impact.”

State Street concludes that financial advisers can help clients be proactive in managing the risks associated with cognitive decline by starting the conversation “long before cognitive decline typically begins. This way, clients gain control over a potentially stressful and difficult situation well in advance.”

The full report is online here. 

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