Compliance August 31, 2015

IRS Issues Guidelines for Cooperative and Small Charities Pensions

The Cooperative and Small Employer Charity Pension Flexibility Act specifies funding requirements for certain pensions that were not immediately affected by PPA funding rules.
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The Internal Revenue Service (IRS) has issued guidance about certain issues relating to the Cooperative and Small Employer Charity Pension Flexibility Act (CSEC Act), which was enacted April 7, 2014. 

The CSEC Act specifies minimum funding requirements and related rules that apply with respect to certain defined benefit pension plans maintained by groups of cooperatives and related entities and groups of charities.

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The IRS explains that Section 430 of the Internal Revenue Code (Code), which was added by the Pension Protection Act of 2006 (PPA), specifies the minimum funding requirements that generally apply to single-employer defined benefit pension plans and multiple-employer plans. However, section 104 of the PPA provided that the effective date for the application of the minimum funding rules under Section 430 and the funding-based benefit restrictions under Section 436 of the PPA is delayed for certain plans maintained by more than one employer that are specified types of cooperative organizations and related entities. For those plans, the minimum funding rules and the funding-based benefit restrictions generally do not apply for plan years beginning before January 1, 2017. 

In addition, legislation passed in 2010 amended Section 104 of the PPA to expand the group of plans covered by the delayed effective date to include certain plans (eligible charity plans) that are maintained by employers that are described in Section 501(c)(3) of the Internal Revenue Code.

NEXT: Rules under the CSEC Act

IRS Notice 2015-58 explains that the CSEC Act added Section 433 to the Internal Revenue Code, which specifies minimum funding rules that apply to CSEC plans for plan years beginning on or after January 1, 2014. The minimum funding rules are similar to rules currently governing these plans; however, they provide that the amortization period for the change in liability resulting from an amendment to a CSEC plan is 15 years instead of 30 years, and Section 433 does not include a requirement to make a deficit reduction contribution as required under pre-PPA rules.

In addition, Section 433 provides special rules that apply to a CSEC plan with a funded percentage of less than 80%. Such a plan is in “funding restoration status.” If a CSEC plan is in funding restoration status, the plan sponsor must establish a funding restoration plan that is designed to bring the plan’s funded percentage to 100% over a period of seven years (or the shortest amount of time practicable to bring the plan’s funded percentage to 100%, if longer).

For the period for which a CSEC plan is in funding restoration status (as certified by the enrolled actuary for the plan), an amount no less than the plan’s normal cost must be contributed for each plan year. If the normal cost is not contributed for the plan year then an accumulated funding deficiency will exist regardless of the size of the plan’s credit balance. A CSEC plan that is in funding restoration status generally cannot be amended to increase benefits or accelerate vesting unless a specified additional contribution is made.

Under the CSEC Act, a number of elections are available to cease to be an eligible charity plan. The IRS also warns that certain eligible charity plans are not CSEC plans, and certain CSEC plans maintained by employers that are Section 501(c)(3) organization employers are not eligible charity plans. The notice answers the question, “What is a CSEC plan?” and describes the elections available.

The guidance applies not only for purposes of the Internal Revenue Code but also for purposes of the parallel provisions of the Employee Retirement Income Security Act (ERISA).

The Markets August 31, 2015

Share Class Offerings Shift With Fiduciary Focus

A majority of asset management firms are reforming share classes and approaches to fees, especially for the qualified retirement plan market. 
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A focus on fairness and fiduciary fitness is driving many investment product providers to implement R6 share classes and other institutional offerings with zero revenue sharing.

Overall, according to the August 2015 issue of The Cerulli Edge, nearly 60% of asset managers will make changes to share class offerings heading into 2016.  In this group, a quarter plans to add share classes, “primarily cited as R6 or some zero revenue share class,” and a similar number will move away from share classes that generate revenue through commissions or sales fees.

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The movement away from commissions and revenue sharing reflects regulators’ focus on fiduciary care and conflicts of interest. In some ways, Cerulli says the ongoing shift represents a return to a way of doing business that was more popular 20 years ago, before investment managers started offering an “alphabet soup” of different share classes.

Share classes diversified for a variety of reasons—partly because of advancing recordkeeping technology and an interest among providers in casting a wide net. Now the focus has shifted, Cerulli notes, and those paying higher fees are demanding better service and a better deal.

It’s also a matter of competition. Keeping with the trend toward low cost, flows “feverishly” moved into the cheapest share classes during 2014, Cerulli says. Institutional share classes captured $165.5 billion of inflows during the year, “eight times that of the next top-flowing share class (Retirement). Looking at flows moving into newly introduced share classes, this same trend continues.”

Cerulli’s findings come from an analysis of the 50 largest asset managers, based on mutual fund assets under management as of year-end 2014. At a high level, Cerulli says there appear to be “tiers of share classes among this universe of firms.”

NEXT: Share class breakdown  

The first tier includes institutional shares, A-shares, retirement shares and C-shares.

“This first tier is offered by more than 70% of the top-50 firms,” Cerulli finds. “Between 30% and 70% of firms also offer the second tier of share classes, which includes no load, B-shares, R6, and an investor share class.”

The third tier comprises an “amalgamation of share classes,” Cerulli says, including adviser, S, N, D, T, and M. “These shares are offered by less than 30% of the top-50 firms.”

Investment providers adding new products seem to be favoring the first tier, as most newly introduced share classes were institutional (470) and retirement (379) in 2014. According to Cerulli, A-shares and C-shares also experienced triple-digit share class introductions.

“Flows for these new share classes were mostly in institutional, accumulating $17.5 billion in 2014, representing 56% of total net flows,” the report says. “Cerulli believes eventually there will be a shake-out of share classes, leaving asset managers with just a few core share classes—a low-cost institutional share class, a share class for retail platforms (typically 40 basis points), a classic 25-basis-point 12b-1 share class, and a bare-bones retirement share class.”

Another important theme highlighter for the retirement market: plan sponsors are looking to separate the fund cost from the revenue “so that the right individuals—and not necessarily the end investor—are paying.”

“Originally, the industry expected to see an increase in the use of collective trusts for defined contribution (DC) plans in light of the intense scrutiny around plan costs, but mutual fund providers responded by creating either a zero-revenue-sharing share class, or a share class with embedded sub-TA fees and zero 12b-1 fees,” Cerulli explains. “R-share class 12b-1 is designed to cover compensation of an adviser or a third-party administrator of the plan. Given the Department of Labor’s focus on fee disclosure and transparency, the use of revenue sharing is generally on the decline.”

NEXT: Tough year so far, across share classes

Cerulli finds that trends have shifted somewhat during 2015, and increased favorability for transparent fee structures has not translated to unbridled momentum for passive investments and the lowest-fee products. The Cerulli analysis shows low-fee, passive institutional strategies experienced “significant outflows in 2Q 2015.”

Outflows from passive products were strong enough for Cerulli to declare that, while no one can know the future of asset flows, “the framework of the active/passive debate will change from an either/or proposition to how both approaches can be used in more customized, objectives-based multi-asset-class strategies.”

Even before the most recent round of volatility spooked investors, the second half of the year had kicked off on a sour note for mutual funds, according to Cerulli’s research.

Mutual funds “bled nearly $11 billion during July,” dragging the year to date inflow total down to $113.7 billion. Asset figures still increased in July due to positive equity market movements, with mutual funds ending the month up 0.1% at $12.5 trillion. Cerulli finds exchange-traded funds (ETFs) closed July up 1.4%, reaching $2.1 trillion after a dip in June.  

More information on obtaining Cerulli reports is available here. 

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