Data & Research August 26, 2019

Defaults Play a Big Role in Savings Outcomes

They impact participation, contributions and asset allocation, according to a research paper supported by a grant from the Social Security Administration.

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According to “Do Defaults Have Spillover Effects? The Effect of the Default Asset on Retirement Plan Contributions,” a research paper published by the National Bureau for Economic Research (NBER), when the Federal Thrift Savings Plan (TSP) switched to a lifecycle fund for a government securities fund as the default investment for participants who did not actively make a choice, participants were saving less.

The sample consists of employees employed at the Office of Personnel Management (OPM) both before and after the change in the default asset allocation. The researchers contend that the lifecycle fund may be considered a more appropriate default in that the allocation is likely preferable to a higher percentage of employees as compared to the conservative fund which may not be well-suited for long-term wealth accumulation.

The findings suggest that employees approach asset and deferral decisions jointly. They found those who were defaulted into the lifecycle fund remained passive and did not increase their deferral rates to maximize the employer match. “This joint decision-making combined with a better-suited default fund may partly explain why employees fail to maximize their employer matching contributions,” according to the white paper.

The paper warns that changing to a default fund that is preferred by more employees may lead people to be less well-prepared for retirement.

“This paper contributes to the growing literature on the unintended consequences of defaults,” the paper says. The researchers point to a previous study which found, while automatic enrollment dramatically increases participation in defined contribution (DC) plans, it comes at the cost of higher persistence by employees at the default contribution rate, which are often set at a rate that does not maximize the match from the employer and may not maintain an adequate level of consumption into retirement. Another study found that the introduction of a lifecycle fund as the default has led some employees to hold portfolios that mix the lifecycle fund with other assets, though lifecycle funds are intended to be standalone portfolios.

Compliance August 26, 2019

IRS Adds Year to Closed DB Plan Nondiscrimination Relief

The IRS still anticipates issuing final regulations on closed DB plan nondiscrimination rules.

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The IRS has issued Notice 2019-49, extending the temporary nondiscrimination relief for closed defined benefit (DB) plans that is provided in Notice 2014-5, by making that relief available for plan years beginning before 2021 if the conditions of Notice 2014-5 are satisfied.

Notice 2014-5 provides temporary nondiscrimination relief for certain closed defined benefit (DB) plans (that is, defined benefit plans that provide ongoing accruals but that have been amended to limit those accruals to some or all of the employees who participated in the plan on a specified date).  Specifically, for plan years beginning before 2016, Notice 2014-5 permits a DB/defined contribution (DC) plan that includes a closed DB plan (that was closed before December 13, 2013) and that satisfies certain conditions set forth in the notice to demonstrate satisfaction of the nondiscrimination on the basis of equivalent benefits even if the DB/DC plan does not meet any of the existing eligibility conditions for testing on that basis.

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A significant number of DB plans have been closed to new entrants, and the plan sponsor of a closed DB plan typically provides a defined contribution (DC) plan for its new hires. Under these arrangements, in the early years after the DB plan has been closed to new entrants, the plan may be able to satisfy the coverage requirement of Employee Retirement Income Security Act (ERISA) 410(b) without being aggregated with the DC plan. However, the Section 410(b) minimum coverage test typically becomes more difficult for the closed DB plan to satisfy over time, as grandfathered employees in the old system typically build seniority and become more highly compensated than younger workers entering the DC plan.

Proposed regulations relating to nondiscrimination requirements for closed plans were published in the Federal Register on January 29, 2016. The IRS and the Department of Labor (DOL) say they expect final regulations to include a number of significant changes in response to comments received. However, it is anticipated that these regulations will not be published in time for plan sponsors to make plan design decisions based on the final regulations before expiration of the relief last provided. Accordingly, the IRS and the Treasury Department have determined that it is appropriate to extend the relief provided under Notice 2014-5 for an additional year.

Legislation being considered in Congress would also make permanent nondiscrimination testing relief for closed DB plans.

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