Client Service August 8, 2022

The New Vesting Schedule Debate

Surveys and anecdotal evidence suggest plan sponsors are shortening their plan’s vesting periods, but there remains disagreement in the industry about whether vesting schedules may in fact disappear.
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Normally a topic of relatively little discussion in financial services media, vesting schedules have become the stuff of headlines.

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Personal-finance writers around the U.S. are offering advice and insight into how employees should regard the schedule in which they vest in their employers’ contributions to their defined contribution retirement plans.

For workers in businesses that have shorter employee tenures, a long-graded vesting schedule could be seen as unfair to workers. But for plan sponsors, vesting schedules can control costs and help with employee retention.

Safe harbor plans must follow some clear vesting rules, but beyond that, sponsors have a lot of flexibility in strategically structuring their plan’s vesting. “My book of business is probably skewed toward non-safe-harbor plans,” says Joe DeBello, managing consultant at OneDigital Retirement + Wealth in Orlando. “So the topic of vesting is a constant in our discussions.”

The Rules

Qualifying as a traditional safe harbor plan requires immediate 100% vesting for participants. A qualified automatic contribution arrangement safe harbor plan with automatic enrollment can have up to two-year cliff vesting, says Eric Droblyen, president and CEO of Employee Fiduciary, a Mobile, Alabama-based third-party administrator. “A lot of times, sponsors go with the QACA safe harbor instead of the traditional safe harbor specifically because they can do two-year cliff vesting,” he adds.

“I would say that more often than not, if somebody’s not forced to allow for immediate vesting in their plan, then most sponsors choose to subject participants to a vesting schedule,” Droblyen continues. ERISA does require that plan sponsors limit cliff vesting to a maximum of three years of service to become 100% vested, and graded vesting can take no longer than six years of service to become 100% vested. “Employers can definitely make their vesting rules more liberal, if they choose,” he says.

The End of Vesting?

One of the primary trends that Kristi Baker and her colleagues at CSi Advisory Services are seeing is sponsors shortening their plan’s vesting period. “We’re having a lot of conversations with our clients around how to recruit and retain employees, and in looking at their retirement plan holistically, one of the issues they’re looking at is, ‘Does a six-year vesting schedule still make sense, for the kind of employees we’re trying to attract?’” says Baker, managing partner at the Indianapolis-based firm. “I’m not seeing many plans use immediate vesting unless they’re a safe harbor plan, but more commonly we see a move to a three- to four-year graded vesting schedule.”

Some employers are doing that because the shorter vesting period is more attractive to employees, Baker says. Whether employees and potential new hires actually pay attention to vesting is industry-specific, she finds. “With some employers that have a lot of hourly or part-time workers, it never comes up,” she says. “But with employers that have more executive-level positions or professional-level positions, people do look into those kind of details now.”

Vanguard’s recent “How America Saves” report found that in 2021, nearly half of plans immediately vested participants in employer matching contributions, while 25% of plans with employer matching contributions used a 5- or 6-year graded vesting schedule. The report covers 4.7 million participant retirement accounts from the more than 1,700 plans for which Vanguard serves as recordkeeper.

Usually the first step in the vesting decision tree with plan sponsors is whether they’re going to go with a safe harbor design, says Jim Sampson, national practice leader for Hilb Group Retirement Services in Cranston, Rhode Island. If not, then an employer needs to start by understanding its goals for vesting. “Are they using vesting to try to retain employees for a certain period of time? Are they using vesting to protect the company’s money?” he asks.

At that point, Sampson also wants to understand whether the employer wants to utilize its retirement plan to help attract new employees. “That is becoming a much, much larger part of the equation in the past year or two,” he says. “Because they’re having a really hard time attracting new employees, a lot of companies now are trying to beef up their entire benefits package, especially the 401(k). We’ve seen a lot of companies go to immediate or shorter vesting. The thought is, if people have to wait years to get the money, it’s not necessarily seen as a strong benefit.”

“That’s especially true when you’re talking about a higher-level employee, in maybe a technical space or medical space,” Sampson continues. “We work with a lot of pharmaceutical and biotech companies, and they’re trying to pull people out of big, big employers, so they’re trying to mirror the benefits those big employers provide. Vesting is almost a non-starter for those companies. But in other workforces—such as restaurants, hospitality and retail—where turnover is high, having a vesting schedule can make sense to an employer.” It saves the company money when an employee leaves quickly, and potentially can motivate employees to stay longer.

Sampson understands the strategic value that some employers see in having a vesting schedule. “But the reality is that vesting might be becoming a dying breed, in this post-COVID workforce we’re all experiencing. Vesting might go out the window because companies find that it’s a detractor to hiring good people,” he continues. “We live in an instant-gratification world: People want it now, and the end of vesting might be a byproduct of that.”

The Conversation Is Changing

Droblyen is asked about the pros and cons, from an employer perspective, of immediate vesting versus having a vesting schedule. “Simply put, if a sponsor goes with immediate vesting, it’s seen as a more generous plan for employees: That money is their money, as soon as it hits their account,” he answers. “The ‘pro’ of having a vesting schedule is that you’re getting some money back, if somebody doesn’t stay with you for long.”

The decision “boils down to a tradeoff” for employers, Droblyen says. “You need to pick what you think is more valuable to your business. Is it more important to have immediate vesting that’s seen as a more valuable benefit by employees, or is saving some money for the employer more valuable? I wouldn’t say there’s a hard-and-fast rule to answer that: It’s more facts and circumstances for individual employers.”

DeBello has read with puzzlement recent media coverage criticizing employers that have a vesting schedule. He doesn’t see a fairness issue with promoting the concept of an employer match to employees as “free money,” while also having multi-year vesting. “We very rarely see employers that tout, ‘It’s free money, with no strings attached.’ If you go on participant sites, almost every modern recordkeeping system is going to show participants their total balance and their vested balance. And every group education meeting for a plan that I’ve been to covers vesting,” he says. “I don’t subscribe to the idea that this is some kind of ‘bait and switch’ or mystery to employees. It is something that employers do strategically, to mitigate costs and hopefully to retain employees.”

For employers with a vesting schedule, the key is to communicate clearly about it with employees and potential hires, Baker says. “Vesting is one of the topics we often talk about in employee meetings, and we explain it in a way that’s straightforward and simple to understand: Vesting in the employer money is based upon an employee’s years of service they have with the company,” she says. “We don’t get much pushback on that.”

The debate about vesting really speaks to a broader issue that’s worth considering, DeBello thinks. “The heart of this issue is, these vesting schedules tend to impact lower-income parts of the workforce that are moving between jobs more,” he says. “I think the bigger issue with retirement security for lower-income employees is coverage: whether an employer offers a retirement plan to its employees. We’re spending too much time focusing on something [vesting] that isn’t the big issue for retirement savings.”

“The employer is giving you money as an employee, and expecting loyalty in return. I think there is nothing wrong with that,” DeBello says. “But the conversation around vesting is changing, and I have to acknowledge that. The types of jobs out there are changing—there are more ‘gig economy’ jobs, and service jobs—and maybe the conversation about vesting needs to change, too.”

Compliance August 5, 2022

Is the Qualified Professional Asset Manager Exemption in Jeopardy?

One expert attorney says that while a recent regulatory proposal issued by the DOL seems sensible, as it seeks to clarify when and how qualified professional asset managers can work with retirement plans and other ERISA-covered investors, the complexity of the package gives her pause.
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In late July, the Department of Labor’s Employee Benefits Security Administration announced a proposed amendment to the Class Prohibited Transaction Exemption 84-14.

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The PTE is commonly known as the “qualified professional asset manager exemption,” and its basic purpose is to permit various parties who are related to retirement plans covered by the Employee Retirement Income Security Act’s fiduciary provisions to engage in otherwise-barred transactions involving retirement plans and individual retirement account assets. To satisfy the QPAM exemption, the assets in question must be managed by QPAMs that are “independent of the parties in interest” to the plan and that meet specified financial standards, among other conditions.

The proposed amendment includes a number of important changes. As summarized in an EBSA press release, the amendment would better protect plans and their participants and beneficiaries by, among other changes, addressing what EBSA calls “perceived ambiguity” as to whether foreign criminal convictions are included in the scope of the exemption’s ineligibility provision. The amendment further expands the ineligibility provision to include additional types of serious misconduct. Other provisions focus on mitigating potential costs and disruptions to plans and IRAs when a QPAM becomes ineligible due to a conviction or other serious misconduct.

Other changes the amendments would make include an update of the asset management and equity thresholds in the actual definition of “qualified professional asset manager” and the addition of a standard recordkeeping requirement that the exemption currently lacks. Finally, the amendment seeks to clarify the requisite independence and control that a QPAM must have with respect to investment decisions and transactions.

A Surprise Proposal

Speaking with PLANADVISER about the implications of the amendment, Carol McClarnon, a partner on the tax group of Eversheds Sutherland, calls it “unexpected and worrying.”

“In its press release announcing the proposal, the DOL named six objectives of the proposed changes,” McClarnon says. “On their face, these objectives would appear to be sensible clarifications. However, the actual conditions being proposed to attain these objectives reveal that the proposal would add significant costs and liability exposure to managers, perhaps even limiting the QPAM exemption as a viable solution.”

As McClarnon observes, before the proposal’s publication last week, the common perception among regulatory experts in the retirement plan industry was that the DOL was unlikely to direct EBSA to take an action like this, as the DOL’s key sub-agency is still operating without a Senate-confirmed head.

“The perception has been that EBSA has put a lot on hold,” McClarnon says. “We did know that the QPAM issue was on EBSA’s radar, but I think it is fair to say that few people expected to see a proposal as ambitious as this to come out right now. Frankly, I was pretty amazed to see this proposal come out.”

A Fundamental Exemption

McClarnon says the QPAM exemption is of fundamental importance to the operation of the modern retirement plan system. This is because so many plans invest in pooled funds and group-style investments with other plans and third parties, and because of the way ERISA defines and treats “parties in interest” to retirement plans or other institutional investors subject to ERISA’s fiduciary provisions. Any party in interest to a given retirement plan may be prohibited from entering into certain transactions with that plan if the transaction will result in additional compensation going to the party in interest, McClarnon notes.

Parties in interest may include, among others, fiduciaries or employees of the plan, any person who provides services to the plan, an employer whose employees are covered by the plan, an employee organization whose members are covered by the plan, a person who owns 50% or more of such an employer or employee organization, or relatives of such persons.

McClarnon explains that certain plan transactions with parties in interest are prohibited under ERISA and are required, without regard to their materiality, to be disclosed in the plan’s annual report to the DOL.

“In practice, the QPAM exemption is used very commonly and for a variety of different purposes,” McClarnon says. “Just imagine if you had, say, 1,000 ERISA-covered retirement plans invested in a given fund. Each of those plans will have a ton of parties in interest. In the most basic terms, what the QPAM exemption does is state that, if you as the asset manager meet the regulatory qualifications, most transactions with these parties of interest in the plan are OK. The new proposal addresses the qualifications in a meaningful way.”

A Burdensome Proposal

Based on her initial reading and discussions with colleagues, McClarnon says the proposal appears to be “so burdensome that it could almost be said to essentially change the availability of the QPAM exemption.” She points out that, in the nearly four decades since the QPAM exemption framework was first established, the financial services world has become far more interconnected.

“In today’s industry, you just have a lot more complexity, with larger conglomerates and highly sophisticated international entities that do business with U.S. retirement plans,” McClarnon says. “The proposed framework, if it is not adjusted after the comment period, will make it very difficult for these types of entities to reliably and efficiently use the QPAM exemption, in my opinion.”

As an example, McClarnon points to the provision in the proposal that declares that the entrance of a QPAM-affiliated person into a non-prosecution agreement will trigger the ineligibility restrictions.

“To me, that’s concerning, because you do not generally speaking admit criminal wrongdoing when entering into such an agreement,” McClarnon says. “There is also a new concept and condition that they have called ‘integrity.’ The proposal says that the DOL can disqualify an entity from using the QPAM exemption based on their own internal examination process and the determination that a QPAM exemption user has not acted with integrity, which they define in the proposal by using various examples and stipulations. In my opinion, there is very little due process recourse for an entity that finds itself in this situation.”

McClarnon says she is perhaps most troubled by the provision in the proposal that seeks to isolate retirement plans from harm if a service provider they work with has its QPAM exemption revoked by EBSA. One must consider the potential consequences of such a framework, she says.

“They don’t want to cause hardships on the plans in cases of disqualification, which makes sense,” McClarnon says. “However, the proposal seems to require that the investment manager sign a written agreement where they declare that, if there is a criminal finding or the ineligibility provision is triggered for some other reason, the QPAM itself has to pick up the full cost of helping the plan make a transition to a new investment. Just imagine the potential cost of this if we are taking about a mega-sized retirement plan or group of plans.”

What Comes Next

McClarnon emphasizes that she understands the DOL and EBSA have a critical job to do in protecting retirement plans and their participants. However, she expects the investment community to respond forcefully to this proposal, and that the comment period could help EBSA constructively refine the proposal.

“The potential for unintended consequences here is so significant,” McClarnon says. “The exemption serves a critical purpose in the current retirement plan system. It is meant to allow plans to be able to invest in things that would otherwise have technical prohibited transaction restrictions on them that do not actually relate to potential operational conflicts of interest. If the proposal is not refined, you could see investment providers not wanting to take on this type of exposure.”

The one element of the proposal she would most want to see changed, McClarnon says, is the contractual requirement related to the QPAM covering the full expense of a fund transition on behalf of a plan.

“I really don’t like the forced contractual requirement,” McClarnon says. “I don’t think EBSA should be telling people these contracts have to be set. I also want to point out that, yes, a giant financial services company may be able to figure out how to make this new framework work, and they may even have the scale and resources to meet the hold-harmless provisions. But a lot of small advisers use this exemption all the time, and in fact it is baked into many standard operating agreements used by all different parties in the industry. It is very common in all kinds of collective investment trust agreements, for example, and we know these investments are becoming more popular. There are just so many traps for the unwitting and the unwary in all this.”

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