The Markets September 28, 2017

CITs in DC Plans Quickly Becoming the Norm

Many asset managers describe 2017 as a “tipping point” for collective investment trust flows from DC plans, according to a new analysis from Cerulli Associates.
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Cerulli’s latest report, “U.S. Defined Contribution Distribution 2017: Re-Evaluating the Use of CITs in DC Plans,” suggests that even “perennial cynics” are beginning to see the distribution opportunity collective investment trusts (CITs) present in the U.S. defined contribution (DC) plan market.

According to Jessica Sclafani, associate director at Cerulli, asset managers that currently do not offer collective trusts or offer a limited number of investment strategies in a collective trust vehicle are “sharpening their pencils and evaluating where a collective trust vehicle may create an opportunity to offer more competitive pricing.”

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As the CIT product set expands, it is important for retirement plan fiduciaries to follow the market developments to ensure their participants are presented with cost-efficient and competitive investments. In fact, according to Sclafani, in today’s evolving marketplace, DC plan mandates “can be won or lost by the difference of a few basis points.”

“Mutual funds consistently represent greater than half of total 401(k) plan assets,” she notes. “The next-largest investment vehicle by 401(k) plan assets is CITs, which hold almost one-fifth of total 401(k) plan assets at this point. Together, mutual funds and CITS hold close to three-quarters of 401(k) plan assets, making them the most widely used investment vehicles for 401(k) plans.”

Given the momentum that continues to build behind CIT investment vehicles, Cerulli believes there is room for CITs to expand from their current share of the 401(k) plan market by taking share from mutual funds. In a survey of 401(k) plan sponsors cited by the reporting, nearly one in five indicate that they anticipate switching the vehicle of at least one investment option from a mutual fund to a CIT in the near future.

Beyond the subject of CITs, Cerulli reports that recordkeepers widely identify “reducing plan administration costs” and “maximizing participant savings” as the top two priorities for defined contribution plan sponsors. Despite the broader retirement industry’s focus on retirement income, none of the recordkeepers surveyed selected “providing in-plan retirement income solutions” as a plan sponsor priority.

“This suggests that the industry may be out of touch with the current realities plan sponsors face. It also intimates that plan sponsors may not fully understand how their organization may be exposed should their employees be unable to retire,” Sclafani suggests. “The increasingly complex regulatory environment clearly continues to weigh on plan sponsors with nearly one-third of recordkeepers identifying ‘minimizing fiduciary risk’ as a top priority for plan sponsors.”

Plan advisers and recordkeepers can help alleviate this pain point among plan sponsors through ongoing education as to what it means to be a fiduciary, Cerulli says.

“This is a concept that Cerulli believes many DC industry stakeholders, from advisers to plan sponsors, still do not thoroughly understand,” Sclafani concludes. “This is reflected in some of the new products that have emerged post-Conflict of Interest Rule that sell fiduciary protection.”

Information on obtaining Cerulli research is available here. 

Compliance September 27, 2017

Safe-Harbor 401(k)s Attractive to Both Sponsors and Participants

Safe-harbor plan designs allow plan sponsors to avoid nondiscrimination testing and allow highly compensated employees to contribute more.
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A plan without a safe-harbor is subject to average deferral percentage (ADP) and average contribution percentage (ACP) testing requirements, notes Jason Gross, Ubiquity Retirement + Savings’ director of National Sales and Development, based in Chicago.

In many cases, the average deferral percentage for non-highly compensated participants limits the amounts highly-compensated participants can contribute to a 401(k). “This can be problematic, especially with a small business,” Gross says.                 

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To remedy this, the Internal Revenue Service (IRS) allows for a safe-harbor plan design which requires committed employer contributions in exchange for eliminating nondiscrimination testing requirements. Steve Friedman, shareholder at Littler Mendelson and co-chair of the Employee Benefits Practice, based in New York City, adds that a requirement is that contributions employers make are fully vested the date they go into the plan.

Gross explains that, under the safe-harbor plan rules, plan sponsors could make a non-elective contribution equal to at least 3% of all compensation for all non-highly compensated employees eligible to participate, regardless of whether they made any elective deferrals. Alternatively, an employer could agree to provide a 100% match on employees’ effective contributions up to 3% of compensation, and a 50%-minimum match on employee elective contributions up to the next 2% of compensation. Gross says the latter is the most popular option.

Plan sponsors may also use an enhanced match formula of 100% of the first 4% of pay that is contributed to the plan (this is the minimum required under this option), and 100% of the first 6% of pay is the maximum allowed to still get a pass on the ACP test.

If plan sponsors get into a financial bind with the cost of offering these plans, the IRS has issued rules for relief.

NEXT: Adopting a Safe-Harbor Plan

The deadline to adopt a new safe-harbor plan is October 1; the IRS requires the first plan year to be at least three months.

According to Gross, most plan sponsors adopting a new safe-harbor plan use a prototype document. They have to fill out certain features they want in the adoption agreement, and it has to be signed prior to October 1. Then a written notice must be delivered to participants before October 1. Deposits of contributions need to be made in October to get that three months of coverage.

According to Friedman, any employer can take advantage of the safe-harbor plan design, not just small employers. And, if a plan sponsor has an existing plan it wants to switch to a safe-harbor design, amendments would be required for matching and non-elective contribution sections and other sections as well. Plan sponsors may wish to restate their plans entirely. Gross adds that switches to safe-harbor plan designs need to happen as of the first day of the plan year, with a 30-day prior notice to plan participants.

The October 1 deadline is not likely to be met for employers that have not already moved to adopt a new safe-harbor plan, but Gross says plan sponsors can consider it for future years. “Small business owners are overwhelmed with their business and often something like this is on their to-do list but continues to be pushed down by other priorities,” he says. “It is important to get the word out about these plans so employers can start planning in advance.”

NEXT: Benefits of Offering Safe-Harbor 401(k)s

Ubiquity’s focus is on small plans—traditionally fewer than 100 employees, and Gross says many plans it puts in place are brand new plans. He adds that many small businesses come with a tax problem after taking years to build their businesses, and a 401(k) is a primary form of retirement savings and tax relief. “There is a low-level of managing tax savings without a safe-harbor plan,” he says. “This is a key piece of our discussion with them.”

A study last year of the 2,767 small business 401(k) plans for which Employee Fiduciary provides Employee Retirement Income Security Act (ERISA) compliance services found 68% of plans use a safe-harbor 401(k) plan design to avoid annual ADP/ACP and top-heavy nondiscrimination testing. But, this is also an advantage to large plans.

According to Friedman, safe-harbor plan designs are important to a lot of employers because employers often have bad news to deliver to highly paid plan participants—namely that they cannot defer enough. The highly compensated often have their contributions curtailed and often matching contributions are forfeited due to failing nondiscrimination testing. “Safe-harbor plans allow highly paid people to make contributions they might not otherwise be able to make and to receive employer match,” he says.

“It seems as though they are becoming more popular as time goes on,” Friedman concludes. “Employers are looking to both retain employees and minimize problems with plan testing. Safe-harbor plans are very attractive to employees.”

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