Compliance February 28, 2023

IRS Proposes Rules That Require Retirement Forfeitures Be Used in 12 Months

A new IRS proposal formalizes guidelines on how plan administrators should manage and use retirement plan forfeitures.

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The Internal Revenue Service proposed new rules on Monday formalizes the timing and use of forfeitures in qualified retirement plans by plan sponsors.

The proposal would more clearly define how plan administrators should handle money forfeited by participants when they leave an employer before the end of a vesting schedule, when they die or when other factors result in funds going back to the plan sponsor. While the rule likely will not change how plan advisers and administrators are currently operating, it would make those processes clearer, says R. Randall Tracht, an attorney with Morgan Lewis specializing in retirement plans and the Employee Retirement Income Security Act.

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“The IRS has long been of the view that the Internal Revenue Code’s tax-qualification rules and requirements generally do not permit defined contribution plans to carry over unused and unallocated forfeitures from year to year,” Tracht says. “The IRS regularly expressed this position in the course of retirement plan audits, but, until now, the IRS had not issued formal regulations setting forth their position.”

In its proposal, the IRS said some defined contribution plan administrators place forfeited funds into a “plan suspense account” in which the money is held before being put to use. The proposed regulations would “generally require” that plan administrators use forfeitures no later than 12 months after the close of the plan year in which the forfeitures happened.

The proposal also specifies the uses for defined contribution plan forfeitures, which are to pay reasonable plan administrative expenses, reduce employer contributions or increase benefits for plan participants.

“Plan sponsors will want to review their plan terms and check with the plan’s recordkeeper to consider whether any changes to the plan’s terms or recordkeeping processes may be desirable,” Tracht says.

The proposed rules are effective for plan years beginning on and after January 1, 2024, and include a transition rule that deems pre-2024 forfeitures to have been incurred in the first plan year beginning on or after January 1, 2024, according to Tracht. This will allow plans time to comply with the new rules.

The IRS said that the proposed regulations are “not expected to require changes to plan terms or plan operations, or otherwise have a significant impact on plans or plan sponsors.” It did say, however, that it is seeking comment from smaller plans and plan sponsors to discuss the “impacts these proposed regulations may have.”

The agency will take public comments online or by mail until May 30 and will set a date for a public hearing if requested.

Client Service February 27, 2023

401(k) Plan Fees Continue Decline on CITs, Lower-Cost Funds

Participants enjoyed lower fees within retirement investments in 2022, due largely to shifts by defined contribution vehicles, rather than from the trend toward fee-only advisement.

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Investment fees for 401(k) retirement plans declined by .03% in 2022 from 2021, a downward trend that has been consistent in the six years of the 401k Averages Book, which was released last week.

Investment fees for 401(k) participants fell to .02% from .05% in 2021, according to the Baltimore-based research firm, with smaller plans incurring slightly higher fees than larger ones with more than 50 employees. The biggest driver for the decline was an uptick in 401(k) investments being put into lower-cost-fund share classes and collective investment trusts, which also tend to carry lower fees as pooled investment vehicles, says the book’s author, Joseph W. Valletta.

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“Plan sponsor and advisor fee awareness created an environment where investment managers had to make new, lower-cost-fund share classes and CITs available to plans to remain competitive,” Valletta says. “Investment costs represent the largest allocation to total plan costs, so that trend moves the needle the most.”

Recent data reiterate that finding, with reporting from Sway Research showing that CITs may top mutual funds as the primary investment in target-date vehicles this year. The benefits of the trend in lower investment fees will pay “significant dividends” to savers in the long run, Valletta said.

Lower Fees, Please

Fees have dropped across the financial advisory industry in recent years, with lower fees charged both within retirement plans as well as in the investing market as a whole, according to Charles Rowlan, senior vice president of business development with Advyzon, a service and portfolio management platform for financial advisers and investment managers.

In a survey Advyzon ran of more than  1,000 registered investment advisers, more than 40% now offer a flat-fee option alone, or alongside an assets-under-management fee-based system. Advyzon saw a 15% jump in the use of flat fees among advisers, with expectations of that growth steadying in coming years, Rowlan says.

Rowlan also says the high flat-fee figure showed him that advisers and clients are looking for different ways to bill to meet cost concerns. The flat fee can, in particular, mitigate how market volatility impacts AUM costs, as well as open a conversation for advisers providing other services beyond just investment management, such as taxes, estate work or other areas crucial to their clients.

Despite those advantages, Rowlan does not see flat fees overtaking AUM any time soon, but rather expects them to be a tool used to match the needs and circumstances of clients. “Very few advisers are using [a] flat-fee [model] exclusively,” he says. “Firms that are doing it are doing it in coordination with AUM-style fees.”

While the flat-fee model is popular in overall investing, it is not a key driver for the retirement investing space, which is dominated by large investment portfolios, according to Valletta.

“Decoupling recordkeeping fees from asset growth would be a factor in the trend to lower fees (shift away from AUM-based fees to flat fees), but since it’s a smaller percentage of the overall pie, not quite as large of an impact,” Valletta says.

Advantage: Larger Plan Sponsors

Smaller retirement plans—defined as 50 participants or about $5 million in assets—had, on average, higher-percentage fees than larger plans, according to the 401k Averages Book.  Small retirement plan fees declined from 1.12% to 1.09% over the past year and are down from 1.18% in 2017.

Meanwhile, large-retirement-plan—1,000 participants or $50,000,000 in assets—fees declined from 0.88% to 0.85% over the past year and are down from 0.95% in 2017, according to the 401k Averages Book.

“We are encouraged to see fees continue to decline for participants in small 401(k) plans. Small business employers have a lot on their plate with deciphering [the] Secure 2.0 [Act of 2022], but small tweaks to their plan’s investment menu and fees can generate significant savings for their employees,” Valletta says.

The 401k Averages Book data is backed up by other industry research. The expense ratios that 401(k) plan participants incur for investing in mutual funds—the most popular investment vehicle—have declined substantially since 2000, according to the most recent research from the Investment Company Institute. In 2000, 401(k) plan participants incurred an average expense ratio of 0.77%  for investing in equity mutual funds. By 2021, that figure had fallen to 0.36%, a 53%  decline.

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