Compliance December 17, 2013

Nondiscrimination Relief for Closed DBs

The Internal Revenue Service (IRS) has temporarily addressed the problem of discrimination defined benefit (DB) plan sponsors may have due to closed plans.
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Notice 2014-5 provides temporary nondiscrimination relief for certain plans that provide ongoing accruals but have been amended to limit those accruals to some or all of the employees who participated in the plan on a specified date. It permits certain employers that sponsor a closed DB plan and also sponsor a defined contribution (DC) plan to demonstrate the aggregated plans comply with the nondiscrimination requirements of § 401(a)(4) on the basis of equivalent benefits, even if the aggregated plans do not satisfy the current conditions for testing on that basis. In addition, the notice requests comments about possible permanent changes to the nondiscrimination rules under § 401(a)(4).

The agency explains that a number of DB plans have been closed to new entrants, and the plan sponsor of a closed DB plan typically provides a 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 § 410(b) without being aggregated with the DC plan. However, the § 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.

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If the closed DB plan cannot satisfy the coverage requirement of § 410(b) on its own, it will need to be aggregated with another plan in order to satisfy that coverage requirement, the IRS continued. If the DB plan is aggregated with a DC plan that covers the employer’s new hires to satisfy the coverage requirement, then it is also required to be aggregated with the DC plan for purposes of satisfying the nondiscrimination requirements of § 401(a)(4). In the typical case, the aggregated plans will fail the requirements of § 401(a)(4) unless they are permitted to demonstrate compliance with the nondiscrimination requirements on the basis of equivalent benefits.

Earlier this month, in an open letter sent to Jacob Lew, Secretary of the Treasury, Senators Rob Portman (R-Ohio) and Benjamin Cardin (D-Maryland) warned nondiscrimination testing requirements designed to ensure retirement benefit parity between higher- and lower-compensated participants can actually hurt retirement readiness figures in certain pension freeze cases (see “Senators Call for Discrimination Test Fix”).

Notice 2014-5 is here.

The Markets December 17, 2013

Portfolio Predictions for 2014

The global economy is improving, inflation will stay moderate and equities will outshine bonds in 2014, say Merrill Lynch and U.S. Trust.
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The chief investment officers of Merrill Lynch and U.S. Trust released their investment strategy overviews for 2014 with key themes investors should know to align their portfolios with macro trends in a transforming world.  

Opportunities and risks in financial markets will be driven by an improving global economy, moderate inflation and gradually rising interest rates, according to Merrill Lynch and U.S. Trust. Their investment teams believe an understanding of the implications of these macro trends will enable investors to position themselves for the opportunities in addition to investing in longer-term transformational trends arising from technological innovation and demographic shifts.

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The main themes reflect a positive outlook, but investors are cautioned to keep potential risks in mind.

Goals are key, says Ashvin Chhabra, chief investment officer of Merrill Lynch. “Investors need to distinguish between what we can and can’t control,” Chhabra says. “We can’t control the market and its performance, but we can help clients set appropriate goals, and tactical weighting and underweighting that is consistent with those goals.”

Stay focused on the primary objective, Chhabra says, categorizing the world we’re in as “not being in equilibrium,” and observing that an interesting dynamic is playing out between bonds and equities. “We recommend clients should first and foremost invest according to their goals and measure progress to these goals on a regular basis,” he says.

U.S. equities have had an excellent run, with the S&P 500 index rising more than 150% since the lows in 2009, Chhabra points out, with rallies in Europe and recently in Japan. As the global economy and asset markets begin to normalize in 2014, Chhabra believes clients should rebalance their portfolios, bringing them more in line with their strategic asset allocations.

Team USA

Risk assets such as equities and credit will likely outperform again in 2014, Chhabra expects, but with an increased risk of an equity correction. “In an environment of lower liquidity and political risks emanating from D.C.’s budget battles and mid-term elections, investors should be sensitive to valuations and more selective among asset classes and regions, he said. “We advise clients to not abandon fixed income as interest rates gradually rise to follow the path of higher growth, but to manage for rising volatility in their bond portfolios. Attractive valuations and a better economy favor technology, energy, autos and manufacturing sectors—what we call ‘Team USA.’”

Consumer spending could pick up in 2014, says Mary Ann Bartels, chief investment officer for portfolio solutions at Merrill Lynch. Over the next 20 years, she points out, 20% of the population will be over the age of 65, making health care and travel/leisure good investment classes. Financial services will also be key, she says, since this population will need retirement services. “Asset managers that can cater to this will be a huge beneficiary” of the longevity revolution, Bartels feels.

“We are heading into a macro and micro environment very similar to that of the mid to late 1990s, when the movie ‘Back to the Future’ symbolized catalytic changes that would soon transform the world,” says Chris Hyzy, chief investment officer of U.S. Trust. “Now, central bank policy is still easy, with or without taper; a coordinated global economic growth lift is underway; commodity prices still have a downward bias; profits should hit another record; job growth is improving, and inflation is well in check.”

Merrill Lynch outlined 10 portfolio themes for 2014:

  • Equities again outshine bonds;
  • Invest in “Team USA,” or technology, energy, automobiles and manufacturing sectors;
  • International equities prove resilient;
  • The equity rotation within the Great Rotation continues: (i) favor select cyclicals over defensives; (ii) U.S. large cap over small cap, and (iii) U.S. multinationals;
  • Fixed income is challenged by greater interest rate volatility;
  • The dollar strengthens;
  • Be selective in emerging markets and favor equities relative to bonds;
  • An expanded investment toolkit offers downside protection and diversification;
  • Within alternatives, hedge fund strategies and private equity are the best commodities; and
  • Tax awareness pays off.

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