5 Things Plan Sponsors (Still) Screw Up

Plan sponsors have a lot of responsibilities and often rely on others to help them keep their plan operating in accordance with the law. And yet, even with the most attentive plan sponsors, mistakes (still) occur. Here’s a list of some of the most common missteps:

1. Not using the plan’s definition of compensation correctly for all deferrals and allocations.

The term “compensation” has several different applications in qualified retirement plan operations, depending on the particular compliance goal. For example, a plan may use one definition of compensation to allocate employer contributions and a separate, distinct one for testing whether employee salary deferrals are nondiscriminatory. Note that one of the top plan compliance concerns identified by the IRS is a failure to identify and apply the correct definition of compensation in a particular scenario.

Note that while plans often use different definitions of compensation for different purposes, it’s important to apply the proper definition for deferrals, allocations and testing. A plan’s compensation definition must satisfy rules for determining the amount of contributions.
You should review the plan document definition of compensation used for determining elective deferrals, employer nonelective and matching contributions, maximum annual additions and top-heavy minimum contributions. Review the plan election forms to determine if they're consistent with plan terms.

2. Not following the terms of the plan document regarding the administration of loan provisions (maximum amounts, repayment schedules, etc.) or hardship withdrawals.

Plan documents routinely provide that hardship distributions can only be obtained for certain very specific reasons, and that participants first avail themselves of all other sources of financing before applying for hardship distributions (these conditions often are incorporated directly from the requirements of the law). Similarly, loans are permissible from these programs only when they comply with certain standards regarding the amount, purpose, and repayment terms.

Failure to ensure that these legal requirements are met can, of course, most obviously result in a distribution not authorized under the terms of the plan document—and, since these types of distributions are frequently quickly spent by participants (and thus not readily recoverable), it can be complicated and time-consuming to set the situation right.

Oh – and don’t forget that we now have some updated final regulations on hardship distribution and conditions.

3. Not depositing contributions on a timely basis

The legal requirements for depositing contributions to the plan are perhaps the most widely misunderstood elements of plan administration. More significantly, a delay in contribution deposits is also one of the most common flags that an employer is in financial trouble – and that the Labor Department is likely to investigate.

Note that the law requires that participant contributions be deposited in the plan as soon as it is reasonably possible to segregate them from the company’s assets, but no later than the 15th business day of the month following the payday. If employers can reasonably make the deposits sooner, they need to do so. Many have read the worst-case situation (the 15th business day of the month following) to be the legal requirement. It is not.

4. Failing to obtain spousal consent.

The IRS has long noted that a common plan mistake submitted for correction under the Voluntary Correction Program (VCP) is the distribution to a participant of a benefit in a form other than the required QJSA (e.g., a single lump sum) without securing proper consent from the spouse.

This often happens when the sponsor’s HR accounting system incorrectly classifies a participant as not married (or when the participant was not married at one point and subsequently got married – or remarried). The failure to provide proper spousal consent is an operational qualification mistake that could cause the plan to lose its tax-qualified status.

5. Paying expenses from the plan that are not eligible to be paid from plan assets.

Plan sponsors are frequently interested in what expenses can be paid from plan assets. It’s important to keep in mind, however, that the first step in that determination involves making sure that the plan document actually allows the payment of any expenses from plan assets.

Assuming that the plan allows it, the Department of Labor has divided plan expenses into two types: so-called “settlor expenses,” which must be borne by the employer; and administrative expenses, which – if they are reasonable – may be paid from plan assets. In general, settlor expenses include the cost of any services provided to establish, terminate, or design the plan. These are the types of services that generally are seen as benefiting the employer, rather than the plan beneficiaries.

Administrative expenses include fees and costs associated with things like amending the plan to keep it in compliance with tax laws, conducting nondiscrimination testing, performing participant recordkeeping services, or providing plan information to participants.
ERISA imposes a duty of prudence on plan fiduciaries that is often referred to as one of the highest duties known to law – and for good reason. Those fiduciaries must act “with the care, skill, prudence and diligence under the circumstances then prevailing that a prudent man acting in a like capacity and familiar with such matters would use in the conduct of an enterprise of a like character and with like aims.”

Oh – and if you’re not “familiar with such matters” – or aren’t certain of that status – it’s a good idea – one might even say “prudent” – to engage the help and support of someone who is.

p.s.: Oh, and when a mistake does occur, check out the IRS Fix-It Guide at https://www.irs.gov/retirement-plans/401k-plan-fix-it-guide.

- Nevin E. Adams, JD

"Make" Shift

Financial literacy has long been touted as something of a “silver bullet” in helping workers make better financial decisions – and now there’s a call to make it a mandatory employment offering. 

Now, we all know that lots of workers get their first (and for many only) exposure to financial markets via their workplace retirement plan. Ditto their only education about investing, diversification, or even mutual funds. Little wonder that those who are tasked with delivering those lessons have long championed the need for some basic level of financial education in school curricula.

The issue was most recently raised earlier this year in a paper titled “Defined Contribution Plans and the Challenge of Financial Illiteracy.” Authored by Jill Fisch of the University of Pennsylvania Law School, as well as financial literacy icon Annamaria Lusardi and Andrea Hasler from George Washington University School of Business, the paper compares the relative financial acumen of what it terms “workplace-only” investors with active investors.

The report notes that the former (some 28% of the investor group) only have investments through an employer-sponsored plan, the latter have private retirement accounts that they have set up themselves and/or other investments. Arguably, and as the paper acknowledges, some of those in the latter group may well have begun their investment experience in workplace plan, but have now rolled those investments into an IRA (the paper says that about half of this group have both a self-directed account and “other financial investments”).

Mandate State?

It’s this combination – what they claim are big gaps in financial literacy coupled with a reliance on a defined contribution-oriented retirement system that is so dependent on individual choices – that has now led these academics to call on for a mandate on employers to fill the gap with financial literacy programs.

Specifically, they propose that employers be required to provide a self-assessment “enabling their employees to measure their financial knowledge and capability.” They suggest that the Labor Department “could introduce minimum requirements as to what should be included in a program to provide the working knowledge and skills necessary to navigate the defined contribution system” – requirements that could, they note, “include both specific information about the 401(k) plan, the investment options contained in that plan, and the process of saving and investing for retirement,” but that could also “extend to more general components of personal financial decision-making that contribute to an employee’s financial well-being.”

‘Big’ Deal

I think it’s fair to say that there are lots of retirement plan savers who aren’t very investment savvy, though I’ve a sense that the academics are overly broad in their characterizations, and perhaps lack a full appreciation for the education that is currently provided in the context of workplace plans. Further, for their assessment of financial literacy (more precisely, the lack thereof), they rely on the responses to a “big three” set of questions. 

Now, those “big three” questions have been utilized in academic circles for years as an assessment as to whether an individual is financially literate or not. I’ll accept at face value the belief of gifted individuals who have studied the subject of financial literacy in far more detail, and with more expertise in such matters than I, that a correct response to those questions constitutes a level of literacy in financial matters.

I’m happy to say that I have, for years, been able to accurately answer those “big three” questions that purport to provide an accurate gauge of financial literacy[i] – but to this day I am unable to articulate exactly how those specific knowledges would help me answer the questions that seem most pertinent to achieving retirement financial security; notably how much should I save, how should I invest those savings, when should I rebalance, and – ultimately – how (and when) do I draw down those savings in retirement.

The studies I have seen – and a point made by the authors of this proposal – suggest that timing is critical to retention. In other words, teaching someone about investments years before they actually have any investments probably won’t have much retentive impact. That’s why the best financial wellness programs are effective – because, rather than one-size-fits-all education, they focus on specific people and targeted groups of people who have specific needs – and do so in a manner proximate in time to either when those decisions must be made, or will have an impact.

It’s hard to argue that a greater focus on financial literacy wouldn’t be of some benefit – though I would say preferably sooner and more consistently than is likely in the employment context. That said, I’m skeptical about the impact of a financial literacy campaign mandate on employers. First off, the vast majority of employers who sponsor a plan already provide some level of education (does anyone not?), on their own, or with the assistance of a recordkeeper, TPA or advisor. A growing number are doing so with the broader emphasis on outcomes and financial wellness. The Labor Department might well be able to craft a more practical set of financial literacy guidelines than the academics, but I doubt it – and that’s assuming they’d even want the job.

Putting that obligation on employers ignores decades worth of experience that many, perhaps most, individuals don’t take full advantage of the education materials already furnished. Moreover that they appreciate – and in most ways and many cases are better served by the convenience of plan design solutions – like automatic enrollment and qualified default investment alternatives – that counter human misbehaviors and help even the financially literate make better choices than busy lives often allow.[ii] 

More significantly, I suspect that a financial literacy mandate on employers who sponsor plans would only mean fewer employers sponsoring plans – and that’s before we consider the potential for a brand new angle for the plaintiffs’ bar.

In sum, there seems little to be gained from a financial literacy mandate on employers. But it’s worth keeping in mind that those who currently participate in those employment-based retirement programs have something to lose.

- Nevin E. Adams, JD

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[i]The Big Three
Consider that, even in making the case that there is a financial literacy gap, the academics rely on what they call the “Big Three” financial literacy questions, specifically:

1. Suppose you had $100 in a savings account and the interest rate was 2% per year. After five years, how much do you think you would have in the account if you left the money to grow?

A. More than $102, B. Exactly $102, C. Less than $102 

2. Imagine that the interest rate on your savings account was 1% per year and inflation was 2% per year. After one year, how much would you be able to buy with the money in this account?

A. More than today, B. Exactly the same, C. Less than today

3. Please tell me whether this statement is true or false: “Buying a single company’s stock usually provides a safer return than a stock mutual fund.” 
♦True ♦False

[ii]Those are mostly accumulation options, however. On the drawdown/withdrawal side, while there are certainly many alternatives, there is arguably still a gap.

It's About Time

Most of the surveys and research in our industry focus on the shortcomings – a lack of savings, of diversity in investment, of failure to maximize the employer match, or to have access to the programs that support those opportunities. There is, however, a shortfall that doesn’t garner much attention.

I’m talking about time.

And while time is often treated as an “enemy” of retirement planning (sometimes under the “longevity” label), certainly when there is a concern about outliving one’s resources, or perhaps when too little time remains to make preparations, there is another aspect: a retirement cut short.   

This is heavy on my mind of late – not just because this week marks the anniversary of the Sept. 11 attacks, though that’s certainly a factor.

My recollections of that awful day notwithstanding, I’ve been particularly mindful of the untimely passing of three individuals of my acquaintance in recent weeks: a relative, a colleague, and an associate here. Two were not even thinking about retirement when their time came – one had been eagerly looking forward with anticipation to a retirement she’ll never have.

Now I’m not privy to the particulars of the financial plans of these individuals – the needs that their unexpected passing may present for others – or what steps, if any, they may have taken to ease the financial circumstances for those they left behind. I hope they had that opportunity, but know all too well that many don’t.

People die tragically and prematurely every day, of course. Most of them are unknown to us, and nearly all are unnamed to us. And as the recent mass shootings remind us, on any given day, any one of us could go to work, or to the store – and simply not come home.

Ironic as it sounds, death is a part of life. Thoughtful individuals prepare for the possibility of death –through faith, sacrifice and, with luck, sound financial planning. However, most don’t dwell on those realities, and that’s doubtless a good thing.

In this business, we spend a lot of time worrying about the risks of outliving our retirement savings. In fact, surveyed workers increasingly seem to rely on an assumption that they will work longer, or save more later, to make up for their current shortfalls.

However, and perhaps particularly on this anniversary eve of the Sept. 11 attacks, it’s worth remembering that we don’t always have as much time as we might think – or want.

It’s time we did.

- Nevin E. Adams, JD

How Gen Z's Retirement Will Be Different

Those “kids” who were just dropped off at college for the first time? By their sophomore year, their generation will constitute one-quarter of the U.S. population. How will their retirement be different?

That’s according to the authors of the so-called Mindset List – now housed at Marist College, having relocated from Beloitt College – has been published each August since 1998. Originally created as a reminder to faculty to be aware of dated references, the list provides a “look at the cultural touchstones that shape the lives of students entering college.” Not to mention those who will go on to be workers and – eventually – retirees.

This fall’s college class of 2023 is the first class born in the 21st Century (2001) – and thus lack a personal memory of the September 11 attacks. According to the authors of the Mindset List:

• This group has never used a floppy disk (heck, they’ve probably never even seen one, except at that “save” icon).
• Their phone has always been able to take pictures.
• They’ve always had Wikipedia as a resource.
• Oklahoma City has always had a national memorial at its center.
• As air travelers they’ve have always had to take off their shoes to get through security (well, unless they have TSA pre-check).
• PayPal has always been an online option for purchasers.
• There’s always been a headlines scrawl on TV.
• They have always been able to fly Jet Blue.
• Troy Aikman’s play calling has always been limited to the press booth.
• They’ve never been able to watch Pittsburgh’s Steelers or Pirates play at Three Rivers Stadium.
• Monica and Chandler from “Friends” have always been married (May 17, 2001).

Despite those differences, the class of 2023 will one day soon be faced with the same challenges of preparing for retirement as the rest of us. They’ll have to work through how much to save, how to invest those savings, what role Social Security will play, and – eventually – how and how fast to draw down those savings.

And yet, when it comes to retirement, the Class of 2023 also stands to have a different perspective. For them:

• There have always been 401(k)s.
• There has always been a Roth option available to them (401(k), 403(b) or IRA).
• They’ve never had to sign up for their 401(k) plan (since, particularly among larger employers, their 401(k) automatically enrolls new hires).
• They may never have to make an investment choice in their 401(k) plan. (Their 401(k) has long had a QDIA default option to go with that auto-enroll feature.)
• They’ve always had access to target-date funds, managed accounts, or similar vehicle that automatically allocates (and, more significantly, re-allocates) their retirement investments.
• They’ve always had fee information available to them about their 401(k). (It remains to be seen if they’ll understand it any better than their parents.)
• There have always been plenty of free online calculators that allow them to figure out how much they need to save for a financially secure retirement (though they may not be any more inclined to do so than their parents).
• They’ve always been able to view and transfer their balances online and on a daily basis (and so, of course, they mostly won’t).
• They’ve always worried that Social Security wouldn’t be available to pay benefits. (In that, they’re much like their parents at their age.)
• Many have never had to wait to be eligible to start saving in their 401(k). (Their parents typically had to wait a full year.)

But perhaps most importantly, they’ll have the advantage of time, a full career to save and build, to save at higher rates, and to invest more efficiently and effectively.

And, with luck, access to a trusted advisor to answer their questions along the way...

- Nevin E. Adams, JD