CPSP 2.3
Qualified Longevity Annuity Contracts
.In 2012, the IRS took steps toward encouraging the availability of such options with the introduction of qualified longevity annuity contracts, or QLACs. QLACs represent an updated, streamlined means to offer a guaranteed lifetime income option in DC plans. In 2014, the IRS issued final regulations that allow plans to exclude the value of QLACs from the account balance of a qualified plan or IRA for purposes of determining age 70 ½, required minimum distributions (RMDs).
Behavioral Hurdles
All of which often result in no action, or certainly a postponement of action - as inertia takes over. Sir Isaac Newton's First Law of Motion - that a body at rest will remain at rest unless an outside force acts on it - holds true here as well as in nature. The term academics use to describe this tendency for individuals to make (or not make) decisions deemed "rational" and/or in their bests interests is "bounded rationality." So, how can plan sponsors use behavioral science to help workers make better decisions?
Default Investment
An employer can retain the responsibility for investing the plan's assets, or allow participants to self-direct all or a portion of their plan assets (as is often the case with 401(k) plans). Self-direction of investments is one of the requirements that an employer must meet if it chooses to take advantage of ERISA Sec. 404(c) fiduciary protection
Why Education isn't Working
The reality is that human beings struggle with complex financial decisions - and the traditional approach to retirement plan education presents them with a series of unknowns, and for many, unknowable, decisions, including: • How much can I afford to save? • How much do I need to save? • How much of that savings should be pre-tax? • How should I invest that savings? • Who should be my beneficiary? • What's a mutual fund? • How do I fill out this complicated form?
As a plan sponsor,
you must, in turn, provide each eligible participant a notice that explains the automatic deferral arrangement, his or her right to elect not to have deferrals automatically made to the plan, and how the person may alter the amount of contributions, if desired. Following receipt of the notice, the plan sponsor must give each eligible employee a reasonable period of time to make an affirmative deferral election, and, on an ongoing basis, of the opportunity to change his or her election. Including an automatic enrollment feature has been an effective way for many employers to increase participation in their 401(k) plans
Robo-Advice
A more recent innovation has been the availability of what's called "robo-advice" - online services that use algorithms to automatically perform many investment tasks done by a human investment advisor, which can be made available directly, or in conjunction with a human advisor. Initially offered by startups, robos are now part of the suite of services offered by major financial institutions and plan service providers. Since providing robo-advice is generally less expensive than human investment advisor, it can be a more affordable way for plan sponsors to offer investment services to the masses. Of course, there are pros and cons to offering robo-advice -and recent surveys suggest that many participants like a combination. In 2017, the Securities and Exchange Commission (SEC) for the first time included robos as part of its examination priorities. Robos are regulated: They have to register as financial advisors, and as brokers-dealers if needed. They also have a fiduciary duty to seek a client's best interest.
What is a PLR?
A private letter ruling or PLR, is a written statement issued to a taxpayer that interprets and applies tax laws to the taxpayer's represented set of facts. It is issued in response to a written request submitted by a taxpayer. A PLR may not be relied on as precedent by other taxpayers or by IRS personnel.
Student Loan Crisis
According to the Federal Reserve, student loan debt has reached a staggering amount: $1.52 trillion. For many younger workers it has become a huge stumbling block to achieving financial wellness, and to saving for retirement. A new in-plan approach to addressing student loan debt is to provide some kind of loan repayment incentive through the 401(k) plan. A May 2018 private letter ruling (PLR) cracked open the door for such plan designs. In the method approved by the IRS, an employee with student loans would be able to enroll in the plan, make monthly student loan payments, and have his or her employer make "student loan repayment nonelective contributions"
Qualified Automatic Contribution Arrangement (QACA)
Another incentive in the law is for arrangements referred to as "qualified automatic contribution arrangements" (QACAs). A QACA is a type of 401(k) safe harbor plan with a few key differences: • There must be an automatic deferral contribution feature that is at least 3% during the initial and second plan year, increasing to 4% during the third plan year, to 5% during the fourth plan year, and increasing to 6% during any subsequent plan years. It cannot exceed 10%. • An employer-provided contribution in the form of either a matching contribution or nonelective contribution, but the matching contribution is slightly less than a regular 401(k) safe harbor plan. • The employer contribution can be subject to a two-year vesting schedule rather than immediate vesting. A QACA may not distribute the required employer contributions due to an employee's financial hardship.
Investment Advice
Approximately, 35% of defined contribution plans offer some form of investment advice to participants. While not directly associated with behavioral science approaches, the nonpartisan Employee Benefit Research Institute (EBRI) has found that individuals with access to an investment advisor set higher savings goals, save more, and are generally more confident in their retirement preparations. In most cases, the provider of the investment advice is a registered investment advisor whose compensation is not impacted by their advice. Investment advisors can be affiliated with a plan service provider, but many are not. Investment advice can be delivered PSCA Survey Data Approximately 35% of Defined Contribution (DC) plans offer some form of investment advice to participants. 21 to the plan participant in any number of ways including inperson, via telephone and internet. Many investment advisors use multiple channels.
Why is Financial Wellness so important?
As noted earlier, in the same way that wellness programs are seen as contributing to better health - and ultimately, less cost and health issues - financial wellness is seen as providing a host of benefits, both objective and subjective to productivity, engagement, and ultimately workforce management. Consider that a recent study by PricewaterhouseCoopers (PwC) found that among stressed workers, half (50%) say they are spending three or more hours each week dealing with personal financial issues, and that 12% of employees admit to missing work occasionally due to financial worries. Not that it's only about decreasing negatives. A 2018 study by the non-partisan Employee Benefit Research Institute (EBRI) of 250 plan sponsors found that midsized employers — those with 2,500 to 9,999 employees — were most likely to say they offer these initiatives to improve their workers' overall satisfaction (67%). On the other hand, the largest employers (>10,000 employees) were most likely to cite increased employee productivity (37%) - and being a differentiator from their competitors (27%). A study3 by employee benefits consultant Mercer on employee financial wellness identified why employee financial wellness is so important: • Everyone has financial issues to address; • Personal financial issues impact professional performance; • Traditional financial education programs are not enough; • Psychology plays an important role; and • It is important to break the vicious cycle and create "the virtuous circle."
Qualified Default Investment Alternative (QDIA)
As part of the Pension Protection Act of 2006, ERISA's 404(c) protection was extended to include "qualified default investment alternatives" (QDIAs), provided certain notice and disclosure requirements are satisfied. Remember that the DOL has always been of the opinion that the plan sponsor/fiduciary is responsible for the investments of the plan - even the investments that are chosen by participants - unless the choice and information requirements of ERISA 404(c) were met. With automatic enrollment, those enrolled aren't making any explicit decisions, potentially exposing the plan sponsor to fiduciary liability for the default investment choice. In proposing regulations for implementing the QDIA, the DOL noted that "Some employers have adopted automatic enrollment plans and many more are interested, but the fact 20 that they are potentially liable for investment losses that may occur in such plans has been a major impediment to wider adoption of this plan design", and that the Pension Protection Act removed several of impediments to automatic enrollment plans, and that it was key to "amending the Employee Retirement Income Security Act (ERISA) to provide a safe harbor for plan fiduciaries investing participant assets in certain types of default investment alternatives in the absence of participant investment direction". Indeed, providing protection for default investments removes one of the barriers employers an employer might have to implementing an automatic contribution arrangement. See the fiduciary module for more details on using ERISA Sec. 404(c) and QDIAs to mitigate investment risk
The participant is worried about not saving enough
Auto Escalation Automatic escalation works in a similar manner and be used with or without an automatic enrollment feature. With automatic escalation, the amount of a participant's existing elective deferrals is increased each year by a set amount. For example, a plan might provide that if a participant makes no contrary election, that he or she will be enrolled in the plan at 3% (this is automatic enrollment). Then, each year thereafter the percentage is increased by 1% unless the employee makes a different election - this is the automatic escalation feature.
Section 1: Behavioral Finance
Behavioral finance is a field that seeks to find explanations for, and solutions to, the seemingly irrational financial decisions that people often make. For years, despite spending millions annually on employee education designed to encourage better savings and retirement outcomes, overall participation rates hovered between two-thirds and three-quarters of those eligible, and deferral rates clustered around the employer match. Enter behavioral finance, and its first widely embraced design, Save More Tomorrow (SMarT), touted by now-Nobel Prize winner Richard Thaler of the University of Chicago and Schlomo Benartzi of the University of California at Los Angeles (UCLA). The pair didn't create the notion of automatic enrollment - under inauspicious names like "negative election", it had been in place at some employers since the early 1980s - but they certainly brought the concept to prominence, culminating in key retirement savings enhancement provisions in the Pension Protection Act of 2006, including automatic enrollment, contribution rate acceleration and qualified default investment alternatives.
Section 3: Promoting Financial Wellness in Plan Design
Financial wellness is an increasingly important objective for workers and plan sponsors alike, with significant implications for the organization's bottom line. As we mentioned earlier, workers are often stymied in making complex financial decisions by a host of behavioral biases. Let's look at how behavioral finance in plan design can help solve some of the common issues employees contemplate: • Should I be saving or not? • I contribute, but am I saving enough? • Is my account appropriately diversified? • Will I outlive my savings?
The participant is worried they will outlive their savings
Historically, most DC plans have not offered life annuities or similar guaranteed income products - and in some cases those businesses relied upon their defined benefit (DB) plans to address the lifetime income needs of their employees. But, with the decline in the availability of DB plans - and the rapidly expanding prevalence of DC plans, there has been a growing interest in how adding lifetime income options could be added to 401(k) plans. There is not widespread adoption of in-plan annuities because the products are expensive and lack portability and employers are concerned about the fiduciary liability of adding a product that depends on the future financial health of an insurance company.
Should participants be saving or not? Automatic Enrollment
In a 401(k) plan, an affirmative deferral election - requiring employees to complete an enrollment form - has been the standard retirement deferral model for years. This model requires the participant to execute a written election to defer receipt of a certain amount or percentage of pay. Beginning in the early 1980s and accelerating since the passage of the Pension Protection Act of 2006, the automatic enrollment model (also sometimes referred to as "auto deferral," "negative election," or "automatic contribution arrangement") has gained popularity, particularly among larger employers. In this model, eligible workers are enrolled in the plan "automatically" at a pre-determined rate of pay, unless the worker specifically "opts out" of participation in the plan. 13 As a plan sponsor, you must, in turn, provide each eligible participant a notice that explains the automat
employee education part 11
In order to accomplish these educational goals, employers have used a variety of materials and media, primarily relying on: 1. Individually targeted, but generalized, communications using regular and Email; 2. In-person seminars and workshops; 3. Enrollment kits; 4. Benefits websites and mobile platforms with savings tools; 5. Personalized retirement income projections; and 6. Fund performance sheets
Eligible Automatic Contribution Arrangements (EACA)
In order to encourage the use of automatic enrollment features, the law includes incentives for certain arrangements called "eligible automatic contribution arrangements" (EACAs). One of the primary incentives of an EACA is plan can permit employees to withdraw automatic enrollment contributions (with earnings) by making a withdrawal election as required by the terms of the plan, which must be within prescribed time frames after the first automatic deferral. This helps alleviate concerns of upset employees who are automatically enrolled
Employee Education
In the past, plan sponsors have provided employee education for a number of different reasons. A study1 by the Plan Sponsor Council of America (PSCA) reveals that among all plans—small to large—the main reasons, ranked by importance, that sponsors offer retirement savings education have been to 1. Increase plan participation; 2. Increase employee appreciation of the plan; 3. Help employees with retirement planning; and 1 PSCA, 60th Annual Survey, 2018 3 4. Increase pre-tax employee salary deferrals
What is the virtuous circle?
Mercer's study explains it as follows: "For employees with low financial courage, engaging in financial wellness programs will be more challenging. How do we empower them to break the cycle? For these individuals, greater support, 'do it for me' solutions and incremental 'wins' that build confidence will be more effective in promoting financial wellness and, therefore, will be an important focus for employers." In the last four years, the percentage of plans that offer a comprehensive financial wellness program has expanded from 16% to 23%. The most common employee concerns addressed by financial wellness programs: • Getting spending under control (41%) • Preparing for retirement (39%) • Paying off debt (31%) • Saving more for major goals (e.g., purchases, home, education) (27%) • Better management of my investments/asset allocation (23%) • Better manage of healthcare expenses/saving for future healthcare expenses (12%) The nonpartisan Employee Benefits Research Institute (EBRI) found an overwhelming majority of workers thought the following financial wellness programs would be either very or somewhat helpful:
Behavioral Hurdles
Most individuals must overcome certain behavioral hurdles, notably: • They are stymied by too many choices • They fear loss more than they value gain • They separate decisions that should be combined • They make decisions based on belief that things will return to the way they have always been • They rely on heuristics - rules of thumb, or educated guesses to make a quick decision
Why Education isn't Working
Numerous studies have shown that financial education does not necessarily produce improved financial behaviors and outcomes. Moreover, financial stress is at an all-time high for workers. Why doesn't traditional financial education work? There are, potentially, several reasons: 1. Good participant intentions often don't translate to actions. Inertia favors inactivity. 2. The information quickly becomes outdated with the proliferation of new financial products. 3. A "one-size-fits-all" approach, generally, does not work. 4. The information does not effectively address why seemingly rational investors make irrational systematic errors when making financial decisions. 5. The employees' cost of other benefits squeezes out 401(k) savings.
Auto-Portability
One of the more widely cited threats to retirement security, and financial wellness overall is "leakage" - loosely defined as a preretirement withdrawal of retirement savings. The reality is that, even in the most amicable of partings, workers have traditionally lacked the discipline to facilitate a rollover to either an IRA or a subsequent employer's retirement plan (assuming those rollovers were permitted) - and thus, the easiest thing to do for most has been to simply request that their vested account balance be paid in cash
Auto-Portability continued
Over the years, a number of changes have been made by Congress to discourage "leakage" of retirement savings at job change. Under the tax code, cash outs between $1,000 and $5,000 on which instructions are not received by the participant must be either be rolled over into an IRA or left in the plan. In addition, the IRS requires plan administrators to withhold 20% from 401(k) distributions. You can bypass the 20% withholding by doing a trustee-to-trustee transfer (rollover) to an IRA. 25 These laws have doubtless served to at least give pause to that individual distribution "calculus" at job change. Indeed, for those with larger accounts, it is often arguably easier and cheaper from an investment management fee perspective to leave your money with an old employer than to roll it over into an IRA. In 2017 research from the Employee Benefit Research Institute (EBRI) applied auto-portability assumptions to several different scenarios, and found that for individuals aged 25-34 in the lowest income quartile, assuming auto-portability for those with balances over $5,000 (indexed for inflation), it could mean nearly a 25% increase in their aggregate balances at age 65. With the same assumptions, but broadened to include autoportability for all balances (not just those over $5,000), the increase was just over 35%, All told, over a 10-year time horizon, partial auto-portability would result in an additional $256 billion in retirement savings, and $1.5 trillion over a 40- year period.
Choice Architecture
Richard Thaler and Cass Sunstein in their 2008 book Nudge: Improving Decisions about Health, Wealth, and Happiness coined a term "choice architecture" to describe an approach that would 7 improve consumer decision-making by minimizing biases and errors - essentially not limiting choice, but "nudging" individuals toward choices that are in their best interest. This approach can include the use of approaches including the use of defaults, structuring the options available, and providing context and/or feedback for the decisions.
"Stretch" Matching Contributions
Roughly half of all 401(k) plans offer employer matching contributions, primarily as a reward or incentive for employees to make salary deferrals. In order to encourage eligible participants to increase their deferral percentages while keeping the cost of making matching contributions reasonable for plan sponsors, some plans incorporate a stretch match formula.
Limiting Investment Choices
The average 401(k) plan has about 20 investment options in its lineup , while studies have shown that too many choices can actually impede participant decisions. This "paradox of choice " has been documented in any number of consumer settings, from jams to food and clothing. What's the right number of investments on your plan menu that avoids choice overload? The ideal number of investments is unique for each plan, and likely for each individual participant. However, these days it is widely accepted that streamlining fund menu options could lead to higher participation rates and higher aggregate savings for participants. The trend in the industry is to reduce the number of investment options to promote choice and reduce fiduciary risk
There are several requirements that apply in order for an annuity contract to be considered a QLAC
When the contract is issued, it must state it is intended to be a "qualified longevity annuity contract" or QLAC. This requirement will be satisfied if this language is included in the contract (or a certificate under a group annuity contract), or in a rider or endorsement with respect to the contract. 2) The QLAC starting date must be no later than the first of the month following the participant's 85th birthday (the maximum age may be adjusted for changes in mortality). The contract could permit employees to elect an earlier annuity starting date than the specified annuity starting date. 3) The annuity must be a life-only annuity; it cannot include a variable contract, equity-indexed contract, or similar contract. QLACs may, however, be structured as a participating annuity contract (i.e., a contract that provides for the payment of dividends) or to provide for certain cost-of-living increases. 24 4) The amount of the premiums paid for the contract under the plan on a given date may not exceed the lesser of $130,000 or 25% of the employee's account balance on the date of payment. 5) The contract is not permitted to make available any commutation benefit (lump sum distribution), cash surrender value, or other similar feature. There are limits on payments to beneficiaries; and annual disclosure and reporting requirements apply
Financial Well-Being
While behavioral finance and "choice architecture" can provide useful strategies to help overcome inertia and guide workers to more optimal solutions, these days the most innovative benefit programs are taking a broader, more holistic view - focusing on financial wellness.
A QLAC is
a type of deferred income annuity, purchased from an insurance company that DC plans may offer plan participant that begins payments at an advanced age, and continues throughout the individual's life. Currently, there are about 14 insurance companies nationwide that offer a QLAC product
