Defined contribution plans do not typically include an option that provides a lifetime stream of income for participants, as pension participants and beneficiaries could rely on in years past. With the switch to DC plans from traditional defined benefit plans, the federal government is very concerned about plan participants having a secure retirement.
As a result, qualified lifetime annuity contract regulations were introduced, and safe harbor annuity selection regulations were issued in an effort to encourage plan sponsors to consider offering annuities in DC plans. The latest guidance from IRS on Oct. 23 — Notice 2014-66 — provided another method to offer annuities.
What impact will this guidance have on your plan?
The latest guidance from both the U.S. Department of Labor and IRS discusses the use of a target date fund available only to participants within a certain number of years of retirement. At the target date, 50 percent of the assets in the TDF would be held in an unallocated insurance contract. At the end of the TDF’s time horizon, it ceases to exist. The 50 percent invested in the unallocated insurance contract would be used to purchase annuities for plan participants investing in the TDF. The remaining 50 percent will be reinvested by the participant or transferred to another qualified default investment alternative.
TDFs are used by many plans as the QDIA for participants who either do not make an election or do not affirmatively elect another option. A TDF generally has a mix of equities and fixed income investments and a target date geared toward its participants’ expected retirement year. The investment mix changes as the TDF matures, with equity positions gradually being replaced by fixed income positions. TDFs are typically time-bound, with the name of the fund including a date by which the asset allocation aims to be at its most conservative. For example, participants in their 40s would consider a TDF with a date of 2040.
Non-discriminatory benefits, rights or features
The benefits, rights or features regulations, also known as BRF regulations, (26 C.F.R. 1.401(a)(4)-4) generally require that some or all of these be available to participants in a non-discriminatory manner. The right to a form of investment, including a TDF is a BRF, for instance. A different BRF exists if one is not available to all participants on substantially the same terms.
Concerns were raised regarding potential discrimination if a TDF is made available only to a select group of participants within a certain number of years before retirement, but the new guidance addresses those concerns.
The TDF described in Notice 2014-66 would be limited to participants within a certain number of years until retirement. For example, a 2020 TDF would be limited to participants who attain normal retirement age in 2020.
IRC 401(a)(4) provides benefits or contributions cannot discriminate in favor of highly compensated employees. If a TDF is offered only to older workers, it is possible that this group could have a disproportionate number of HCEs.
Notice 2014-66
The notice indicates that regulatory authority allows IRS to provide alternative methods for satisfying nondiscrimination requirements. In it, IRS concludes that a series of TDFs offered in a DC plan in which participation in some TDFs is restricted to participants of certain ages can be treated as a single BRF, provided that a number of conditions are met:
- the series of TDFs is designed to serve as a single, integrated investment management program, managed by the same investment manager using generally accepted investment theories. The only difference among the TDFs is the mix of investments chosen to achieve a risk level that is age- appropriate;
- some of the TDFs available to participants in the older age group include deferred annuities, which do not provide a guaranteed lifetime withdrawal benefit or a guaranteed minimum withdrawal benefit. A GLWB permits a participant to withdraw a certain percentage, for example, 5 percent, each year. Should the account balance be reduced to zero, an insurance company would guarantee the withdrawal amount for the rest of the participant’s life. A GMWB is similar, but with the guaranteed payment limited to a specific period of time. IRS is considering whether to issue guidance related to the use of these guarantee features within a DC plan;
- the TDFs do not hold employer securities that are not readily tradable on established markets; and
- fees and administrative expenses for each TDF in the series are determined in a consistent manner.
Example: The notice describes a 401(k) plan that provides a series of TDFs managed by an investment manager (as defined by ERISA Section 3(38)) that acknowledges in writing that it is a plan fiduciary. The TDF holds no employer securities. Each TDF is available only to participants who will reach normal retirement age around the target date of the fund. Each TDF is a QDIA and the plan sponsor will provide all the necessary QDIA disclosures. The TDF available to participants age 55 or older holds unallocated deferred annuity contracts purchased from an insurance company that is independent from the investment manager and the annuity does not contain the guarantees noted previously.
As the group of participants ages, a larger portion of the fund’s assets will be used to purchase deferred annuities. TDFs available to participants under age 55 do not include a deferred annuity feature.
The TDF is dissolved at its target date, at which time a participant will receive an annuity certificate representing the participant’s interest in the annuity contract held by the TDF. The remaining portion of a participant’s account is reinvested in other plan investment options.
Mary B. Andersen is president and founder of ERISAdiagnostics Inc., an employee benefits consulting firm that provides services related to Forms 5500, plan documents, summary plan descriptions and compliance/operational reviews. Ms. Andersen has more than 25 years of benefits consulting and administration experience. She is a CEBS fellow and member of the charter class. She has also achieved the enrolled retirement plan agent designation and has been a frequent speaker on compliance-related issues. Ms. Andersen is the contributing editor of Thompson’s Pension Plan Fix-It Handbook.
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