Rydal-Meadowbrook Civic Association

On April 10th President Obama released his proposed budget for the 2014 fiscal year, which contains several provisions that could have a direct impact on 401(k) plans. Following are highlights of those provisions. It is important to note that these ideas are proposals only; that a long and involved legislative process would need to take place before any of them became law; and that some or all of them may never become law or may become law in a substantially revised form.

Cap on Retirement Plan Accumulations (often referred to as the $3 million cap)

This proposal would limit the amount any individual could accumulate in tax-favored retirement accounts, which include IRAs and all types of tax-qualified defined contribution or defined benefit plans but does not include non-qualified plans. The limit is the lump-sum amount needed to purchase the maximum annuity benefit available from a defined benefit plan. The current annuity limit is $205,000 and that number is adjusted annually for inflation. The lump-sum amount needed to purchase a $205,000 annuity was calculated at $3.4 million in the president’s budget but varies as interest rates change. We are currently in a very low interest rate environment and if interest rates increase, that would decrease the lump-sum cost of purchasing an annuity, thereby effectively decreasing the accumulation limit. Amounts contributed in excess of the accumulation limit would need to be returned under rules similar to the rules that apply to excess deferrals. Excess accumulations that occur solely as the result of investment earnings and gains would not need to be returned.

Twenty-Eight Percent Cap on Deductions and Exclusions

This proposal would limit the value of certain deductions or exclusions from income for taxpayers in the 33%, 35% or 39.6% tax brackets to 28%. For example, if someone in the 35% tax bracket had $100,000 in deductions and exclusions, the value of those tax advantages would be limited to $28,000 instead of the $35,000 they would be worth under current tax law. The types of deductions and exclusions counted toward the 28% cap are broad-based and include many non-benefit related items, such as the mortgage interest rate deduction. They also include contributions to defined contribution plans and IRAs, as well as employer-sponsored health insurance costs paid for by employers.

Automatic IRA Proposal

This proposal would require any employer that has at least 10 employees and that has been in business for at least two years to facilitate payroll deduction contributions into IRAs for the employees unless the employer offered some other type of qualified retirement plan. Contributions would be set at a 3% default rate, but employees could opt out or change the contribution rate. Employers could designate a single IRA trustee or custodian or could let employees pick their own. A default investment fund, as well as a handful of standard, low-cost investment alternatives for employees to actively invest in, would be specified by statute or regulation. Employers with less than 100 employees would receive a tax credit to offset the cost of setting up the automatic IRA arrangement and could also receive a more generous tax credit if they choose to start up a qualified plan instead of offering automatic IRAs.

Nothing in this publication constitutes legal or tax advice upon which any third party may rely.

DOL Offers Tips on the Selection and Monitoring of Target Date Funds

In February of 2013 the Department of Labor (DOL) published an educational piece designed to assist plan fiduciaries with the selection and monitoring of target date funds. The article, “Target Date Retirement Funds – Tips for ERISA Fiduciaries,” provides an overview of what target date funds are and how they work. It explains the concepts of “‘target date” and “glide path” and the difference between a “to” or “through” approach to asset allocation within a target date fund. It also recommends that plan fiduciaries take the following steps when selecting and monitoring a target date fund: 

1.     Establish a prudent process for comparing and selecting target date funds. Include an evaluation of performance, fees and compatibility with the investment needs of plan participants.

2.     Establish a prudent process for periodic review of selected target date funds. Review any changes in the fund, such as a change in the investment manager or any lack of consistency with stated objectives, as well as any changes to the plan’s objectives for offering the fund. Consider replacing the fund if there are changes warranting that action.

3.     Understand the fund’s underlying investments and how they will change over time. Review the principal strategies and risks as defined in prospectus documents. Make sure you understand the glide path and whether the fund will reach its most conservative allocation at or after the target date. Understand what the most conservative allocation is and what degree of equity exposure and risk remains at that allocation. Consider whether that degree of risk is consistent with how employees are likely to use the fund (for example, will they be cashing out the day they retire or taking periodic withdrawals over the course of their retirement years).

4.     Make sure you understand all the fees associated with the fund. This includes fees for the underlying funds and fees for the target date fund itself, as well as any sales loads or other expenses.

5.     Evaluate whether to use a custom or pre-packaged fund. Inquire as to whether it is better to use a “pre-packaged” target date fund, which may use the investment vendor’s proprietary funds as the underlying investments, or a custom fund which may offer the ability to use the plan’s core funds as the underlying investments. Take into account the benefits of diversification as well as the costs involved in using a custom fund. [It should be noted that some pre-packaged funds use a diversified mix of non-proprietary investments as the underlying investments.]

6.     Develop an effective employee communication program. The program should include both legally required disclosures as well as general education about target date funds.

7.     Use commercially available sources of information. Take advantage of information and services that may assist in the evaluation of the target date fund.

8.     Document the selection and review process. Include documentation of how individual investment decisions were reached.

If you are interested in reading the entire DOL article, it can be accessed at http://www.dol.gov/ebsa/newsroom/fsTDF.html.