Finance

By Mark Olsen, Managing Director at PlanPILOT

The Pension Protection Act (PPA) of 2006 introduced a groundswell for the growth of defined contribution (DC) assets in qualified default investment alternatives (QDIA). It also created a windfall for asset managers who provided QDIA investments, particularly those affiliated with a recordkeeping platform. Over the last 16 years and counting, the QDIA market has evolved in theory, but with limited implementation of newer ideas. This article offers a quick hit on where we have been, provides a high-level summary of the range of QDIA offerings in today’s marketplace, identifies key assessment and decision points, and provides insight for plan sponsors to consider when evaluating their current QDIA relative to the range of newer offerings in the marketplace. 

A Look Back in Order to Look Forward…

While likely rudimentary to most of us reading this article, refreshers can be valuable when assessing current state. When money is contributed to an employee’s retirement account and no investment election has been made, the money can then be defaulted into a QDIA. The Department of Labor (DOL) advises that a QDIA must be “diversified so as to minimize the risk of large losses.” Three types of QDIAs are considered safe harbor:

1. A mix of investments that factor in a participant’s age or retirement date—known primarily target-date solutions (TDs)
2. An asset mix based on a participant’s current contributions and existing plan options that also considers the person’s age or retirement date (among other metrics)—known as professionally managed account services (MAs)
3. A mix of investments that accounts for the demographic characteristics of all employees—known as balanced funds (BFs)

The winner over the last almost two decades has been TDs, which have amassed the vast majority of DC market share. According to Morningstar, 98% of DC plans offer a TD and 80% of all 401(k) of participants are invested in one. (1) Simply put, out of the gate, TDs gained momentum in investment management-bundled solutions connected to recordkeeping platforms. After the passage of PPA, plan sponsors tended to select TDs affiliated with their recordkeeper given the newness of the solution and (presumed) ease of decision-making and bundled pricing. MAs picked up very little in the way of default assets, and the use of balanced funds as the default was and remains a very distant third. As the years have passed, TDs have remained the primary default offering, but the landscape of TD providers has expanded. (2) MAs have gained momentum, but primarily as an add-on service, meaning the concept of a “completion portfolio” such that MA offers is appealing—but tends to be on platforms as an “opt-in” and pursued by participants who have higher asset balances, more complex financial situations, and those nearing retirement or moving into retirement. The balance of this article will spend time on the evolution of TDs and MAs, as BFs have not garnered assets due to the static nature of the solution.

Simplicity No More

What began as a rather oversimplified approach to selecting an appropriate QDIA (i.e., default to the recordkeeper’s offering) has transitioned into a more complex proposition (and rightly so). After all, sponsors have become more aware that the QDIA selection is arguably one of the most important decisions a plan fiduciary can make. Plan sponsors must consider a litany of critical factors in the evaluation process of a QDIA, each with the potential of having a material impact on establishing plan suitability and participant outcomes. Below we summarize many of the most critical assessment and decision points:

• Off-the-shelf or custom strategy: Preference for a pooled provider solution (most often also a single investment manager) or a solution tailored to plan circumstances (most often with open architecture and multiple investment managers)
• Asset allocation: Asset classes and sub-asset classes that underpin the asset allocation of QDIA
• Glidepath: The way asset allocation transitions over time with participants 
• Investment implementation: Passive, active, or blend investment management
• Tactical or dynamic management: Periodic trading within asset classes and investment strategies based on market environment 
• Retirement income strategies: Embedding income solutions such as guarantees or non-guaranteed payout strategies 
• Hybrid QDIA: Migration from one QDIA to another (e.g., target date to managed accounts) 
• Other considerations: Assessment of ensuring a commensurate trade of value-for-cost, access on recordkeeping platform, etc.

Broadly speaking, the needle has not moved significantly in terms of where the assets reside just yet, but many plan fiduciaries have begun to evolve their approach and/or consider alternatives. There are many examples of evolution that indicate traction may increase over time to newer solutions. To start, it is most common today for sponsors to consider the wide-open landscape of competing QDIA providers instead of merely defaulting to the plan sponsor’s recordkeeping QDIA solution. (3) Also, many large DC plans (~$1B +) have either considered or have migrated to custom target-date solutions. As well, the market has moved from a binary investment management approach of active or passive investment management to including blend strategies that incorporate both. And, more recently, there are several providers that offer a hybrid QDIA—or a QDIA that starts the glidepath journey as a TD and migrates to an MA as a participant moves closer to retirement. Not to be overlooked is the ever-expanding continuum of QDIA offerings that incorporate retirement income strategies, ranging from an embedded guarantee to an endowment model with a target yield. 

So, What Should a Plan Fiduciary Do?

Likely evident at this point is that the process for evaluating which QDIA is most suitable for your plan is not straightforward. Instead, it is iterative and even meandering…and quite dependent on plan circumstances and objectives, participant and demographic needs, and committee beliefs and philosophies. Further, the regulatory and legislative environment continues to change such that relooks are a valuable way to consider those changes and focus areas. Perhaps the most important takeaway from this article: if you are a plan fiduciary, it is important to gain awareness of the growing range and complexity of the QDIA landscape. It is vital to understand the evolving marketplace and take an opportunity to assess your plan needs accordingly. As with anything DC related, there is never a single right answer (i.e., process is most important) and nothing about DC is static (i.e., be attentive to the fluidity of the offerings in the marketplace and suitability for your plan). 

Conclusion

A QDIA review can actually be looked at as a gateway for your plan committee to clarify plan objectives. Ultimately, we hope this article encourages plan sponsors to lift their heads up and consider (or reconsider as the case may be) if your committee is due for a deeper look at your QDIA given marketplace evolution and changing plan needs. 

Want to learn more? Call us at (312) 973-4913 or email mark.olsen@PlanPILOT.com. 

About Mark

Mark Olsen is the managing director at PlanPILOT, an independent retirement plan consulting firm headquartered in Chicago. PlanPILOT delivers comprehensive retirement plan advisory services to 401(k), 403(b), and 457 plan sponsors. His specialties include plan governance, investment searches, investment monitoring, and plan oversight. Mark is recognized as a leader in the industry and speaks at national conferences, including those organized by Pensions & Investments, Stable Value Investment Association, and CUPA-HR.

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(1) https://retirementincomejournal.com/article/target-date-fund-assets-grow-to-3-27t-morningstar/
According to Morningstar, 98% of 401(k) plans offer a target date and 80% of all 401(k) participants are invested in a target date.

(2) https://www.cnbc.com/2022/03/06/target-date-retirement-funds-work-up-to-a-point-when-to-reconsider.html
According to Morningstar’s 2022 Target-Date Strategy Landscape Report, five providers control 79% of TD assets as of March 2022 (Vanguard, Fidelity, American Funds, BlackRock, and State Street).

(3) https://www.plansponsor.com/research/2021-target-date-fund-survey/?pagesec=2
Callan’s 2021 DC survey reported that only 23% of plan sponsors used their recordkeeper’s target-date in 2020 compared to 67% in 2010.

By Mark Olsen, Managing Director at PlanPILOT

This article offers insight into a growing area of focus for plan sponsors, which is whether or not retaining participant assets in the defined contribution (DC) plan at retirement is a priority. As DC plans have grown into their role as the primary retirement vehicle for most plan participants, it begs the question: What does that mean for the destination of retiree assets? 

By Mark Olsen, Managing Director at PlanPILOT

Contrary to popular belief, an employer-sponsored retirement plan is more than just a benefit for employees; there are actually many ways the plan sponsor can benefit as well. From attracting and retaining key employees to tax-deductible contributions and expenses, a retirement plan is a benefit that can work well for everyone involved. 

Despite the benefits, it can be difficult to sort through all the information out there and truly know which plan is best for you and your business. It doesn’t have to be this way! We at PlanPILOT can help you sort through the many retirement options available to plan sponsors. In this guide, we’ll explore the pros and cons of the safe harbor 401(k) and how to decide if it’s the right option for you.

What Is a Safe Harbor 401(k)?

A safe harbor 401(k) is named after the “safe harbor” provision in the tax code which states certain alternative conduct will be considered compliant for a particular rule or requirement. In this case, a safe harbor 401(k) plan will be exempt from annual nondiscrimination testing as long as the employer makes fully vested contributions to every eligible employee’s account. (1)

Plan sponsors can choose which type of safe harbor plan they would like to adopt, which provides flexibility in finding a plan that fits your needs. 

• Basic safe harbor match: (2) The employer must match 100% of employee contributions on the first 3% of compensation, then 50% of contributions on the next 2% of compensation. The matching contributions are only limited to employees who are actively deferring funds into the plan. This means you could contribute to fewer employees but you will probably contribute more per person. 
• Non-elective safe harbor: (3) With this plan, employers will contribute 3% of all eligible employees’ salaries, regardless of whether the employees contribute themselves. In this case, you would contribute to a greater number of employees but less per person.
• Qualified automatic contribution arrangement (QACA): (4) This plan is also known as a safe harbor plan with an automatic enrollment feature. It is used to automatically enroll employees into the plan at a savings rate of 3%. The employer can then choose to make matching contributions or non-elective contributions at a reduced rate. The QACA match plan requires employers to match 100% of contributions on the first 1% of employee compensation, then 50% of contributions on the next 5% of compensation. The QACA non-elective plan, on the other hand, requires employers to contribute 3% of compensation to all eligible participants. Both plans require that employer contributions fully vest after two years, which is more favorable to plan sponsors and can be used to promote employee retention.

Pros

There are many benefits to a safe harbor 401(k) plan, including:

• Exempt from annual nondiscrimination testing: A safe harbor plan is considered compliant with the major annual tests (ADP, ACP, and top-heavy) as long as the mandatory contribution levels are met. This alleviates a significant administrative burden and expense on the plan sponsor’s side.
• Increased contributions: Since safe harbor plans are not tested for nondiscrimination, employers and highly compensated employees can both contribute more to their accounts without fear that the plan will be considered non-compliant.
• Tax-deductible contributions: Like other 401(k) plans, employer contributions are tax-deductible up to 25% of covered compensation paid, limited to $305,000 of compensation per employee. (5)
• Attract & retain employees: The required employer contributions are an attractive benefit to employees who are looking for long-term stability and growth within the company. This can help attract and retain top prospects.

Cons

While the benefits of a safe harbor 401(k) are enticing, it’s important to keep the cons in mind as well:

• Costly contributions: Choosing a safe harbor plan means you will be required to make employer contributions every pay period or at the end of each plan year. These can quickly add up, especially if you have a lot of eligible employees. If you don’t keep up with the contributions, your plan could lose its tax-qualified status, resulting in hefty fines and penalties.
• Immediate vesting: Unless you choose the QACA plan, safe harbor plans require immediate vesting of employer contributions. That means employees will automatically be entitled to 100% of the funds should they quit or get fired. This can make it easier for employees to leave, reducing overall retention rates.
• Annual administrative requirements: Safe harbor plans must deliver notice to plan participants every year, at least 30 days before the plan year ends. This notice must detail each employee’s rights and obligations under the plan. (6) Ensuring that notices are sent in a timely fashion can add an administrative burden to the plan sponsor.

Making the Right Choice

Choosing the right retirement plan offering, whether it’s a traditional 401(k) or a safe harbor plan, comes down to several factors, including employee count and demographic, participation levels, company cash flow, previous compliance issues (if any), and desired plan design. 

At PlanPILOT, we help retirement plan sponsors sort through these factors to determine the right choice for their employees and their companies. If you are considering a safe harbor 401(k) and would like more information on the pros and cons, call us at (312) 973-4913 or email mark.olsen@PlanPILOT.com.

About Mark

Mark Olsen is the managing director at PlanPILOT, an independent retirement plan consulting firm headquartered in Chicago. PlanPILOT delivers comprehensive retirement plan advisory services to 401(k) and 403(b) plan sponsors. Drawing on more than two decades of experience, Mark provides institutional retirement plan consulting to 401(k), 403(b), and defined benefit plans. His specialties include plan governance, investment searches, investment monitoring, and plan oversight. Mark is recognized as a leader in the industry and speaks at national conferences, including those organized by Pensions & Investments, Stable Value Investment Association, and CUPA-HR.

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(1) https://www.irs.gov/retirement-plans/plan-sponsor/401k-plan-overview

(2) https://www.paychex.com/articles/employee-benefits/is-a-safe-harbor-401k-right-for-you

(3) https://www.paychex.com/articles/employee-benefits/is-a-safe-harbor-401k-right-for-you

(4) https://www.investopedia.com/terms/q/qualified-automatic-contribution-arrangements-qacas.asp

(5) https://www.irs.gov/retirement-plans/plan-sponsor/401k-plan-overview

(6) https://www.irs.gov/retirement-plans/notice-requirement-for-a-safe-harbor-401k-or-401m-plan

By Mark Olsen, Managing Director at PlanPILOT

As the world continues to recover from the effects of the COVID-19 pandemic, there has been an increasing movement in American society to look beyond just ourselves and consider the impact we’re making on the people and the world around us. This has gone beyond just individuals and has permeated corporate expectations as well.