Developing a pension plan document can be a difficult undertaking. When creating a plan document, the plan sponsor must be aware of not only IRS and ERISA regulations, but also of keeping administrative costs low while providing maximum benefit to their employees. Because of this, employers should consider adding provisions in order to streamline plan operations, reduce plan overhead costs, and provide better retirement planning to participants.
One simple, but immensely beneficial, provision is auto enrollment. Adding an auto enrollment provision to a plan is an easy way to ensure compliance with federal law. Federal law requires employers to notify their employees of the plan’s participation requirements and when the employee is eligible to participate in the plan. Traditionally, once employers inform their employees that they are eligible, the employer must wait to receive acknowledgement from the employee that they wish to participate before beginning deferrals. Employees also have the option to decline to participate. Automatic enrollment, however, immediately enrolls employees into the plan when they are eligible and begins deferring a part of the employee’s wages at a default percentage stated in the plan, unless the employee elects otherwise. Adding an auto enrollment provision, effectively requires employees to opt out of the plan rather than opt in. This eliminates the hassle of repeatedly following up with employees to ensure that they properly complete the necessary paperwork to enroll or decline participation in the plan in a timely manner. It is also a great benefit to employees, getting them in the plan and focused on retirement as soon as possible.
Another key provision to reduce a plan’s administrative burden, and possibly avoid an audit, is auto distribution of account balances below $5,000. In many industries with high employee turnover, employees will enter a plan, begin making deferrals, and then separate from their employer all in a short period of time, resulting in a large number of terminated employees with small balances within the plan. These small account balances often become a major burden to employers. These accounts remain inactive for long periods of time racking up management fees and artificially inflating the number of plan participants. This buildup of small account balances is potentially costly to the plan sponsor, because once the plan has over 120 participants, the plan must engage an independent auditor to audit the plan. By adding an automatic distribution provision to a plan, employers can efficiently manage the number of plan participants and reduce their administrative costs, all while avoiding the need for a potentially costly plan audit.
While many plan sponsors seek to structure their plans to reduce their costs as much as possible, ensuring that their employees are adequately prepared for retirement should be another important goal of managing their plan. Those sponsors wishing to take in interest in their employee’s retirement savings patterns, may want to take advantage of various tracking features of their plan. Many plans offer the ability for sponsors to quickly view the average funds available to each employee. Using this information, plan sponsors can get a better idea of how prepared their employees are for retirement. If these results show that many employees are not making adequate deferrals, plan sponsors may be interested in adding an automatic contribution escalation provision to their plan. Under this provision, an employee’s contribution amount is automatically increased each year by a certain percentage. For many employers, this is a simple way to help employees increase their retirement savings without requiring yearly input from employees. Gradually increasing an employee’s contribution amount is helpful in maximizing investment returns and ultimately plan savings. Enabling escalating contributions by default will greatly increase participants’ returns in the long run. If employees do not want to make increased contributions, they can always opt out of the escalating contributions provision.
Another plan provision that could greatly benefit employees is changing the default investment options. When an employee chooses to make deferrals, but does not select which funds to invest in, their contributions will be invested in the plan’s default option. Often, these default options are money market funds or other similar low-yield investments. Many employees who invested in these default options find that they have much less money than they expected when they choose to retire. Although it is ultimately the employee’s responsibility to appropriately invest their retirement contributions, employers can help their employees by selecting better default investments, such as target funds. Target funds are intended to adjust risk based on the employee’s estimated date of retirement. Typically, as the time to retirement increases so too does the risk that an employee can accept, and therefore the potential yield of the target fund. This often means that target funds with very distant retirement dates will be heavily invested in stocks and only slightly in bonds and other fixed income vehicles. As the retirement date approaches, these funds will be rebalanced to focus more on fixed income vehicles and less on stocks. Utilizing these target funds as the default investment option will greatly benefit employees in the long run.
Creating an effective and efficient plan document requires significant time and energy. Plan sponsors often have various goals that they wish to accomplish but only limited resources available. Employers typically want to ensure compliance with applicable regulations while keeping administrative costs low and maximizing benefit to their employees. All of the above provisions are excellent ways to increase the utility of a pension plan and will greatly benefit both plan sponsors and participants.
Adam Brigandi, CPA, MBA
Adam is a Supervisor who works with both nonprofit and special education clients. His auditing experience allows him to assist in vital audit functions such as systems testing and analysis.