Wednesday, June 24, 2015

On Successful RFPs and Circuit Breakers

This morning, I read an article that appears in the June issue of Plan Sponsor magazine. What attracted me to it was a blurb in the email blast "NewsDash" that magically appears in my inbox every weekday morning (actually, I highly recommend NewsDash for benefits professionals).

What I found strange about the article is that it is largely a compendium of quotes from a few defined contribution recordkeeper search consultants. But, it never quite brings them together to inform the plan sponsor on what makes for a successful RFP. Instead, it is somewhat akin to listening to a roundtable discussion, but only hearing about 1 comment in 20 and that without any context.

Since this article left me somewhat cold (and that on a day when our heat index is supposed to exceed 105), I decided to think about this myself. I've been involved in RFPs (not necessarily defined contribution or even benefits) in what I view are all of the possible contexts:

  • A bidder
  • A search consultant
  • A proposal evaluator
  • An end user (the client)
Ultimately, in my opinion, the client is looking for the best value, however they define value. Some place a very high value on the relationship with the provider. Some consider it most important for participants to have a great user experience. Others focus on employee education. Still others think that price is the winner.

Each of those may be a reasonable position to take. But, it is also important to understand that there are more than just the issues of value. 

A typical proposal scoring process assigns a weighting or point value to a number of categories. Finally, the bidder with the highest weighted score is usually the winner. 

I'd like to make some changes to this. In doing so, I am going to steal some terminology from other areas.

We all know that having a relationship manager who doesn't care about you makes the relationship untenable. It's a turn-off and it should kill the deal with that particular provider. Similarly, if you are going to be the point person (on the client side) for the relationship and you just really dislike the relationship manager, that relationship won't work either.

I refer to this and other similar deal killers as circuit breakers. That is, if the breaker is turned off, the circuit doesn't connect and the deal cannot happen.

The client should establish circuit breakers. You might also think of them as minimum standards. Here are a few to consider (with a DC recordkeeping bias):
  • Unacceptable relationship manager (if you really like the potential vendor other than that, you might be able to force a relationship manager of your choosing)
  • Fees above a certain pre-set level
  • Poor participant experience
  • No projection tool on the vendor website
  • Requirement to use a particular percentage of proprietary funds
I think this is fairly clear, but suppose it's not. Consider that Vendor A has the best scoring proposal. That is, Vendor A, using the pre-determined scoring mechanism gets a score of 185 out of a possible 200. Neither of the other two potential vendors scores above 160. But, you have heard from a friend at another company that the assigned relationship manager does not usually return phone calls in the same week that they are received. You view this as unacceptable. If Vendor A will not give you a different relationship manager, then they have triggered a circuit breaker and they are out of the running.

Triggering a circuit breaker outweighs a great score. Think about it. It makes sense.

Tuesday, June 23, 2015

Is IRS Stepping Up Nonqualified Audits?

Two weeks ago, the IRS released nonqualified deferred compensation audit techniques guide. While no one can be certain, this would seem to signal that the Service is showing more interest in auditing these plans, available almost exclusively to the highest paid of employees.

For years, many have thought that nonqualified (NQDC or NQ) plans to be a significant area of tax abuse and a potential source of tax revenue for the federal government. And, whether this is simply a much needed update or the beginning of a push, the language in the guide would seem to suggest where the IRS thinks there are problems.

Let's look at the paragraph headers in the guide as a means of determining where the focus is likely to be:

  1. Examining Constructive Receipt and Economic Benefit Issues
  2. Audit Techniques
  3. Examining the Employer's Deduction
  4. Employment Taxes
  5. Important Note [related to 401(k) plans]
  6. The American Jobs Creation Act of 2004 [the law that brought us Code Section 409A]
Constructive Receipt and Economic Benefit Issues

Here, the guide instructs auditors to look for assets set aside free from creditors for the benefit of employees. It also instructs these auditors to look to see how executives can use the benefits in these nonqualified plans. For example, if a SERP might be pledged as collateral, then the employee has enough control to have constructively received the benefit and is subject to current taxation, or was when the benefit was first constructively received. 

For employers with any knowledge of NQDC plans or those who use counsel who work at all in this area, getting this right falls under the heading of basic blocking and tackling. So, while the IRS might be able to find some defects here, it would not seem to be a source of significant revenue.

Audit Techniques

In this section, frankly, I think that the IRS is grasping at straws. It asks auditors to interview personnel most knowledgeable about the plans. Further, the auditors are encouraged to review Forms 10-K and to learn whether the company uses a consulting firm to assist with its NQDC plans. 

There seems to be little glue holding this section together. Instead, what I am seeing is that their may be a needle in a haystack and a fortunate auditor might find that needle. Other sections of the guide may prove more fruitful.

Examining the Employer's Deduction

Generally, the amount and timing of the employer's deduction must match the amount and timing of the executive's inclusion in income. Looking from the outside in, this would seem to be simple. But, corporate tax returns, especially for large corporations are quite complex. Similarly, a corporate executive is fairly likely to have a complex tax return. It's not unlikely that treatment of income from NQDC plans is nowhere near the top of the priority list for either the corporate tax department or for the executive's accountant. 

In fact, in my experience, some corporate tax departments do not have significant familiarity with this type of plan (some have exceptional knowledge). Similarly, and perhaps more glaring, many personal accountants, again in my experience, just don't know much about nonqualified plans. 

The Internal Revenue Code is a complex instrument. The instructions to government forms, especially if you include the various Publications that they reference, are quite confusing. If an accountant deals with particularly few NQDC plans, it would not be shocking to find that accountant confused by their tax treatment. Certainly, I would not expect them to confirm that the amount and timing of inclusion in income coincides with the corporate tax deduction.

Employment Taxes

This is the section that deals with FICA and FUTA taxes. Until the cap was removed from Medicare wages, this section would have been ignored. The reason is that although nonqualified deferred compensation is subject to these taxes when it is both vested and reasonably ascertainable (a technical term meaning that a knowledgeable person can figure out about how much it is worth), virtually all NQDC participants earned far more than the Social Security Wage Base each year. But, when the cap at the Wage Base was removed for Medicare taxes, new NQDC was necessarily subject to that tax. 

The regulations on this topic are, in a word, confusing. Specifically for what are known as non-account balance plans (generally defined benefit SERPs), the guidance on how to perform calculations was likely written by someone who did not know what they were prescribing and the guidance on the actuarial assumptions to be used in those calculations is virtually nonexistent.

However, in my experience with this topic, the IRS does have strong opinion on what the Treasury Regulations mean and intend. That said, when the regulations under Section 3121(v) were issued, I co-authored a research memo on the calculation of the amount of FICA wages from NQDC plans (the focus was on non-account balance plans). To say that the authors went back and forth many times before agreeing on the intended methodology is an understatement. To think that similar authors at other actuarial consulting firms would reach exactly the same conclusion is no plausible. Add to that the various accounting and tax firms who might have their own opinions and you would certainly have a lack of consistency. About 15 years ago, however, one IRS examiner that I spoke with off the record said that there was just one consistent method available under the regulations.

Said differently, while I don't know how much revenue is potentially available, the calculation of employment taxes with respect to NQDC plans, and specifically non-account balance plans would not all meet with the approval of that particular examiner.

Important Note [related to 401(k) plans]

The coordination of qualified 401(k) plans and NQDC plans that provide for deferrals in excess of those allowed in the qualified plan seems like it should be simple. It's not. In particular, it's not if the two plans (qualified and nonqualified) are administered by different providers (or if one is administered externally and the other internally). Generally, these plans allow participants to defer amounts where IRS limits would otherwise preclude such deferrals. In the simple situations where the 401(k) plan passes nondiscrimination testing, this is pretty easy. But, when the plan is forced to refund deferrals due to test failure or when deferrals are restricted in hopes of making the testing work, things can go horribly wrong. Do the two separate administrators communicate with each other? It's doubtful.

There is likely not a lot of revenue for the government to find here, but there are probably a large number of very small problems.

The American Jobs Creation Act of 2004 [the law that added Section 409A to the Internal Revenue Code]

I've written about 409A here many times. If you are interested, go the little search box at the top of the page and type 409A. I'd be surprised if you get fewer than 25 hits in this blog, but I've not counted. 

As is often said about relationships, it's complicated. 

The regulations are long and were written in a fashion similar to the regulations under Section 3121(v). Frankly, I don't think the people who worked on the project did a bad job writing the regulations. They're not perfect, but they wouldn't have been perfect if you or I had written them either, so we must be careful with our criticism.

But, certain parts of the regulations that have lots of calculational elements where the calculations almost necessarily must be performed by actuaries were written by attorneys. I know some of those attorneys. They're smart people. And, they spent lots of time understanding the statute and developing regulations to enforce that statute. They could have done far worse.

The people that I know, however, who worked on the project are not actuaries. While they have some familiarity with actuarial calculations, they don't actually do them and I think they would tell you if you asked candidly that they have only a minimal understanding of them. Yet, for certain types of plans (mostly non-account balance plans), there is much in the way of actuarial calculations that determines potential tax liabilities. 

Frankly, we don't know what was intended. We tend to reference the FICA regulations, but even there as I noted above, the regulations are not prescriptive.

Section 409A is a mess. I don't think anyone intends to violate it, but there are lots of people who don't get it right. Finding the violations is difficult, but if examiners do find violations, with those violations will come some fairly meaningful tax revenue.

*           *          *          *          *           *             *              *             *            *            *           *          *

So, that's my take on where the IRS is headed and what value it has to them. Time will tell if I got it right for a change or not.

Friday, June 19, 2015

The Problems with Disclosures Mandated by the Government

In Congress, we are blessed with two committees among whose designated functions are to deal with employee benefits issues. In the Senate, it's the Health, Education, Labor, and Pension Committee, also known as the HELP Committee, a misnomer if I have ever heard one. In the House of Representatives, it's the Committee on Education and the Workforce (Ways and Means takes over when taxes enter the picture).

For as long as I can remember, these committees have had a pretty significant focus on helping employees to better understand their benefits and benefit programs. On the retirement plan side, much of this is done through mandated disclosures. In fact, the Pension Protection Act of 2006 (PPA) was crammed full of disclosure requirements.

You know, it's not easy to prepare informative disclosures. The best of them would give an employee or participant all of the information that they truly value in a nice, concise, easy-to-read format without any information that is of no value to them. Every time that a disclosure includes information that a reader doesn't care about, he or she is much more likely to put that disclosure down or file it in the proverbial circular file. In fact, while I can't cite any, I feel sure that some scholarly research has been done on the topic.

There are some serious difficulties with this whole concept. What's important to you may be worthless to me and conversely. Our levels of understanding our different. Our situations are different. Our needs are different. So, mandating what goes into disclosures is by no means an easy task.

To the credit of the various government agencies with purview over such disclosures (usually the Department of Labor (DOL)), they have endeavored for the most part to provide model, fill-in-the-blank disclosures for employers and plan sponsors to use. To their discredit, those model disclosures have plenty of language in them that is one or more of confusing (to the average reader), meaningless (to the average user), and of very little value to anyone unless they can both understand it and find that it applies to them.

On the topic of employee benefits, generally, I don't think it would be unfair to say that I have more understanding and interest than the typical reader. But, there is plenty in those disclosures that is of no value to me. I'll be honest; I rarely read them anymore. When I do, I usually look for one or two specifics that I know are in there and then put the disclosure down.

The DOL has done a much better job than the Securities and Exchange Commission (SEC), however. Have you ever read a stock prospectus? Did you stay awake? Did you understand it? It may be 50 pages of fine print. How can anyone be expected to digest and comprehend what is in there? Isn't it really just a CYA for the issuer?

By the same token, many plan sponsors use their required disclosures as CYAs for themselves. While they could often use the disclosures as a means to communicate information useful to their participants by adding in valuable information, that's an expensive and time-consuming process with attendant risks in our ever more litigious society.

So, here is a cry to reduce the number of required disclosures. Suggest instead that those who are currently required to issue the disclosures take the time and money saved and actually communicate to their intended audiences. Survey after survey shows that employees would much rather hear what they have than attempt to read boilerplate materials. Employees who appreciate what they have are happier. Happier employees are more productive. Productive employees make their companies more money.

Listen up government; I'm talking to you.

Thursday, April 23, 2015

Despite the Best Efforts of the Government ...

Despite the best efforts of the federal government and of governmental agencies, most Americans in the workforce today really have no idea how they are going to retire or if they are going to be able to retire. Disclosures are much more comprehensive than they were in earlier years. Opportunities for tax-favored savings have grown. Plan designs that truly encourage savings have become common.

So, where did things go wrong?

To consider this, let's look at a brief history of retirement plans -- very brief in this case.

In the beginning (Genesis in this case is known as ERISA), most American workers who were fortunate enough to have company-provided retirement plans were in defined benefit plans. In fact, Section 401(k) had not yet been added to the Internal Revenue Code. So, while some industries tended to favor thrift plans (after-tax savings plans that often also provided for an employer match), university systems and certain other tax-exempt organizations tended to have 403(b)s, and professional corporations often had money purchase and profit sharing combinations, lots of workers had DB plans as their backbones.

And, the workforce model fit with DB plans. Likely, the company that you worked for at age 30 would be the one you would retire from. As a retention device, there were lots of goodies that came with staying with that company until at least age (usually) 55. Another wonderful device known as subsidized early retirement, sometimes combined with early retirement windows, allowed companies to manage their workforces without the need for layoffs. In DB plans, there is no such thing as leakage if you stay with the same company.

So, a worker really didn't have to know all that much. What they did know is that when they retired, they would have a combination of their pension and their Social Security and that between them, that felt like enough to live on.

As the Old Testament evolved, so did the landscape change. Gradually, DB plans were replaced by 401(k) plans until we were faced with the New (world) Testament where the bulk of American workers were no longer accruing defined benefits. And, in a 401(k) plan, as we all know, it's really difficult for a participant to figure out exactly what he can buy for the rest of his life with an account balance.

And then there were disclosures.

Now, we get disclosures about the level of fees being charged against our accounts in a plan. I'm in this business. I can't read them. While the wording is not bad, those disclosures are so boring that even if I try, I am unlikely to make it through the first paragraph.

And, there are proposals that will require my employer (through a TPA) to tell me just what my 401(k) may grow to and how much per year that will be worth in my retirement. But, those all use assumptions.

I can understand those assumptions. If you are reading this, it's likely that you can as well. But, how about the poor participant who doesn't know if 6% annual investment return is reasonable? How about the poor participant who doesn't know whether retiring two years later is worth very much in terms of leading to a more comfortable retirement?

Savings plans are a good supplement, but with the current level of communications, to me, they are not the answer. Computer-based models might help, but even then, they would be dependent upon the assumptions underlying the modeling. If plan sponsors choose them, those assumptions might be reasonable in the aggregate, but very rarely for any given individual. If participants choose them, then they need more education than they can ever expect to get on those selections.

From where I sit, there is no easy answer.

Perhaps it's time to return to Genesis. When plans were funded responsibly, costs were controllable and participants who retired under a DB system with some amount of voluntary savings are generally doing pretty well in retirement.

But, will you?

Thursday, April 9, 2015

When Did We Stop Being Inquisitive?

I can still remember much of my childhood, so most of my readers should be able to remember theirs, as well. Childhood has its phases. There is the "no" phase which usually occurs somewhere around age 2 or 3 in which it doesn't matter what our parents say, we answer "no." A bit later on, there is the "why" phase in which in doesn't matter what our parents tell us to do, we ask "why?"

At the time, I'm certain that all of those whys were very annoying to our parents and for those of us who have been parents in our own right, they were annoying to us too.


Sometimes, asking why is a good thing, perhaps not to the extent that a 5-year old might do it, but oftentimes asking why gives us perspective into what we really need to do.

This extends itself into the benefits world as well.

Let's consider a not particularly made up hypothetical situation. A client informs their consultant that they want to change their 401(k) plan to make it a safe harbor or to make target date funds their QDIA. Or, on a different topic, they say that they need to move to a high-deductible health plan. If we, as consultants don't ask, but the client chooses to volunteer some information, we might learn that they read about the increasing popularity of whichever of these that it was or they heard about them at a conference.

There are several approaches that a consultant can take to that request. Sadly, the one that we often jump at is 'we can help you with that' as we salivate knowing that we just sold a new project. So, we're going to do what the client asked us to do not what the client needs us to do.

Let's suppose.

Let's suppose that we asked why.

Why do you want a safe harbor plan? Why do you want to use target date funds? Why do you want a high-deductible health plan (HDHP)?

Perhaps upon hearing the client's answer, we'll know that they are headed in the right direction. On the other hand, perhaps they are not. Because everyone else is doing it is not always a good reason.

Suppose we focus for a moment on the high-deductible health plan (I haven't written about health care for a while). When we ask why, the client tells us that her company's health care expenses have increased to rapidly and that they need to reduce that cost. Introducing an element of consumerism, she tells us, will make employees part of the buying and spending decisions and save the company money.

Strictly with respect to the health care plan, I expect that she is correct. In total, she may be correct. But, if cost is the issue, isn't it important that she understands the secondary and tertiary savings and costs?

Some data on HDHPs suggests that employees in those designs are more likely to skip certain medical procedures. In some cases, that's good. The procedure might not be necessary and not having it performed will save money at no personal risk to the employee. On the other hand, the procedure might truly be advisable. But, since the first $5,000 of cost may be borne by the employee, he may decided that is not money that he wants to spend. He chooses to forgo the procedure.

What are the non-primary effects of that decision? Here are a few potential ones:

  • The employee should have had the procedure and develops a more severe condition later on that is far more expensive to treat.
  • The employee, when that more expensive procedure becomes absolutely necessary, will be out of work for an extended period of time generating another significant cost to the company.
  • The employee may become disgruntled with the employer because this new plan design "forced" him to not have his advisable procedure. Disgruntled employees are usually either less productive or they quit, or both.
These are all meaningful costs, but they are not ones that we can truly predict. We know that some of them will occur, but, in my opinion, the best that we can do is to model some scenarios and see where they might fall out. Perhaps understanding the full picture will help our client to better understand the decision she is considering.

But, we'll never know how to paint that picture if we're not inquisitive.

Don't forget to ask why.