Simplifying Retirement Plans
According to the latest data, participants are utterly and hopelessly confused about their retirement plans. From lifecycle funds, to the different types of withdrawals/rollovers (a recent white paper cited that participants are more likely to interpret a rollover as a “trick one teaches a dog”), to how the plans themselves are taxed - you name it, and participants know little about it. And more complicated topics like glide paths and vesting schedules? In many cases you might as well be speaking Klingon.
The confusion is not limited to retirement plan participants. Show of hands out there: how many of you can accurately explain the 410(b) coverage test and the general non-discrimination test of 401(a)(4)? How about the details for how the 15-year catch-up election works for 403(b) plans? And what are QMACs and QNECs and how do they work? If you answered all these questions correctly, give yourself a big high five! I suspect, however, that there would be many wrong answers if plan sponsors were quizzed.
Okay, I know what you’re thinking - simplifying retirement plans is like simplifying the tax code. But, Congress has actually made some rather significant efforts to simplify retirement plans over the years; from eliminating many of the needlessly complicated differences between 401(k) and 403(b) plans (anyone remember the Maximum Exclusion Allowance?), to simplifying the hardship distribution rules. The DOL and IRS have stepped in as well, from simplifying the 5500 reporting form (DOL) to providing much clearer guidance on how to properly administer a 403(b) plan (IRS). Finally, recordkeepers are getting better at communicating with retirement plan participants in a simpler fashion by using proven behavioral finance techniques, particularly when it comes to investments.
However, there is much work to be done. Many retirement plan provisions are still hopelessly complex (e.g., the required minimum distribution (RMD) rules and the 15-year catch-up elections) and should probably be eliminated altogether (note that there is proposed legislation that would eliminate some types of RMDs). And 5500s are still way too complicated, along with the withdrawal, rollover, and transfer rules. And don’t even get me started on the 403(b) investment restrictions and the withdrawal provisions that apply to each investment type! Hopefully, the government will continue to simplify these provisions.
In the interim, plan sponsors can work with their recordkeepers to simplify participant communications as much as possible. Eliminating jargon such as “vesting schedule,” “glide path,” “rollover,” and the like, and removing numbers, particularly percentages, from retirement plan projections (since many participants suffer from math anxiety) can help. Plan sponsors should not be embarrassed to ask their trusted adviser to explain how a retirement plan provision or non-discrimination test works if they are unclear - it is far better than making a mistake that comes back to bite you later!
Note: This feature is to provide general information only, does not constitute legal advice, and cannot be used or substituted for legal or tax advice.
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