IPS Advisors November Retirement Report

Advisor Insights: Understanding the Differences Between Index Funds and Underlying Indexes
 
Over the past few years, there has been an increasing trend to add passively managed funds to retirement plans in place of actively managed funds. This trend has been fueled by disclosure requirements, trends toward reducing participant investment expenses, and now, the Department of Labor's new Conflict of Interest rule. As they work with their plan advisors, plan fiduciaries should understand the differences between an index fund and the fund's underlying index.
 
A large misconception about index funds is that their only distinguishing feature is their fees. What many investors don't realize is that all index funds are not created equally. Index funds manage obstacles that indexes themselves don't face. A key difference between indexes and index funds is that index funds are exactly that - funds. Hence funds must actually transact in securities whereas indexes do not.
 
As an example, when Standard and Poor's recently added Coty (COTY) to the S&P 500 Index to replace Diamond Offshore Drilling (DO), S&P simply recalculated the index values based on the closing prices of the securities on the effective date. Index funds that track the S&P 500, however, had to sell out of their positions in DO and purchase COTY, plus rebalance the weightings of any remaining securities that were impacted by the change. Trading in these securities exposed the funds to transaction costs such as commissions and market impact. Additionally, funds face the risk that their realized trade prices on the securities may be different than the values used to calculate the index, creating a difference in performance. 
 
In this example above, the impact of these factors is generally small. Where the impact is more meaningful is in areas such as fixed income and international equities where liquidity in the securities tends to be significantly lower, there are more securities in the indexes, and changes are more frequent. The Barclays Aggregate Index, for example, has over 8,500 securities in it, with many of them not trading every day. In addition, the index rebalances on a monthly basis, so managers tracking this index must constantly adjust the fund.
 
Index funds must also efficiently manage flows in and out of the funds, dividends and interest payments, mergers, tax consequences and securities lending - all challenges that the underlying indexes do not face.
 
Just like active funds, evaluating index funds requires careful analysis beyond fees and should also include performance and risk. For more information on this subject, and how we assist our clients with due diligence of both active and passive investments, please contact your IPS Retirement Plan Consultant or email ipsadvisors@ipsadvisors.com
Locating Missing Participants
 
At one time or another all plan sponsors will likely be in the position of having to locate missing participants. If the delivery of necessary communications is encumbered because a participant cannot be located, there exists a fiduciary requirement to perform a "reasonable search" for this "missing" participant. There are various search methods that would be considered as reasonable good faith efforts, including: Certified Mail (with a return receipt) to the last known address; checking records of other benefit plans (i.e., employer-provided health plan); and, using a commercial participant-locating service.
 
In the event that your plan allows cash-out distributions on terminated participants with account balances under $1,000, or rollovers to an IRA for balances between $1,000 and $5,000, be sure to check the provisions described in the plan document. Typically a rollover to an IRA on behalf of these participants can be accomplished for participants deemed to be missing. For more information on this topic, please contact your IPS Advisors Retirement Plan Consultant.
Employee Demographics May Impact Owner's Percentage of Retirement Plan Contributions
 
A common goal for business owners when designing a retirement plan is to provide a reasonable benefit level to their employees while maximizing the benefits to themselves. Most times this is accomplished with an aged-based or "cross-tested" design that allocates differing contribution levels based on an employee's class.

It is important to understand that changes in your employee demographics from year to year may have a dramatic effect on the allocation of contributions. Even the addition or termination of one employee may reduce the allocation to the business owner or require an increase in contributions for the staff. Consider this situation: A business with 10 employees designed a plan in which the owner and his spouse were receiving approximately 89 percent of the total contributions. The following year the business lost one of the younger employees. The allocation percentage for the owner and spouse went down to 70 percent.

Bottom line: Be aware that changes in employee demographics can impact the owner's percentage of the plan contributions. If you have questions about the addition of new employees to the plan or existing participants leaving the plan, please contact your IPS Advisors Retirement Plan Consultant.
Compliance Calendar Reminders
 
December 1: Deadline for sending annual 401(k) and (m) safe harbor notice, annual qualified default investment alternative (QDIA) notice, and annual automatic contribution arrangement notice. (For administrative ease, a combined notice may be provided for these notices.)

December 15: Extended deadline for distributing Summary Annual Report (SAR) to participants (if Form 5500 was extended).

December 31: Deadline for issuing corrective distributions for prior year's ADP/ACP testing failures with 10% excise tax. 
IRS Announces 2017 Pension Plan Limits 
 
On October 27 the Internal Revenue Service (IRS) announced the annual cost of living adjustments for 2017. The annual contribution limit remains the same at $18,000, catch-up contribution limits remain the same at $6,000, and HCE definition limit continues to be $120,000. A few other limits increased including the annual combined DC limit which increased to $54,000, the annual compensation limit which increased to $270,000, and the top heavy key employee dollar limit which increased to $175,000. Plan sponsors can click here for a downloadable comparison table of the 2017 Limits. 
 
Additionally, we have provided a sample employee memo you can share with your employees, via our Communication Corner segment below.
Employee Communication Corner
 
This month's employee memo provides participants with the cost of living adjustments affecting dollar limitations for pension plans and other retirement-related items for tax year 2017. 
 
Click HERE to access the memo and share with your employees.  
If you have questions, please contact your dedicated IPS Advisors Employee Benefit Specialist, or contact one of our Retirement Plan Consultants below:
 
Tim Thurston, AIF®
Manager, Retirement Plan Services
(214) 443-2410
Tammy Woodman, QKA, AAMS®
Defined Contribution Consultant
(214) 292-4123

 

The information provided is for educational purposes only. This information is from sources we believe to be reliable, but we cannot guarantee or represent that it is accurate or complete. The opinions are those of the writer, and the opinions and information presented are subject to change without notice.

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