Most of the concern about the proposed regulation to speed up deposits of 401(k) withholdings has focused on problems employers might have getting contributions to their plan's trust within the required time. But there is another issue: whether immediate deposit of contributions into the trust, before you have good data, will create serious record-keeping problems.
The cost of solving these problems will outweigh any benefits derived from the accelerated deposit of employee contributions contemplated by the proposed regulation. Because defined contribution operating expenses are often borne by plan participants, this new additional cost will fall on just the individuals the Department of Labor is trying to protect.
The issue the Labor Department is focusing on is this: Between the time money is withheld and the time it is transmitted to the trustee, who benefits from the earnings on it; that is, who captures the float? In a daily valued plan, the employer captures the float for the period during which it and the record keeper are scrubbing the data.
What is the float worth? Assume a plan has 10,000 participants making an average of $35,000 per year and contributing an average of 4%. If the plan uses a weekly batch process, the float can last up to 10 business days, or 14 days in total (picking up two weekends). Based on those assumptions, and assuming an interest rate of 6%, total float is worth a maximum total of $32,219 per year, or a mere $3.22 per participant per year.
Under the proposed rule, it might be possible for some employers to get contributions to the trust in one day from the date a payroll is cut. It will not be possible, however, within that time, to accurately post those amounts to participant amounts, that is, it will not be possible to determine (1) whether the amount contributed is the right amount, (2) which participants get what allocations, and (3) what amount is allocated to which investment fund.
In order to allocate to participant accounts and execute the participants' directed investment purchases, you need good data. In a large plan, with 50,000 to 100,000 participants, the data you start with is rarely 100% correct. That means that at the gross level, the amount of money withheld from some paychecks is too much, from others too little.
For some plans, primarily those that are valued monthly and use unit accounting, the inability to post money received by the trust immediately to participant accounts will not present a problem. That is because those plans use an accrual accounting methodology, allowing them to process financial transactions on a retroactive, "as of" basis. For other plans, particularly daily valued plans using share, or mutual fund, accounting (the vast majority of daily valued plans), a fundamental premise is that plan investments and participant records are always equal. Not being able to post immediately will create problems for these plans that are significant.
More plan sponsors are offering participants the benefit of daily valuation with real-time investment switching. More than 40% of large corporate defined contributions plans now are valued daily.
Daily valuation is generally more efficient than monthly valuation. Part of why a daily system is more efficient is that it uses share accounting. With share accounting, a participant's balance is based on the value of the assets in the participant's account. Thus, with share accounting, if you put in $1 and direct that it be invested in, say, a small-cap fund, you get $1 worth of small-cap fund shares.
In contrast, in unit accounting, commonly used for monthly valued plans, the plan has a fund that holds shares in, say, a small-cap fund, and the plan's fund is valued separately. A participant who puts in $1 doesn't get $1 worth of the small-cap fund shares. Instead, the participant gets $1 worth of plan fund units. The plan fund buys the small-cap fund shares throughout the month, and at month-end cuts a value. At that point you determine how much small-cap fund shares the $1 bought.
Sending money before sending clean data creates three problems for a daily valuation system.
First, because money is deposited before it can be allocated to investment funds, the trustee would have to keep the books on an unallocated short-term investment fund account. Currently, the employer deposits withholdings in its own account pending the data scrub, and the employer keeps the books on that account and handles, via that account, any reimbursement of overcontributions. Adding the trustee to the process would place another layer on the process - the trustee must build an interface with the employer's payroll.
Second, where there is an undercontribution, the record keeper must request a special contribution. Now, money flows pursuant to a request for a single check, or wire transfer, once the data has been cleaned. In the new system, the record keeper would in the event of an underwithholding, have to provide for two fund transfers - one from the STIF account and one from the employer. Again, another layer of process is added to the system.
Third, a special allocation would be required of the earnings on the STIF account. Such an allocation would add still another layer of process and cost.
None of these problems seems significant taken in isolation. They are significant primarily because they undercut a core principle of daily valuation: daily systems work because assets always equal participant account balances. The system is in proof at all times; there is no need for reconciliation, because money does not go in until you know (1) that it is the right amount and (2) exactly where it is supposed to go. When you add an unallocated STIF account to a daily valued plan, to hold plan contributions for which you do not have good data, you violate this principle.
The marginal gain in the speed with which employee contributions are deposited in a trust is not ultimately worth the increased costs to the system - costs that participants often are asked to bear. With a rule that allows a period of 15 days following the end of the month in which the withholding is made before deposit is required, the system can be made to work the way it is supposed to, allowing both the plan sponsor and the service provider time to ensure proper investment, compliance with regulations and an efficient program for employees.
Michael P. Barry is managing director-plan advisory services at Bankers Trust Co., New York, and Thomas S. Doty is vice president-product management, defined contribution services, at Bankers Trust Co. of New Jersey Ltd., Jersey City.