Although its supporters praise its potential for lower fees and greater flexibility compared with retail individual retirement accounts, the deemed IRA isn't drawing much attention.
Available for about six years, the deemed IRA has been adopted by a few large government plans such as the New York City Deferred Compensation Plan, and some smaller ones but not many others, according to plan executives, consultants and the few record keepers that administer deemed IRAs. The reasons range from concerns about the extra legal and administrative efforts to a lack of familiarity with how the optionworks.
“Our peers say they're interested, but they just haven't done it,” said Dean Weltman, plan compliance officer for the $10 billion New York City Deferred Compensation Plan, which has been offering a deemed IRA since 2006. “It requires additional communication and administration. It's not an arduous process, but it does take time.”
Deemed IRAs, which are allowed by Section 408(q) of the Internal Revenue Code, enable participants to invest in the same low-cost investment options available to DC plans. The costs are often lower than those for a retail IRA. The deemed IRAs keep participants' assets under the same administrative roof as the employer's defined contribution plan, thus giving plans more negotiating power with providers and reducing one form of leakage — when retirees roll over plan money into IRAs.
“We see a need for it in the marketplace,” said Alison Borland, retirement strategy leader for Aon Hewitt, Lincolnshire, Ill. “Our research shows there's a segment of the marketplace that would choose it,” including midsize and large plans, and corporate and government plans.
Aon Hewitt, the fourth largest defined contribution record keeper by assets, has decided to test the market on whether to offer deemed IRAs on its platform.
Aon Hewitt has been conducting market research for about six months, and Ms. Borland said her firm is about halfway through its evaluation. “The feedback from clients so far has been positive, but we'll only do it if clients see value in it.”
Ms. Borland, who declined to identify clients, cited asset retention by plans, lower fees for participants and the ability for spouses to transfer IRA accounts as the key selling points.
It's hard to measure the potential interest in deemed IRAs; few consultants keep track of sponsor interest in them. Even Aon Hewitt, which conducts periodic surveys of DC plans, hasn't included questions about deemed IRAs in its questionnairesOne recent indication of some interest in deemed IRAs comes from Pacific Investment Management Co. LLC, Newport Beach, Calif., which released its annual survey of defined contribution consultants in March. Thirty-two percent of consultants said they believe clients “are likely or somewhat likely” to add a deemed IRA to their plan, according to the survey of 29 consultants representing more than 2,350 DC clients.
Forty-six percent said it was “unlikely” clients would add deemed IRAs at this time “as they have not discussed deemed IRAs,” the survey said. The other 21% are unsure and need to learn about deemed IRAs. “From a sponsor standpoint, it makes sense to retain (participants') assets to drive down fees,” said Stacy Schaus, senior vice president and head of PIMCO's defined contribution practice.
Creating a deemed IRA requires cooperation from the record keeper and custodian. It also requires setting up a group trust to serve as an umbrella for all retirement vehicles, getting approval from the IRS and revising the custodial agreement. The custodian must separate the assets in the deemed IRA from the DC plan even though the assets may be commingled for investment purposes.
Mr. Weltman said it took about nine months for the New York City Deferred Compensation Plan to set up the deemed IRA, including all legal clearances, revising plan documents and communicating with employees. The longest step in the process was getting an OK from the IRS, he said.
The New York City plan's deemed IRA had $86 million in assets by the end of 2010.
New York City plan executives explained the deemed IRA to participants by offering a comparison with retail IRAs. “We showed them it was lower fees, better options and somebody who they knew,” said Mr. Weltman, referring to participants' familiarity with the New York City plan administration.
The New York City plan record keeper is FASCore, a unit of Great-West Retirement Services, Greenwood Village, Colo., which also provides a platform for traditional rollover IRAs for interested sponsors, said Gregg Seller, senior vice president for government markets at Great-West.
Although Great-West has a few clients examining deemed IRAs, Mr. Seller said the only taker in the government market so far has been the New York City plan. Information on Great-West's corporate clients offering deemed IRAs was not available.
One reason for the slow uptake of deemed IRAs relates to a participant's retirement strategy. Money placed in a deemed IRA can't be withdrawn before age 59½ without incurring a penalty, Mr. Seller said. However, if a participant has money in a 457 plan, which appears to be the most popular source for deemed IRAs, the 457 plan doesn't impose a similar penalty. “As long as this advantage exists, participants may not find the deemed IRA attractive,” he said. Mr. Seller also speculated that deemed IRAs wouldn't be attractive to corporations that discourage participants from keeping their assets in DC plans after they retire.
Legal, regulatory and administrative issues appear to be primary reasons sponsors have been reluctant to choose deemed IRAs, wrote Anne Arvia, senior vice president for retirement plans at Nationwide Financial Services Inc., Columbus, Ohio, wrote in an e-mail.
“It's important to remember that they involve additional administrative effort and responsibilities for plan sponsors, many of whom may not have the dedicated staff and capacity to effectively manage their existing plans,” wrote Ms. Arvia, whose company has a few clients offering deemed IRAs.
One Nationwide client is the Sacramento (Calif.) Metropolitan Fire District. It began offering a deemed IRA in July 2005 “as another avenue for employees to put money away for retirement and to take advantage of economies of scale,” said Matthew Reyman, a firefighter and chairman of the deferred compensation committee for the fire district.
“It offers a decent fee structure and investment options” that are the same as those offered by the fire district's 457 plan, which has $79.8 million in assets and 30 investment options, he said. There are 721 participants in the 457 plan and 59 are in the deemed IRA, which has $677,000 in assets.
Mr. Reyman said the deemed IRA — available in a traditional or Roth structure — remains underused in part because most employees are considered ‘safety employees' and are able to retire at age 50. If they placed assets in a deemed IRA, they would have to wait until 59½ to take a distribution without incurring a penalty, he said.
“Because most individuals don't know their exact retirement exit strategy during their early working years, having the flexibility to take funds upon ‘separation' looks better than age 59½," he said.
The City of Los Angeles provided legislative authority in 2007 for its deferred compensation plan to add a deemed IRA ,but implementation is on a back burner pending resolution of certain matters, said Steven Montagna, program manager for the $3.2 billion plan.
One issue is administration. “We found that not every trustee/custodian providing services to a defined contribution plan is necessarily going to be capable (or) willing to take on the burdens of IRA administration," Mr. Montagna said. "Or, if they do, it may involve modification of an existing service agreement and/or additional fees.”
Another issue is the federal law passed last year allowing 457 plans to add a Roth savings option. “Originally, the big plus of a deemed IRA was adding the Roth savings feature,” Mr. Montagna said. “Now we'll be able to offer that through Roth 457. We need to see participant response to the Roth 457 first before assessing whether there's an appetite for more.”