ICMA Retirement Corp. (ICMA-RC) of Washington, is one of the first to boldly jump into what it's dubbing the "Sidecar IRA," technically known as the "deemed IRA."
The retirement plan administrator is expecting to make the new offering available via Internet enrollment to participants of its 457 plan sponsor/clients in the first quarter of 2003.
Like 401(k) defined contribution plans, 457's are offered to employees of state and local governments and some not-for-profit groups.
Under 2001 tax law revisions, beginning this Jan. 1, employers will be allowed to offer a separate IRA savings account to employees under existing employer-sponsored defined contribution plans, including 401(k), 403(b), and 457 plans.
Just like those pre-tax dollars employees have withheld from their salaries and invested into their defined contribution plans, employees will be able to elect to have amounts withheld from their salaries, deposited into their Sidecar IRA.
This can be of special benefit to employees who max out their annual defined contribution plan contributions, which will increase to $12,000 in 2003, but want to set aside extra money for retirement.
The Sidecar IRA can take the form of either a regular contributory IRA or a Roth IRA. Under the regular Sidecar IRA, employees will be allowed to sock away $3,000 annually beginning in 2003, but must pay taxes when contributions are withdrawn later, at retirement age.
Under a Roth IRA, employees may make contributions on money already taxed - but the beauty of a Roth IRA is that not only does the money grow tax-deferred, like a regular IRA, but when an investor withdraws the money at retirement, that, too, is tax free. Many financial planners say Roth IRAs are most beneficial to younger employees in lower current tax brackets.
While the U.S. Department of the Treasury has yet to iron out some technicalities and issue final regulations regarding the new Sidecar IRA, ICMA-RC sees great potential in the new tagalong IRA plan.
According to Girard Miller, president and CEO of the firm, Sidecar IRA participants will be able to plump up savings for retirement through now familiar payroll deductions, and will likely have access to a menu of familiar investment choices that may already be available within their DC plans.
In addition, participants will see streamlined consolidated statements that will show both defined contribution and IRA plan assets.
Bumper Cars
But employers, and consequently, mutual fund providers, may derive the greatest benefits from the Sidecar IRA. Employers can use it as yet another enticing benefit to offer to employees, said Kurt Walten, product director at ICMA-RC. "But we also see it as a retention tool," Walten said.
Furthermore, for money managers, giving employees an additional retirement savings tool will make them less likely to jump ship, or, if you will, bumper cars to a competing IRA.
When employees retire or leave a company, they often take those defined contribution assets and roll them over into an IRA, Walten said. According to ICMA-RC, evidence has shown that employees are likely to roll those assets into an existing IRA plan. If that existing IRA plan happens to also be with the employer, employees could very well roll DC plan assets directly into the employer-held IRA, said Walten. Employers will essentially be taking those assets out of one pocket and putting them into another.
"If you can plug in a [Sidecar] IRA, and get a foot in the door, you could have a leg up on the competition," said Ben Norquist, director of strategic development at BISYS Retirement Services of Brainerd, Minn.
Maintaining assets not only allows employers to preserve the plan's economics and ability to negotiate lower costs with plan providers, but enables employers - and the mutual fund companies who offer their funds in those plans to employees - to retain assets, according to ICMA-RC executives.
Asset retention has been one of the biggest thorns in the side of mutual fund providers who either offer bundled defined contribution services, including offering their mutual funds to employers, or just make their funds available within scores of DC plans administered by others.
According to research by Spectrem Group, the research and consulting group in Chicago, employees who rolled assets out of DC plans, more often rolled them into IRAs invested in competitors' mutual funds. In a May 2001 report, Spectrem estimated that through 2006, some $2.7 trillion in assets will have been on a roll, as employees retire or change jobs.
While it's great if investors can squirrel additional savings into a Sidecar IRA, its availability may have no impact on the vast majority of employees, said Robert Wuelfing, managing director of R.G. Wuelfing & Associates, a retirement plan consulting and professional development firm in Simsbury, Conn.
The Sidecar IRA may have some marketing and sales appeal, but it may fall seriously short of becoming the new-new investment vehicle for the masses.
"It will be a way for providers to get to the high-net-worth audience," he said. "But given that the average participant doesn't max out his or her 401(k) contributions, what would be the benefit?" he asked.
According to the October 2001 report "Contribution Behavior of 401(l) Plan Participants" released by the Employee Benefit Research Institute, the not-for-profit, Washington, employee benefit data and policy organization, in 1999, the most recent year the data was released, only 18% of higher-salaried 401(k) participants contributed the maximum amount to their plan in 1999, with rates falling to as low as 11% at lower salary levels.
Moreover, because the contributions are deducted from employee compensation on a pre-tax basis, individuals can't take a tax deduction for the amount contributed to the Sidecar IRA. "For most people, I can't see it," Wuelfing added.
As Sidecar IRAs try to nudge their way into the retirement plan landscape, employers will have issues to consider. "Employers have to go in with their eyes open," Walten said. One sticking point could be the additional fiduciary responsibility employers will have for the Sidecar IRA accounts, he said. Also, disclosures tend to be more voluminous for IRAs, he agreed.
DC Plan sponsors must also decide whether to offer the same or comparable lineup of investment vehicles, including mutual funds, for their Sidecar IRAs, Walten said.
ICMA-RC offers its own lineup of mutual funds, the $8 billion 19-fund Vantagepoint Funds complex, managed by Vantagepoint Investment Advisers, a subsidiary company. ICMA-RC is still deciding what to offer, but expects to make a mix of its funds, as well as outside funds available to plan sponsors, Walten said.
In addition, since many 401(k) participants are accustomed to receiving matching contributions from their employers, will employers be pressured to also make some contribution to the adjacent Sidecar IRA?
No one knows, yet, but some employers may want to toss in a small matching contribution, Walten said.
"It's going to take a while for this all to play out," he added.
