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Practice Management

Making a Change to a Retirement Plan? Grandfathering May not Be a Panacea

It’s common practice to put some kind of grandfathering in place when a change is made to a retirement plan. But that may not always be ideal, a recent analysis suggests. 

In “Why Grandfathering Can Backfire,” an entry in the Cammack Retirement Top of Mind blog, Michael Webb observes that grandfathering some aspect of retirement plans may be helpful, but in some circumstances, it may only seem to be so. 

There are some circumstances in which grandfathering makes sense, Webb says; for instance, if an employer changes the number of outstanding loans an employee is allowed to take from their retirement plan from unlimited to three, grandfathering the change so that employees with many outstanding loans do not have to pay off the loans beyond three immediately makes sense. 

Still, he writes, “On paper, grandfathering often sounds like a good idea when a retirement plan change might be perceived by existing employees as being a negative,” adding, “when plan sponsors attempt to soften the blow, they often come to regret it - whether it be immediately or five years down the road.”

Webb outlines the reasons for his rationale:

  • If a grandfathering change favors existing employees and newly hired employees are not eligible for it, those new employees eventually will find that out. And probably from other employees, not you. 
  • Sometimes grandfathering changes may favor newly hired employees and create hardship for existing employees. For instance, introducing automatic enrollment and making all employees eligible benefits all employees, whereas automatically enrolling only new hires means that some employees may not save for retirement as well and may even need to work longer than they expected. 
  • Not treating employees equally in some instances can result in a plan that is subject to nondiscrimination testing requirements failing a test. And if a particular employee group is disproportionately highly compensated, test failures may occur more often than in just one year. 
  • Some changes, such as changes concerning investments, can put a plan at risk of having to explain to an investigator why it made certain changes, especially if in the process of trying not to disrupt some employees a plan did not change bad investments.  

“For the most part, if a change is going to be made that is best for the plan as a whole, plan sponsors who rip off the band-aid and make the change for all will be happier in the end,” writes Webb.