ERISA’s standard of prudence for Fiduciaries is not that of a prudent layperson but rather that of a prudent investment professional. A plan Fiduciary must act “…with the care, skill, prudence, and diligence under the circumstances then prevailing that a prudent person acting in a like capacity and familiar with such matters would use…”
A lack of familiarity with investments is no excuse, according to some court rulings if Fiduciaries are unsure what to do. Here are a few essentials when it comes to investment selection and ongoing monitoring;
- Ensure an understanding of your investment portfolio’s purpose and objective with a clear definition of success.
- Adopt an investment strategy with expectations for both risk and return, including selecting a default fund in a participant-directed defined contribution plan
- Adhere to an investment policy statement
Selection & Monitoring Best Practices
Here are several investment selection and monitoring best practices that we have identified and put into place with our clients:
- Objective – A defined contribution plan such as a 40(k) DC plan participants savings objective is to accumulate adequate savings for retirement, and Fiduciary decisions should be made with this goal in mind
- Metrics – Sponsors can assess participants progress towards their objective by using a variety of metrics:
- Participation rates,
- Combined participant and employer contribution rates,
- Participants who contribute enough to receive 100% of the company match,
- Asset allocations – % of assets in cash and % of assets in target-date funds.
- Diversification of Fund Lineup – ERISA recognizes the benefits of diversification. What matters is not the individual risk of a specific investment, but how the entire portfolio seeks to manage risk and return. Plan Fiduciaries are not prohibited from offering or investing in high-risk assets if, in the Fiduciary’s judgment, the portfolio in its entirety presents a prudent level of risk and return. Plan Fiduciaries should offer a broad range of investment options covering multiple investment categories and asset classes.
- Comply with 404(c) Regulations – ERISA and corresponding DOL regulations limit an employer’s liability for investment losses resulting from investment decisions made by plan participants if certain requirements are met.
- Fiduciaries are still responsible for selecting prudent and diversified investment choices as well as monitoring the investment options.
- Relief applies when the participants assume effective control of investment or when participants are invested in a Qualified Default Investment Alternative (QDIA)
- Plan must offer a minimum of three diversified options designed to enable participants to create an investment portfolio based on the risk and return characteristics appropriate for them.
- Participants must have the right to change exchange investment funds or contributions allocations at least quarterly.
- Follow all the requirements of the fee disclosure under 404(a)(5)
- Conduct a 404(c) review – related to plan documentation, the investment review process, and training and awareness for the plan’s Fiduciaries.
- Limit Complexity – evaluate the plan investment lineup in light of the demographics and investment experience of the participant population. A less experienced population likely calls for a simple menu and easy to understand choices which would include target-date funds.
- Create an Investor Policy Statement – an IPS defines the purpose, objectives, and measures of success for the plan.
- Once an IPS is created, the committee must adhere to it unless it is imprudent to do so
- Any departure from the IPS should be documented including the reason why
- The committee should review the IPS annually to ensure that it continues to reflect the plan’s objectives and meet the needs of the plan participants
- While changes to the IPS are expected to be infrequent, possible changes include major shifts in the workforce demographics, significant growth of the plan, and the performance of existing investment options.
- Implement a Qualified Default Investment Alternative (QDIA) – The default fund is used when a plan participant fails to make an investment selection for their elective contributions or an employer contribution, or in cases where participants are automatically enrolled in the plan. Generally, a QDIA is a target-date fund based on the participant’s age.
- Establish a process for comparing and selecting target-date funds
- Establish a process for the periodic review of selected target-date funds.
- Understand the fund investments and the allocation between different asset classes and how these will change over time
- Review the fund’s fees and investment expenses
Using a Tiering Approach when Setting the Fund Lineup
When putting together a 401(k) fund lineup, we use a tiering approach to meet the needs of our clients by;
- Offer a range of Target Date Funds
- Broad-based line up of Index Funds
- Domestic – Small, Mid, Large cap
- International – Developed and Emerging Markets
- Style – Value, Blend, & Growth
- Bonds – Domestic & International, High Yield & Inflation Protection
- Sector Funds
- Exposure to all 11 sectors of the S&P500 Index
By taking a tiered approach, we cater to the diverse needs of your employees from those that take a hands-off approach to their portfolio management using a Target Date Fund, to those you want a more active approach through Index and Sector Funds.
Investment selection and monitoring are just one of many Fiduciary best practices that we cover as part of our employer-sponsored retirement plan series. We designed this series to help support businesses of any size to help you reduce potential liability and provide a plan that best serves your employees.
Contact us for more information about any of these best practices or to see how we may better support your company and employees with a low-cost, high service employer-sponsored retirement plan.