It's often said that it is an ill wind that doesn't blow somebody some good. While the recent downturn has indeed been an ill wind for all concerned, it does hold out the possibility that plan fiduciaries may learn valuable lessons.
The significant drop in participant account balances, coupled with the Supreme Court's recent decision allowing participants in individual account plans to sue fiduciaries for perceived breaches impacting only their accounts (rather than requiring that the breach affect the plan as a whole), means that the savvy fiduciary must learn these lessons quickly and well.
MISSING THE TARGET
ERISA allows individual account plans (including 401(k) plans) to permit participants to direct the investment of their accounts. Where participants do so, fiduciaries are relieved of liability for any losses that flow from those elections. Prior to the enactment of the Pension Protection Act, no relief was available where a fiduciary invested a participant's account in the absence of a participant election.
The PPA extended the relief to fiduciaries who invest a non-electing participant's account in a default investment, so long as the investment qualifies as a qualified default investment alternative. One requirement to constitute a QDIA is that the investment fit within one of three investment categories typified by: a balanced fund appropriate for all participants under the plan, professional management of the participant's account, or a targeted-date retirement fund or life-cycle fund.
The need to select a fund that would be appropriate for all participants under the plan effectively restricts the ability to use a balanced fund as a QDIA. As a result, many, if not most, plans have opted for a target-date fund as the QDIA.
Target funds are actually funds of other underlying funds designed to match investors with an appropriate investment mix given their current age and expected retirement date. Fiduciaries now know that equity allocations vary widely among funds with the same target retirement date maintained by different fund managers.
According to a study released by the Financial Research Corp., equity allocations for 2020 target date funds ranged from 51 percent to 95 percent. More disturbing, according to an Ibbotson Maturity report, the average target maturity fund suffered a loss of 17.3 percent during the fourth quarter of 2008. Plan fiduciaries must realize that by selecting a target-date fund, a poor performance by any one manager can serve to doom the performance of the overall fund.
Fiduciaries must not be lulled into falsely believing that the inclusion of target-date funds as a QDIA will insulate them from either losses or liability. While a properly selected QDIA will provide protection for investing a non-electing participant's account in the QDIA, no protection is provided for the actual selection of either the type of QDIA chosen or the specific fund.
This means that care must be taken in selecting the fund itself, with consideration given to a review of the underlying funds in terms of the fees, performance history, and the potential for the target-date manager to select funds that can skew in favor of higher fees at the expense of performance.
Moreover, procedural prudence requires not only that fiduciaries properly evaluate the options selected, but also document why certain options were selected and others discarded.
Recently, some plan participants have pursued litigation claiming that fiduciaries have opted for investment choices with excessive fees sometimes involving revenue-sharing arrangements.
A recent case suggests that such claims may fall short where the plan offers a significant number of options (in that case, the plan offered 23 mutual funds) with varying investment styles and ranges of fees, coupled with a brokerage window option (that is, the option to invest in any mutual fund made available by a specified brokerage). The court was clearly persuaded that the sheer number of options, particularly the availability of the brokerage window, meant that the plaintiffs had more than enough to choose from.
While plans will not wish to overwhelm participants, fiduciaries should review their plans' investment options with a view towards making sure that the number of available options is sufficient to, and in fact does, provide a range of not only investment categories, but fees as well. Particular emphasis should be given to making sure that some of the available options are at the low end of the fee spectrum. Some plans may wish to consider allowing a brokerage window option so long as the mutual fund is available and actually purchased through a plan-specified brokerage.
The Department of Labor previously proposed regulations governing a vendor's obligations to disclose fee and expense information to plan fiduciaries, and a separate set of regulations detailing a plan fiduciary's disclosure obligations to its participants. However, as a result of the recent change in administrations, neither set has been issued.
This fact should not, however, dissuade plan fiduciaries from ensuring that sufficient fee and expense information is in fact obtained from plan vendors and released to participants. A fiduciary desiring to avoid litigation should be sure to obtain and release full fee information.
The DOL's view is that, even absent specific regulations, a fiduciary has an obligation to know all the fees generated by a plan's investment with various vendors. Further, in the event of litigation, those fiduciaries who have fully disclosed the cost associated with each investment option will be in a much better position to successfully fend off potential liability.
Insurers have been marketing new generations of annuities, which can be purchased solely from a participant's account, are portable and are designed to be more compatible with defined-contribution plans.
Given declining account balances, it is understandable that both participants and fiduciaries would explore the use of a guaranteed-income product in a defined-contribution plan. However, the lack of real official guidance specific to some of these products means that plan sponsors and fiduciaries may be well-served by fully exploring all of the potential issues, and perhaps awaiting more specific official guidance.
STILL A SAFE HARBOR?
Employers that have converted traditional 401(k) plans to safe harbor arrangements are now dealing with the ramifications of that decision. The safe harbor design allows the company's highly compensated employees to defer the maximum elective contributions without regard to what is contributed by other participants. However, the trade-off is a required employer matching contribution or non-elective contribution (i.e., contribution made without regard to an employee's contribution).
Until quite recently, it was only possible toprospectively reduce or suspend thematching contribution once the plan year had begun, but the employer that hadelected the nonelective safe harbor option was effectively stuck. In responseto significant outcry from practitioners and employers alike, the IRS hasrecently issued guidance which now allows either type of contribution to besuspended once the plan year has begun subject to the issuance of additionalparticipant notices and the adoption of a plan amendment.
Pamela D. Perdue is of counsel to the St. Louis law firm of Summers, Compton & Wells PC, as well as the author of Qualified Pension and Profit-Sharing Plans, and Pamela D. Perdue's Pension & Benefits Update, a semi-monthly newsletter published by the Tax & Accounting business of Thomson Reuters.
(c) 2009 Accounting Today and SourceMedia, Inc. All Rights Reserved.
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