7 Things to Know About the New ESG Regulation

A little more than a week ago, the U.S. Department of Labor unveiled its much-anticipated final ESG rule.  There’s a lot to unpack in that regulation (and the rest of the 236-pages that help explain its process and rationale), but here’s a few things that seem particularly important to note at the outset.

There are some (important) things that did NOT change.

First, and to my mind, foremost, the Labor Department noted that “The duties of prudence and loyalty require ERISA plan fiduciaries to focus on relevant risk-return factors and not subordinate the interests of participants and beneficiaries (such as by sacrificing investment returns or taking on additional investment risk) to objectives unrelated to the provision of benefits under the plan.

But it also included an important clarification:

“…the final rule amends the current regulation to make it clear that a fiduciary’s determination with respect to an investment or investment course of action must be based on factors that the fiduciary reasonably determines are relevant to a risk and return analysis and that such factors may (emphasis mine) include the economic effects of climate change and other environmental, social, or governance factors on the particular investment or investment course of action.”

It does away with “pecuniary” as a standard (or at least as a word claiming to be the standard).

The Trump Administration’s version defined pecuniary (a term “introduced” to the ERISA lexicon by the United States Supreme Court in the Fifth Third v. Dudenhoefer decision[i]) as “a factor that a fiduciary prudently determines is expected to have a material effect on the risk and/or return of an investment based on appropriate investment horizons consistent with the plan’s investment objectives and the funding policy established pursuant to section 402(b)(1) of ERISA.” 

However, that word choice was determined by the Labor Department to be causing “confusion” and to have a “chilling effect” — “deterring fiduciaries from taking steps that other marketplace investors would take in enhancing investment value and performance, or improving investment portfolio resilience against the potential financial risks and impacts associated with climate change and other ESG factors.”

However, and despite what some saw as an implication in the proposed regulation, the final regulation does NOT mandate consideration of ESG factors.

Quite the contrary—quoting from the Labor Department:

“The final rule makes unambiguous that it is not establishing a mandate that ESG factors are relevant under every circumstance, nor is it creating an incentive for a fiduciary to put a thumb on the scale in favor of ESG factors.” 

“Outside the ERISA context, investors may choose to invest in funds that promote collateral objectives, and even choose to sacrifice return or increase risk to achieve those objectives. Such conduct, however, would be impermissible for ERISA plan fiduciaries, who cannot sacrifice return or increase risk for the purpose of promoting collateral goals unrelated to the economic interests of plan participants in their benefits.”

It treats QDIAs just like any other investment option in the plan.

The Trump Administration in its preliminary regulation had barred funds with an ESG focus from qualifying as a qualified default investment alternative (QDIA), and then—following criticism on that front—in its final regulation modified the provision in the proposal on QDIAs to prohibit plans from adding or retaining any investment fund, product, or model portfolio as a QDIA or as a component of such a default investment alternative, if its objectives, goals or principal investment strategies include the use of non-pecuniary factors.

The new regulation removes that distinction, noting that “QDIAs would continue to be subject to the same legal standards under the final rule as all other investments, including the prohibition against subordinating the interests of participants and beneficiaries in their retirement income to other objectives. QDIAs also would continue to be subject to the separate protections of the QDIA regulation.”

That said, the Labor Department says it expects to see an increase in the number of QDIAs that are ESG funds—though, considering the number currently in the market (and there are some), that hardly seems a controversial call.

Eliminated additional disclosure/labeling requirements associated with alternative investments with collateral benefits.

The Trump era regulation imposed a requirement that competing investments be indistinguishable based solely on pecuniary factors before you could turn to collateral factors to break a tie—oh, and even then, you would have had to comply with a special documentation requirement on the use of such factors.

The final rule, on the other hand, replaces that with a standard that instead requires the fiduciary to conclude prudently that competing investments, or competing investment courses of action, equally serve the financial interests of the plan over the appropriate time horizon—and, having determined that they equally serve those goals, is not prohibited from selecting the investment, or investment course of action (like an ESG focus), based on collateral benefits other than investment returns. 

And they no longer have to document that evaluation (which, interestingly enough, turns out to be one of the cost benefits[ii] associated with the new rule). 

Participant preferences can (still) play a role in menu design.

Now, in my experience, plan sponsors (and advisors) have long considered participant preferences in menu design. Not to the subordination of prudent fiduciary standards, of course—though there have been concerns that some might not see it that way. 

Well, the new regulation contains a new and interesting provision that “clarifies” that fiduciaries “do not violate their duty of loyalty solely because they take participants’ preferences into account when constructing a menu of prudent investment options for participant-directed individual account plans. If accommodating participants’ preferences will lead to greater participation and higher deferral rates, as suggested by commenters, then it could lead to greater retirement security."

Now, notice that while such considerations don’t necessarily violate the duty of loyalty—but there is no setting aside of the standards of prudence in evaluating and monitoring those investments noted above.  More specifically, those decisions need to be evaluated “taking into consideration the risk of loss and the opportunity for gain” compared to the opportunity for gain “with reasonably available alternatives with similar risks.”   

As noted above, there’s a lot to unpack here—and we’ll continue to do so right up to the Jan. 30, 2023 effective date—and beyond.

- Nevin E. Adams, JD

 

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[i] In that case, the nation’s highest court concluded that the responsibilities of an ESOP fiduciary must be directed toward the duty to provide benefits and defray expenses—and that any non-pecuniary interests, such as Congress' strong encouragement of employee stock ownership, did not warrant an alteration of the fiduciary standard.  

[ii] Noting that in view of the “large scale of investments held by covered plans, approximately $12.0 trillion, changes in investment decisions and/or plan performance may result in changes in returns in excess of $100 million in a given year,” the Labor Department estimates that 20% of defined contribution and defined benefit plans (149,300 plans with some 28.5 million participants) will be affected by the regulation “because their fiduciaries consider or will begin considering climate change or other ESG factors when selecting investments.” In the Labor Department’s estimation, for each plan, a “legal professional will need to review paragraphs (b)-(c) of the final rule, evaluate how these provisions might affect their investment practices and assess whether the plan will need to make changes to investment practices. The Department estimates that this review will take a legal professional approximately four hours to complete, resulting in an aggregate cost burden of approximately $91.5 million or a per-plan cost burden of approximately $613.[ii]”

That said, the Labor Department noted that plan fiduciaries “generally already undertake deliberative evaluations as part of their investment selection decision-making process and this final rule does not add burden to those deliberations; but rather, the final rule clarifies that the scope of those deliberations may include climate change and other ESG factors within the confines of paragraphs (b)(4) and (c)(1) of the final rule. The Department does not intend to increase fiduciaries’ burden of care attendant to such consideration; therefore, no incremental costs are estimated for these requirements.”

Advisor Value ‘Adds’

Most of the attempts to affix a value to having an advisor tend to focus on investment returns or cost savings. Both are valid, objective measures that can have a real, substantive impact on retirement security—but, at least with the best advisors—there’s usually more.

Indeed, years ago as a fiduciary of another firm’s 401(k) plan, and while I had always felt comfortable with the decisions the plan committee had made, as our little company grew to be less little, I was increasingly aware of the personal liability associated with my role, and the small amount of time I was able to dedicate to the task alongside my “day job.” 

That advisor delivered in all the ways I had hoped he would—but there was value well beyond that in terms of the structure he brought not only to our discussions, but to our process. Things like:

The Discipline to Meet

Internally driven committee meetings are frequently a casualty of whatever crisis emerges on any particular day. As human beings we are wont either to assume that nothing will happen unless we are present, or that because others will be there, our voice isn’t required.

Having a committee and not having committee meetings is potentially worse than not having a committee at all. In the latter case, at least ostensibly you know who is supposed to be making the decisions. But if there is a group charged with overseeing the activities of the plan, and that group doesn’t meet, then one might well assume that the plan is not being properly managed, or that the plan’s activities and providers are not prudently managed and monitored, as the law requires.

However, the presence of an outside advisor helps bring a seriousness both to the gathering itself and the agenda.

The Discipline to Educate

Individuals are chosen to be on these committees for a variety of reasons, some better (and some much better) than others. But the first thing our advisor did at that first committee meeting was to acquaint the members with what was expected of them. That included the requirement to act solely in the interests of plan participants and beneficiaries, the importance of process (and documenting that process), and the implications of the prudent expert rule.

It also included reminders that by being on this committee they were a fiduciary under ERISA, that that brought with it personal liability (and, in our case, how the company had chosen to insure them), and that each of us was responsible for the actions of other plan fiduciaries. 

Sure, I could have delivered all those messages—but it meant a lot more coming from that external, expert resource.

The Discipline to Establish an Investment Policy Statement

While I have known attorneys who have counseled against having a written investment policy statement (IPS), I can’t recall a plan advisor of my acquaintance who wouldn’t insist on it (I may now hear from some, of course). ERISA doesn’t require one—and some lawyers see it as a smoking gun (if you don’t follow its terms, it certainly can be). But in its best form it establishes investment guidelines for the plan—and plan fiduciaries, and plan advisors in particular, will generally find it easier to conduct the plan’s investment business in accordance with a set of established, prudent standards if those standards are in writing. And in writing crafted in the objective, cold, clear light of day, rather than in the throes of tumultuous market (or plan) conditions.

In sum, you want an IPS in place before you need an IPS in place—and in my experience any advisor worth their salt will demand that as a starting point.

The Discipline to Remove Funds

As human beings we are largely predisposed to leaving things the way they are, rather than making abrupt and dramatic change. Whether this “inertia” comes from a fear of the unknown, a certain laziness about the extra work that might be required, or a sense that advocating change suggests an admission that there was something “wrong” before, it seems fair to say that plan fiduciaries are, in the absence of a compelling reason for change, inclined to rationalize staying put.

As a consequence, you routinely see new fund options added, while old and unsatisfactory funds linger on the plan menu, a general reluctance to undertake an evaluation of long-standing providers in the absence of severe service issues, and an overall inertia when it comes to adopting potentially disruptive plan features like automatic enrollment or deferral acceleration.

Whether or not the plan has an official IPS, plan fiduciaries are expected to conduct a review of the plan’s investment options as though they do. Sooner or later, that review will turn up a fund (or two) that no longer meets the criteria established for the plan. Oh, and make no mistake—there will be someone with money in that fund, maybe even a senior executive.

Rational thought reminds us that leaving an inappropriate fund on the plan menu—and allowing participants to invest in it—is a bad thing. But human beings, including those who serve on plan committees, have a hard time walking away from a “bad” investment.

The Discipline to Document

I’ve heard it said that when it comes to ERISA, “prudence is process—but only if you can prove it.” To that end, a written record of the activities of the plan committee(s) is an essential ingredient in validating not only the results, but also the thought process behind those deliberations.

But as anyone who has ever participated in a group meeting of any kind knows, it’s hard to fully participate while taking notes. And sometimes those notes don’t make sense by the time you get around to writing them up. An advisor can help with that—and that matters because those minutes can provide committee members (both past and future) with a sense of the environment at the time decisions were made, the alternatives presented, and the rationale offered for each, as well as what those decisions were. They also can be an invaluable tool in reassessing those decisions at the appropriate time.

The current emphasis on fees and plan costs, while important, brings to mind a quote by Oscar Wilde, who once famously described a cynic as someone “who knows the price of everything and the value of nothing.”

As an advisor, what are YOU bringing to the table?  As a plan sponsor, what are you getting from your advisor?

- Nevin E. Adams, JD

Thanks, Giving

While it’s the celebration following a successful harvest held by the Pilgrims and members of the Wampanoag tribe in 1621 that provides most of the imagery around the holiday, Thanksgiving didn’t become a national observance until much later.

Incredibly, it wasn’t marked as a national observance until 1863—right in the middle of this nation’s Civil War, and at a time when, arguably, there was little for which to be thankful. Indeed, President Abraham Lincoln, in his proclamation regarding the observance, called on all Americans to ask God to “commend to his tender care all those who have become widows, orphans, mourners or sufferers in the lamentable civil strife” and to “heal the wounds of the nation.” 

We could surely stand to have some of that these days.   

Thanksgiving has been called a “uniquely American” holiday—and so, even in a year in which there has been what seems to be an unprecedented amount of disruption, frustration, stress, discomfort and loss—there remains so much for which to be thankful. And as we approach the holiday season, it seems appropriate to once again take a moment to reflect upon, and acknowledge—to give thanks, if you will.

I’m once again thankful that so many employers (still) voluntarily choose to offer a workplace retirement plan—and, particularly in these extraordinary times, that so many have remained committed to that promise. I’m hopeful that the encouragements of prospective legislation, if not the requirements of same, will continue to spur more to provide that opportunity. 

I’m thankful that amidst all the turmoil and strife in our political system, we’ve seen near-unanimous bipartisan support for legislation that stands to enhance the retirement of tens of millions of Americans.

I’m thankful that so many workers, given an opportunity to participate in these programs, (still) do.

I’m thankful that the vast majority of workers defaulted into retirement savings programs tend to remain there—and that there are mechanisms (automatic enrollment, contribution acceleration and qualified default investment alternatives) in place to help them save and invest better than they might otherwise.

I’m thankful for the dozen or so state IRAs for private sector workers that, despite relatively high opt-out rates, are providing millions of Americans an opportunity to save through payroll deduction.  I’m even more thankful that the employer mandates associated with these programs are encouraging employers to consider more robust workplace retirement savings programs, like 401(k)s.

I’m thankful for new and expanded contribution limits for these workplace retirement programs—and even though it was spurred by dramatic increases in inflation and the prospect for higher costs in retirement, I’m hopeful that that will encourage more workers to take full advantage of those opportunities.

I’m thankful for the Roth savings option that provides workers with a choice on how and when they’ll pay taxes on their retirement savings.

I continue to be thankful that participants, by and large, continue to hang in there with their commitment to retirement savings, despite lingering economic uncertainty, volatile markets, rising inflation, and competing financial priorities—and that their employers continue to see—and support—the merit of such programs.

I’m thankful for qualified default investment alternatives that make it easy for participants to benefit from well diversified and regularly rebalanced investment portfolios—and for the thoughtful and ongoing review of those options by prudent plan fiduciaries. I’m hopeful (if somewhat skeptical) that the nuances of those glidepaths have been adequately explained to those who invest in them, and that those nearing retirement will be better served by those devices than many were a decade ago.

I’m thankful that our industry continues to explore and develop fresh alternatives to the challenge of decumulation—helping those who have been successful at accumulating retirement savings find prudent ways to effectively draw them down and provide a financially sustainable retirement.   

I’m thankful that the ongoing “plot” to kill the 401(k)… (still) hasn’t. Yet.

I’m thankful for the opportunity to acknowledge so many outstanding professionals in our industry through our Top Women Advisors, Top Young Retirement Plan Advisors (“Aces”), Top DC Wholesaler (Advisor Allies), and Top DC Advisor Team lists. I am thankful for the blue-ribbon panels of judges that volunteer their time, perspective and expertise to those evaluations.

I’m thankful for the opportunity to give advisors a voice in acknowledging the best recordkeepers in the industry via our new Advisors’ Choice accolade.

I’m thankful that those who regulate our industry continue to seek the input of those in the industry—and that so many, particularly those among our membership, take the time and energy to provide that input.

I’m thankful to be part of a team that champions retirement savings—and to be a part of helping improve and enhance that system.

I’m thankful for those who have supported—and I trust benefited from—our various conferences, education programs and communications throughout the year—particularly at a time like this, when it remains difficult—and complicated—to undertake, and participate in, those activities. 

I’m thankful for the involvement, engagement, and commitment of our various member committees that magnify and enhance the quality and impact of our events, education, and advocacy efforts. 

I’m also thankful for the development of professional education and credentials that allow the professionals in our industry to expand and advance their knowledge, as well as the services they provide in support of Americans’ retirement. 

I’m thankful for the constant—and enthusiastic—support of our event sponsors and advertisers—again, particularly during a period when so many adjustments have had to be made.

I’m thankful for the warmth, engagement and encouragement with which readers and members, both old and new, continue to embrace the work we do here.

I’m thankful for the team here at NAPA, ASPPA, NTSA, ASEA, PSCA (and the American Retirement Association, generally), and for the strength, commitment and diversity of the membership. I’m thankful to be part of a growing organization in an important industry at a critical time. I’m thankful to be able, in some small way, to make a difference.

I’m particularly thankful for the education, support, and availability of programs in our private retirement system that have allowed me to contemplate my own “retirement” in just a few more months.

But most of all, I’m once again thankful for the unconditional love and patience of my family, the camaraderie of an expanding circle of dear friends and colleagues, the opportunity to write and share these thoughts—and for the ongoing support and appreciation of readers… like you.

Wishing you and yours a very happy Thanksgiving!

- Nevin E. Adams, JD

Things to Ponder

In the course of my day, I talk to (and email with) people, read a lot, and every so often jot down a random thought or insight that gives me pause and makes me think. See what you think.

It’s not what you’re doing wrong; it’s what you’re not doing that’s wrong.

The best way to stay out of court is to avoid situations where participants lose money.

The key to successful retirement savings is not how you invest, but how much you save.

Does anybody still expect their taxes to be lower in retirement?

If you don’t know how much you’re paying, you can’t know if it’s reasonable.

Everybody wants a pension, but nobody seems to want an annuity.

Everybody’s “committed to the business”…until they aren’t.

Retirement income is a challenge to solve, not a product to build.

“Stay the course” is only good advice if you were on a good course to begin with.

Does anybody but lawyers actually read those legal “disclosures?” (that’s a rhetorical question.)

When selecting plan investments, keep in mind the 80-10-10 rule: 80% of participants are not investment savvy, 10% are, and the other 10% think they are. But aren’t.

There’s no such thing as a passive ESG fund.

“Don’t put all your eggs in one basket” applies to all life decisions.

What’s the “target date” for a “through” retirement date target fund?

92% of participants defaulted in at a 6% rate do nothing. 4% actually increase that deferral rate.

Plan sponsors may not be responsible for the outcomes of their retirement plan designs, but someone should be.

Sometimes just saying you’re thinking about doing an RFP can get results.

Hiring a co-fiduciary doesn’t make you an ex-fiduciary.

“Because it’s the one my recordkeeper offers” is not a good reason to select a target-date fund.

Given an opportunity to save via a workplace retirement plan, most people do. Without access to a workplace retirement plan, most people don’t.

Disclosure isn’t the same thing as clarity. Sometimes it’s the opposite.

Nobody knows how much “reasonable” is.

You want to have an investment policy in place before you need to have an investment policy in place.

The same provider can charge different fees to plans that aren’t all that different.

The biggest mistake a plan fiduciary can make is not seeking the help of experts.

Thanks to all who have inspired these—by thoughts, words and (mis)deeds—past, present and future.

- Nevin E. Adams, JD

Campaign Premises

If you have turned on a TV, walked by a radio, driven down a residential street, gotten an unsolicited text or answered a phone (or more likely let it go unanswered) in the past month, you will, of course, be aware that our nation will officially go to the polls today.

I say “officially,” but of course, our nation has been “going” to the polls—or at least casting votes—for several weeks now. And while some states (and voters) have done so in elections past, a combination of factors means that the process of voting, like so much of our lives the past couple of years, is going to be “unprecedented,” both in terms of the breadth and volume of votes cast prior to election “day”—and perhaps on that day itself.

And yes, it’s been a particularly nasty—one feels compelled to say “unprecedented”—election cycle.

Now, we all carry on as though the nation has never, ever seen anything like this—but perhaps it would be more accurate to say that it hasn’t …in our lifetimes. Students of history will, of course, remember that the nation literally split apart in the 1860s, but even before that there were the “Alien and Sedition Acts” in the late 1700s, the so-called Whisky Rebellion in 1791-94, the Sedition Act of 1918, the Alien Enemies Act in 1942—and let’s not forget from when the Tea Party of 2009 drew its inspiration. As for the outsized impact and biases of the media, hard as it may be to believe the founding fathers (not to mention elected officials throughout the 1800s) would very likely have characterized today’s voices as “restrained” (of course, they weren’t subjected to it 24/7).

Indeed, while much is made of what appears to be an extraordinary level of polarization in perspectives, the pernicious influences of social media, and the pervasive editorializing of the “news,” it remains my sense that at the level of the individual our nation is not so cleanly demarcated into “blue” and “red” as pundits would have us believe. Moreover, while we surely have our individual differences, I suspect at most levels the voting public is not as polarized in their opinions on key issues as are the individuals seeking their vote, or the process[i] that produces those individuals. 

None of that should be read as an acceptance of, or acquiescence with, the current state of affairs. Like most of you (I suspect) I find the tone and tenor of most in the public square today (both “sides”) to be both vitriolic and toxic. We have real problems to solve, crisis of which to steer clear—and some from which we need extrication in the here and now.

The issues that confront our industry—and the nation’s retirement—important though they surely are, are unlikely to be the issues that motivate your choices on the ballot this year. That said, it’s worth remembering that elections matter there as well—that the “sweep” of control often creates the biggest issues for retirement policy, be it the tumult of the Tax Reform Act of 1986, the flirtation with Rothification, the ardor for financial transaction taxes (that make no allowance for retirement savings), and “equalization” of tax treatment that might well discourage plan formation. And just how powerful bipartisanship (still) can be in terms of producing thoughtful, meaningful legislation like the SECURE Act—not to mention the SECURE 2.0 (still) waiting in the legislative wings.  

As I write these words, it’s hard to imagine that we’ll know how it will all turn out by Election Day’s close. The good news, whether it be a result, or in spite of, the current level of vitriol, the American public’s interest in expressing its opinion by actually taking the time to go to the polls—or in pursuing an absentee ballot—appears to be surging. Elections do have consequences, after all—and, if the last several elections have taught us nothing else, we now know that votes—even a single vote—can matter.

Here’s hoping that—whatever your position on the issues—you take the time to vote this election. It is not only a right, after all, it is a privilege—and a responsibility.

Here’s also hoping that those who find themselves in office as a result conduct themselves accordingly.

  - Nevin E. Adams, JD

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[i] Which can probably not be said at this point for the perspectives of those who actually made it to the ballot. But then, if they want to stay there, they can’t long ignore the voice/will of the people.

Is Retirement Saving ‘Wasted’ on the Young?

 The academics are at it again.

In a paper provocatively titled “The Life-Cycle Model Implies that Most Young People Should Not Save for Retirement” no fewer than four of them take 48 pages to make that case. The “trade press” breathlessly intoned “Most Young People Should Not Save For Retirement in Their 401k,” “Many young people shouldn’t save for retirement, says research based on a Nobel Prize–winning theory,” “Under 35? Don’t Save For Retirement Yet, These Experts Say,” “Economists Say Enjoy Your Youth and Save Later.” At least one had the temerity to offer a contrasting viewpoint (see “A New Paper Says Young People Shouldn't Save for Retirement. Advisors Disagree”), while The Street at least called it out as “This May Be the Worst Financial Advice Ever Shared.”

Like most research, the conclusion is a premise based on assumptions. Here the most basic is that this thing called a “life-cycle model” is worth considering in the first place. Now, granted, it’s the “Nobel Prize-winning theory” noted above—so mere mortals might be inclined to give it some breathing room.  But the underlying premise behind it is that individuals prefer to smooth out their consumption over their lifetimes, or—as the authors of the paper put it, assuming that “rational individuals allocate resources over their lifetimes with the aim of avoiding sharp changes in their standard of living.” Now, I don’t know about you, but my aspirations—and I consider them rational—have always been a bit higher than that.   
 

As it turns out, the authors here do anticipate some growth in income over time—indeed, that’s a contributing factor in their logic about putting off saving for retirement. Buttressing this are three basic arguments; first that since high-income workers tend to experience “wage growth” over their careers (and thus, for them “maintaining as steady a standard of living as possible therefore requires spending all income while young and only starting to save for retirement during middle age”—that’s right, it REQUIRES spending). Second, that low-income workers “receive high Social Security replacement rates, making optimal saving rates very low”—which apparently means that if you’re at a low-income level now, you’d (only?) be looking to maintain that level into retirement (and certainly, if you’re spending.  The final point has to do with what was then an artificially low interest rate environment that they claim “make a front-loaded lifetime spending profile optimal”—basically, at least at that point in time, they argue you might as well spend the money because there’s no economic advantage in saving. But what about market gains, you say? Hang on, we’ll come back to that in a minute.

‘Star’ Bucks?

Now, if you find yourself scratching you head at all that gobbledygook, it seems to boil down to this—you’ll get more “value” out of spending all of a smaller income now than you will suffer by depriving yourself—so that you can spend later when you’ll have more money to spend. Or something like that.  But to put some numbers behind those assumptions, you have to do a little financial alchemy—create some sort of “value” for consumption—something beyond a mere price tag. How much DOES that cup of Starbucks that we’re always telling people to forego actually mean to them in terms of what academics call “utility”? Indeed, that’s another required assumption here—and it’s key in terms of assessing the perceived trade-offs. 

What’s also odd here is that they actually talk about the “welfare costs” of automatic enrollment—essentially treating an individual who has been defaulted into saving as the equivalent of being scammed by a Nigerian prince. 

And for those of you wondering what happened to the “magic” of compounding those savings, the authors have a direct, but quizzical response: “…there is no power of compound interest when real interest rates are zero. While individuals could invest in risky assets with higher expected returns (which we do not model), those higher returns are merely compensation for taking on the additional risk.” So, basically, in this magical theoretical world… it’s a “wash.” 

Oh—and leakage? Well, in this world, since participation in plans by younger workers (who are particularly vulnerable to things like mandatory cash outs), they comment that, “Viewed from this perspective, leakages from 401(k) balances for young workers might be interpreted as correcting a mistake rather than a major problem in need of further government policy.” That’s right—early cash outs are a good thing (doubtless the taxes and penalties are considered a well-deserved “punishment” for the mistake of saving). 

That said, the authors do offer some caveats—they admit that they’re focused on saving for retirement, and that there may, indeed be reasons for saving earlier for non-retirement purposes. But they also admit that their model “does not account for uncertainty about future wages, employment, or health.”   They acknowledge that “if the wage profile is uncertain, or if there is a risk of future unemployment, individuals may wish to begin saving for retirement earlier in life in case future earnings do not turn out as expected.”

Ya think?

- Nevin E. Adams, JD

My 'Retirement' Account

I’ve spent my entire working career working with retirement plans—but most of it not focused on a retirement plan of my own.

In that sense, I am perhaps like many, maybe most of you. Oh, I thought about retirement (a lot, just not mine), maxed out my 401(k) (when I wasn’t co-funding college tuitions), and was at least intellectually cognizant of the potential costs of living for decades without a salaried paycheck. Much has been made of how difficult it is for younger workers to grasp the reality of retirement—but the reality is that retirement “myopia” is not limited to younger workers.

That said, and as you will hopefully have seen in the lead post today, I have announced my “retirement” —though it’s not retirement[i] in the traditional cessation of work sense. Yes, while I love what I do and the people I do it with (for the very most part)—I’ve been cranking out a daily news service (and then some) pretty much every working day (including vacations) across multiple firms and audiences since 1995.[ii] Simply stated, I am at a point in my life where I am ready (financially and spiritually) to spend less time “working”—and more time focusing on the things I want to spend time doing.

If you’ve ever left a job you love (even for one you hope to love more), then you’ll appreciate just how important it is to be leaving your work in good hands. To that end, I am thrilled to have John Sullivan coming on board. He has been a good friend and kindred spirit over the past several years. He, like I when I joined the ARA, is excited at the prospects of helping contribute and shape retirement policy, rather than merely observing and commenting upon those efforts. I’m thrilled that both he (and Brian Graff) want me to continue to contribute content and perspective to those efforts—and that I have been asked—for at least the next two years—to continue to lead the content development of the nation’s leading, largest and most significant retirement plan advisor conference, the NAPA 401(k) Summit. 

Beyond that, my plans for “retirement” (and yes, I am going to continue to describe it with quotation marks) are still emerging. Some travel, yes—some time with family, for sure—perhaps (finally) the book that I have been meaning to write for years… but was too busy writing to get around to it.   

It has been my great good fortune to have “stumbled” as a part-time college internship into a profession that I love—one that has not only provided a good living (albeit with some bumps along the way), but to which I could, with a clear and enthusiastic conscience, invest heart and soul (not to mention blood, sweat and the occasional tears) in pursuit of a noble goal—helping strengthen and support Americans’ retirement. I’m doubly fortunate to have had the opportunity to share with—and hear from—so many of you over the years.

I’m thankful for the opportunity I have been given here, and to have the opportunity to not just explain but to shape retirement policy with your support, and those of the incredible team here at the American Retirement Association. I treasure what I have learned and continue to learn, as well as the people it has been my great joy to work with and learn from over the years. 

More importantly, I look forward with great anticipation to this next phase of my career…as we all continue working for America’s retirement.

Stay tuned!

- Nevin E. Adams, JD

 

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[i] My actual “retirement” date is still months away, of course (Feb. 28, 2023)—and with any luck at all, Congress will pass legislation sometime before the end of this year that will, once again (as it did in 2019), “complicate” my holidays. Indeed, I continue to tell folks that I am “retiring,” but not quitting. 

[ii] And working in this industry since 1978…

Are You ‘Anti’ Social?

 You may have missed it, but there’s been a bit of a “hub-bub” brewing on social media…about the impact of, and perhaps even the utility of, social media. Here’s some thoughts—and some tips. 

JD Carlson of Retireholics “fame” kicked things off with a post intriguingly titled “Forget About Social Media Content and Run Your 401(k) Business.” Oh, there were words[i] that followed, but you really didn’t have to read more than that to see where he was going.

Well, about a nanosecond after that post appeared on…social media… Sheri Fitts who, as you may know, spends a fair amount of her time and energy helping advisors (and other retirement professionals) be more effective on…social media… pushed back on JD’s basic premise. A bit.

Her argument was basically that while social media was important (we’ll come back to that), doing so without a clear focus or strategy was a mistake—but that ignoring the marketing impact of social media was perhaps a larger one.  And then, Faith Teope (who I’ve bantered with previously) took to LinkedIn to offer yet a third perspective—which seemed to be basically a message of “if it feels right for you, do it.” 

Influence Shells?

Now, all of these folks have arguably made, or at least enhanced, a name/brand for themselves on social media. They have followings, post regularly, and I think it’s fair to say—at least in the retirement space—are what would be considered “influencers.”

I’ve been on Twitter since 2008—LinkedIn even longer. Facebook (yes, I AM a Boomer, after all) since my kids got on it. I’ve read books on the subject of social media, attended conferences and training sessions (live and online) about how to use/leverage these tools—and spent a lot of time over the past couple of decades waiting for the day when the actual response to a LinkedIn (or Twitter) post…mattered. I don’t mean the “likes” that Twitter shares, or the “impressions” or number of “followers” these platforms attribute to one’s account. They’re valuable metrics, of course—widely shared (and sometimes trumpeted). 

But as much as I enjoy social media—and relish the relationships that I have found and fostered there, in my experience it's still a bit of an echo chamber—one frequented by people who are already “on” social media. Indeed, it seems for the very most part the people who are “there” are there to promote the use and value of social media to those not yet in that “club.” Not that you won’t find valuable content there—but plan sponsor clients? Participants? 

Don’t get me wrong—I am one of those folks “on” social media. I have tons of “followers” on LinkedIn, and spend some time each week cultivating and expanding that reach. People read and comment on what I post there, and I’m grateful and appreciative of that engagement. Having said that, I continue to do what I do there not because I see much current value in doing so—but rather because I feel that one day there MIGHT be—but don’t sense that that day is here yet.[ii]

What to Do (and Not)

So, at the risk of being non-controversial, I’m going to concur (I think) with most of what has already appeared in this discussion thread—and offer some unsolicited social media “guidance”:    

First things first. Doing social media, and certainly doing social media “right” takes time and energy, and my sense is that the ROI payoff for most is modest at best. It will take more time than you think, and likely return less than you hoped—and that’s time away from the business of running your business. If you’re not focusing on the business end of your business, no amount of two-minute TikTok videos (however captivating) is going to help that. Let me repeat—first things first. Unless, of course, you plan to get into the business of teaching folks how to do social media.  

If you’re going to do it, do it right. That means having something interesting to say, something worth sharing. Share it regularly—and professionally. This is about building a brand (you). But remember you’re marketing you and your expertise—not a product. You know how you fast forward past the commercials on a DVR? People will scroll past sales pitches even faster (though LinkedIn may still count that as a “view”).

Set reasonable, modest goals. I have had the benefit (inherited, for the most part) of a large and widespread email audience for more than two decades now (though I hope I’ve since earned and expanded on that). My expectations for social media engagement were (and remain) high, likely too high, compared to email clicks and opens. Know that going into it you probably won’t get much, if any, in the way of “return.” 

Nurture the engagement you do get. Like, share, forward—but by all means COMMENT as you do on the content you see as valuable. It will be good for your visibility, likely expand your network—and it will keep you engaged with topic(s) you care about. It’s also good for your “shelf life.”        

Remember that you don’t need to do it. Honestly, my sense is that most of the folks you ostensibly want to reach (clients and prospects) aren’t (yet) spending a lot of time on LinkedIn (or Facebook, or Twitter, or even TikTok—at least not intentionally). Doing it before you’re ready will be counter-productive at best, and if your clients—prospective or current—aren’t “there,” do you really need to be?  If you’re not yet ready—don’t. 

After all, there are plenty of advisors enjoying a great deal of success today…without relying on social media.

- Nevin E. Adams, JD

 

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[i] For those of you who like more words, “What’s more effective, a post on LinkedIn with 11 likes and one comment from your co-worker or good old-fashioned marketing concepts like strategic partnerships, custom emails, networking, webinars, mailings, events, email blasts, client referrals programs, etc.? For most of you, the latter will crush 100% of the time when talking about actual ROI.”

[ii] And if you’re unaware of the “hub-bub” about which I started this piece, you are proving my point.

Have You Hugged Your TPA Today?

If you work with TPAs—third party administrators—you might want to avoid bugging them this week. 

As you may well know (certainly if you work with TPAs), this year, Monday (Oct. 17th) is the deadline to file Form 5500s, and for most TPAs, that’s a pretty all-consuming focus. So much so that every year on the day AFTER the Form 5500 filing deadline, John Hancock declares an annual day of recognition for TPAs. 

Now, to its credit, John Hancock goes so far as to note that National TPA Day is also a reminder to financial professionals (especially those still getting established) that partnering with TPAs may be an important pathway to success. Not that everyone feels that way, of course.

I’m talking about the disconnects in focus between retirement plan advisors and TPAs—an issue that is, perhaps, as old as ERISA itself—this “tension” between these two critical roles. Not in every case, of course—there are plenty of advisors that will tell you how many times their TPA partner has gotten them out of a real mess, and TPAs that will commend the leadership demonstrated by their advisor teammate. But that, it seems, isn’t the majority experience, though it proves it can be that. 

As it turns out, I’ve spent some time on both sides of that “divide,” and a fair amount of time able to observe both from a distance. I’ve listened to groups of TPAs gripe about advisors who “won’t stay in their lanes”—and advisors frustrated with TPAs who, when asked what time it is, insist first on explaining how a watch is made. I can remember personal experiences trying to explain complex plan design decisions with real-world implications—only to have the decision-makers decide it was time to step out for the equivalent of “brandy and cigars” with the plan advisor, leaving the decisions—undecided.   

The beauty of these times—and our associations—is that I was able to reach out on an ad hoc basis to folks that I knew could also appreciate both sides of the “debate,” and who cared enough to try and do something about it. This core group—Mary Patch, Chad Johansen, JD Carlson, Shannon Edwards, Justin Bonestroo & Amanda Iverson—have given up a LOT of their time and energy over the past many months to this undertaking. COVID helped in some ways—nobody was travelling as much, and we’re all now well accustomed to meeting virtually to solve problems. 

Our collective sense was that what makes the difference in these relationships is having a shared set of goals and expectations, alongside role clarity and confidence in the perspectives and expertise of the partner(s). We started with posts that have run on NAPA-Net on a monthly basis beginning last year (links below), came to something of a crescendo with a special TPA panel at the 2022 NAPA 401(k) Summit, and ultimately culminated in a checklist of sorts that you can find here. Think of it as a relationship pre-screener.

That checklist alone (and we’re hoping you’ll reconsider Compliance Administrator or Compliance Consultant as replacements for that awful TPA moniker) won’t solve all communication/expectation issues, but we hope it will be a solid foundation to open a dialogue. At its most basic, it should allow you to find out what services potential (or current) TPA partners provide, which are standard to their practice(s), and which are “extra.” But ultimately—and most significantly—it is designed to align expectations. 

There may well be things on this list of which you are unfamiliar—if so, this would be a good time to find out more about them, as I assure you, they are important, and SOMEBODY should be attending to them.  The core team is now working on some background explanations—if some jump out at you for a quicker explanation, please let me know. I—and indeed the entire core team—would love for you to begin using this checklist in your partner discussions—and to let us know what works—and of course, what doesn’t in the days and weeks ahead.

My undying thanks again to the core team for the love, humor, friendship and passion on this effort–– and to about a dozen advisors (you know who you are) who provided some terrific insights and perspective as the checklist neared completion. 

And ultimately to you, gentle reader, for helping us build this bridge…

- Nevin E. Adams, JD

Finding the Right TPA Partner

Bundled Versus Unbundled: 5 Myths

Resource ‘Full’?

What’s in a Name?     

(What Is) The Most Important Retirement Number

 What’s the most important number when it comes to retirement?

Once upon a time it might have been considered to be “65”—that traditional age for retirement—but even though it’s the default in many retirement calculators, until recently it hadn’t even been the most common age for actual retirement. Heck, it’s not even “good enough” for full Social Security benefits these days.[i] 

Perhaps a more precise focus number in retirement planning is the one that purports to provide some level of financial security in retirement[ii]—indeed, some years back there was a commercial that prompted folks to determine their “number”—a reference to a financial result that was deemed necessary to “retire the way you want” (and perhaps when you want, though that wasn’t part of the “pitch”).

But while that was (and is) “A” number, in order to get to it, for it to have any semblance of actually fulfilling that promise (premise?), you had to first get to several other numbers; how long you expected to live in retirement is a big one—and one dependent on another number, the age at which you planned/hoped to retire—not to mention how much you expected to need in order to live in retirement.  And that, generally, if somewhat unartfully, is typically considered to be dependent on yet another number—a percentage of the amount you lived on PRE-retirement—all of which might well turn out to be dependent on yet another number—the financial resources available to you. And that likely turns out to be a product of several other numbers—personal savings, pensions, Social Security—and yes, that’s even more math, as those often depend on other…numbers, as they are impacted by markets, taxes, drawdown rates, etc... 

Little wonder that surveys show that so many haven’t made even a single attempt to make that retirement readiness assessment—and that includes “guessing” at it.

Well, for my money (literally) there may not be one single most important number about retirement, but if you’re ever going to have decent shot at achieving a modicum of the peace of mind that long-term financial security provides, you need to have at least a sense of things, a reality “check” if you will. To that end, the Plan Sponsor Council of America’s annual 401(k) Day[iii] education campaign is a great place to start in terms of pulling together the numbers that will both tell you how much you need—as well as the all-important how much you have—to do the math, to—in the words of this year’s 401(k) Day campaign—“know your numbers.”[iv]

Let’s face it, if that most important number is when can you afford to retire—or at least to not have to rely on a regular paycheck—well, it may feel like you need a crystal ball—but you’ll have a better shot at accurately predicting that future if you start with some sense of not only where you want to be (and when), but where you are. 

So, whether you’ve never done “the math”—or done it a zillion times—this 401(k) Day it’s worth taking another look—to make sure things (still) add up—and to do that, you first need to know the numbers—your numbers—the most important number of all. 

- Nevin E. Adams, JD 

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[i] https://www.ssa.gov/benefits/retirement/planner/agereduction.html

[ii] Though these days I suppose that is more accurately described as that point in life when you no longer depend on a regular paycheck. 

[iii] For the past several years, the day after Labor Day has been designated 401(k) Day (yes, there’s a tie-in with labor/workers, but just as significantly, the Employee Retirement Income Security Act (ERISA) was signed into law by then-President Ford on the day after Labor Day in 1974).

[iv] For plan sponsors[iv]—and those who support their efforts—the campaign also brings forth some important numbers about the retirement plan that has been, and will likely continue to be, such an integral component of the financing of those longer-term goals and aspirations. Significantly, along with benchmarking resources like PSCA’s Annual Survey of Profit-Sharing and 401(k) Plans, it can also help you assess how your plan and plan design matches up against—well, the “competition.”

‘Standing,’ Still

Our industry has long fretted over how 401(k) participants will respond to volatile markets. And perhaps not surprisingly, these days the headlines are, generally speaking, full of “stay the course” assurances.   

That said, as recently as a month ago the headlines—even OUR headlines read things like “Light 401(k) Trades in July Even as Wall Street Posts Strong Month, Hot July Brought Cool 401(k) Traders, July Brings Much-Needed Calm to 401k Trading Activity, 401(k) Trading Light in July Despite Market Gains.” As though this is a surprising result.

In fact, as long as I can remember, our industry (or at least its headline writers) has long been somewhat amazed that participants have been as “resilient” in the face of volatile markets as they have—consistently—been over time. We’ve rationalized that ostensibly rational behavior in different ways, at different times. In 1987 (before there was daily trading in 401(k)s) it was said that the markets had come back before participants (via those once-a-quarter transfer windows) had a chance to respond. In 2001-2002, we told ourselves that our brilliant education programs (not to mention the ubiquitous “stay the course” messages) had an impact. In 2007-2008, we comforted ourselves with the notion that there was nowhere (else) to go (granted, that wasn’t really comforting).

Today—though it’s not really mentioned—I’d like to believe that it has something to do with the shift to professional asset allocation products[i]; target-date funds and managed accounts. After all, haven’t we told participants that the purpose of these platforms was to leave the business of investing to the professionals?

But whatever rationale we may want to apply, the reality has always been that there’s not much trading activity in 401(k) accounts, even during periods of extreme volatility and concern. This is routinely borne out by annual reports from Vanguard and Fidelity, and more frequently tracked (on a monthly basis) by Alight[ii]. Inevitably the commentary commends those who “stay the course,” because those who do transfer monies tend to “lock in” their losses, selling low and buying high. Those who do transfer serve as cautionary tales—perhaps even reassuring the participants who, once again, failed to do anything.      

The reality is that participants, generally speaking, aren’t really qualified to make these kind of investment decisions, particularly during periods of extreme volatility. Let’s face it, even the best self-directed investors typically have a day job that doesn’t allow the time or inclination to keep up with the markets, or the trends that underlie them (not to mention that some of those great investing ideas at 10:00 AM fade by the time that fund trading actually occurs at the market close). The advent of daily valuation allowed us to make quick, if not always wise, decisions—but, thankfully, most don’t. 

The bottom line is that while the counsel provided participants during times like these is generally “stay the course”—that counsel is valid only if the course you’re on was correct in the first place. 

  - Nevin E. Adams, JD

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[i] Indeed, Vanguard notes that in 2021, only 3% of all pure target-date fund investors made an exchange, a rate nearly five times lower than all other investors.

[ii] The Alight 401(k) index recorded 7.5 times normal trading on Feb. 22 as Russian troops massed near the Ukraine border, 2.9 times normal trading the next day, and 6 times normal trading on Feb. 24 when the invasion began.  But “normal” is “when the net daily movement of participants’ balances, as a percent of total 401(k) balances within the Alight Solutions 401(k) Index™, equals between 0.3 times and 1.5 times the average daily net activity of the preceding 12 months.” Vanguard’s assessment of 2021 activity is that only 8% of participants traded, and just 4.3% did in 2022 (through June 30) while Fidelity says just 5% did (and 85% of those only did so once). Principal reported 2.44% traded, according to a MarketWatch report.   

5 Dangerous Fiduciary Assumptions

There’s an old saying that when you assume… well, here are some assumptions that can create real headaches for retirement plan fiduciaries.

Assuming that the worst-case deadline for depositing participant contributions IS the deadline for depositing participant contributions.

The legal requirements for depositing contributions to the plan are perhaps the most widely misunderstood elements of plan administration. A delay in contribution deposits is also one of the most common signs that an employer is in financial trouble—and that the Labor Department is likely to investigate.

Note that the law requires that participant contributions be deposited in the plan as soon as it is reasonably possible to segregate them from the company’s assets, but no later than the 15th business day of the month following the payday. If employers can reasonably make the deposits sooner, they need to do so. Many have read the worst-case situation (the 15th business day of the month following) to be the legal requirement. It is not.

Assuming that not being required to have an investment policy statement means you don’t need to have an investment policy.

While plan advisers and consultants routinely counsel on the need for, and importance of, an investment policy statement (IPS), the reality is that the law does not require one, and thus, many plan sponsors—sometimes at the direction of legal counsel—choose not to put one in place.

Of course, while the law does not, in fact, specifically require a written IPS—think of it as investment guidelines for the plan—ERISA nonetheless basically anticipates that plan fiduciaries will conduct themselves as though they had one in place. And, generally speaking, plan sponsors (and the advisors they work with) will find it easier to conduct the plan’s investment business in accordance with a set of established, prudent standards—if those standards are already in writing, not crafted at a point in time when you are desperately trying to make sense of the markets.

In sum, you want an IPS in place before you need an IPS in place.

Assuming that ERISA’s required fiduciary bond covers your liability as an ERISA plan fiduciary. 

These are two very different things with similar names. Suffice it to say that the Fidelity Bond required by ERISA protects the plan and its participants from potential malfeasance on the part of those who handle plan assets. The plan is the named insured in the fidelity bond. 

On the other hand, Fiduciary Liability Insurance typically protects the plan’s fiduciaries from claims of a breach of fiduciary responsibilities—an important protection since ERISA plan fiduciaries have personal liability, not only for their actions, but for the actions of their co-fiduciaries. The cost of the insurance can be paid by the employer or by the plan fiduciary—but not from plan assets.

Assuming that hiring a fiduciary keeps you from being a fiduciary.

ERISA has a couple of very specific exceptions through which you can limit—but not eliminate—fiduciary obligations. The first has to do with the specific decisions made by a qualified investment manager—and, even then, a plan sponsor/fiduciary remains responsible for the prudent selection and monitoring of that investment manager’s activities on behalf of the plan.

The second exception has to do with specific investment decisions made by properly informed and empowered individual participants in accordance with ERISA Section 404(c). Here also, even if the plan meets the 404(c) criteria (and it is by no means certain it will), the plan fiduciary remains responsible for the prudent selection and monitoring of the options on the investment menu (and, as the Tibble case reminds us, that obligation is ongoing).

Outside of these two exceptions, the plan sponsor/fiduciary is essentially responsible for the quality of the investments of the plan—including those that participants make. Oh, and hiring a 3(16) fiduciary? Still on the hook as a fiduciary for selecting that provider.

Assuming you have to figure it all out on your own.

ERISA imposes a duty of prudence on plan fiduciaries that is often referred to as one of the highest duties known to law—and for good reason. Those fiduciaries must act “with the care, skill, prudence and diligence under the circumstances then prevailing that a prudent man acting in a like capacity and familiar with such matters would use in the conduct of an enterprise of a like character and with like aims.”

The “familiar with such matters” is the sticking point for those who might otherwise be inclined to simply adopt a “do unto others as you would have others do unto you” approach. Similarly, those who might be naturally predisposed toward a kind of Hippocratic, “first, do no harm” stance are afforded no such discretion under ERISA’s strictures. That said, the Department of Labor has stated that “[l]acking that expertise, a fiduciary will want to hire someone with that professional knowledge to carry out the investment and other functions.”

Simply stated, if you lack the skill, prudence and diligence of an expert in such matters, you are not only entitled to get help—you are expected to do so.

- Nevin E. Adams, JD

A Guide Path for Your Glide Path(s)

A recent report—and a new wave of litigation—reminds us that all target-date funds are not designed the same. 

We all know that target-date funds are different, even if their names sometimes suggest otherwise.  Different management teams both set and monitor asset allocations—allocations that can vary widely with regard to the type and quantity of underlying assets. Fees can certainly be different, and some favor a reliance on passive investing versus an active engagement. But the difference that can often account for many of the other differences is the glide path, and more specifically the glide path’s “goal”—and here I am referring to the difference between funds that opt for a “to” retirement versus a “through” retirement focus. 

Now, admittedly it’s a “target date” fund, not necessarily a retirement date fund—and indeed if those were once upon a time considered one and the same, that’s apparently no longer the case. Indeed, and as a recent stream of litigation reminds us, the largest target-date fund providers these days are nearly all in what we call “through” retirement date funds, meaning that their glidepath is designed to carry you past the traditional retirement date “through” to the end of your life.

That’s not an illogical approach—after all, once you get to 65, your odds of making it to 85 (or beyond) are surprisingly good, and two decades is a lifetime[i] (and then some) when it comes to investment time horizons. Indeed, and without question, target-date funds have been a godsend for millions and millions of individuals who are time-pressed and lacking in investment expertise. Let’s face it, even those who have a fair degree of investment acumen find it challenging to keep up with the demands of personal portfolio management alongside the demands of a daily schedule. 

That said, a recent Morningstar whitepaper cautioned (in its title, helpfully) “Plan Sponsors May Not Always Consider Participants’ Behavior or Needs When Selecting Target-Date Glide Paths.” That paper cautioned that “through” glidepaths generally include around 13 percentage points more in equity at age 65 than their peers invested in “to” glide paths, as the average “through” series holds 46% in stocks versus just 33% for the average “to” series. That makes them riskier (or at least more volatile), and potentially riskier than those defaulted into those options may know—or desire.

Therein lies the rub—the Morningstar paper also reminds us that nearly a decade ago the Labor Department provided some "Tips for ERISA Fiduciaries" regarding target-date funds. Tips that included the importance of “Establish[ing] a process for comparing and selecting TDFs,” under which the Labor Department suggested that plan fiduciaries “… should consider how well the TDF’s characteristics align with eligible employees’ ages and likely retirement dates. It also may be helpful for plan fiduciaries to discuss with their prospective TDF providers the possible significance of other characteristics of the participant population, such as participation in a traditional defined benefit pension plan offered by the employer, salary levels, turnover rates, contribution rates and withdrawal patterns.”

Considering the variety of workforce demographics, and the relatively small number of target-date providers garnering the majority of money flowing into TDFs, it seems unlikely that many plan sponsors have yet really focused on the Labor Department’s tips, specifically with regard to questions of demographic alignment with the TDF glidepaths. For those who haven’t, it’s certainly worth a (re)consideration. 

And while you’re at it, it might be a good idea to make sure that it’s aligned with the communication and education to the participants who’ve been placed upon them.

- Nevin E. Adams, JD

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[i] More cynically perhaps, one can understand and appreciate the interests of those designing the glidepaths in assuming that those invested there would choose to continue to retain that investment expertise, rather than cycle it down and reinvest in a completely different asset class.

‘Damned’ (Even) If You Do

 The flurry of lawsuits unleashed on holders of the BlackRock LifePath target-date funds is not without precedent—but it’s surely a head scratcher.

I’m referring, of course, to the recent swarm of lawsuits challenging nearly a dozen of the nation’s largest 401(k) plans and their decision(s) to select, and hold, on their investment menu the BlackRock LifePath target-date fund suite. It’s a decision that the Shah Miller law firm (on behalf of multiple ex-participant plaintiffs) says was the result of fiduciaries who “chased low fees” over performance.[i]

Of course, it’s not unusual for these types of lawsuits cite obscure articles as authority, rely on Form 5500 data that often doesn’t tell the whole story, state as fact things that are really only theories (or opinions), lean on averages, or base comparative conclusions on surveys distorted by sampling size or content. 

But in a characterization straight out of George Orwell’s 1984, this one draws straight from a point of analysis that, to my eyes, anyway, seems to say one thing while the plaintiffs’ attorneys claim to see something completely the opposite. “War is peace,” if you will.

Setting aside for a minute the reality that performance isn’t necessarily indicative of an imprudent process[ii]—and that it’s been far more common over the past two decades for fiduciaries to be challenged on the allegedly “excessive” fees than performance (though the latter is often tagged on to the fee claim), the plaintiffs here have challenged the selection of a fund suite that Morningstar has identified as among the “best” in that category—run by an “innovative team with topnotch resources.”

Nor is the Morningstar evaluation irrelevant here—indeed, the plaintiffs lean heavily on it to draw their conclusions of poor performance, though they do so primarily by challenging the benchmark, insisting that the suite be benchmarked against other target-date suites—despite their striking difference in focus and glidepath. See, the BlackRock series operates with a “to” retirement date focus, rather than the “through” retirement focus that most others in this space have now embraced (and all of the ones the plaintiffs point to). That means, of course, that the asset allocation, certainly in the components nearing retirement age, are more conservative than those that are managing for 20-30 years beyond that. And—in bull markets, anyway—more conservative often means lower performance. On the other hand—and certainly if your goal is to wind down your investment risk as you approach retirement… and here one can’t help but remember 2008… (not to mention 2022…) 

Not that the BlackRock glidepaths are overly conservative—in fact, the Morningstar commentary (and the lawsuits that cite it) acknowledge that for newer target date funds—those for younger investors—BlackRock’s have tended to be more equity-laden, at least compared with those the plaintiffs would have serve as its benchmark. This lawsuits seem to mistake this difference for some kind of “equity discrepancy,” rather than a deliberate, thoughtful glidepath, one oriented to do what all target-date funds once claimed to—to move to more conservative asset allocations as one neared the target date (and, arguably still do, though the “throughs” have a different endpoint in mind). 

There is, of course, a certain tendency among plan fiduciaries to seek the comfort of the pack in making plan design and investment decisions—which is understandable when one considers the personal liability that comes with that assignment. But these suits seem to create a not-so-subtle inference that any glidepath that varies from the through retirement “pack” is going to be viewed as imprudent—not based on a bad or unreasoned theory, but rather based on a specific time window when certain strategies simply don’t match those of different philosophies. 

So, how is this particular approach constructed? The analysts at Morningstar see it this way: “This index-based series benefits from BlackRock’s robust approach to asset allocation and a research-intensive culture. They keep costs low by investing exclusively in passive index funds, though this gives management fewer tools to outperform over shorter periods compared with more active strategies that can tactically tilt the portfolio or select talented active managers. Yet, the team continues to innovate, with current research looking at ways to get targeted fixed-income exposures across the glide path.”

The report goes on to note that, “Continuing to revisit prior assumptions and make proactive changes that are backed by rigorous research gives us confidence that the team will continue to evolve the series over the long term to investors’ benefit.”

Little wonder then that the BlackRock suite winds up with a “gold” Morningstar Analyst rating. 

What’s harder to figure out is why the plaintiffs’ bar decided to take to task the large plans and plan fiduciaries that opted for this suite and approach. 

Well, perhaps except for the obvious.

- Nevin E. Adams, JD

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[i] There were other allegations that varied with the plan targeted, but the LifePath funds and performance was the dominant claim.

[ii] At this juncture we have no way to know what processes, if any, the charged plan fiduciaries have in place to provide the prudent process and review required of plan fiduciaries—not that the plaintiffs have kept that from inferring its absence. 

Could ESG Options Undermine Participant Outcomes?

Despite surveys to the contrary, a new study finds that overall interest in ESG strategies by participants is “relatively weak” and “driven by naïve diversification.”

The difference may, of course, be attributed to the difference between what individuals say—and what they actually do. Unlike surveys that purport to capture participant (and plan sponsor) sentiments, the research by David Blanchett of PGIM and Zhikun Liu of the Employee Benefit Research Institute (EBRI) looks at the actual allocation decisions of 9,324[i] newly enrolled DC participants who are self-directing their accounts in a DC plan that offers at least one ESG fund. 

‘Weak Preferences’

They do so in a paper titled “ESG Fund Allocations Among New, Do-It-Yourself Defined Contribution Plan Participants,” they claim to find that overall interest in ESG strategies among these participants is “relatively weak,” with only 8.9% of participants having any allocation to an ESG fund and average allocations to ESG strategies of just 18.7% among those holding any ESG funds.[ii] Indeed, while they note “some clear demographic preferences for ESG funds (e.g., among younger participants with higher incomes),” they find that ESG allocations appear to be “primarily a function of weak preferences, driven by naïve diversification.”

Now, that hardly sounds like the heightened interest and engagement with those options that some participant surveys have captured (well, aside from that by younger participants with higher deferral rates and higher incomes). However, the research claims that the two factors which appeared to drive the largest allocations to ESG funds were not related to participant demographics, but rather the number of funds in the participant portfolio and the percentage of participants in the respective DC plan allocating to an ESG fund. 

If that seems a confusing descriptor, they found a “notable increase” in the probability of owning an ESG fund as the number of portfolio holdings increases—basically, the more funds the individual holds, the more likely he or she is to have an ESG offering among them. This tendency they characterized as attributable to “naïve diversification”—again, basically, if you’re simply picking a larger number of funds overall, then they concluded that the decision to allocate to the ESG fund is “likely based on a weak preference, not necessarily conviction in ESG.” Said another way, if you’re picking a lot of different funds, the more you pick, the better the odds that an ESG fund will (randomly) be among them.

On the other hand, those looking for a more optimistic future for ESG might take heart from their conclusion that “the fact ESG allocations increase as more participants in a plan allocate to ESG funds suggests plan interest effects could be an especially strong driver of future growth in ESG funds (despite relatively low usage today).” In fact, they noted a “notable plan interest effect, whereby ESG allocations are significantly higher in plans where general ESG usage is higher.”

Plan Sponsor Cautions

That said, the current decision-making by those participants appears to be “sub-optimal” (worse than you might expect) from a return standpoint—with the researchers here basically finding that participants who self-direct their portfolios have significantly lower expected returns than those using professionally managed investment options, such as target-date funds—something that proponents of professionally managed asset allocation solutions shouldn’t find surprising. To put it another way, those more likely to pick ESG funds are more likely to be the “do it yourself” (DIY) types—and those don’t do as well as those professionally managed solutions. This, as the researchers point out, can be an “important consideration for plan sponsors when adding ESG funds to the core menu to the extent they entice participants to self-direct their accounts.” So, adding an ESG fund might encourage more DIY investing by those interested in ESG—and that interest pulls them away from the professionally managed, higher-returning alternatives.   

In fact, an additional analysis suggests that those DIY participants have expected returns that are approximately 100 basis points lower than investors using professionally managed portfolios, such as target-date funds and managed accounts. And this, the researchers comment, suggests that adding ESG funds to core menus may create additional implicit return “costs” for participants—by adding those options that encourage participants to make choices other than professionally managed multi-asset options (e.g., target-date funds).[iii]

Overall, the researchers comment that their analysis paints a “mixed picture about the actual participant interest, and drivers of demand, for ESG funds in DC plans and suggests that plan sponsors should take a thoughtful approach when considering adding ESG funds to an existing core menu.”

Or—it seems fair to say—when adding (or subtracting) any funds at all.

- Nevin E. Adams, JD

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[i] Of the 9,324 participants included in the dataset, only 833 had some allocation to an ESG fund, which is 8.9% of the total.

[ii] Among participants with an allocation to an ESG fund, the average allocation was 18.7%, with a standard deviation of 19.0%. The total average balance allocation to ESG funds is 1.7% (including all participants). There are only 56 participants (0.6% of the total) with ESG allocations greater than 50% of their balance and only 19 participants (0.2% of the total) with 100% of their balance in ESG funds. “In other words, even among participants who select the ESG funds, they almost always play a relatively supporting role as part of the overall portfolio.”

[iii] Some of the issues here are no doubt a consequence of current menu constructions. In the sampling studied, no plan offered more than five ESG funds, and the vast majority (approximately 76%) offered only one ESG fund. “This suggests it would be relatively difficult to build a diversified portfolio using only the ESG funds in DC plans currently,” the authors note. Moreover—and adding to the reality that it is “relatively difficult to build a truly diversified portfolio using only ESG funds”—they explain that roughly half of all ESG funds available are large blend funds. Only 13 of the funds (8.7% of the identifiable category total) are fixed income funds, and only 12 (8.1% of the identifiable total) are balanced funds. “The difficulty associated with building a diversified portfolio with only ESG funds has important implications on overall portfolio efficiency. If allocating to ESG funds requires participants to opt out of using a professionally managed portfolio option (e.g., target-date funds or retirement managed accounts), it may negatively impact future expected returns”—a cost the authors say they plan to quantify in a future work.