A PEP-spective on Fiduciary Reviews

  Some months back, the Labor Department published an intriguing three-part “proposed rule” that, to my eye, offered helpful fiduciary tips that go well beyond pooled employer plans (PEPs).

The title alone — “Pooled Employer Plans: Big Plans for Small Businesses” — told you all you needed to know about the motives behind the publication. And, true to form, both the data provided on the current state of pooled employer plan adoption and the focus of the request for information (RFI) included were very much in the spirit of removing barriers to PEP adoption, if not outright promotion of the same.

But what I viewed as the third part of the publication (though it’s labeled V. Fiduciary Tips for Small Employers Selecting a PEP) was, to my eye, the most intriguing aspect, in no small part because it served as a valuable reminder that there ARE fiduciary considerations in making that choice — something that purveyors of that option have been known to gloss over.

As I was recently scanning these — it occurred to me that these admonitions could — and should — be broadly applied to pretty much any new plan option — and not just for small employers.

To that end, consider the following as a fill-in-the-blank template, replacing the word PEP with, say — alternative investments, cryptocurrency, retirement income, or a managed account. Consider:

The Considerations

1. Consider what ________ [i] has to offer you and your employees.

The PEP-focused explanation emphasizes an opportunity to leverage economies of scale, as well as to free up time for plan fiduciaries to run their business “…while simultaneously providing your employees with an opportunity to save and achieve retirement security.”  While that buries the lead a bit, it’s a reminder that your actions need to be prudent and in the best interests of plan participants and beneficiaries” — but mostly a reminder to consider the benefits and costs of the service(s) under consideration.

• Make sure you understand the type of ____________ under consideration.

The PEP-focused explanation notes that, while this option has certain things in common, they aren’t all the same, and don’t operate in the same way — that plan fiduciaries should consider the needs and best fit, and the importance of considering several before making a choice. The same thing is true with pretty much every option that might be under consideration, as the labels retirement income, alternative investments, and managed accounts are widely applied to very different products and operational considerations.

• Make sure you consider the experience and qualifications of the _______.

While the pooled plan provider (PPP) is mentioned here, every service offering is delivered by a provider of some type, and as this tip reminds, “understanding the experience and qualifications” of this entity “…is one of the most important — if not the single most important — aspects….” That means you need to ask and understand “questions relating to the quality of their services, customer satisfaction, prior litigation or government enforcement matters…” as well as “the number of employers and participants in the plan and the amount of its assets….” Basically, you want to make sure that the entity is capable — and has a track record — to fulfill the promises that have been made, and the needs of your plan.

• Make sure you ask questions about ________ fees.

This one really doesn’t need any more explanation, other than a reminder not only to find out what the fees are and who pays them, but also who is getting paid, notably any third parties — or third parties that might be providing compensation to the provider you’ve hired.

• Make sure you understand the investment options.

Of course, for some of the possibilities noted above, this (alternative investments, crypto) is the investment option under consideration and definitely should be understood. Ditto retirement income, which comes in many shapes and sizes (and was recently included in the executive order regarding alternative investments).

• Ask questions about your exposure to fiduciary liability for investments.
• Ask questions about your exposure to fiduciary liability should you join _____.
• Don't forget to monitor ________ on an ongoing basis.

One of the interesting call outs in the PEP document was that “under federal law, employers joining a PEP are legally responsible as fiduciaries for the proper selection of investment options for their employees unless the pooled plan provider hires an investment professional to act as a fiduciary with respect to investment selection.”  Interesting in that, again, some of the purveyors of those options have tended to gloss over/downplay this aspect.

That said it’s good to remember that, barring some kind of special provision, you are personally liable for the prudent selection and ongoing monitoring of all plan investments and services. All of which are embodied in the three tips listed above.

• Make sure you fully inquire about the implications of exiting _____.

I’ve heard it said that it’s a lot easier to get INTO a PEP than to get out of it (though that may just be a nasty rumor, and is doubtless a function of the PEP you have gotten into) — but the same could apply to any number of the other services outlined above, notably retirement income and alternative investments.

The tip here notes that it’s good to ask about any timing or penalty-imposed restrictions from a PEP, but similar impediments might, of course, be found with retirement income or different types of alternative investments. The bottom line here is that while you may not need to exercise an “exit” strategy, you need to know what the implications for the plan and participants would be if it came to that.

In Sum

So there in a nutshell you have it. For any/every product service being considered, make sure you know what benefits/costs it brings to the plan/participants, the capabilities/sustainability of the entity providing it, the fees (and who’s getting them), the process/costs for exiting — and that you have an ongoing personal liability/responsibility for monitoring the services, once engaged.

• Nevin E. Adams, JD

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[i] Just fill in the blank with the applicable service/product under consideration: managed account, retirement income, alternative investments, crypto, etc.

Between a Rock and a Hard Place

  Plan fiduciaries might well have gotten a case of severe whiplash last week.

I’m referring of course to the dual announcements from the Labor Department (a) rescinding its previous position on cryptocurrency in retirement plans and (b) indicating  that it in some fashion plans to review/change the current so-called ESG rule through a formal regulatory notice-and-comment period — presumably rather than defend the current version which had been challenged in court. That, and any day now it’s expected that the Administration will (similarly) soften, if not shift, its previous take on private equity investments in defined contribution plans.

Doubtless many are cheering these new developments; others, of course, will see this as either a danger, or a diminution of fiduciary responsibility. And some, surely, will like one, but not the other. 

Regardless, if you’re a plan fiduciary trying to figure out what is right and prudent to consider as plan investments — well, by any rational measure these shifts are abrupt, if not contradictory in effect if not purpose.   

Now, admittedly the world has changed since the Labor Department first staked out positions on these matters — markets have matured, definitions (notably ESG) have “evolved,” and while time inevitably allows us to review past experiences in a different light — we all know what has actually happened is that the Trump Administration looks at the world of retirement plans (and markets generally) differently than the Biden or Obama and even the Bush Administration(s). And even if the standards of conduct established by ERISA haven’t changed, the application of those standards apparently has. Yes, over the course of time and experience, as you would hope/expect, but more accurately over the course of change in administrations.

Worse, we live in a time when the plaintiffs’ bar — without a hint of irony — manage to find fault both with failing to add a stable value option, and the decision to add one rather than a money market alternative, to challenge as imprudent target-date funds that don’t mirror the (different) glidepaths of the rest of the “pack,” or to claim that following the legal terms of the plan document in forfeiture dispositions runs afoul of one’s fiduciary obligations. 

Add to that the growing industry chorus that a less-than-active consideration of mechanisms like in-plan retirement income constitutes a failure to consider “best interests” — and it’s no wonder that prudent plan fiduciaries feel themselves stranded in the middle of a “damned whether you do – or not” minefield.

The reality is that plan fiduciaries have always had to thread a needle of sorts; trying to act solely in the best interests of participants on matters in which they often lack the requisite expertise to make that evaluation — and in matters for which they bear personal responsibility. It’s why many do — and all arguably should — tap into the insights and experience of those who have that expertise. 

But in this “rock and a hard place” environment, you can’t fault plan fiduciaries for choosing to avoid or defer making big changes in plan design when the rules — and rule makers — change so abruptly.

• Nevin E. Adams, JD

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.”

A Thumb on the Scale(s)?

Years back I remember being part of a Q&A with a group of plan sponsors—the focus was the challenge of not only getting, but keeping their plans in compliance, while also looking for creative ways to engage and encourage participants. Then at one point, a tired looking gentleman, expressing frustration with the pressures of audits and litigation, said: “I wish the DOL would just tell us what to do.” 

I cautioned him at the time that he ought to be careful what he wished for—that he might just get it.

Sure enough, in mid-March the Labor Department issued a “compliance assistance release” which was unique both in format and, arguably, focus. It reminded plan fiduciaries of the significance of their review and assessment of prudence of plan investments—and then said in no uncertain terms that it had concerns about the ability of cryptocurrency to meet those high standards. Indeed, the release plainly stated that those who did include such options could “expect to be questioned about how they can square their actions with their duties of prudence and loyalty…”—not just as standalone options on the menu, but even through a brokerage account. And so, while not an outright prohibition, it seems fair to say that it’s likely to have what lawyers call a “chilling effect” on cryptocurrency as a 401(k) investment option.

In late December the Labor Department issued a statement on the use of private equity in participant-directed plans—stating that, except in a minority of situations, plan-level fiduciaries of small, individual account plans are not likely suited to evaluate the use of PE investments in designated investment alternatives (DIAs) in individual account plans. It represented a step back from a June 2020 information letter that affirmed that PE investments “as a component of a professionally managed multi-asset class vehicle structured as a target date, target risk or balanced fund” can be offered as an investment option for participants in defined contribution plans under ERISA. It seems likely that some private equity firms (or those promoting such investments) had taken the initial guidance as something of a green light to promote those options beyond the limitations of the original letter—leading the Labor Department to clarify its position—and, arguably, to shut down active consideration of those options, at least by “small, individual account plans.” 

And then, of course, there’s the focus on ESG options, which the Trump administration clearly tried to undermine with its proposed and then (slightly muted) final regulation—and which the Biden administration first announced that it would not enforce, and has since then, with its own proposed regulation, sought to swing the pendulum in favor of those options—arguably to the point of not only encouraging, but requiring, consideration of those factors.

The reality is, of course, that times change. And even if the long-standing precepts of prudence and fiduciary responsibility haven’t changed, the environment in which those determinations are made has. Cryptocurrency wasn’t a “thing” until fairly recently (and it didn’t take long to find its way into 401(k) platforms), and those who may have misapplied (accidentally or “on purpose”) the Labor Department’s statement on private equity needed to be reminded. ESG is certainly a relatively recent—though not brand new—focus—but plan fiduciaries can perhaps be forgiven for feeling a bit “whipsawed” by the shifting sentiments between administrations.

Generally well-intentioned, the perspective of even the most seasoned and expert regulatory professional sometimes fails to appreciate the impact in the “real” world. That’s the value in the access—and influence—that NAPA, armed with the input, insight and perspective of NAPA members, provides to these processes. Insight and influence that allows you to “put a thumb on the scale” in providing a practical and pragmatic perspective on the rules and regulations that guide our industry— now, and in the days ahead. 

- Nevin E. Adams, JD

p.s.: Speaking of which, this would be a great time to get involved via the NAPA DC Fly-In Forum. Check it out—and apply today—at https://napadcflyin.org.

'Hacking" Stances

A couple of Saturdays back I discovered that one of my online accounts had been “hacked.” 

The good news is that I “discovered” this via transaction emails confirming what appeared to be purchases—a half dozen of them… for various, small-ish (though not small) amounts… all about 4:00 a.m. on a Saturday morning. And trust me, while the pandemic has certainly fueled my online purchases, both the number and the timing were not normal behaviors (nor was the Chinese text in those emails).

The even better news was that I was able to flag those transactions via the provider—and via my credit card company—almost immediately (apparently the foreign hackers and I were the only ones awake at that hour). Even though there was no damage done by this incursion (aside from some temporary heartburn), it brought home to me again the importance of protecting all of my online accounts.

Like many, perhaps most, of you, I have long found managing the sheer volume of online passwords and varying criteria daunting. Oddly, the ever more complex (and varying) password requirements—different lengths, different combinations of caps, numbers and “special” characters, not to mention forced resetting of those passwords—has, if anything, tended to leave me being more casual than I should be regarding some of the practices I know are important. That said, and while I am far from a cybersecurity expert, I try to stay current on the latest advice from those who are—and trust me, it’s a moving target. 

As it turns out, the Labor Department recently issued a set of guidance on the issue of cybersecurity,[i] and while our more immediate focus here has been on the expectations of plan sponsor/fiduciaries, advisors and recordkeepers (particularly in view of the recent reports of Labor Department audits on these practices), my recent experience reminded me that it’s worth noting—and sharing here—the list of “online security tips” for participants included in that guidance. 

Use Strong And Unique Passwords

The most detailed of the tips is also perhaps the most important. The Labor Department recommends that you “use letters (both upper and lower case), numbers, and special characters”—which is increasingly mandated anyway—and to “use 14 or more characters.” We’re also advised not to use letters and numbers in sequence (like “1234” or “abc”), to change passwords every 120 days (or if there’s a security breach—p.s. you probably won’t hear about it until at least 30 days after it’s been detected), and—despite all these strictures—to not only not write it down, but not to “share, reuse, or repeat passwords.”

This is both the most obvious—and in my experience—most nettlesome of the recommendations. Of course, the more complicated the password, the less likely a hacker is to be able to “hack” it. And, unfortunately, the less likely you are to be able to remember it. I’ve seen suggestions on how best to manage this—most commonly these days (including from the Labor Department) the suggestion to use a password “manager.” 

But for those who find that process intimidating (or inconvenient), what I’ve found most useful is the idea of using phrases that are familiar or meaningful to you, but would amount to gibberish in a password field. Something like (for those who took typing classes in high school) “thequickbrownfoxjumped,” particularly if combined with some kind of numerical reference (perhaps “thequickbrownfoxjumpedh1.” You can also use a random combination of words like “fleetwoodChicago1978” (which happens to be when/where I saw Fleetwood Mac perform), or maybe a random combination of month and year (though avoid birthdates, anniversaries, and such)—perhaps something like “januarY2019” (I try to capitalize something other than the first letter). One other neat trick is to use spellings that may mean something to you, but aren’t in the dictionary—like dixshunary, or Septimber. 

The challenge, of course, will be remembering which (random) combination(s) you used for what. But if that leads you to write it down, keep that in a safe place—and don’t store it on your computer! 

Use Multi-Factor Authentication

The very first thing I did with the account that had been hacked (once I had reestablished control) was to set up multi-factor authentication. I have made a practice of doing this with all my accounts, and can only assume that years back, when I set up the account in question, they either didn’t have it available, or I considered it too much of a hassle to set up. No more.

Basically, this means that when you log on and/or initiate a transaction, the system requires the confirmation of a second credential. The most common set up would be to send you a code via text (to a phone number you’ve established on file) or to an email address. If you don’t have this set up yet on your online accounts—do it right away. It’s a life (and savings) saver. And always, always, always, be sure that you are set up to receive notifications any time your account or account information has been changed! Oh—and it bears noting here that the password to your email account is perhaps the most important—because if they hack your email account as well, they can intercept those confirmation emails, and delete them before you even know it has happened! 

Keep Personal Contact Information Current

Odds are the accounts you access with some frequency have current contact information. The problem is, retirement savings often don’t fall into the “with some frequency” category. Let’s face it, we’ve long been advised that we shouldn’t be constantly checking in on our retirement savings, but there’s nothing that says you can’t look without touching. Particularly if you have left some 401(k) balances “behind” with a prior employer.  

Close Or Delete Unused Accounts

It’s unfortunately not uncommon for folks to use the same password(s) for multiple accounts—but using those same passwords for accounts you don’t use (or perhaps don’t even remember using) and ones with current, and perhaps monetary implications, can leave you exposed. You may have gotten one of those (badly spelled) emails from individuals who claim to have accessed your webcam and/or planted some kind of “trojan horse” on your PC, and by way of proof—show you the password that they’ve stolen. While those kind of intrusions are certainly possible, odds are what they did instead was tap into your email—and password—from an old blogging account or such that you simply walked away from years ago. 

There are a couple of easy ways to check out your potential vulnerability—https://haveibeenpwned.com/ or https://monitor.firefox.com/. 

One the DOL ‘Missed’

Now, for all the value in the tips provided, there is some irony in one they missed—the importance of logging on to your 401(k) account(s) regularly. 

If you have an online account—and these days you may have more than one—and particularly following a change in recordkeepers (and with the recent wave of consolidation there’s been a lot of that[ii]), it is imperative to log on ASAP, and not only establish the unique password noted above, but also set up the multi-factor authentication, provide answers to key security questions, and make sure that you are set up for electronic notifications of any changes to your account. Did I say ASAP? I mean now. 

After all, if you don’t lay claim to that account—quickly—it’s all the easier for a hacker to do so.   

- Nevin E. Adams, JD

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[i] It’s worth acknowledging here that recently there have been numerous situations where plan fiduciaries have been sued for various account intrusions, including participant accounts at Abbott Laboratories (Split Decisions in 401(k) Theft Suit for Plan Sponsor, RK), Estee Lauder (Recordkeeper, Plan Sponsor Charged in 401(k) Account Theft), MandMarblestone Group (Court Backs TPA Counterclaim on Plan Sponsor in 401(k) Cyber Theft Case) and Boeing (Man Charged with Retirement Account Thefts).

[ii] As an additional note of caution, I have now had two of my 401(k) accounts converted (by and from different providers) without the beneficiary information. Now, sooner or later, should it become necessary, the paperwork I submitted once upon a time will surely suffice (and since my spouse is my beneficiary, it shouldn’t matter)—but it’s a good idea to double check such things while you are setting up that password, etc.

5 Things the DOL Wants You to Know About TDFs – That You May Have Overlooked

Target-date funds continue to expand in usage and popularity – but there are some things the Labor Department wants you to know about TDFs that you may have overlooked.

When the Labor Department published its “Target Date Retirement Funds – Tips for ERISA Plan Fiduciaries” in 2013, I was pleased to see it, and to discover that it could be read ¹ (and understood) in about 15 minutes.

But in preparation for a recent webcast on the topic, I took a fresh look at that document, and found some nuggets that I hadn’t really picked up on the first time around.

It’s Not Just About Fees and Performance

As part of a reminder about the importance of establishing a process for comparing and selecting TDFs, the Labor Department specifically references considering prospectus information, such as information about performance (investment returns) as well as investment fees and expenses.
However, in that same topic point, the agency says that plan fiduciaries should consider how well the TDF’s characteristics align with eligible employees’ ages and likely retirement dates, “as well as 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.”

‘To’ Versus ‘Through’ Matters

Considering what can be some pretty significant outcome differences in glidepaths between “to” (those that build to a specific target retirement date) and “through” (those that assume a glidepath to death), I’ve always found it curious that the Labor Department’s tips don’t make more of what seems a pretty big structural difference in these offerings.

While the “to” and “through” focus is covered in “Target Fund Basics” in the piece, under the bullet regarding “understand the fund’s investments,” the Labor Department’s information sheet notes that “some funds keep a sizeable investment in more volatile assets, like stocks, even as they pass their ‘target’ retirement dates,” going on to explain that “these funds” are generally for employees who don’t expect to withdraw all of their 401(k) account savings immediately upon retirement, but would rather make periodic withdrawals over the span of their retirement years. That approach is contrasted with the “to” version that the Labor Department says are “concentrated in more conservative and less volatile investments at the target date, assuming that employees will want to cash out of the plan on the day they retire.”

But what’s key here is the closing sentence: “If the employees don’t understand the fund’s glide path assumptions when they invest, they may be surprised later if it turns out not to be a good fit for them.”

Indeed.

Higher Costs Can Be Justifiable

It should come as no surprise that the Labor Department’s tips include an admonition about the need to be attentive to the impact of fees on retirement savings, and the structural layering typically associated with TDFs that can imbed layers of fees as well.

However, rather than merely condemning options that carry higher fees, here the Labor Department notes that, “If the expense ratios of the individual component funds are substantially less than the overall TDF, you should ask what services and expenses make up the difference,” going on to note that added expenses may be for asset allocation, rebalancing and access to special investments that can smooth returns in uncertain markets that “may be worth it.”

Custom TDFs Could Be Viable Alternatives

The Labor Department tips note that “a ‘custom’ TDF may offer advantages to your plan participants by giving you the ability to incorporate the plan’s existing core funds in the TDF,” and that “nonproprietary TDFs could also offer advantages by including component funds that are managed by fund managers other than the TDF provider itself, thus diversifying participants’ exposure to one investment provider.” It does acknowledge that there are some “costs and administrative tasks involved in creating a custom or nonproprietary TDF, and they may not be right for every plan.”

This “tip” was actually pretty plainly spelled out in one of the headlines – and yet, I remember thinking at the time that this wouldn’t be a very popular approach for most. But times are changing, technology continues to advance, and for advisors looking to differentiate themselves in the development of what is likely to become the largest plan investment, custom TDFs would seem to be a more viable solution than ever.

You Might Have to ‘Break Up the Set’

A TDF is, of course, a plan investment, and like any plan investment, if it fails to pass muster, a plan fiduciary would certainly want to remedy that situation, including removing the fund if necessary. That said, TDFs are frequently, if not always, pitched (and I suspect bought) as a package. While each fund in the family is reviewed separately, and certainly should be, breaking up the set certainly carries with it a series of complicated consequences, not the least of which are participant communication issues and glide path compatibility. Not that those can’t be overcome – and not that those complications would be deemed sufficient to retain an inappropriate investment on the plan menu – but it doesn’t take much imagination to think about the heartburn that might cause a plan sponsor.

However, as the Labor Department’s tips remind us, should a TDF’s “investment strategy or management team changes significantly, or if the fund’s manager is not effectively carrying out the fund’s stated investment strategy, then it may be necessary to consider replacing the fund.” That’s right – “the” fund. Similarly, the Labor Department cautions that “if your plan’s objectives in offering a TDF change, you should consider replacing the fund.” Again, note the use of the singular, not the plural.

Finally, one item not included in the piece – but arguably one that applies to every fiduciary situation – is that if you lack the requisite expertise to make the decisions as the prudent expert the law requires, you should engage the services of someone who has that expertise.

- Nevin E. Adams, JD

See also:

• 5 Things You Should Know About Target-Date Funds
• Target-Date Fund Misperceptions Abound

Footnote

1. The key bullets outlined in the DOL tips are simple and straightforward – and to my eyes pretty much fiduciary common sense. They included suggestions/admonitions to: (1) establish a process for comparing and selecting TDFs; (2) establish a process for the periodic review of selected TDFs; (3) understand the fund’s investments – the allocation in different asset classes (stocks, bonds, cash), individual investments, and how these will change over time; (4) review the fund’s fees and investment expenses; (5) inquire about whether a custom or non-proprietary target date fund would be a better fit for your plan; (6) develop effective employee communications; (7) take advantage of available sources of information to evaluate the TDF and recommendations you received regarding the TDF selection; and (8) document the process.