In order to receive the benefits of ERISA §404(c), plan fiduciaries must comply with certain requirements. The following recommendations will help advisors and plan sponsors evaluate their efforts.
- Fiduciaries should not “set it and forget it” when it comes to target date funds (TDFs).
Fiduciaries should follow an objective process to evaluate TDFs, understand the TDFs’ investments and fees, and periodically review them. Key areas of focus and questions to consider include:
- Review the fund lineup to ensure it includes a review of the funds included in the TDF and the individual managers that oversee the TDF. When considering a pre-packaged product offered by an investment firm that may also serve as the plan recordkeeper in bundled situations, examine whether the TDF comprises only proprietary funds of a single firm. Don’t fail to compare other available options without proprietary funds.
- “To” versus “through” matters. Off-the-shelf TDFs are not customized to the specific circumstances and characteristics of particular plans. Decide whether the TDFs’ glidepath of “to retirement” or “through retirement” is appropriate. Consider, for example, participants’ contribution and withdrawal patterns, the average retirement age, and the existence of other benefit programs, all of which can affect the investment time horizon for the TDF.
- Managing fees is important since they directly erode participants’ assets and they can vary significantly. Pre-packaged TDFs may include bundled fees including asset management fees for the various investment mandates. Bundled fees may be appropriate, but fiduciaries must understand the fee structure and components to accurately compare TDF products. If the expense ratios of the individual component funds are substantially less than the overall TDF, fiduciaries should ask what services and expenses make up the difference.
- If the TDF is not pre-packaged, make sure the TDF provider understands the other benefit plans offered by the sponsor, including traditional defined benefit plans, salary levels, turnover rates, contribution rates and withdrawal patterns so that the sponsor and provider can together consider the impact of the TDF’s glidepath and asset allocations on the employee population.
- Advisors can develop custom ETFs to help plans meet their fiduciary duties and control the risk exposures and fees for participants, but must be sure they are appropriate for the plan. Some questions to consider:
- What asset classes does it include and how does the glidepath progress?
- Should the fund include alternative investments, and, if so, what would be the appropriate investment allocation?
- What is the mix of active and passive management?
- What are reasonable fee levels?
- Do any pre-packaged TDFs satisfy the analysis?
- What is the best way to implement the custom TDF?
- If you’re considering ESG investments as part of a plan lineup, consider competing views.
Selecting an ESG-themed investment option without regard to possibly different or competing views of plan participants or the returns of comparable non-ESG options would raise questions about the fiduciary’s compliance with ERISA. For example, selecting as ESG target date fund as a QDIA would not be prudent if the fund would provide a lower expected rate of return than available non-ESG alternative target date funds with similar degrees of risk.
- For plans that include TDFs with a lifetime annuity option, make sure the fund satisfies IRS requirements in order to avoid separate nondiscrimination tests.
Most of those options are only offered to older employees and they cannot include certain employer securities that are not readily tradeable on an established securities market, as well as other regulatory requirements.
- Don’t blindly recycle last year’s QDIA notice.
If the plan provides default investment options for participants who fail to make affirmative selections, make sure participants receive a QDIA notice that complies with legal requirements. Participants must be provided with the notice 30 days in advance of the effective date and each year. They should also be given the prospectus, any material relating to voting, tender or similar rights provided to the plan, a fee disclosure statement, and information about the plan’s other investment alternatives. The investments comprising the QDIA should also be reviewed to make sure they satisfy DOL Reg § 2550.404c-5(e).
- Check all documents thoroughly.
Plan fiduciaries should check the plan’s investment policy statement, investment management agreement, investment guidelines and related plan documentation to ensure that any investment option is permitted by the plan.
- Make sure to document the evaluation of these and other appropriate considerations, and keep it in a centralized file.
While you’re at it, calendar future review dates so that they don’t get overlooked. Some questions to ask:
- Has the fund’s strategy or management team changed significantly?
- Is the manager effectively carrying out the fund’s stated objective?
- Have the plan’s objectives changed and should any funds in the lineup be changed?
- Review the fund’s prospectus and offering statement. Do the fiduciaries understand the strategies and risks? Do any TDFs continue to invest in volatile assets even after the target date and, if so, do the fiduciaries understand and have they clearly communicated that to participants?
- Revisit employee communications.
Employees should understand the investment options available to them and communications should be written with a style and content appropriate for the workforce. If they do not understand a TDF’s glidepath when they invest, for example, they may be surprised later if it turns out not to be a good fit for them. Consider surveying employees or a sample of them to make sure they understand.
Allison Brecher, general counsel with Vestwell, has over 15 years of legal and regulatory experience, handling high profile and complex litigation involving employee benefits, ERISA, regulatory matters, data privacy and electronic discovery. She can be reached at allison.brecher@vestwell.com.
Carol Buckmann, co-founding partner of Cohen & Buckmann, P.C., has worked as an attorney in the employee benefits field for over 30 years, dealing with some of the foremost issues in ERISA, including pension plan compliance, fiduciary responsibilities and investment fund formation. She can be reached at carol@cohenbuckmann.com.
Lauri London, investment adviser and corporate attorney with Cohen & Buckmann, P.C., is an expert in investment adviser regulation and has over 15 years’ experience as in-house counsel and Chief Compliance Officer to investment advisers. She can be reached at lauri@cohenbuckmann.com.