This 401(k) Specialist article introduces Pooled Employer Plans (PEPs) as follows:
Pooled Employers Plans were born out of Congressional efforts to make employer-sponsored retirement plans available to more workers to help solve the retirement savings crisis. The SECURE Act, signed into law at the end of 2019, essentially created PEPs to address/solve a pair of longstanding issues that kept Multiple Employer Plans from achieving widespread adoption: the “one bad apple” rule and “common nexus” requirement.
The concern is that some small employers might not look into everything before making the decision to join a PEP, or in choosing which one to join.
Most importantly, employers need to realize that they are held to the highest level of responsibility in their selection of a Qualified Default Investment Alternative (QDIA) because employers choose this investment on behalf of beneficiaries who are unable or unwilling to make an investment decision — these beneficiaries are financially unsophisticated and extremely vulnerable.
Safe QDIAs
The most popular choice of QDIA is a target-date fund (TDF), but the funds that are most frequently chosen are not a good fit for small employers. Small employers should view their 401(k) as an asset of the company, but losses in default investments can turn this asset into a liability.
As explained in this article, there are two distinct TDF cohorts — Safe and Risky. PEP employers should choose a Safe TDF if they want happy employees and want to focus on running their business rather than their 401(k).
Employers run companies that demand most of their time and energy. They don’t have the time and knowledge to run their 401(k) plan, so they hire consultants who design the plan and choose the investments. One of those investment choices stands out from all the rest because it is a choice made on behalf of the financially illiterate, namely a TDF.
Employers considering a PEP should know and understand why a particular TDF is being used, and that it is Safe. In this case, popularity is not safe.
Risky QDIAs
What employers do not know is that consultants have come to believe that they have to choose from among the largest TDF providers. These are fine firms, but their TDFs are excessively risky near the target date when people are retiring. They comprise the Risky cohort. 2020 TDFs are for people retiring in and around 2020.
The Risky cohort 2020 TDFs recently lost more than 15% in just one month – the month ending 3/20/20. Similarly, their 2010 funds lost more 30% in 2008. They are not safe. By contrast, the Safe cohort lost less than 4%.
Investment losses are exceedingly painful for those in or near retirement because they no longer have the security of a paycheck. Losses in the TDF that an employer chooses can hurt the employer’s business, as employees blame their employer for their losses, and demand the employer to make them whole by increasing wages and employer contribution matches.
Also, psychologists have identified a strong connection between financial wellness and health. Investment losses make people sick.
PEPs should not let the 401(k) asset turn into a liability.
Running the business
There are unforeseen risks in businesses and in 401(k) plans. Employers know what they have to do in their businesses. They do not need the headaches that come with shocks to their default 401(k) investment. Employers are the only ones who can solve this problem.
Employers can avoid these alarming and time-consuming distractions by choosing a TDF in their PEP that defends against investment losses. The most popular TDFs do not provide this protection, so PEP employers need to break from the crowd, to be different.
The Safe cohort of TDFs ends at the target date with less than 30% in risky assets while the Risky, albeit most popular, TDFs are more than 90% in risky assets, namely 55% in equities plus 35% in risky long-term bonds. The Safe cohort has been the best performing in 2008, 2011, 2018, and the first quarter of 2020, when they defended against losses.
Prudence
Choosing Safety transforms employers from being confused and ill-equipped to being competent, generous, and disciplined. They know that their most vulnerable employees are protected.
The Coronavirus pandemic is not over. Its economic effects will be felt for many years to come. Safe TDFs allow employers to focus on running their businesses in these challenging times.
The best fiduciary protection is beneficiary protection.
Ron Surz is President of Target Date Solutions and CEO of GlidePath Wealth Management. He is also the author of Baby Boomer Investing in the Perilous Decade of the 2020s. He can be reached at Ron@TargetDateSolutions.com.