Here are five incorrect, yet commonly held beliefs regarding a good retirement plan offering:
- Fiduciary imprudence is demonstrated by poor investment performance.
- The lower-cost option is always the safer and better offering.
- Limiting investment options protects participants.
- There’s one right method for all plans.
- Following a popular approach limits liability.
Plan sponsor/retirement planning committees that believe these assumptions are failing to offer the best retirement plan possible to employees. In the process, they are exposing their organizations to legal risk.
The Legal Risk
Over the past several years there has been an increasing legal trend in the employee benefits world. Employee Retirement Income Security Act (ERISA) litigation involving alleged breaches of fiduciary duties on the part of retirement plan sponsors is rising.
How can I protect my company from a lawsuit? The answer is, you can’t. Anyone can bring a lawsuit against you. The real question is: How can I defend myself and my company in the case of an ERISA lawsuit?
You and the members of your plan sponsor/retirement planning committee are responsible. This is where an understanding of fiduciary obligations protects you and your organization and is also the foundation for offering the best retirement plan possible.
In short, a fiduciary is one who acts in the best interest of another. In the case of ERISA law and retirement plans, that means that plan fiduciaries must always act in the best interest of plan participants and the participant’s beneficiaries. But what does that entail? Let’s uncover the truth behind these five common fiduciary misperceptions.
Fiduciary Imprudence Is Demonstrated by Poor Investment Performance
While investment performance is undoubtedly important, the prudent approach to mitigating fiduciary risk is to have a clearly identified process by which you make investment decisions. Start with an investment policy statement. If you don’t have one, get one. This is critical to establishing the fact that you have a guideline to determine which investments are appropriate for your plan. It is also helpful to have an independent fiduciary advisor assist your plan sponsor/retirement planning committee in reviewing, analyzing, selecting, monitoring and documenting your investment decisions. If your process is defined, thoughtful and well-documented, you can defend your investment decisions in case of an audit.
The Lower Cost Option Is Always the Safer and Better Offering
It’s true that higher cost options may erode returns. Actively managed funds are typically more expensive than index funds, but in a well-designed process these investment options play an important role in an investment menu. A strong plan provides employees with an investment menu that includes both active and passive options. ERISA does not require fiduciaries to “scour the market” for the cheapest option. The bigger concern of higher cost versus lower cost comes into play when we speak of share classes.
ERISA and Share Classes
Each investment option or mutual fund is typically available in multiple share classes: same investment, different pricing levels. It’s critical to understand the different share class options that are available and select the appropriate option for your plan. This has been a very big issue with ERISA fiduciary breach lawsuits. Reach out to an investment professional if you don’t understand the share class puzzle. This can easily get your organization into trouble.
Limiting Investment Options Protects Participants
As many organizations discover, too many options can result in a “paralysis by analysis” situation. Yet, it is critical that participants have a selection of investments that reflect a broad range of investment styles with different risk-and-return characteristics.
Often, investment menus have several investment options in the same style. For instance, they may have three options that all fall under the large-cap growth category or the small-cap value category. This is unnecessary and can be confusing. Participants may think that they are diversifying their account by investing in all three options. In fact, they still have all of their money in the same style. This is not diversifying. A better investment menu includes a broad range of investment options without confusing employees with too much of the same style. Provide plenty of options in a well-designed, process-driven menu. Keeping the process of selecting and monitoring the investment options straightforward is key to a successful employee experience.
There’s One Right Method for All Plans
Employee demographics, plan size, organizational culture and goals all play a critical role in determining what is right for your plan. There is no one-size-fits-all retirement plan. It all goes back to the clearly identified process that is utilized to make critical decisions for your retirement plan. Begin with the end goal in mind, which is to provide employees with an opportunity for a successful retirement. The means to this end is to take your fiduciary responsibilities seriously and always act in the best interest of your plan participants.
Fiduciaries are entitled to consider participant preferences, participant age and level of investment sophistication. For example, a global investment management firm’s investment menu is different than that of a home health-care organization. Employee demographics dictate the right method for each plan. Again, utilizing a well-defined, well-documented, fiduciary-based process to make the decisions will lead you to solid ground. It will also lead to better retirement outcomes for your participants.
Following a Popular Approach Limits Liability
And finally, remember your parents asking, “if everyone jumps off a bridge, would you?”
As a plan fiduciary, you have to make decisions for the right reasons. “Everyone else is doing it” is not a good reason. The herd mentality and fear-based decisions fall short of prudence. Fiduciaries are required to act for the exclusive benefit of the plan’s participants and the participant’s beneficiaries. If you follow this critical rule, your job as a fiduciary becomes easier.
Think of it this way: As an owner, executive or manager, you are probably a participant in the retirement plan.
So, what do you want your plan to look like?
About the Author
Robert Gibson is a fiduciary consultant at Marsh & McLennan Agency Retirement Services.