Fiduciary Considerations
Selecting and monitoring investments in a defined contribution (DC) plan like a 401k can be intimidating and confusing to most HR and benefits professionals who do not have a financial background. But with the help of good professional partners like a plan advisor, it does not have to be that hard or take too much time to understand important fiduciary considerations. Remember, if you’re confused, think about how your employees feel.
There are two primary fiduciary responsibilities when selecting a DC plan’s investment lineup which include:
- Diversification
- Reasonable fees
According to Eric Drobleyn, an ERISA lawyer with a Third Party Administrator (TPA), on diversification under 404c:
- To qualify for 404(c) relief, a fund lineup must include at least 3 core options with materially different risk and return characteristics. Generally, a lineup that includes equity (stock), fixed income (bond), and capital preservation (money market or stable value) funds satisfies this requirement.
- A 401k fiduciary can pick additional funds, but they are not obligated to do so to meet ERISA diversification requirements.
Most plans have too many funds. According to UCLA Professor Shlomo Benartzi who brought behavioral finance to the DC world, the right number of options is seven-to-nine funds not including target date funds (TDF). Too many choices lead to confusion, bad decisions or worse, no action. Choice architecture helps – think about giving people three options:
- Do you want someone else to manage your investments, which includes about 90% of people? If yes, all money flows into a TDF or default option.
- Do you want to pick your own funds, which include 9% of investors? Choose from the plan’s menu.
- Do you want to have greater choice? Use a brokerage window.
Another decision is whether you want to hire a co-fiduciary advisor to help select investments which is changing as a result of the new DOL rule. A 3(21) fiduciary recommends the funds but the ultimate decision remains with the company. Under 3(38), the co-fiduciary makes the decisions with the only obligation by the company to determine whether the person or entity is qualified and is properly discharging their duties.
ERISA is confusing and, like with investments, can be intimidating. If you don’t understand the fundamentals of running a plan or selecting investments or if something does not feel right, it may be time to start thinking about changing your partners starting with your plan advisor.
