Posted on Jan 24, 2018

For several years now, the responsibility for financing one’s retirement has increasingly shifted from the employer to the employee. According to the Bureau of Labor Statistics, over the 15-year period from 1985 to 2000, the primary retirement plan participation of employees moved from defined benefit plans to defined contribution plans, such as 401(k) plans. And that trend has certainly continued.

401(k) Plan Features

A key feature in most 401(k) plans is that participants make their own investment choices from a set of options offered by the plan. The fact that participants make their own investment choices might lead business owners to conclude that participants — and participants alone — are responsible for the consequences of these decisions. However, plan fiduciaries, such as the employer plan sponsor, are not automatically absolved of responsibility for a participant’s investment decisions merely because the plan offered choices and participants made them. In order for a plan fiduciary to escape liability for losses resulting from a participant’s investment decisions, the 401(k) plan must comply with the Employee Retirement Income Security Act (ERISA) Section 404(c).

Exercise of Control Defined

According to the regulations, participants are able to exercise control when they have the opportunity to give investment instructions to an identified fiduciary and when they have the opportunity to obtain sufficient information to make investment decisions. “Sufficient information” includes a description of the investment alternatives, their objectives, risk/return, type, diversification, fees, expenses and sales loads. Participants must also receive an explanation of how to give investment instructions and any limitations. The regulations include specific requirements for plans that offer employer securities as an investment option.

401(k) Compliance With Section 404

According to regulations issued by the Department of Labor, a 404(c) plan is one in which participants have the opportunity to exercise control over assets in their individual accounts (see box below) and the ability to choose how to direct those assets from a broad range of investment alternatives. The regulations spell out in detail how these two requirements are met and how compliance with each aspect is needed to secure the protection that 404(c) offers.

The “broad range of investment alternatives” must include at least three diversified investment options that enable a participant to materially affect the potential return and minimize the risk of large losses. While most 401(k) products today include more than this minimum number of investment options, the plan sponsor (perhaps with the assistance of an investment professional) still needs to determine whether the asset classes and style of the funds offered satisfy the diversification, potential return and risk minimization requirements.

It is important to note that ERISA Section 404(c) imposes no obligation on plan sponsors to offer investment advice to participants. Also, 404(c) protection is only available to the extent that a participant directs the investments of his or her individual account. It also requires several communications to be made to participants, including notice that the plan intends to comply with 404(c) and that participants are responsible for the results of their investment decisions.

Market Factors

Events from several years ago make a strong case for seeking 404(c) protection. Two bear markets in the 2000s hit investors hard, including many 401(k) participants. Market gains that came easy faded quickly and 401(k) balances plummeted. Corporate scandals have led to collapsing retirement plans at affected firms. Questionable trading activity within mutual funds was reported in the news. All these events have focused attention on 401(k) investment performance and the potential liability of plan fiduciaries for investment losses.

Caution: The relief that ERISA Section 404(c) provides plan fiduciaries is not absolute. Regardless of 404(c) compliance, plan sponsors continue to have the duty to act prudently and solely in the interest of plan participants when selecting the investment options offered by the plan. Furthermore, both investment managers and their offerings must be monitored to ensure that there continue to be prudent choices.

NOTE: Under the Pension Protection Act, signed into law in 2006, retirement plan sponsors and fiduciaries are allowed to hire and compensate “fiduciary advisors” to supply investment advice and make investment transactions for participants and beneficiaries of defined contribution plans and beneficiaries of IRAs. A fiduciary advisor can be a registered broker or dealer, a registered investment advisor, a bank or similar financial institution, an insurance company or an affiliate, employee, agent or representative of one of the above.

Posted on Oct 16, 2017

The Pension Protection Act, passed in 2006, gave a major boost to automatic enrollment 401(k) plans. These plans enable companies to include employees in their plans unless they choose to opt out of participation. Now, new proposed regulations provide guidance for default investments. Auto-enrollment plans were available before the law passed. But the Pension Protection Act overcomes certain state law hurdles that hindered these plans in the past. Employers can limit the automatic feature to new-hires or extend it to the existing workforce. To further encourage retirement savings, the new law makes it easier for employers to automatically increase the percentage of an employee’s salary directed to the account.

“Too many workers, some overwhelmed by investment choices or paperwork, are leaving retirement money on the table by not signing up for their employers’ defined contribution plan,” said Former U.S. Labor Secretary Elaine L. Chao. “This regulation would boost retirement savings by establishing default investments for these workers that are appropriate for long-term savings.”

One likely side effect of installing an auto-enrollment plan is larger allowable salary reduction contributions for higher-paid employees, because lower-paid workers are contributing more.

Prior to the Pension Protection Act, plan sponsors were often reluctant to assume the responsibility for making investment decisions without specific direction from participants. Thus, the sponsors typically sought to minimize exposure by limiting default investments to money market funds and other conservative vehicles.But once a company decides on an automatic enrollment plan, the question is: Where to invest the money?

Now plan sponsors have more options. Under the new Labor Department regulations, a participant is treated as exercising sufficient control over the account assets if these six basic requirements are met:

  • Assets invested on behalf of participants are allocated to “qualified default investment alternatives.”
  • Participants have the opportunity to direct investment of the assets in their accounts (but not direct the assets).
  • Participants must receive adequate notice.
  • Materials provided to the plan about investments are made available to participants.
  • Participants have sufficient time to transfer assets.
  • The 401(k) plan must offer a range of investment alternatives.

Default investments should be diversified to minimize the risk of large losses. In addition, if a participant chooses not to direct the investment of assets in his or her account, age is the only objective and readily available factor for making an investment decision on his or her behalf. Other factors — including risk tolerance and total investment assets — do not have to be taken into account.

In summary: The Pension Protection Act can result in key changes for your company’s plan. According to the Labor Department, approximately one-third of eligible workers do not participate in their employer-sponsored 401(k) plans. With the new regulations, your company can increase participation dramatically. Consult with your tax adviser and benefits professional to find out how to take advantage of the new law and to help ensure compliance.