It's often said that it is an ill wind that doesn't blow somebody some good. While the recent downturn has indeed been an ill wind for all concerned, it does hold out the possibility that plan fiduciaries may learn valuable lessons.
The significant drop in participant account balances, coupled with the Supreme Court's recent decision allowing participants in individual account plans to sue fiduciaries for perceived breaches impacting only their accounts (rather than requiring that the breach affect the plan as a whole), means that the savvy fiduciary must learn these lessons quickly and well.
MISSING THE TARGET
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ERISA allows individual account plans (including 401(k) plans) to permit participants to direct the investment of their accounts. Where participants do so, fiduciaries are relieved of liability for any losses that flow from those elections. Prior to the enactment of the Pension Protection Act, no relief was available where a fiduciary invested a participant's account in the absence of a participant election.
The PPA extended the relief to fiduciaries who invest a non-electing participant's account in a default investment, so long as the investment qualifies as a qualified default investment alternative. One requirement to constitute a QDIA is that the investment fit within one of three investment categories typified by: a balanced fund appropriate for all participants under the plan, professional management of the participant's account, or a targeted-date retirement fund or life-cycle fund.
The need to select a fund that would be appropriate for all participants under the plan effectively restricts the ability to use a balanced fund as a QDIA. As a result, many, if not most, plans have opted for a target-date fund as the QDIA.
Target funds are actually funds of other underlying funds designed to match investors with an appropriate investment mix given their current age and expected retirement date. Fiduciaries now know that equity allocations vary widely among funds with the same target retirement date maintained by different fund managers.
According to a study released by the Financial Research Corp., equity allocations for 2020 target date funds ranged from 51 percent to 95 percent. More disturbing, according to an Ibbotson Maturity report, the average target maturity fund suffered a loss of 17.3 percent during the fourth quarter of 2008. Plan fiduciaries must realize that by selecting a target-date fund, a poor performance by any one manager can serve to doom the performance of the overall fund.
Fiduciaries must not be lulled into falsely believing that the inclusion of target-date funds as a QDIA will insulate them from either losses or liability. While a properly selected QDIA will provide protection for investing a non-electing participant's account in the QDIA, no protection is provided for the actual selection of either the type of QDIA chosen or the specific fund.
This means that care must be taken in selecting the fund itself, with consideration given to a review of the underlying funds in terms of the fees, performance history, and the potential for the target-date manager to select funds that can skew in favor of higher fees at the expense of performance.
