It’s time to rethink retirement plans

An investment fiduciary’s duty of loyalty demands that the investor’s best interests guide the decision-making process.

Moreover, close attention must be paid to the consequences of decisions, and corrective action must be taken if those decisions are not serving the investor’s interests. Sometimes limited fine-tuning is all that is needed; at other times, no amount of tinkering seems to achieve the desired results, and a complete reassessment of the approach is required.

It appears to me that participant direction of retirement plan assets fits in the latter category.

For participant-directed portfolios, such as most 401(k) plans, the investment fiduciaries are detached from the execution of investment decisions. They are not able to modify individual portfolios directly, even when circumstances suggest changes are needed to serve the investors’ best interests.

Instead, they create the conditions under which employees, who rarely have financial backgrounds, are responsible for evaluating their own retirement income needs, analyzing the investment choices available to them and maintaining a portfolio that is appropriate to the changing circumstances they will face on the road to retirement.

But, as the legal and regulatory evolution of 401(k) plans amply demonstrates, there is no simple formula that will reliably equip participants to make good investment decisions in preparation for retirement. Following the debut of 401(k) plans in 1980, the inability of participants to manage their own accounts effectively became clear.

In 1992, the Department of Labor introduced the 404(c) safe harbor, whereby plan sponsors can avoid liability for participants’ investment decisions, as long as the sponsors provide investors a sufficient range of appropriate investment choices and adequate information to make informed judgments.

Yet the experiences of plans using this safe harbor showed that broad menus of investment choices and education about the risks, expected returns and objectives of the various choices did relatively little to prevent participants from making poor investment selections.

The tinkering continued, as Congress created another safe harbor in the Pension Protection Act of 2006 to shield plan sponsors from liability associated with the advice given to individual plan participants by a professional fiduciary adviser. Relatively few plans have taken advantage of this safe harbor, however, largely because of the cost of delivering individualized advice and meeting complex disclosure and audit requirements.

Even without safe harbors, cost and complexity are inherent concerns for participant-directed plans. Because a participant holds a separate account, rather than an interest in a commingled aggregate portfolio, the costs of participant-directed plans can be higher than they are for sponsor-directed portfolios.

Additionally, plan participants are likely to pay more of these costs than the plan sponsor, thus reducing plan sponsors’ incentive to control costs. In fact, fees have become such an issue that participants have filed several lawsuits alleging breach of fiduciary responsibility by plan sponsors for being inattentive to fees in the selection of service providers and the specific investments included in the plan.

So, despite the tinkering of regulators and legislators, and the best efforts of most plan sponsors, participants continue to be generally ineffective in their investment behavior.

What more can be done to correct participant-directed-plan deficiencies, consistent with the fiduciary duty of loyalty? Perhaps it is time to ask whether the whole concept of participant direction is a losing proposition for investors.

Centrally administered portfolios, like those of foundations, endowments and defined benefit plans, are less complicated. Investment fiduciaries have direct control of the process and are accountable from design to execution. The investment committee or chief investment officer, usually with the support of professional advisers and money managers, makes asset allocation decisions, directs the investments, and can change the portfolio composition as needed.

Plan sponsors and their advisers should consider whether a fundamental change in their approach for 401(k) and other defined contribution plans from participant direction to investment committee or trustee direction of the assets would better serve the best interests of the investors they work for.

Blaine F. Aikin is president and chief executive of Fiduciary360 LP in Bridgeville, Pa.

Related Topics: Retirement INsight