Given today's increasingly regulated environment and the growing focus on the importance of retirement savings, most sponsors of defined contribution (DC) plans — including §401(k), §403(b) and §457(b) plans1 — have established or are in the process of establishing a structured process for overseeing plan operations. Most sponsors are struggling to provide and manage an efficient program that promotes retirement savings at the same time it:
- Avoids potentially costly litigation over issues such as fees charged to participants and
- Improves the organization's ability to attract, motivate and retain top talent.
In Sibson Consulting's experience, the most effective way for employers to manage a DC plan is through a well-defined process of plan governance and management with clear allocation of roles and accountability. Organizations that establish and maintain retirement and investment committees give themselves the best opportunity to meet their obligations in overseeing the plan.
Call to Action
Why are employers playing a more active role in managing their DC plans? Reasons include:
- The Litigious Climate Employee class-action lawsuits concerning fees, fund choices and other aspects of DC plans have been filed by those who think their plans have underperformed because they were improperly managed.
- A Stronger Focus on Plan Governance Plan sponsors are required to exercise appropriate due diligence in assuring that plans are administered correctly and in a cost-effective manner. The fiduciaries who oversee the plan directly have an even higher responsibility. An expanding regulatory environment presents additional challenges.2
- Greater Fee Transparency Detailed service-provider fee disclosures to plan fiduciaries are now mandatory under final regulations on participant and plan sponsor §401(k) fee transparency recently published by the Department of Labor (DOL). In addition, this information is now required to be reported on Form 5500, Schedule C. Fee disclosure requirements from fiduciaries to participants are on the horizon.
- Significant Investment Losses in Recent Years The economic downturn and the continuing malaise have had a huge impact on savings and investments, including participant account balances in DC plans. Declines of 20 to 40 percent were common during the initial downturn and accounts took another hit from late 2009 through the early part of this year. As a result, many employees have become much more risk-averse. Plan sponsors who want to mitigate participant backlash and bitterness are looking into and adding investment education and/or advice programs and best-in-class investment alternatives to their DC plans.
- The Plan's Critical Role as a Source of Retirement Income DC plans are now the primary retirement vehicle for many employees. The decline in availability of the defined benefit (DB) plan and the decline of the final-average-pay format for those remaining means that most individuals will have to self-fund a large portion of their retirement income.
The Retirement Committee: Role, Structure and Importance
A properly structured and resourced retirement committee serves as the bedrock on which a DC plan is anchored. Having a committee rather than one person oversee the plan will provide a broad base of talent, a wide range of input and different points of view, which will improve plan management. In general, the committee's activities will focus on the following areas:
- Alignment of the Plan Design with the Organizational Objectives of the Plan Sponsor This is often addressed through a process of competitive benchmarking focused on specific talent segments that support the plan sponsor's recruitment and retention objectives. For example, if a plan sponsor wants to improve the retention of experienced long-service colleagues, an age/service-based contribution formula may be considered. Alternatively, if a plan sponsor is more concerned with the recruitment of younger more mobile talent, a uniform/incentive-based formula may be more appropriate. Although the retirement committee generates plan design recommendations, those recommendations would be implemented only if the plan sponsor agrees.
- Oversight of Plan Operations Is the plan being run in accordance with the plan documents? Ongoing operational oversight in accordance with the terms of the plan and governing regulations should be conducted and documented. This is best supported by internal and external reviews of the plan's recordkeeper, which should focus on specific areas that have the potential for errors (i.e., loan administration, withdrawal processing, enrollment notification and default administration).
- Oversight of Administrative Functions Are the various transactions being processed correctly? Ongoing administrative oversight of plan operations in accordance with governing regulations should be conducted and documented. This oversight should focus on disclosure of plan expenses, hardship and unforeseen emergency withdrawals, qualified domestic relations orders, blackout periods and other factors. It is essential that all administrative processes and committee decisions are documented, appropriate and consistent with the terms of the plan and governing regulations.
Seemingly small oversights in DC plan management can grow into costly problems if left uncorrected. In many cases, rectifying these mistakes offers plan fiduciaries an opportunity to improve plan management and save money. (Sidebars throughout this article present common mistakes and describe how specific employers corrected them.)
Although the size and makeup of the retirement committee will vary from organization to organization, in most cases, it should include four or five members with backgrounds in HR, management, legal and finance. In some cases, an employee representative may be appropriate, especially if the plan is collectively bargained. Internal and/or external legal counsel should be available to support the operations of the committee.
The retirement committee typically is responsible for deciding how the plan is to be administered and selecting service providers. It must establish and agree to contractual terms with the selected vendors and then monitor the services provided to ensure they are operating the plan in compliance with its provisions, regulatory requirements and contractual terms. (See the sidebar "Mistake Number One: Not Changing When Change Is Needed.")
Any delegation of responsibility by the plan sponsor or by the committee as to specific employees (HR or benefits personnel) or third-party providers must be clearly distinguished and documented. Appropriate levels of liability insurance should be in place to cover the members of the committee and any employees who are delegated to perform plan-related tasks. Fidelity bonds also are required for the members of the committee, among others.
The retirement committee must regularly monitor plan outcomes to watch for issues of concern, such as:
- A sudden inflow or outflow of participant dollars to or from individual funds,
- Participants whose investment allocations may suggest a need for enhanced investment education/advice (such as young employees investing solely in stable value funds),
- "One funders" — employees with all their money in only one fund other than an asset allocation fund, (See the sidebar "Mistake Number Two: Offering Participants 'Too Much Choice.'")
- A marked increase in hardship withdrawals and loans, and
- Changes in the rate of participation.
The committee is responsible for monitoring benefit payment processes and procedures. In some cases where the committee is responsible for deciding appeals, it may even have to override the recordkeeper and approve a hardship distribution. The committee also needs to ensure that an independent auditor conducts the required annual financial audit and then carefully review the audit results for any actionable items.
Another of the retirement committee's most important responsibilities is often participant communications. It must oversee the delivery of appropriate plan information to participants as well as take steps to inform participants about their retirement savings and their investment decisions.
The organization's retirement committee should meet periodically, usually quarterly or semi-annually. It is important for a member of the committee to take notes and document the meeting proceedings. Any decisions made by the committee that affect the plan must be documented and may ultimately lead to the creation of plan amendments, written procedures, written policies and defined processes.
Like any plan fiduciary, the retirement committee must maintain the plan and its assets for the exclusive purpose of providing retirement benefits for participants and beneficiaries and defraying the reasonable costs of administering the plan, with the care, skill and diligence that a prudent person would use in similar circumstances.
The Investment Committee: Role, Structure and Importance
The investment committee is focused on selecting and monitoring the performance of the various investment vehicles that the plan offers. It may require a different set of skills from the retirement committee.
The investment committee, which can be a subcommittee of the retirement committee or an independent committee, should include representatives from HR and the organization's executive suite. As with the retirement committee, there may be employee representation. Internal and/or external legal counsel should be available to support the committee. The investment committee should meet two to four times a year and its meetings and decisions must be documented. It can also assist the participant communications efforts by providing investment-focused information and guidance.
It is very important for the investment committee to develop a formal investment policy that will guide all decisions about the plan's investment options. This policy must clarify the responsibilities of all parties and identify the types of investments the plan will offer along with the criteria and processes to select and obtain the chosen investment vehicles in the DC plan. Investment choices are becoming increasingly complex and may include stable value funds (general, commingled or separate), target date funds (custom or "off the shelf"), guaranteed-income products (inside and outside of the plan), managed-account products and self-directed brokerage accounts. The policy itself will need to be periodically reviewed and updated to evolve along with the plan and the financial environment. (See the sidebar "Mistake Number Three: Investing in the Wrong Share Classes.")
The investment policy will define how funds will be monitored and when funds will be replaced or removed, when necessary. The committee will continually evaluate fund performance, given the context of the dynamic investment climate. In addition, the investment committee must assure that the plan administrator has received the full required disclosure of the myriad of administrative and investment related fees as well as any revenue sharing agreements and must review their appropriateness in the marketplace.
Service providers charge fees for a variety of services, including recordkeeping, custodial trustee services and participant communications/education. Although vendors may not charge a direct fee for these services, depending on the size of the plan, these service fees may be imbedded in the investment fund expense charges. Other fees may include charges for investment advisory services, participant loans, processing qualified domestic relations orders, managed account services, a discount brokerage window and compliance services. There are also investment fees, which can include charges for management and operations, sales, redemptions, wraps, mortality risk and administration, broker of record, contingent deferred sales, sub-transfer agencies and, at least for the time being, §12(b)-1 fees.3 (See the sidebar "Mistake Number Four: Failing to Monitor Vendor Fees.")
Although the fee monitoring process can be laborious, the best way to assure appropriate due diligence on fee levels is to:
- Document how the vendor was chosen. The selection process should include the use of competitive bidding and negotiations for both lower fees and a more transparent contractual fee structure with appropriate benchmarking.
- Expressly request full fee disclosure. By law, the service provider must disclose all indirect and direct fees, but asking for it directly may elicit better and timelier compliance.
- Provide plan participants with information. Participants need to be informed of information relevant to their investment options.
The Role of the Independent Advisor: Expertise and Perspective
A growing number of plan sponsors have retained independent advisors to support the operations of their retirement and investment committees. The independent advisor is a resource with broad market knowledge and insight into market trends that can provide investment, compliance, administrative and communications advice to support decisions on investment fund offerings, vendor selection and appropriate administrative and investment-related fees as well as administrative efficacy and overall plan compliance. In short, the independent advisor acts as a watchdog and a bulldog, serving as the plan sponsor's advocate in working with vendors to keep them responsive to the plan's needs.
Requirements and expectations for DC plans are becoming more complex and the plans are increasingly critical to the financial security of participants and, as a result, to the organizations that sponsor them. Plan sponsors need to be aware of this shift in focus and acknowledge their importance in supporting their employees' ability to make the best use of the opportunities offered them. DC plans that are overseen by a retirement committee and an investment committee, both served by an independent advisor, will be well prepared to deal with what lies ahead.
About the author:
Robert McAree is a senior vice president in the New York Office of Sibson Consulting. He has special expertise in the design, administration and communication of retirement programs. He can be reached at 212.251.5368 or firstname.lastname@example.org.
1 A §401(k) plan is a tax-advantaged retirement savings plan available for for-profit corporations. A §403(b) plan is a similar type of plan available, in addition to 401(k) plans, for public education organizations and tax-exempt charities. A §457(b) plan is a somewhat similar type of plan available, in addition to the other two types of plans, for governmental employers.
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2 Recent regulations and other government pronouncements have provided wakeup calls to plan sponsors. For example, the Internal Revenue Service's issuance of the final §403(b) regulations, combined with the Department of Labor's clarification of 5500 reporting requirements for §403(b) plans subject to the Employee Retirement Income Security Act, have placed more obligations on §403(b) plan sponsors. The historical "hands-off" approach provided too much leeway to §403(b) plan vendors to offer investment products that may not have been the best choices for the employees.
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3 The §12b-1 fee is an annual marketing or distribution fee on a mutual fund. It is considered an operational expense and, as such, is included in a fund's expense ratio. It is generally between 0.25-1% (the maximum allowed) of a fund's net assets. The amount can be used to offset administrative or recordkeeping expenses in addition to paying for third-party providers.
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