Participants in 401(k) plans need to make three fundamental
decisions: Should I participate? How much should I defer? And how should I
invest? This article focuses on the last question; more specifically, it looks
at one way to dramatically improve 401(k) participant investment returns.
The investment provisions of the Employee Retirement Income
Security Act (ERISA) are based on generally accepted investment principles,
such as modern portfolio theory. Applied at the participant level, that means
the law assumes that participants will be invested in portfolios. In other
words, participants are expected to either select among the plan’s investments
to craft portfolios in their accounts or, alternatively, to select
professionally designed portfolios such as target-date funds. Unfortunately,
most participants don’t know how to construct portfolios or don’t realize the
importance of balanced portfolio investing. Fortunately, ERISA provides in
404(c) that, if plans satisfy the 404(c) conditions, fiduciaries will not be
liable for imprudent investment decisions by participants. However, in my
experience, many plans don’t satisfy those conditions. In these cases,
fiduciaries should protect against possible claims by helping participants
improve their investing.
And, even if a plan satisfies 404(c), giving fiduciaries a
defense against claims for losses due to imprudent participant investing, there
is an important reason for improving participant investing: to help
participants reach their retirement goals.
Historically, when plans switched providers, most opted to
“map” participants into the investments on the new platform. When mapping,
fiduciaries select investments from the new provider that are similar to those
at the old provider and then move participants’ accounts to the similar
investments in direct proportion to their old investments. There is a fiduciary
safe harbor for mapping, but only if the new investments are reasonably similar
and if a plan satisfied all of the 404(c) conditions immediately before the
mapping. In addition, the plan must give participants an opportunity to direct
their investments on the new platform prior to the conversion. In other words,
plans that want fiduciary protection cannot simply move the money from the old
investments to the new investments without giving participants the opportunity,
in advance, to pick their own on the new platform.
A better alternative to mapping: Fiduciaries should consider
moving participants into a qualified default investment alternative (QDIA). If
a plan gives participants the opportunity to direct their investments on the
new platform prior to the conversion, and if the QDIA regulation requirements
are satisfied (such as notice and information), the fiduciaries will benefit
from the QDIA safe harbor for the participants who don’t direct their
investments and are defaulted into the QDIA.