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With the equity markets in steep decline since last week and experiencing a 5.5 percent drop at the market close today, companies and their employees may share some anxiety about the company's 401(k) plan and the responsibilities governing such plan. This alert discusses some issues facing companies and their workforces and the ways in which companies should respond to these issues.
Issue 1: Proper asset allocation
Prior to the equity market declines in late 2008, the United States' equity markets had been largely positive in the nine years since the "dot com" bubble burst in 2000-2001. This widespread increase fostered investor optimism, and many participants responded by all but ignoring their own 401(k) accounts because those accounts were making money. When the markets are down in a widespread manner, participants and companies tend to assume it is a broad market sell-off, and there is nothing specific to their plan. Only in stagnated markets do participants and plans focus on fees and asset allocation.
Plan sponsors should be continually monitoring fees, proper investment options, and asset allocation. Asset allocation particularly should guard against large drops and guard against large increases to provide a steady return. Too often participants and companies choose prudent investment options without asset allocation tools.
Plan sponsors should ask themselves whether the plan has some combination of model mutual fund portfolios, target date funds, individual education/advice availability, and access to such tools by participants.
Issue 2: Looking beyond the investment options and fund expense ratios to the retirement plan and its component parts
With the equity market declines in 2008 companies began to reduce headcount. This reduction in force included human resources and finance professionals who monitored and serviced much of the needs of the retirement plan. Committee members who had previously only reviewed fund investment performance with the support of the investment advisor were suddenly thrust into ongoing operations with the Plan and its component parts.
It is critical for plan sponsors to understand how a retirement plan works and the duties of the record keeper, third party administrator, and the independent advisor. In addition, plan sponsors should be familiar with the tools available to the company. There are differences in the way an insurance company platform charges the plan participants, such as through wrap fees, and a trust based platform charges the plan participants. The manner in which the platform uses a third party administrator is different from the entities that do administration in-house. And advisors differ in how they are paid and from what source. Understanding the plan and benchmarking the plan's options is a critical exercise to meeting the fiduciary duties of providing prudent investments.
It is imperative for plan fiduciaries to ask themselves if they understand the roles of the plan service providers and whether they have benchmarked the costs and services of the plan's service providers. The investment fund performance is not the only charge affecting a retirement plan. A proper benchmark of service providers should be done at least once every five years.
Issue 3: Understanding the impact of auto enrollment
Automatic enrollment has lessened the focus on enrollment education and allowed many companies to phase out education entirely. However, automatic enrollment has the impact of keeping deferral percentages at the level at which the participant was enrolled, usually at the amount of the match. As many companies do not feel comfortable enrolling employees at more than 3 percent, testing issues in companies are amplified by limited high deferral percentages from non-highly compensated employees. Most education resources are still focused on enrollment into the plan and not educating employees about proper investment allocation and risk tolerance. When the employee and the plan do not have the initial enrollment relationship, the plan must engage the participants in some manner to achieve proper investment strategy.
Plan sponsors should evaluate whether their communication and education campaign remains the same post-auto enrollment and whether participants gain access to information to allow them to make a change to their accounts.
Issue 4: A failure to keep perspective in today's information world
The ease of access to information and data is a double edged sword. Participants' greater access to information and greater media options leads to an awareness of issues. Most participants could not tell you that the market dropped 22 percent on "Black Monday" in 1987, but can tell you that the market is down more than 10 percent over the past week. While the issues are not new, they are different, and a keen understanding of the market and its performance is necessary to assist weary and news starved participants.
Plan sponsors should recognize a shift in focus from the reaction to a particular day's events and focus on the long-term investment choices in the plan. With proper asset allocation tools, proper understanding of the Plan and its component parts and charges, and proper education on the impact of automatic enrollment, a Plan should be able to respond with confidence to its employees that it is not what matters today, but what matters at retirement.
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