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from Spencer’s Benefits Reports: Testifying at a June 18 hearing of the Department of Labor and the Securities and Exchange Commission (SEC) on issues related to 401k participants’ investments in target-date funds, both the Profit Sharing/401k Council of America (PSCA) and the American Benefits Council called for flexibility in any regulations governing such funds.
Speaking on behalf of the PSCA, Ian S. Kopelman, a partner with DLA Piper and chair of its employee benefits and executive compensation practice group, initially noted, “More and more employers are deciding that target-date funds are a beneficial investment offering and are rapidly adding them to their 401(k) plans. Preliminary analysis of PSCA data for 2008 finds that 58% of private employer defined contribution plans offer target-date funds; up from 25% in 2005 and virtually none in 2000. Over half of plans with automatic enrollment have a target-date fund as the default investment.”
According to Mr. Kopelman, “Mutual fund products continue to be the product of choice for qualified plans. Our research indicates that 78% of plan target-date investments are mutual fund products. Most plan sponsors are satisfied with their target-date investment options, despite weak performance during the recent market crisis. Only 13% of sponsors are dissatisfied and only 1% is very dissatisfied. Such support, however, reflects neither apathy nor blind approval. Nearly two-thirds (64%) of the sponsors are considering changes to their target-date investments. The focus on improvements to target-date funds under consideration is concentrated in two key areas—diversifying the assets in the investment and selecting top quality investment managers to oversee investments.
“Financial investment experts, by an overwhelming majority, recommend three basic principles for long-term capital appreciation. First, diversification among bonds, equities, and cash-like investments provides the maximum balance between risk and return. Second, once an investment allocation is determined, periodic rebalancing is necessary to preserve the allocation ratio. Finally, the asset allocation ratio should be altered as an investment horizon shortens to favor risk aversion over returns. These three principles are the bedrock that defines a prudent overall investment policy for a defined contribution plan. Target-date funds embrace these principles and apply them automatically to individual plan participants based on the participant’s age and assumed retirement date.”
Mr. Kopelman went on to state, “The selection and monitoring of an investment fund offered within a plan is subject to the fiduciary requirements of ERISA. Once an investment is selected, the fiduciary must monitor it to ensure that it remains a suitable plan investment. What absolutely is not required is to ensure that a plan investment always results in positive returns. Even prudent investors can suffer an investment loss. We are confident that both agencies support this proposition, despite the intense publicity surrounding the recent market events.”
“Glide Paths”
According to Mr. Kopelman, “All target-date funds have different ‘glide paths,’ the ratio of the three asset classes for each age cohort. A glide path automatically implements the three investing principles. The current controversy about target-date funds centers on the appropriate glide path as a participant reaches the assumed retirement age, usually age 65. For the most part, there is little debate whether a 65-year-old retiree should hold equities in his retirement account. The question is ‘how much?’ That brings us back to the fiduciary process. The overwhelming body of financial advice indicates that a new retiree should hold a substantial percentage of equities in his retirement account, in the general area of 50%. A plan fiduciary is, to a large degree, bound by this body of expert knowledge and ignores it at considerable risk.
“The impacts of Social Security and other retirement assets are often overlooked when analyzing glide paths. We suggest that a prudent plan fiduciary should be able to make general assumptions about Social Security income and other retirement plans offered by the employer when assessing a target-date fund glide path. A target-date fund is not required to be the optimal investment for each individual participant; it must be a prudent plan investment for the participant population in whole.”
Mr. Kopelman went on to conclude, “Another debate regarding target-date funds is whether the glide path should be frozen at the target retirement age. We believe that it should extend throughout the life of the participant or beneficiary if the plan permits retired participants, terminated employees, or beneficiaries to remain in the plan beyond the normal retirement age. A case in point is that a retiree may remain in a target-date fund plan investment long after retirement. The investment must be prudent for this individual and freezing a glide path at retirement age may violate this principle.”
Lynn Dudley, senior vice president of policy for the American Benefits Council, asserted, “Employer plan sponsors take their fiduciary responsibility very seriously and currently devote substantial resources toward the investment selection process and detailed communications to employees. As these agencies consider new regulations governing these funds, it is essential that they avoid overly prescriptive rules for a specific type of fund.”
Allison Klausner, assistant general counsel—benefits for Honeywell International also testified at the hearing on behalf of the Council and urged the agencies to draft regulations that do not mandate the features and characteristics of target-date funds. “The focus should be on whether the existing process employed by fiduciaries is designed to identify target-date funds that are appropriate as an investment within a menu of investment funds and as a default investment fund for participants,” Ms. Klausner stated. “Any regulations should permit plan fiduciaries to make prudent decisions appropriate for its body of plan participants.”
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