May 13, 2009
A sputtering economy and declining stock market have taken a huge toll on investors' portfolios, including employees' 401(k) accounts. Some studies show that stock market drops resulted in the average 401(k) account balance falling nearly 30 percent in 2008. This occurred despite participant contribution levels that continued at slightly higher rates than in 2007.
Losses can be frightening to any investor, but they may be particularly alarming to employees. For many 401(k) participants, their plan accounts represent their largest single asset outside of their homes, and a primary expected source of retirement income. And in many cases, 401(k) accounts represent participants only experience with stock market investing. Such high stakes, coupled with fear and inexperience, could be fodder for lawsuits in which employees look to recover losses.
ERISA Section 404(c) can protect plan fiduciaries from liability for the consequences of participants' investment decisions -- if the provisions of that section are followed. However, fiduciaries continue to have the duty to act prudently and solely in the interest of plan participants when choosing the investment options offered by the plan and when selecting investment managers.
Under the law, both investment offerings and investment managers must be monitored to ensure that they continue to be prudent choices. Lawsuits could be forthcoming in the wake of the 2008 U.S. Supreme Court case of LaRue v. DeWolff, Boberg & Associates, which ruled a plan participant can sue plan fiduciaries to recover individual losses alleged to be caused by a breach of fiduciary duty.
Clearly, present-day circumstances provide ample motivation for 401(k) plan sponsors to take steps to make sure they adequately protect themselves. It is an important time to review the administrative processes and fiduciary procedures associated with your plan, including those related to investment managers, investment line-up and fees. The following are among the issues to consider in conducting such a review:
- Investments. Review your plan's investment choices to determine whether the selection available to participants is appropriate. Does the line-up offer options along the risk and return spectrum for all ages of participants? Are any pre-mixed funds, which are based on age or expected retirement date, appropriate for your employee population? If the plan includes a default investment for participants who have failed to direct investment contributions, review the option to ensure that it continues to be appropriate. If your company plan currently does not have a written investment policy in place, or does not use an independent outside consultant to assist in selecting and monitoring investments, take steps to incorporate these into your investment procedures.
- Fees. 401(k) plan fees have recently come under criticism. Last week, a bill was introduced in the U.S. House of Representatives that would require greater 401(k) fee disclosure to participants. Determine the amount of current participant fees associated with your plan's investments, and benchmark them against industry standards.
- Investment managers. Review (or create if you don't have them) the written processes your plan has in place for the selection and monitoring of investment managers.
- Administrator. The plan administrator is the face of the plan to employees. Solicit and monitor participant feedback on the administrator so that you know about problems before they grow into headaches. Further, have criteria in place to assess the plan administrator's performance on an ongoing basis and to benchmark performance against industry standards.
- Compliance. Are your plan's administrative procedures in compliance with current regulations? If you intend your plan to be a participant-directed individual account plan, are all the provisions of ERISA Section 404(c) being followed?
Communicating with Participants during Tough Economic Times
With the market changing so much over the past year, it's likely that written communications that were appropriate during times of surging account values may not be appropriate today. Revisit your plan communications materials and assess them accordingly. Saving for retirement remains vital to employees' future financial security, but different messages may be needed to convey this.
Given today's economic climate, many 401(k) participants will consider moving what's left in their accounts to non-stock-fund investments, perceiving them to be safe from market volatility (though overlooking the risk of low returns not keeping up with inflation). Some will scale back their contributions, or stop participating altogether.
It is an important time for effective 401(k) communications to dissuade employees from taking rash actions that can have a negative impact on their long-term savings.
What kinds of messages are appropriate for 401(k) participants during these challenging economic times? Some considerations:
- A 401(k) remains one of the best, most efficient ways to save for retirement. Regardless of recent investment results, the pre-tax advantage and any employer match make a 401(k) plan an ideal way to save. For example, remember that, for every $100 contributed, the entire $100 is invested in the plan, not reduced for taxes as it would be for other types of investments, or if it were paid to the employee in wages. Any employer match increases investment potential. So even if performance is off, the loss is generally not as great in a 401(k) plan as it would be in some other types of investments.
- A change in the outside investment environment, such as a down stock market, presents an opportunity to reassess one's investment strategy and asset allocation. Market shifts have a significant impact on many individuals' asset allocations, resulting in portfolios that may be inappropriate for their ages, retirement horizons and degree of comfort with risk. Although financial advisers typically suggest an annual rebalancing to maintain appropriate investment risk, many people ignore this advice. This might be a good opportunity to buy stock at historically low prices.
- For employers that make financial counseling services available to employees, now is a good time to remind them of this resource. Employee assistance programs (EAPs) frequently offer financial counseling, a service that may be overlooked. Or these services may be available through a voluntary benefit plan. Employers may also be able to secure investment advisers to come in and meet with employees, through their 401(k) plan vendors. Remember not to directly give financial advice to employees through individuals who work for your organization.
- Make sure employees know that the 401(k) plan operates according to federal regulations. And while the value of their accounts may be affected by market ups and downs, it won't be affected by your organization's ups and downs, as plan assets are not commingled with company funds.
- Remind employees that the stock market and accompanying weak economy will eventually resolve themselves. 401(k) plans are part of a long-term retirement savings and investment strategy. The economy moves in cycles, and if an employee is invested appropriately for his or her age, investments and 401(k) account values will likely rebound in time.
For more information, consult with your employee benefits adviser and your attorney.
Putting Match Contributions on Hold
To help survive the recession, many organizations are suspending or reducing matching contributions to employees' 401(k) retirement plans. For example:
- Weyerhaeuser declared in an SEC filing that it would end 401(k)contributions beginning on May 1.
- As part of its "Recession Plan" to strengthen financial performance, the Reader's Digest Association announced a series of steps, including a freeze on company 401(k) contributions, a reduction in its workforce, and forced unpaid time off.
- The Corcoran Gallery of Art in Washington, D.C., announced it would stop employer contributions to its pension plan in May. The Museum estimated it would save $520,000 this fiscal year by suspending deposits.
If your company is planning to reduce or suspend matching contributions, here are some steps to take:
- Make sure you comply with regulatory requirements for the plan, including non-discrimination requirements.
- Keep in mind that changes may not be allowed if your organization has collective bargaining or other employment agreements.
- For mid-year suspensions, check IRS requirements for plan compensation limits.
- Review past written communications to participants to ensure they can't be interpreted as promising ongoing match contributions.
- Don't just provide the required legal information to employees. Make sure the news is delivered in a considerate way, emphasizing the changes are necessary to avoid further job cuts and remain financially healthy.
The Basics of ERISA Section 404(c)
The Employee Retirement Income Security Act (ERISA) is a federal law which was enacted in 1974 to protect participants in private industry pension and health plans.
ERISA section 404(c) relieves plan sponsors and other fiduciaries from liability when participants or beneficiaries are considered to have exercised "independent control" over the assets in their retirement accounts.
The protection applies only to investments directed by participants -- not to those directed by the plan sponsor or required by the plan. To receive ERISA section 404(c) protection, a plan must satisfy certain requirements involving plan design, administrative requirements, investment menu options and information disclosure to participants.