(From the July 31, 2006 issue of Deloitte's Washington Bulletin, a periodic update of legal and regulatory developments relating to Employee Benefits.)
401(k) Sponsors Addressing Challenges Raised by Stock Market Volatility, Corporate Scandals
During the late 1990s, all stock market investors -- including 401(k) plan participants -- seemed to have the Midas touch. So far the current decade has proven to be more challenging for all investors, be they amateurs (like most 401(k) participants) or seasoned professionals. But corporate scandals and the stock market's ups and downs have created new challenges for 401(k) plan sponsors and fiduciaries as well. The 2005/2006 edition of Deloitte's Annual 401(k) Benchmarking Survey ("Survey") -- conducted by Deloitte Consulting LLP, the International Foundation, and the International Society of Certified Employee Benefit Specialists -- indicates plan sponsors and fiduciaries are rising to these challenges by offering a diverse variety of investment options, regularly evaluating and benchmarking the performance of their plans' investments, and replacing funds that perform poorly.
The number of investment choices available to the average 401(k) plan participant is 17, up from 15 in 2004. A majority of Survey respondents offer the following core investment options to their plans' participants:
Beyond these options, significant numbers of 401(k) plans are expanding their offerings to include time-based lifestyle funds (44 percent). These funds gradually change their focus from growth to principal preservation as the target retirement date nears in order to protect near retirees from short-term stock market fluctuations. Risk-based lifestyle funds, which are being offered by 31 percent of 401(k) plans, also are common. Other popular options include passively managed global equity funds (32 percent), emerging market funds (31 percent), real estate funds (18 percent) and sector funds (15 percent).
Slightly less than one-third (30 percent) of Survey respondents make employer stock available as an investment option to 401(k) plan participants. However, only 12 percent of Survey respondents match employee deferrals in employer stock, down from 15 percent in 2004. Also, of those plan sponsors who match participant contributions in employer stock, more than two-thirds (68 percent) permit participants to reallocate those matching contributions to other investment options immediately.
A small but growing number of 401(k) plans are offering Treasury Inflation Protected Securities (TIPS), which feature an inflation-protected guaranteed rate of return. According to the Survey, 9 percent of 401(k) plans now offer TIPS, up from 3 percent previously.
In the interest of giving participants maximum flexibility, some 401(k) plans offer brokerage "windows" which entitles participants to invest in any stocks and/or mutual funds. The Survey indicates 17 percent of 401(k) plans offer self-directed brokerage windows, and 12 percent offer mutual fund only windows.
Selecting and Monitoring Investment Options
Selecting investment options for 401(k) plans is a fiduciary act under ERISA. Most plans have formal written procedures in place regarding fund selection (78 percent) and formal written investment policies (83 percent) to guide fiduciaries as they carry out their duties.
Of course, fiduciary obligations do not end with selecting investment options. Fiduciaries have an ongoing responsibility to monitor those investment options and make changes as needed. More than half (58 percent) of the Survey respondents evaluate and benchmark the performance of their plans' investments on a quarterly basis, 14 percent do so semiannually, and 22 percent do so on an annual basis. The rest use another schedule (1 percent) or do not have a formal schedule (5 percent). Two-thirds of Survey respondents have internal committees responsible for monitoring investments. But 55 percent of respondents reported using an outside investment consultant, and 38 percent reported using their plan recordkeepers, to at least help with this function.
Dealing with Underperforming Funds
Almost two-thirds (66 percent) of Survey respondents indicated they handled underperforming funds by replacing them. In fact, more than half (57 percent) said they have replaced a fund due to poor performance during the past two years and 76 percent have done so within the last five years. However, almost one in five (19 percent) respondents never has replaced a fund due to poor performance.
Other approaches to handling underperforming funds include continuing to monitor the funds (51 percent), adding additional funds with the same investment style (17 percent), freezing the funds (16 percent), and phasing out the funds over a period of time (15 percent).
It is one thing for 401(k) plan sponsors to make sure participants have sound investment options to choose from, but quite another for them to make sure participants have the skills and resources to make sound investment decisions. According to the Survey, 38 percent of respondents make individual financial counseling/investment advice available to all participants and another two percent make this service available to some participants. Another seven percent are in the process of implementing an individual financial counseling/investment advice feature. But 53 percent do not offer this service at all, primarily due to concerns about potential fiduciary liability and cost. However, of those who do not offer individual financial counseling/investment advice, 34 percent cite lack of employee interest as one of their reasons.
About the Survey
A total of 830 401(k) plan sponsors from a broad spectrum of industries participated in the Survey. The respondents do not represent a random sample of 401(k) plan sponsors, so the results cannot be projected to all plan sponsors. However, the Survey offers a highly detailed snapshot of the policies, features, objectives, and expectations of the respondents and the people who manage the respondents' 401(k) plans.
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