Change to employer directed from employee

[Guest S FISCHER]

Plan sponsor wishes to change the deferrals and match investments of the safe harbor 401(k) from employee to employer directed. What if anything should he be worried about? How much notice needs to be given to the employee? Besides admin hassles, any reason not to do this plan amendment as a mid year change? Any insight would be helpful.

[Guest yukon]

Wow...too many "idiot" jokes to choose from. Why on Earth do they want to do this?

[QDROphile]

I would be interested in the applicable idiot jokes, because this is really the right thing to do in concept. Or perhaps you were referring to a joke to the effect that it is about time that people recognize that idiots should not be forced (or allowed) to invest their retirement funds.

You will hear all sorts of balderdash about how exit timing is critical and unilateral action will defeat the great investment strategies in place and cause great losses. I don't buy it.

You will be working with a professional investment manager in the transition. Get a good one and a good lawyer and then quit worrying about all the flak you will get (and you will). This is actually not a bad time to be making this move. Fewer people think they are investment geniuses these days.

[mbozek]

I think the cleanest way to change the investment of plan assets is to make the change prospectively-- and allow employees to continue to manage their own accounts for amounts contributed prior to the date of the change. Otherwise the BRF rules should be reviewed if employer is going to eliminate self direction on current acount balances. (Self directed investments are not protected under the cutaback rule.) I am assuming the plan allows the employer to amend any investment options at any time.

Second option: the plan sponsor can terminate the plan and transfer assets to a new plan with employer direction of assets. ER should consider hiring an investment advisor to avoid any issues of fiduciary responsibility for investments before taking over investments. ( I hope the ER doesnt think that he/she can do a better job of investing than the employees)

[Guest yukon]

QDROphile: So the argument is: people typically make bad investors, so that right should be taken away...??? It would seem at a time when 404© is among the top issues with larger plan sponsors, and the events of recent past (Enron, et.al.), that converting a plan to employer-directed would not necessarily be a good idea. Anyway, I agree with one part of your advice....get a good lawyer.

[Guest FREE401k]

QDROphile had it right when he used the word "forced". It's not that people make bad investment choices so we're taking that right away, it's that people make bad investment choices so we shouldn't force them to do so. Our Plan Sponsors offer a professionally managed investment option in addition to the other typical investment choices, and they use that professionally managed investment option as the default for new enrollees. This lets people who don't know a stock from a bond (which according to USA Today is most Americans) not be forced into making their own investment choices if they don't want to be. We think this is the ultimate 404© protection. Nobody will pop up at retirement and say "Hey Mr. CEO with your MBA and wing-tipped shoes, you made 15% each year while you watched me make 3%. Now I'm ready to retire and I'm broke. You forced me to do something you knew I was woefully unprepared to do, then sat there and watched me do a terrible job at it. What are you gonna do about it?"

[Guest yukon]

Good point. Maybe my initial reaction was too quick. I'm beginning to come around.

[MWeddell]

I'll throw in my two cents. In terms of trying to lessen the chances of fiduciary liability, if one has a plan that allows participants investment choice, complying with ERISA 404© somewhat lessens fiduciary liability. However, I don't think there's a clear consensus on whether a 404© type plan bears more or less fiduciary risk than a plan where assets are invested as directed by the employer or trustee.

[Alonzo]

The worry I would have in this situation is that a participant will be cashed out of his investment at a really bad time. It strikes me that you would want a long lead time to make this change mandatory, and have a period which allows participants to "hand it all over to the professionals". I can see participant unhappiness if the change is made abruptly, without much communication. And, as we know, participant unhappiness can generate legal action.

[QDROphile]

And what time is not "a really bad time" for those people who don't understand investments and think they don't want to sell until the price comes back? That is essentially what you are talking about (or some variation on it) and that is why the average investment return on self directed accounts is so poor. Unless the plan offers a so-called brokerage option, it is very unlikely that that the plan has a type of investment that is so time sensitive. You could have a more exotic investment such as a futures contract or option that could be extremely sensitive to timing. Otherwise the importance of timing of a sale is a dangerous delusion.

[Alonzo]

QDROphile:

If somebody is moved out of their low yield safe fund just in time for a stock market plunge (because the fund is now actively managed), that employee will complain, particularly if that employee is close to retirement. He might delay his retirement. He may even sue. Remember the First Union litigation?

I am not saying that making the switch is a bad idea. But you can't move from one retirement investment model to another without lots of communication and allowance for employees who have operated under the current retirement investment model.

[QDROphile]

So what do you do for the 63 year old who is in a safe fund? Announce the change, wait two years and then change the system? Then what about the 62 year old who was in a safe fund who became 64 in those two years? A two year period may not be enough to assure that a managed fund will outperform a fixed investment fund. Where do you draw the line unless you simply add a new managed fund and go to the system described by FREE401k, at least for a full investment cycle (whatever that is these days)?

I don't suggest that advance notice and communication are not important. I don't know what an adequate notice period would be. What I suggest is that the plan will get many mistaken comments about investment timing.

[mbozek]

QDRO/Alonzo- to avoid this problem why not just change the investment to employer direction for contributions prospectively. then you would avoid the the fid issues u raise.

Also there is no fid liability for decline due to market change or systemic risk... Mere plunge in markets due to economic conditions is not a basis for liability.

A-I dont understand your reference to First Union-- What does this have to do with the original question???

Q- is change from employee direction to S & P 500 imprudent investment? Since 75% of active investment managers underperform S & P 500 each year is moving from employee direction to index fund imprudent?- remember prudent investing under ERISA adopted the principle of asset allocation embodied in index funds.

[Alonzo]

I referred to First Union as a roughly analagous situation that triggered litigation. (Although the switch did not involve moving out of 404©, it did involve moving from one set of funds to another, just to see some of the old funds do far better than the First Union funds.)

QDROphile, I am sympathetic to your point that at some time the transition has to end. A solution to transition problems would be to allow in-service distributions to individuals over age 59.5 so that they indeed can continue managing their own investments in their own IRA, if they feel strongly about that. This may be a better solution than the ideas I was propounding in earlier posts. What I am wary of is unilateral employer action without sufficient communication. That always leads to a perception that the employer is up to no good.

[Guest FREE401k]

Instead of an all-or-nothing proposition where you switch everyone from ee-directed to er-directed, think about adding an er-directed (e.g. professionally managed) option and letting people choose between the two. As I mentioned before, this is how we set up plans for our clients and it works beautifully - usually between 75-100% of participants pick the professionally managed option. It is presented to employees something like this:

Our plan offers two basic investment choices:

Professional-Directed Investment (PDI): If you would rather not make your own investment decisions, you may elect the PDI option. PDI allows you to leave the investment decisions up to a team of professional investment managers.

Employee Directed Investment Option (EDI): If you would like to make your own investment decisions, you may elect the traditional EDI method. EDI allows you to decide your own investment strategy, choosing from (however many) investment funds.

If anyone would like more detailed information about this, feel free to e-mail me directly.

[mbozek]

A: First Union switched investment options from low cost index funds( S&P 500) to its own proprietory funds which had loads of 100 bp or more with worse performance for employees who had worked at Core states Bank (which FU acquired). The issue was whether a PT had occurred because FU execs who decided to change funds were benefiting FU (as a party in interest) because FU would collect mgt fees on the captive accounts. A change to funds which may have some lower lower rates of return over a comparble period without any other action by the fiduciary is not a basis for bringing a a claim for breach of fiduciary action.

[Alonzo]

The first union case I had in mind involved the acquisition of Signet bank. What I remember of it had an awful lot to do with whether plan amendments had authorized the actions, and the great earnings a fund associated with Capital One was earning. I could be wrong. I did not do a LEXIS search before I wrote my post, and I am no lawyer.

Anyway, the point of my posts was not a discussion of case law but more a worry about disavantaging participants close to retirement.

[mbozek]

part. within 5 yrs of retirement should move most their assets to stable value funds, gvt funds and bond funds, not to other equity investments, to avoid market adjustment when they retire. E.g., people who converted equity account balances to annuities beginning on Nov 1, 1987 from DC plans sufferrred a big drop in monthly benefits because the value of their acount balance declined by 20-25 % as of Oct 31. I know a lot of people in their 50s and 60s who had 80% or more of their ret. funds and other assets invested in equities including er stock at the end of 2000. They refused to diversify their assets because they did not want to miss out on future gains.

[Alonzo]

It's a fair point to indicate that many investors do not act wisely. My example on top of page 2 involved an investor who did act wisely, and then was kidnapped into other funds because the plan reverted to employer direction. As we know, institutional investors invest for the good of the plan as a whole, not neccessarily for the good of a specific individual. So, instead of having his capital conserved, our hero loses part of his nest-egg, and has to wait until the market recovers.

Really, for the participant, defined benefit plans are the best solution to this problem.

[mbozek]

DB benefits only work for career service employees if the plan provides a final average benefit. Also most DB plans do not provide cola increases, so that after about 18 years purchasing power of the benefit declines by 50%. Finally the discounts for early retirement, cost of J & S annuity, etc. reduce the value of most DB annuities to ss benefits. In the corporate world DB plans are prized not because of the benefits but because the surplus is considered corporate earnings on the financial statements. Therfore it is in the sponsors interest to maximize return and minimize payouts which is why companies do not provide colas.