Individual Rate of Return Calculation

[SRP]

Can anyone point me to a source (or share your own examples) which provides guidance on reasonable formula's used to calculate an individual participan't investment rate of return that can be communicated via a participant account statement?

I am assuming that any reasonable method can be used to determine this individual rate of return on an accoun statement. I would expect that it is prudent to describe (on the statement) to a certain detail the formula/manner used to arrive at the rate.

Although I have used various methods of calculating rate of return for other purposes, I have never actually communicated this to a participant such as providing it through an account statement generated by a recordkeeper.

Any help would be appreciated.

Thanks

[david rigby]

The method used by the IRS for the Schedule B (for DB plans) is:

i = 2I/(A+B-I), where

A = BOY value

B = EOY value

I = net investment return amount (not rate) = B-A-Contributions+Payments

The result (i) is a rate/percent. This formula assumes all transactions occur in the middle of the period, so it may not be appropriate for all uses, especially if the transactions are "front-loaded" or "back-loaded" in the period. However, it usually provides a reasonable value, even for comparison purposes.

[Peter Gulia]

The method that David Rigby describes is in use with some recordkeepers. (Some furnish it regarding a year and a quarter.)

A few observations:

If a plan fiduciary chooses to furnish this information, the same statement should include a plain-language explanation of the formula, why the illustrated return “rate” is only an approximation, why that illustration likely doesn’t match a “rate” that could be computed by counting the actual flows of the account, and the conditions under which the illustration might or might not closely approximate the account’s return.

If a statement includes any investment-return information, the same statement should include a plain-language explanation that the past isn’t an indication of the future. To try to avoid the mind-numbing haze that comes from something that looks like “disclaimer” language, a plan fiduciary should write this with an emphasis and style that makes it noticeably different from what most securities people write.

Even if the plan fiduciary is certain that participants will ignore all explanations, it’s still worth doing. If a plan fiduciary volunteers to furnish information that’s not required by law, its fiduciary duties require it to communicate carefully – with a prudent expert’s appreciation of the possibility that a participant could be misled or otherwise harmed by information that isn’t sufficiently explained.

[MSN]

Are there many small/mid sized plan fiduciaries out there that draft language that is incorporated on a statement?

Are you saying that a fiduciary who "chooses" (by way of selecting a recordkeeper, in most instances) to not include the explanation of the ROR calc has not adequately performed his/her fiduciary duties?

[Peter Gulia]

Whether any particular decision is or isn’t a fiduciary breach always depends on all of the surrounding facts and circumstances. Although the call for “care, skill, prudence, and diligence” is unchanging, the measure is what one would do applying those behaviors and skills “under the circumstances then prevailing”. ERISA § 404(a)(1)(B). A decision that’s wrong for a $100 million plan might be sensible for a $10 million plan.

To answer MSN’s question, yes, there are fiduciaries of smaller plans that don’t merely eat out of a recordkeeper’s can but add their own language to individual-account statements.

Some recordkeepers provide a “slot” to put plan-customized language on a statement. While such a slot often is limited to a specified number of lines and characters, a careful writer can convey information in two or three sentences. If space is very tight, an explanation’s last or second sentence might point to a website page that provides more information.

Another choice: a recordkeeper might give a plan administrator a choice to include or “suppress” a rate-of-return display. Until one finds a way to explain the information, a plan fiduciary could consider whether potential harms to participants who might misunderstand the information might outweigh potential benefits to those who might understand and might use the information. (Even if a good explanation of a rate-of-return approximation could be furnished, some plan fiduciaries believe that the display is unnecessary for a participant who would understand the information, and useless or even harmful for a participant who wouldn’t understand the information.)

While smaller plans might have fewer good choices, there’s always some choice – even if that’s pushing a recordkeeper to improve its services, or finding another service provider.

The one thing that’s not acceptable is for a plan administrator to abdicate responsibility for individual-account statements. ERISA § 105(a)(1)(A) makes account statements the plan administrator’s duty. ERISA § 105(a)(2)(A)(iii) requires that a statement “be written in a manner calculated to be understood by the average plan participant”. ERISA § 404(a) calls a plan administrator to act diligently and as a prudent expert would in carefully considering what is or isn’t helpful for an “average” participant. A fiduciary can’t delegate to a non-fiduciary. And while service providers can offer tools that plans might want, they should design them to let the plan fiduciary be in charge.

If our society’s pensions are provided from participant-directed investments for individual accounts, it’s time for us to care about building good “train tracks”, and to recognize that the information of an individual account is itself part of a plan’s benefit.

[RCK]

Our provider (high profile, big plans) uses essentially the XIRR calculation in EXCEL, and includes links to pages and pages of description on how the calculation is done and what it means.