How do you invest a retirement plan that does not provide participant-directed investment?

[Peter Gulia]

Imagine an individual-account (defined-contribution) retirement plan that does not provide participant-directed investment.

 

Imagine the participants range from 18-year-olds to workers in their 90s.

 

If you were the plan’s trustee or investment manager with complete authority and responsibility to decide the plan’s investment policy, what would you do?

 

Would you decide an asset allocation grounded on some average of the participants’ ages?

 

Is there another method you might use to balance the potentially differing interests of younger and older participants?

 

Is there some other way—without changing the plan’s provisions—to manage this fiduciary challenge?

 

[C. B. Zeller]

If I were the fiduciary in this case, I would invest in the manner of a prudent person familiar with such matters. Furthermore I would diversify the investments in order to reduce the risk of a large loss.

For real though, there is no reason that the ages of the participants need to dictate the plan's investment strategy. Assuming that the plan provides that gains and losses will be allocated to each participant's account in the same manner, then the fiduciary needs to decide what constitutes an appropriate level of risk and return for the plan and invest accordingly. Any age-based investment strategy (e.g. higher risk for younger participants and lower risk for those closer to retirement) would by design be counter to the interests of certain segments of the plan population.

A particularly sophisticated fiduciary might seek to use an immunization strategy to hedge against investment losses. This is typically more applicable to a defined benefit plan where the plan has fixed liabilities that it can anticipate, but the concept could apply to a DC plan as well. However the costs of doing so may be prohibitive for a small plan.

[Bird]

We have a fair number of these plans - mostly small enough that we don't worry too much about the risk of a lawsuit.

Generally I agree with C. B. Zeller.  Not too terribly worried about trying to manage by average age or other actual age weighting.  We do try to stay ahead of things and suggest raising cash if it is apparent that a large distribution is going to be in the works.

We're (TPA) not typically directly involved in the asset allocation strategy, but we (I) have been doing this long enough to know red flags when we see them, and to say "hey, what are you doing here?"

[Peter Gulia]

C.B. Zeller and Bird, thank you for your observations.

Any others?

 

[Mr Bagwell]

Why not just go the participant directed route?  Seems like a very straightforward approach to me.

The plans that I see that are not participant directed are of the mindset that they are smarter then their employees and must protect them from themselves.  That may be true, by why take the risk?

 

[Luke Bailey]

A balanced fund. There is a temptation to think that a generic, old-fashioned balanced fund that does not take age into must violate fiduciary duty, and maybe someone will claim that, and even claim that successfully (some courts will do anything), but how can that be? Before the 404(c) regs in the late 80's, many plans had just one fund, and ERISA really assumes there will be one fund, with 404(c) being the exception that has swallowed the rule. Amending a plan to make it self-directed is at least traditionally viewed as a settlor function, not fiduciary, although if someone wanted to pay me to do it I might try to argue that given the easy of implementing self-direction in today's market, and its obvious advantages for a diverse labor force, the decision not to be a 404(c) plan was fiduciary.

[BobbyV]

In addition to all of the above my two cents worth is that the investment fiduciary will need to be sensitive to the plan's liquidity needs as participants retire.  Looking ahead to who accounts for how much of the plan assets and forecasting when they are likely to want to be paid is important.

[Peter Gulia]

Luke Bailey and BobbyV, thank you for your further observations.

 

[FPGuy]

Broadly speaking (i.e. not to get into asset class/composition specifics), lot to be said for using a core or more of balanced and/or tactically managed funds. Like potato chips, one might not be enough except for smallest plans, and even then...Alternatively a traditional 60:40 portfolio provides generally the same structure but with more control of underlying holdings. Maybe further overweight equities if employees can take in-service withdrawals beginning at or around normal retirement age. Maybe underweight equities somewhat if average age is particularly high.

[thepensionmaven]

Similar question, did not know if I should start another topic or not.

We handle a profit sharing plan that is invested in annuities.  The previous TPA had been using the balance forward method of crediting gains and losses, but that is not my question.

If the accounts lose money, all participants share in the loss.  

The accounts are being taken over by a new investment advisor who was reviewing the annuities - each one is within the surrender period so he has to freeze them.

One of the participants terminated and is looking for her money.  If she receives her money based on her  12/31/2020  account value, would not all participants share in the surrender fee as part of the investment gain/loss as of 12/31/2021?

[ESOP Guy]

13 minutes ago, thepensionmaven said:

Similar question, did not know if I should start another topic or not.

We handle a profit sharing plan that is invested in annuities.  The previous TPA had been using the balance forward method of crediting gains and losses, but that is not my question.

If the accounts lose money, all participants share in the loss.  

The accounts are being taken over by a new investment advisor who was reviewing the annuities - each one is within the surrender period so he has to freeze them.

One of the participants terminated and is looking for her money.  If she receives her money based on her  12/31/2020  account value, would not all participants share in the surrender fee as part of the investment gain/loss as of 12/31/2021?

Let's clarify something here.

 

Are you saying that Participant A's account balance equaled the value of say annuity 1.   Participant B's account balance equaled the value of say annuity 2.  Is that what is going on?

 

Or

 

Is the value of everyone's account actually made of the value of all the annuities combined? 

 

I ask because the first thing I described is an individual balance type plan and the other is a pooled form of accounting.  I think the answer to your question might depend on if this is a pooled plan or not. 

 

I really think the original sin (beside using annuities in the plan) was valuing the annuities without factoring in the surrender charge every year.  That is to say the fee should have been baked into the account balances until there were no more surrender fees.  That in my mind is the real FMV of them.   If the plan terminated how much cash would the plan have?   The annuity values less the surrender value is the answer so that is the value that should have been used each year to value those assets.  That would have stopped this issue but that is water under the bridge as they say. 

[thepensionmaven]

I am speaking of pooled money in something like 10 annuities.

 

[ESOP Guy]

Yes, it sounds like the rest would end up getting the surrender fee as part of the income allocation it sounds like.  To me the solution is to value the contract net of the fee until there is no fee.   That would seem to have the effect to stop that.  It would at this point however mean everyone takes a one time hit of all the possible fees. 

It has been a long time since I have dealt annuities with these kinds of fees in a plan so maybe I am not thinking it through fully.   

[Bird]

18 hours ago, thepensionmaven said:

The accounts are being taken over by a new investment advisor who was reviewing the annuities - each one is within the surrender period so he has to freeze them.

You didn't ask, but this is almost purely a psychological issue - it feels better not to pay the surrender charge but the reality is that the higher expenses over the remaining surrender period are roughly equal to the surrender charges.

17 hours ago, ESOP Guy said:

I really think the original sin (beside using annuities in the plan) was valuing the annuities without factoring in the surrender charge every year.  That is to say the fee should have been baked into the account balances until there were no more surrender fees.  That in my mind is the real FMV of them. 

100% correct.  The accumulated values are meaningless except in the case of death.  Always use cash surrender value net of surrender charges.