Tuesday, January 19, 2010

401(k) plans: Achieving the Lake Wobegon effect

Channeling the serene Minnesota town from
Employee Benefit Adviser
By Roger Levy
December 1, 2009
One might imagine in regard to the 401(k) plans found in Lake Wobegon that all the employers are models of fiduciary conduct, all investment expenses are low and all investment returns are above average. In the rest of the country, however, much work needs to be done to improve 401(k) investment performance.
This article suggests some alternatives consultants, 401(k) providers, employers and participants might consider…
Professional management
…What's really needed is a basic acknowledgment that participant-directed accounts don't work. The signs were there even before the market meltdown. …
While few investors survived 2008 unscathed, there is evidence to suggest that professionally managed pension investments fared better than investments that were participant-directed.
According to Milliman, investment returns within the largest 100 U.S. pension plans were -18.9% in 2008, compared to a -28.3% median rate of return in the same year for 401(k) plans, as reported by Hewitt, another pension consulting firm. …
… [These] statistics suggest that where investments are managed by investment professionals, … investment returns will be better. …
The solution to the problem is not to add more bells and whistles to what is an already overly complex employee benefit, but to take the investment decision out of the hands of plan participants and put it in the hands of professionals on a trustee-directed basis. This is perfectly permissible and, by following prudent investment practices, can be achieved without increasing the employer's fiduciary exposure.
First, the plan must be amended to make it trustee-directed. Then, the following steps should be taken:
* The employer appoints a trustee who will accept responsibility for investment direction. This could be a corporate trustee or members of management.
* The trustees(s) name the plan fiduciaries to manage the plan assets. The fiduciaries could be members of the investment committee that oversees the selection and monitoring of the plan's current participant-directed investment options.
* The investment committee adopts a new investment policy statement. This sets out the investment guidelines which will control how contributions are to be invested.
* The investment committee then selects an investment manager. Then it delegates to him or her the day-to-day management of the prudent investment of the plan assets according to the new investment policy statement.
As long as the manager to whom investment authority is delegated is a Registered Investment Advisor, bank or insurance company that acknowledges in writing its fiduciary status, the plan trustees and fiduciaries are relieved of their fiduciary responsibilities for managing the assets.
However, they remain responsible for prudently selecting managers, establishing appropriate investment guidelines and monitoring investment performance, just as they are for the participant-directed plan. …
Embrace annuities
Another alternative for employers who want to help participants protect themselves from large losses is to introduce annuities as an investment option within the plan.
Annuities provide a guaranteed rate of return and a guaranteed income upon retirement, which can increase under some annuities if market returns exceed the guaranteed floor.
However, annuities are a tax-deferred investment vehicle, and some see them as a bad idea because they potentially add cost.
…The answer is because of the guaranteed income and the potential to take full advantage of market upswings.
Also, today, a variety of annuity arrangements are emerging from reputable insurance companies which are not as costly as those of yesteryear, and improvements in recordkeeping and the design of annuity products is making them increasingly attractive as a 401(k) investment option. Such an option could be included in both a trustee-directed plan as well as one that is participant-directed. …

Levy, LLM, AIFA, is CEO of Cambridge Fiduciary Services, LLC, a fiduciary adviser and audit firm with offices in Greenwich, Conn. and Scottsdale, Ariz. He can be reached at (480) 607-2608 or

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