Secrets to a Successful 401(k) Plan

Over the holidays I was catching-up on my reading. One of the articles I came across involved a debate over which metric was more effective in assessing the success of a defined contribution plan, a plan’s rate of participation or a plan’s deferral rates.  While I realize that the article was not discussing “success” in terms of legal success, I still found the article’s premise interesting.

Given the recent legal developments involving pension plans and the increase in cases involving plans either being held liable or settling cases, I think any discussion of a plan’s success must include an evaluation of its ability to create a true “win-win” situation for both the plan participants and the plan itself so as to avoid legal liability issues.

The Department of Labor is expected to release new fiduciary standards sometime in 2013, with the general consensus being much more stringent requirements.  Even without the new DOL standards, ERISA already requires plans and plan fiduciaries to meet various duties, including the fiduciary duty of loyalty and the duty of prudence.

The fiduciary duty of prudence requires plans and plan fiduciaries to always out the interests of the plan participants and their beneficiaries first. The duty of prudence consists of various responsibilities, including the duty to avoid unnecessary expenses and the duty to provide participants with a selection of investment options that allows them to minimize the risk of significant losses and “sufficient information to allow plan participants to make an informed decision.”

I recently released a white paper on the Active Management Value Ratio,  proprietary metric that allows investors and fiduciaries to analyze the cost efficiency of actively managed funds.  The white paper clearly shows that a number of the leading mutual funds used by pension plans are not cost efficient, in some cases even reducing a plan participant’s return. It could be argued that such inefficiency could constitute a breach of fiduciary duty, clearly not a sign of a successful plan.

Plans and their fiduciaries are required to provide plan participants with a sufficient selection of investment options to reduce the risk of large losses and sufficient information to evaluate such investment options and make informed investment decisions. In short, in most cases this simply is not happening.

In  most cases plans are primarily an assortment of expensive, highly correlated equity-based mutual funds that unnecessarily expose plans and plan fiduciaries to unlimited personal liability. Furthermore, in many cases plans fail to provide plan participants with all of the information they need to make informed decisions, resulting in liability exposure for both the plan and its fiduciaries.

Many plans and plan fiduciaries mistakenly believe that they do not face any personal liability by virtue of their mistaken belief that they have complied with ERISA Section 404(c). However, Fred Reish, one of the nation’s leading ERISA attorneys, has testified that over his twenty plus years of ERISA practice, he has never seen a plan properly comply with all of Section 404(c)’s requirements. Consequently, there are a lot of plans and plan fiduciaries that do not realize the risk exposure that they actually have.

In determining whether a defined contribution plan is a “success,” I would suggest that a more meaningful analysis would be whether the plan presents a true win-win situation for both the plan participant and the plan and its fiduciaries by complying with all of the fiduciary requirement required under ERISA and applicable legal decisions, which in turn would reduce any potential lioability exposure for both the plan and its fiduciaries.

About jwatkins

I am a securities and ERISA attorney. I am a CFP Board Emeritus™ and an Accredited Wealth Management Advisor™. I am a 1977 graduate of Georgia State University and a 1981 graduate of the University of Notre Dame Law School. I am the author of "CommonSense InvestSense: The Power of the Informed Investor" and " The 401(k)/403(b) Investment Manual: What Plan Sponsors and Plan Participants REALLY Need To Know. " As a former compliance director, I have extensive experience in evaluating the legal prudence of various types of investments, including mutual funds and annuities. My goal is to combine my legal and compliance experience in order to help educate investors and investment fiduciaries on sound, proven investment strategies that will help them protect their financial security and/or avoid unnecessary fiduciary liability exposure.
This entry was posted in 401k, 401k compliance, 401k investments, 404c, 404c compliance, compliance, fiduciary compliance, fiduciary law, retirement plans and tagged , , , , , , , , . Bookmark the permalink.

1 Response to Secrets to a Successful 401(k) Plan

  1. Pingback: Secrets to a Successful 401(k) Plan

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