More and more unions are creating defined contribution (DC) plans for their members, raising a critical question for trustees of Taft-Hartley plans: Should they manage the plan investments themselves or permit participants to direct the investment of their individual accounts? There is no right or wrong answer; both have pluses and minuses.
Participant direction could potentially reduce trustees’ liability
In a trustee-directed DC plan—as in a defined benefit (DB) plan—trustees are legally liable for the investment decisions they make. But in a DB plan, participants’ benefits are not tied to investment performance, so participants are generally not concerned about how well or poorly the investments in the trust perform. Absent severe underfunding or other failure of the fund, DB participants will get the pensions they’ve earned. However, in a DC plan, participants are more sensitive to investment performance—over the long term and the short term—because their benefits are equal to the value of their accounts. If participants are unhappy with the performance of their individual accounts and believe the trustees made imprudent investment decisions, they can potentially sue the trustees, claiming a breach of fiduciary responsibility.
But a provision of the Employee Retirement Income Security Act (ERISA) known as Section 404(c) could protect DC plan fiduciaries from liability should participants experience poor performance as a result of their own investment choices. In general, to take advantage of Section 404(c), the plan must provide at least three investment options with different risk and return characteristics and permit participants to switch among them at least quarterly. Plan officials must also give participants certain information about the investments, including fees and performance. Note, however, that even though 404(c) protects fiduciaries when participants make their own investment decisions, fiduciaries remain responsible for selecting and monitoring the investment options on the plan’s menu.
Participant direction demands more education and communication
The rules for participant-directed plans require that participants be given quite a bit of information, including quarterly statements and a host of additional notices and disclosures. But perhaps even more challenging is educating participants so they can make sound investment decisions. Some trustees believe that many of their participants are unwilling or unable to manage their own plan investments. In general, U.S. DC plan participants seem to agree. According to J.P. Morgan’s 2016 Plan Participant Research, only about a third of those surveyed feel a strong sense of confidence in their ability to make key investment decisions. What’s more, nearly 60% of participants indicate that they want “help selecting my investment strategy” and prefer to “leave most of the ongoing investment decisions to experienced investment professionals.” Because many participants are uncomfortable making investment decisions, most DC plan menus include target date funds—typically a fund of funds, investing in a variety of asset classes—or other funds that have a mix of asset classes. Target date funds automatically rebalance to become more conservative as the participant ages. They can be attractive options for participants who don’t wish to make their own investment decisions.
Recordkeepers for participant-directed DC plans often have retirement planning calculators and financial education resources on their websites that participants may find helpful. Most recordkeepers maintain websites and call centers where participants can access account balance and investment information, and switch among investments at any time. While this ready access allows participants to easily monitor their retirement nest egg, it could also encourage them to overreact to short-term market swings and make investment changes at inopportune times.
Trustee direction may have potential efficiencies
When a plan’s assets are managed by the trustees in a single pool, the plan may be eligible to invest in lower-cost vehicles, depending on the size of the investment and the fee break points. In addition, to potentially enhance performance and increase diversification, the trustees could invest some portion of the trust’s assets in alternative investment categories, in line with the plan’s strategic asset allocation parameters. These assets may be too risky, too illiquid or otherwise unavailable for a participant-directed plan’s menu. Trustees can retain professional investment advisors who can provide research and recommendations for the trustees to consider; trustees may even hire discretionary investment managers who can assume fiduciary responsibility for some or all investment decisions.
Source: J.P. Morgan Asset Management.
Consider member needs and perspectives
Some members may like the idea of having control over the investments in their DC accounts. Such autonomy could allow them to tailor their investments to their specific needs and objectives and make them feel more connected to their benefits. Participants’ ability to exercise control and the potential for trustees to reduce their liability may help explain why most corporate DC plans have opted for participant direction. However, some studies have found that average investors on their own typically underperform the market.1 So it’s important that trustees consider members’ characteristics, desires and investment expertise when deciding who should direct plan investment decisions.
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1 See, for example, DALBAR Quantitative Analysis of Investor Behavior, December 2016.