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Industry Pros Comment On ERISA Advisory Council Draft Recommendations
by Christopher Carosa, October 29, 2024
The ERISA Advisory Council is trying to get feedback on several ideas it is considering to address its study of the effectiveness of Qualified Default Investment Alternatives (QDIAs) in both the accumulation and decumulation phases of retirement. FiduciaryNews.com has been made aware of four potential draft recommendations. We presented these ideas to experienced fiduciary professionals for their comments. Bear in mind that the recommendations expressed here are not final versions and may not be adopted. They are presented for discussion purposes only.
Draft Recommendation #1:
The first recommendation is to “Create sub-regulatory guidance in the form of a comprehensive ‘Tips’ document to provide a road map – a procedurally prudent process for selecting decumulation options inside or outside of a QDIA – incorporating:
Criteria the fiduciary should consider, and
General principles taken from past court rulings on fiduciary litigation”
This is along the lines of the 2013 TIPS document for Target Date Funds. How useful will this be for plan sponsors? For plan participants?
“It can’t hurt, though I think the ‘general principles taken from past court rulings’ is problematic, as they don’t seem to be uniform in certain aspects,” says Nevin Adams, industry thought leader and author, self-employed/“retired,” in Maryville, Tennessee. “That said, I don’t think the tips document is well-utilized, and I suspect the impact on participants to be neglible…at best.”
“Providing a road map for a procedurally prudent process with respect to decumulation options would likely prove useful to plan fiduciaries from a litigation risk perspective, because it will be more difficult for plaintiffs to challenge a process recommended by the Department of Labor,” says Marcia S. Wagner of The Wagner Law Group in Boston, Massachusetts. “However, procedurally prudent process is not a check the box activity, and that may particularly be the case with respect to decumulation, which has more factors to take into account than the accumulation stage. Further, listing factors that a fiduciary should consider does not ensure that they will be adequately implemented, and to the extent the guidance with be based upon existing case law, plan fiduciaries should already be familiar with those principles. Plan fiduciaries will derive some benefit from having this type of guidance, but I do not believe that it will have a significant effect in terms of encouraging employers who have not to date focused upon decumulation options from introducing them. Any benefit to plan participants will be limited, because the guidance will likely have only a limited effect on the manner in which decumulation options are introduced and/or implemented.”
“When a federal agency such the DOL issues sub-regulatory guidance, it does not have the authority of federal agency regulations, but it could be pointed to as best practices recommendations and would likely be relied on by the DOL in investigations,” says Michelle Capezza, Of Counsel at Mintz, Levin, Cohn, Ferris, Glovsky and Popeo, P.C. in New York City. “Comprehensive tips or best practices regarding selection of evolving forms of QDIAs (including as lifetime income options) would be helpful to plan sponsors and participants, but it should be clear that they are reasonable guideposts to consider under applicable facts and circumstances and not mandates.”
“A TIPS document for decumulation strategies could be incredibly beneficial for plan sponsors, offering a practical and straightforward approach to an area that has grown in complexity as more participants reach retirement age,” says Richard Bavetz, investment advisor at Carington Financial in Westlake Village, California. “Plan sponsors often face the challenging task of selecting decumulation options without a standardized process to guide them, and this uncertainty can increase their exposure to fiduciary risk. This document would offer them more confidence in making informed choices that prioritize participants’ best interests by providing a roadmap that includes specific criteria to consider—such as assessing income needs, managing longevity risk, and considering the tax implications of various options.”
Draft Recommendation #2:
The second recommendation is to “Provide guidance to plan sponsors and other fiduciaries that could be used to improve participant education, notices, transparency, and disclosure regarding QDIA investments in all phases of participation (accumulation, transition, decumulation) including decumulation options in or outside the QDIA.”
This is meant to increase and/or improve participant education. Does this provide an opportunity to enlighten plan participants about certain risks associated with Target Date Funds (e.g., sequence of return risk)?
Ron Surz, President of Target Date Solutions in Sacramento, California, says, “Regarding the largest QDIA, namely target date funds, the Department should: 1) Review the theory that fund companies say they follow to confirm or disaffirm whether that theory is actually being followed. My read is that the theory is not being followed (click and open links to the theory). Theory is much safer near retirement (80% risk-free) than practice that is 90% risky – stocks plus long-term bonds; Examine the claim that personalized target date accounts can realistically be personalized for people who do not want to engage by simply using recordkeeper data. I say personalization works for self-directed people because they want to engage. They can manage their own personalized glidepath. Also, plan fiduciaries can personalize a custom glidepath for all defaulted people, adhering to DOL tips to use a glidepath that conforms to demographics.; and, 3) Address the benchmark challenge. The de facto benchmark is Vanguard, but this is high risk at the target date. At a minimum there should be an alternative low risk benchmark like the SMART TDF Index.”
“Well-intentioned, but I’m skeptical on the ability to showcase even the implications of what seems to be a massive shift from “to” retirement date glidepaths to “through” by most of the major TDF providers,” says Adams. “People (including plan fiduciaries) have been very (too?) trusting on these glidepaths relative to the communications about design and application.”
“While the proposal to increase or improve participant education about QDIAs will provide an opportunity to enlighten plan participants of the risks associated with target date funds, here too it is difficult to measure the usefulness of such education,” says Wagner. “In theory, you want plan participants and plan beneficiaries to have as much information as possible in order to allow them to make informed decisions, but plan participants might regard increased disclosure about risks as just another attempt by plan sponsors and plan fiduciaries to protect themselves if the QDIAs do not perform as expected. Further, if a discussion of risks associated with target date funds is combined with the other types of risk associated with any investment option, the impact of disclosures specific to target date funds will be lessened.”
“Certainly the timing of poor investment returns can impact the duration of retirement savings,” says Capezza. “It is important for plan participants to receive education regarding their plan investments, including information regarding fund glide paths, but plan fiduciaries must ensure that the line is clear between investment education and fiduciary advice and that plan participants work with professional investment advisors that may be made available as a plan service or through their own channels.”
“The opportunity to enlighten plan participants and educate them about the risk of not having enough money for a secure retirement comes with the disclosure of a complete and accurate sum of the investment management fees accrued to the adequate consideration of every transaction directed and defaulted into a ‘target date or similar’ qualified default investment alternative (QDIA) not registered under the Investment Company Act of 1940, processed pursuant to ERISA section 404(c) and taken from plan assets through the fund-of-funds operating paradigm,” says Vito Milillo retired with nearly four decades of experience in the ERISA governed trust and custody businesses at Bankers Trust Company, The Chase Manhattan Bank, and JPMorgan Chase Bank, N.A. “A plan administrator who discloses, for example, that the expense ratio of an unregistered target date income fund-of-funds is 15 basis points, then translates that into a $1.50 cost for every $1,000 invested in that fund must also know they are held to a “complete and accurate” standard in the fiduciary requirements for disclosure of participant-directed individual account plans (Rule 404a-5). 29 CFR 2550.404a-5(b)(1). The “actual knowledge” of this sum rests with plan sponsors and named fiduciaries who initially select underlying investments held by a target date or similar QDIA, and direct the accrual of reasonable management fees against their fair market values, have these facts. Whether they disclose those facts, completely and accurately, is a serious fiduciary matter that every section 404(c) plan participant has the right to confirm.”
“This recommendation provides a unique opportunity to educate plan participants on some of the hidden risks associated with Target Date Funds (TDFs), such as sequence of return risk,” says Bavetz. “Many participants choose TDFs because they appear to be a “set it and forget it” option that adjusts risk over time, but they often don’t fully understand how these funds work or the potential impact of market fluctuations, especially as they near or enter retirement. Sequence of return risk, for instance, is the possibility that poor returns early in retirement could severely affect the sustainability of their savings, even if the market recovers later.”
Draft Recommendation #3:
The third recommendation is to “Change the safe harbor for automatic rollovers to individual retirement plans (29 CFR § 2550.404a-2) to align the investment safe harbor for involuntary, automatic rollovers with the Qualified Default Investment Alternative safe harbor as provided at 29 CFR § 2550.404c-5.”
Here the intent is to make it possible for a plan/IRA to apply the QDIA safe harbor to involuntary rollovers. But will this impact plan participants?
“Aligning the safe harbor for automatic rollovers with the Qualified Default Investment Alternative (QDIA) safe harbor could provide greater security and potentially better growth opportunities for plan participants whose accounts are automatically rolled over into an IRA,” says Bavetz. “When small-balance accounts are involuntarily rolled over—often due to a job change or other employment transition—they typically end up in very conservative investments, like money market funds or cash equivalents, that prioritize preservation but offer minimal growth. For participants, this approach limits their ability to benefit from the potential for long-term growth, even if they still have a long investment horizon before retirement.”
“To the extent that auto-portability becomes more common, modifying the safe harbor investment option for involuntary automatic rollovers to IRAs to align with the QDIA safe harbor in tax qualified plans will have a limited effect, because the amounts held in IRAs will be reduced, but there is a logic in having the same type of default investment options in both qualified plans and IRAs,” says Wagner. “However, the trustees and custodians of IRAs will not be interested in monitoring QDIA investment options to the same extent that fiduciaries in qualified plans need to monitor them.”
Capezza says, “The alignment of these rules would provide more specificity regarding the permissible investment product for the rolled-over funds which provides fiduciaries with liability relief and which is required to be designed to preserve principal and provide a reasonable rate of return consistent with liquidity.”
Draft Recommendation #4:
The fourth recommendation is to “Confirm the documentation needed to ensure participants have ‘actual knowledge’ as provided at 29 U. S. C. §1113(2) to ensure adequate notice and to reduce plan sponsor and fiduciary concerns about belated, aged claims about Qualified Default Investment Alternatives—whether or not they include decumulation options. decumulation options.”
This is designed to remove one concern plan sponsors have about offering decumulation options, whether in or outside the QDIA. How can this be accomplished in a practical way? In other words, how can “actual knowledge” be confirmed?
“There is only one way to confirm if a fiduciary has disclosed a complete and accurate sum of the fees that reduce returns for an unregistered target date or similar QDIA,” says Milillo. “What is disclosed as a gross expense ratio for the QDIA must be reconciled to the ‘adequate consideration’ expense accruals on fund accounting systems for all of the acquired funds and the acquiring fund.”
“I’d start by not requiring ‘actual knowledge’ but rather a standard of ‘even a third grader should know…’ or perhaps something that holds to account ‘willful ignorance,’” says Adams.
“There needs to be a uniform basis for determining actual knowledge,” says Wagner. “There should not be a separate basis for determining actual knowledge with respect to decumulation options than for any other conduct by a plan fiduciary. Further, there is currently a Circuit split with respect to the actual knowledge requirement, with respect to exactly what it is that a plan participant or beneficiary must have actual knowledge of. For example, the most complete disclosure regarding QDIAs will not indicate the manner in which in practice they have been monitored. Additionally, establishing that a plan participant read a document does not necessarily mean that he or she has actual knowledge of what he or she has read, if the manner in which the disclosure is drafted is not such that the disclosure would be understandable by the average plan participant. It may be that actual knowledge can only be confirmed if a plan participant or beneficiary acknowledges in writing that he or she understood the disclosure that was provided to him or her.”
“The Supreme Court has held that to satisfy the actual knowledge requirement for the three year statute of limitations period under ERISA Section 413, a plaintiff must in fact have become aware of that information,” says Capezza. “While evidence of distributing information electronically or a participant’s willful actions to ignore receipt of the information might be helpful in defense of a fiduciary breach case, an amendment to the ERISA statute regarding demonstration of actual knowledge would be welcomed.”
“Plan sponsors could implement a layered documentation approach that combines technology with participant engagement to practically confirm that participants have ‘actual knowledge’ of their investment options and any associated decumulation features,” says Bavetz. “One effective way to achieve this is through a multi-step confirmation process: when participants receive information about their QDIA and decumulation options, they could be required to acknowledge receipt and understanding through an electronic signature or by completing a brief, interactive quiz or survey, similar to continuing education protocols. This approach ensures that the participant has received the information and engaged with it actively, which can strengthen the case for ‘actual knowledge.’ Additionally, sponsors could provide participants with periodic, simplified summaries and reminders of their QDIA choices and any available decumulation options via multiple channels, such as email, secure portal notifications, or text messages. Each communication could request a confirmation of receipt or prompt the participant to review the investment’s details again. By establishing a regular cadence of notifications and using clear, concise language in communications, sponsors could make it easier for participants to stay aware of their options.”
Christopher Carosa is an award-winning online news producer and journalist. A dynamic speaker, he’s the author of 401(k) Fiduciary Solutions, Hey! What’s My Number? How to Improve the Odds You Will Retire in Comfort, From Cradle to Retirement: The Child IRA, and several other books on innovative retirement solutions.