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5 Areas Where Target Date Funds Increase 401k Plan Sponsors’ Fiduciary Liability

5 Areas Where Target Date Funds Increase 401k Plan Sponsors’ Fiduciary Liability
March 26
00:03 2019

In his best-selling book Influence – The Psychology of Persuasion, behavioral psychologist Robert Cialdini describes a half dozen “weapons of influence.” He defines one of these – “Social Proof” – as the condition in which “we view a behavior as more correct in a given situation to the degree that we see others performing it.” With Target Date Funds (“TDFs”) growing by more than 10 times in roughly 10 years to exceed a trillion dollars in defined contribution assets, you don’t need much more evidence to conclude we have Social Proof.

With TDFs multiplying like rabbits, they’d appear to be the ultimate “safe zone” for the 401k plan sponsor. Cialdini, however, suggests “safety in numbers” may represent the ultimate irony. Just because everyone else is doing it doesn’t mean it’s safe. Cialdini writes Social Proof “provides a convenient shortcut for determining how to behave but, at the same time, makes one who uses the shortcut vulnerable to the attacks of profiteers who lie in wait along its path.”

For all their convenience, for all their popularity, the increased reliance on TDFs does not necessarily shield the 401k plan sponsor. We spoke to corporate retirement plan advisers from across the country. They identified 5 ways TDFs expose plan sponsors to fiduciary liability. What follows are the result of those interviews:

Fiduciary Duty:
TDFs are not a panacea. While the 2006 Pension Protection Act does define them as an acceptable QDIA, choosing to place them on the investment menu doesn’t automatically indemnify the 401k plan sponsor. “A major issue is the target date fund safe harbor may lull an employer into a false sense of security regarding the investment choices,” says Joshua Escalante Troesh, President of Purposeful Strategic Partners in Alta Loma, California. “Sponsors still have a responsibility to choose appropriate investment options, educate employees on choices, review the investment outcomes, and monitor the investment advisor. Simply using the QDIA safe harbor by setting target date funds as the defaults does not eliminate the liability of the employer.”

It’s therefore critical that plan sponsors look at TDFs in the same manner they look at all other investment options. They can’t be seen as boilerplate solutions. “The problem with TDF fiduciary practices is they are relying on (1) any QDIA will do and (2) you can’t go wrong with the Big 3,” says Ronald Surz, President of Target Date Solutions in San Clemente, California. “So, fiduciaries, primarily consultants, are not vetting their TDF selection, and in doing so opting for way too much risk, especially at the target date. The Duty of Care makes fiduciaries responsible for avoidable harm that befalls their beneficiaries.”

Fees & Conflicts-of-Interest:
Given their popularity, and perhaps with a slight nod to Cialdini’s warning, nearly every serious investment product provider offers some form of TDF. It may be the classic marketing strategy of “if you build it, they will come.” But should they in all cases? “Unfortunately, target date funds are not the silver bullet many 401k providers claim they are,” says Escalante Troesh. “Target date funds increase fees due to the fact employees must pay the fees for the fund management on top of the fees for the sub-funds the target date fund invests in. If the funds are poorly chosen, or specifically chosen by a provider for their high fees, the additional cost to the employees can result in liability for the employer. In fact, many of the recent lawsuits over retirement plans have been based largely on the high fees the employees incur within their retirement accounts. This problem is most common with retirement plan providers who are insurance companies or broker/dealers where the adviser earns commissions from the investment and has an incentive to put higher-cost proprietary funds into the retirement plan.”

Due Diligence:
These first two areas of exposure naturally lead to a third. An overwhelming majority of 401k plans offer TDFs. As we have seen, they represent an ever-growing bulk of plan assets. The sheer size demands exacting due diligence in the selection and monitoring process. “If more assets are in one product,” says Michael Tanney, Managing Director of New York City based Wanderlust Wealth Management, “the sponsor has an obligation to even more carefully scrutinize the investment manager, execution, fees, etc. There’s a concentrated risk that is created.”

Despite the generic name, it’s often incorrect to assume one can compare TDFs on an apples-to-apples basis. For example, are their glide paths “to” or “through”? “Target date funds are not cookie cutter, and they are not necessarily the right solution for every plan,” says Robin Solomon, an attorney in the Benefits and Compensation practice of Ivins, Phillips & Barker, in Washington DC. “As with any investment fund, the selection of a target date fund series requires careful analysis and decision-making by plan fiduciaries.”

 

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Education:
Expanding on this last point, it is simply true that TDFs contain too many moving parts. This impacts not only the due diligence process, but also plan sponsor education. “Not all target date funds are created equal,” says Matthew Zokai, Senior Advisor Retirement Services at 1st Global in the Dallas/Fort Worth Area. “It is imperative for Plan Sponsors to understand how they work and to have a documented process for how they review, select and monitor their target date series. Factors such as glide path, number of asset classes used, active versus passive management and expense should all be taken in to account when selecting the appropriate target date series for your qualified plan. Without a prudent process plan sponsors could absolutely be increasing their fiduciary liability.”

It’s not just plan sponsors. Plan participants need good education so they can also understand the specifics of the particular family of TDFs the plan offers. “The assertion is that a TDF will contain an appropriate mix of investments over time, and will adjust appropriately over time, for someone who intends to begin withdrawing money in Year X,” says John C. Hughes, an ERISA/benefits attorney at Hawley Troxell in Boise, Idaho. “That is a simple and comforting concept. However, it is more complicated than that, as exemplified in part by the Department of Labor’s 2013 ‘Target Date Retirement Funds – Tips for ERISA Plan Fiduciaries,’ which is suggested reading for any plan fiduciary adding TDFs to their investment line up. The bottom line being that the chosen TDFs still should be understood.”

Compliance:
It’s mandatory, then, that plan sponsors look at TDFs within the total construct of the plan, it’s participants, and the mission of the plan sponsor. “TDF funds are not perfect investments and by no means are they all created equal by each investment firm that manages them,” says Rick Skelly, Client Executive Service at Marsh McLennan Agency in San Diego, California. “If a sponsor doesn’t consider the specific dynamics of their workforce (Age, Education & Distribution habits of termed or retired employees), they could pick a TDF solution that may not be the best fit for their population. If a sponsor can’t back up their decision on which type & style of TDF solution they picked, it could be deemed an imprudent investment for their plan or a fiduciary breach. This arguably could be a difficult claim to win by a participant due to diversity of workforce, but there is risk in the decision of which TDF to use.”

When considering the potential – if not underestimated – liability associated with TDFs, perhaps it’s best to listen to the warning Cialdini provides regarding Social Proof: “It should never be trusted fully… we need to look up and around periodically whenever we are locked into the evidence of the crowd.”

Next Week: What can a plan sponsor do to mitigate any increase in fiduciary liability caused by target date funds?

Christopher Carosa is a keynote speaker, journalist, and the author of  401(k) Fiduciary SolutionsHey! 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, practical business tips, and the history of the wonderful Western New York region. Follow him on TwitterFacebook, and LinkedIn.

Mr. Carosa is available for keynote speaking engagements, especially in venues located in the Northeast, MidAtantic and Midwestern regions of the United States and in the Toronto region of Canada.

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Christopher Carosa, CTFA

Christopher Carosa, CTFA

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