Brighton Perspective

New 401(k) Plan Disclosure Rules

As 401(k) plans have become more popular, plan participants have become increasingly responsible for making their own retirement savings decisions. The Department of Labor (DOL) has become concerned that participants in self-directed 401(k) plans (those that allow participants to direct the investment of their own accounts) might not have access to, or might not be considering, information critical to making informed decisions about the management of their accounts--particularly information on investment choices, fees, and expenses.

As a result, in October 2010, the DOL issued new regulations that require self-directed 401(k) plans to provide detailed information to participants about the plan and its investments, on a regular and periodic basis, so that participants can make informed investment decisions. Some information must be provided on an annual basis, and some information must be provided quarterly. For most plans, the initial annual disclosure must be furnished no later than August 30, 2012. The first quarterly statement must be furnished no later than November 14, 2012 (for July through September).

If you're currently participating in a 401(k) plan, chances are you're already receiving similar information as a result of an earlier set of DOL regulations. However, employer compliance with the older regulations was voluntary, whereas the new disclosure rules are mandatory for all self-directed 401(k) plans. Even participants in plans that previously complied with the earlier disclosure rules will see some changes when the new regulations take effect. For one, you'll receive more detailed information about investment fees and expenses. Another change is that plan investment information must be provided in a chart, so that you'll be better able to compare investment alternatives. And plans will no longer be required to automatically provide a prospectus, although one must be provided if you request it.

These new disclosure rules apply to 401(k) plans and other plans that allow participants to direct their own investments, but they do not apply to IRAs, SEPs, or SIMPLE IRA plans. They also do not apply to plans that are not covered by the Employee Retirement Income Security Act of 1974 (ERISA), including governmental plans, owner-only plans, certain 403(b) plans, and certain church plans.

Borrow from your 401k?

From Morningstar, good example of why it's not necesarily a great idea to borrow form your 401k.

"Barbara is 40 years old, has a child in college, and needs to take out a loan to help with tuition.
She is considering either a home-equity loan or a loan from her 401(k), and is not sure which
would be the better choice. She has heard that taking out a loan from a 401(k) is painless, since
“you don’t pay penalties and pay the interest to yourself, not to a bank.” What should she do?
Many 401(k) plans offer a loan provision and the process is fairly easy. There is no credit check
(since you are borrowing from yourself); the interest rate is usually low (maybe a percentage
point or two above prime); you can generally borrow up to 50% of your vested account balance
to a maximum of $50,000; you have up to five years to repay the loan (longer for loans used
to purchase a primary residence), and the plan administrator usually deducts the loan payments
automatically from your paycheck.

However, the real cost of borrowing from your 401(k) is not the rate you pay yourself in interest, but
the amount you would have earned on your balance had you just left the money in the account.
This is called an “opportunity cost,” and it can be significant. In addition, if Barbara loses or changes
jobs, a 401(k) loan will most likely come “due in full” within a limited amount of time, while a
home-equity loan will not. The balance is taxed as if it were ordinary income and, unless she is at
least 59 years old, failure to pay the 401(k) loan back by the due date triggers a 10% penalty.

So, what are Barbara’s choices? In general, if she can take out a home-equity loan at a lower after-tax
cost than the return she expects to receive on her 401(k), she should choose the home-equity loan."

401ks and Investment Advice

A recent survey by Hewitt and Financial Engines (Bill Sharpe) suggests that participants who use the "help" options available via their 401k plan - target-date funds, managed accounts, online advice, etc. do much better than their peers who do not.

Interestingly, those not using the "help" services typically had higher risk levels which did not decline as they approached retirement. I have noticed while reviewing client 401k portfolios that often the risk is "embedded" in their portfolios and typically not something someone with little free time to review their portfolios would notice. For example, many will have significant allocations to company stock, which is risky given their current financial health is also dependent on said company. Further, they may have excessive exposure to their own industry, following the mantra to invest in what you know. However, again, their current financial health is wed to the same industry. A downtown in the industry, think financials in 2008, could lead to job loss, investment losses as the company stock declines and additional investment losses as the sector declines. That's a lot of risk that can be overlooked easily by uniformed or busy participants. And that's just one type of risk! Using the available services and/or having your financial advisor review your401k allocation quarterly makes sense now and for retirement.

Planadviser.com

Planadviser.com.

Larger DC plans are turning to consultants more frequently to help with plan management. This trend should extend to smaller plans as well. Smaller plans, particularly those in the "micro" market, say less than $25 million in plan assets, can benefit from a consultant's services. The plan trustees are frequently the owner(s) of the company and are more focused on the daily responsibilities of managing the business. The consequence is benign neglect of the 401k plan.

Yet, the 401k plan can be a fantastic recruiting and retention tool. A well-structured plan offering strong investment options and excellent service (24/7 online access, loan management, investment tools, etc) can help employees plan and save for retirement and help improve employee morale. The consultant can help the trustees meet their fiduciary responsibilities and support the success of the plan in several ways - investment policy statement (blueprint for the plan), investment manager selection, plan monitoring and performance reporting, client service (why participate?, economic outlook, investment education, etc).

Smaller plan trustees should give thought to utilizing a consultant as the benefits can be meaningful.

Have you rebalanced your 401k yet?

How many investors entered September of 2008 with a heavy overweight in domestic equities? How many ignored their 401k's during the six month decline that followed? How many benefited as a result, over the last 5 months as equities have recovered (still 25% below the early September level and roughly 33% below the October 07 S&P peak)? How many moved to cash at some point during the decline and are still sitting in cash now?

Whether you "cashed-out" or stayed in equities, the asset allocation you had established 12 months ago is most certainly out of sorts now. Take time to review your allocation now and consider what it should be in light of the current market and economic environment. Also consider your risk tolerance - to what extent did the 9/08 to 3/09 decline clarify for you what your true risk tolerance is? If you went to all cash quickly, you probably have a much lower threshold than you thought.

Strive for true diversification - look for exposure globally rather than just domestic and ensure you have exposure to asset classes other than equities. Use the asset allocation tools on your plan provider's website and research the options available in your plan. Take advantage of the improvement in financial markets to reduce your risk (if you're still overweight equities) or to improve your return potential (if you're 100% cash). Going forward, try to revisit your 401k asset allocation quarterly and make changes as necessary.

You Should Use a Retirement Plan Consultant

The last twelve months have left many retirement plan participants less confident in their ability to successfully manage their accounts. In fact, the survey found 76% of participants believed that making investment advice more available would have a strong positive impact on employees and 44% believed it would also have a strong positive impact on the company. Ask yourself the following questions:

1)    Does your plan have a QDIA?

2)    Does your plan have at least one option in domestic large cap, mid cap and small cap equity, foreign equity, core fixed income, high yield, short-term, intermediate term and long-term government fixed income, foreign fixed income, emerging markets (equity and debt) commodities, real estate and at least one QDIA option?

3)    Do you know the average expense ratio for the fund options in your plan lineup?

4)    Do your participants have 24/7 access to their accounts?

5)    Are you using a financial advisor to provide plan consulting and employee educational services?

6)    Is it time for a plan check-up?

A retirement plan consultant can help address all of these questions. Plan sponsors have a fiduciary duty to manage the plan in the best interests of plan participants. Consultants can help plan sponsors meet their duties by:

1)    Writing the Investment Policy Statement – one of the first documents requested by the DOL when auditing a plan.

2)    Selecting or guiding the selection of investment options – helping to ensure that the plan has at least one QDIA and offers diversification among investment options – asset classes, styles, firms, etc.

3)    Providing on-going evaluation and performance analysis of the investment options and recommending changes when needed.

4)    Providing guidance on plan design, selection and implementation including retaining the plan administrator.

5)    Providing on-going educational services to plan participants.

It isn’t necessary or required to use a consultant, but it can be highly beneficial. After all, the primary business of most plan sponsors is not retirement plan management. Thus, using a consultant, while not absolving the plan sponsor of fiduciary responsibility, can enable the plan sponsor to do what it does best – grow the business.

Housekeeping

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planadviser - Small-Business Owners Worry About Keeping 401(k) Match

planadviser - Small-Business Owners Worry About Keeping 401(k) Match.

Many small businesses are feeling the pinch of the economic downturn. Consequently, many are postponing establishing a retirement plan and/or are cutting back on their employee match in an effort to save money. When critical, it must be done, but if the option is available, small businesses should make every effort to cut costs elsewhere saving the employee match for worst case scenarios. The match is a significant employee benefit and a meaningful retention tool. Cutting the match is a signal, whether intentional or unintentional, to employees regarding the well-being of the firm and/or management's "respect" for employees.

This survey also noted that many small businesses are desirous of working with advisors. Obviously, I fully support that desire. While retaining an advisor does not eliminate the small business owner or management's fiduciary duty, it does help the owner or management meet this responsibility and should help make business life easier for all involved.

Investment Policy Statements

This article discusses Investment Policy Statements and makes several excellent points. IPS are commonplace among defined benefit plans and endowment/foundations in the institutional world. They are the foundation upon which the Trustees, as fiduciaries, build, manage and monitor their portfolios. The IPS states the return objectives, risk tolerance, time horizon, liquidity needs, investment parameters and benchmarks and any special items that must be considered. From this document, every party involved in managing the portfolio can derive their responsibilities. It matters.

Yet, it is almost non-existent for individual investors and for defined contribution plans. I've noted before it is at the top of the list of DOL requests when the DOL audits a DC plan. So, it should be top of mind for the fiduciaries involved in managing the DC plan - management, consultant, managers, etc. It is just as relevant to individual investors, who I believe, should view their portfolios as endowments. The IPS lays out the same critical guidelines as for institutional plans and provides the reference material for all participants. If you have not created an IPS yet, do so. If you have, review it and make sure its up to date. If your advisor hasn't suggested creating one or has dismissed suggestions to do so, consider a new advisor. Many are loath to admit, but once we assume responsibility for managing client assets, my believe is we assume fiduciary duty to perform in the best interests of our clients (individual or plan participants in a DC plan). The IPS should be step 1.

Don't Give Up the Match!

Over the weekend, more companies announced suspensions of their 401k company match. For large corporations this is not likely an issue as the bread of participation is high and enough employees will continue to participate such that discrimination testing will not be a concern. However for small businesses, this can be a critical issue. A new survey by Fidelity suggests the match is a key reason employees participate. In fact, when the match is paired with immediate vesting, the participation rate can be as high at 89%. Offering a match can increase participation by as much as 9%. This can be invaluable toward maintaining plan compliance with discrimination rules. So, if you, as a small business owner and/or decision-maker, are considering suspending your company match weigh the potential plan compliance issues carefully before making that decision.

How does your 401k compare?

The Employee Benefit Research Institute released its 09 survey on 401k performance - Here - that highlights several items of interest. Performance was impacted by:

1) Account balance size - individuals with larger account balances suffered larger % declines
2) Tenure with firm - longer tenured employees suffered larger % declines (I'm sure account balance & tenure are highly correlated)
3) Equity concentration - clearly higher equity concentrations lead to larger declines

On average, 401k accounts were down roughly 25% compared to (37%) for the S&P 500 and +5% for the Barclays Aggregate Bond Index. At issue for many is an excessive allocation to equities regardless of age. Remember, the "rule of thumb", a starting point, is that you hold a % equal to your age in fixed income. So a 60 year old will have 60% of their assets in fixed income. That number can be adjusted to fit your personal situation. 

The report also notes however, that thanks to consistent contributions and employer matches, account balances are significantly higher than in 2000. Those aged 36-45 for example, saw their account balances increase by more than 100% on average despite the 2000-2002 and 2008 bear markets.

Going forward, the report recognizes that new rules which promote automatic enrollment and QDIAs (qualified default investment alternative) will help plan participants recover and move forward toward their retirement goals. Why? Auto enrollment ensures participation and QDIAs such as life-cycle funds and target date funds help improve participant asset allocations because they make that fixed/equity decision for you.

My Company Just Cut it's 401k Match?!

Regardless of your belief about the rate of taxation at retirement, the advantages of tax-deferred compounding are significant and shouldn't be overlooked simply because your employer no longer matches. While other tax-advantaged investments exist, if the 401k was well designed and the plan sponsor adhered to its fiduciary duty, the plan will likely have lower expenses than other tax-advantaged options and will have more than adequate diversification. Staying with your contributions forces you to continue saving for retirement and enables you to continue to enjoy the benefits of tax-deferral. Of course, don't neglect your asset allocation. That's critical to long-term success.

You may have other options and they're worth exploring. Does your plan offer a Roth account? If yes, consider funding this account. Your contributions are after-tax but all growth is tax-free even when you withdraw it during your retirement years. If you don't have the Roth option, you could open a self-directed IRA and max your contribution. Upside is you control the investments, downside is the max is less than in your 401k. So, consider all of your options carefully but make a point, as long as your personal situation enables you to do so, of continuing to contribute to some form of a tax-deferred account.