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AdvisorNews - February, 2014

New Product Evaluates Target-Date Funds

May 14, 2013 ( – Plan Sponsor Advisors (PSA) has released a diagnostic tool which helps determine the best target-date strategies for retirement plans based on behaviors and demographics.

Earlier this year, the U.S. Department of Labor (DOL) issued additional guidance on target-date strategies, recognizing how widely they differ. As part of their guidance, the DOL suggested not only evaluation of performance and risk, but additional examination of how well a target-date strategy aligns with a plan’s employee demographics (see "EBSA Offers Tips for Selecting TDFs").

In response to this need, PSA developed a proprietary diagnostic tool called the TDAnalyzer. With it, PSA’s investment team evaluates target-date options using plan specific demographics to determine the likelihood of realizing an income replacement objective.

“The financial crisis of 2008 shed light on how many plan sponsors and advisers were too focused on historical performance measures. Since then, more attention has certainly been given to risk measures; however, PSA believes that even more scrutiny is required,” stated Donald Stone, managing partner and CIO of PSA.

“Plan specific information such as age, salaries, current balances, deferral rates, and Social Security benefits are incorporated to determine a required retirement balance. PSA’s TDAnalyzer simulates potential wealth accumulations for various target date options and compares the output to the targeted required retirement balance,” said Preet Prashar, CFA, investment analyst for PSA. “We combine results from our TDAnalyzer with qualitative and quantitative analysis to select the most appropriate target date series for particular plans.”

TDAnalyzer seeks to answer questions such as:
Is the glide path a good fit for your plan?
Will your target date solution achieve its income replacement objective? And at what risks?
Have the underlying managers added value to the asset allocation?
PSA is a Chicago-based retirement benefit consulting firm focused on helping plan sponsors to improve participant outcomes. For more information about the TDAnalyzer, call 312-348-1253 or e-mail This email address is being protected from spambots. You need JavaScript enabled to view it..

Fiduciary Obligation to Select Appropriate Share Classes

Posted on May 14th, by Fred Reish

I imagine that, by now, you have heard about the Court of Appeals decision in Tibble v. Edison. While the court decided a number of issues, the most important one is that fiduciaries have an obligation to select appropriate share classes for their plans. Closely related to that is the trial court’s admonition that fiduciaries must ask about the available share classes.

ERISA imposes both a fiduciary rule and a prohibition on spending more than reasonable amounts for operating a plan, including the investment costs. The Tibble decision was about the reasonable expense ratios for plan investments. However, rather than looking at the evaluation of mutual fund expenses in the traditional way (that is, comparing expense ratios to those of other funds), the trial court found, and the appellate court agreed, that plans must use their purchasing power to select the appropriate share class. The practical consequence is that advisers should make recommendations based on the share classes available and must educate plan sponsors about the available share classes, including their costs, and plan sponsors (typically acting through their plan committees) must understand that multiple share classes may be available and must investigate which are best for their plan and participants.
That could be a daunting task. Just consider that some mutual funds may have 10 or more share classes. That could include, for example, A, B, C, I, R-1, R-2 shares, and so on. This will place an additional burden on advisers . . . and, in that sense, may favor advisers who focus on retirement plans.

But, it is more complicated than that. Share classes for mutual funds and separate account “classes” for group annuity contracts may, for these purposes, be virtually identical. If that is true, advisers will need to educate plan sponsors on the classes available in group annuity contracts. Then, advisers will need to help plan sponsors select the appropriate separate account class for that particular plan. Since some insurance companies offer group annuity contracts with 10 or even 15 separate account classes, advisers will need to be more attentive to the alternatives that are available and will need to work with plan sponsors to understand the share and separate account classes (including the revenue sharing and compensation aspects) and to select the appropriate classes based on the size and needs of the particular plan.

In the future, we could see litigation where advisers did not educate plan sponsors on the availability of alternative classes and do not make appropriate recommendations.

Reenrollment: Better process, same great benefits

Asset allocation and portfolio diversification are two important factors for participants to consider when saving for retirement. In fact, successful retirement investing often depends on appropriately diversifying holdings and allocating assets.

Yet, in participant-directed defined contribution (DC) plans, some employees are not well-diversified, having adopted extreme asset allocations that don't necessarily match their investment goals. To correct these portfolio errors, plan sponsors are increasingly looking to a reenrollment strategy to help move their participants back on track toward a more secure retirement.

Reenrollment is an emerging plan-design strategy aimed at improving participant portfolio diversification. It can be a powerful method to address a plan's asset allocation problems and the inertia of plan participants. Reenrollment resets participant investments, directing current and, typically, future holdings into a qualified default investment alternative (QDIA) such as a balanced fund, managed account, or life-cycle or target-date fund. Reenrollment is designed to improve plan asset allocation, is sanctioned by the Pension Protection Act of 2006 (PPA), and can provide the dual benefits of improved portfolio diversification for participants and fiduciary protection for plan sponsors. (A minimum 30-day advance notice and an opt-out provision are among the requirements to qualify for fiduciary protection.)

"Reenrollment is appropriate anytime plan sponsors see a portfolio construction problem in their plan," said Ellen Kranick, a manager in Vanguard Institutional Investor Group Product Management. "It can be an especially appropriate strategy for sponsors who've taken steps to educate participants—and have not seen results."

Ms. Kranick said that Vanguard offers technology to simplify the process for sponsors and participants alike. "We've upgraded our technology and now offer participants a web experience that displays how they are affected by a reenrollment in their plan, whether they've opted in or out, and what their fund allocation is today versus what it would be after the reenrollment," Ms. Kranick said. "Participants can get up-to-date information anytime online, so there's no confusion about where their money is allocated."

Reenrollment research and results

Even though most DC plans offer a broad range of prudent investment offerings, plan sponsors have observed that some participants make portfolio construction errors, concentrating their investments in employer stock, in specific asset classes or styles, or holding overly conservative or aggressive portfolios.

Vanguard data on the quality of portfolio construction, based on several million participant accounts, confirms this point. According to Vanguard's How America Saves 2013: A report on Vanguard 2012 de­fined contribution plan data, 1 in 4 participants makes significant portfolio construction errors, holding a portfolio with either 100% equity, 100% fixed income, or greater than 20% company stock.

The prevalence of portfolio construction problems such as these—as well as results from plans undergoing reenrollment—is leading to increased interest in reenrollment among plan sponsors. In one case study, a Vanguard-recordkept plan with 3,500 participants showed significant reductions in extreme asset allocations, and the percentage of participants with appropriately diversified portfolios rose from 40% to 80% in one year. An aggregate look at seven plans with a total of more than 20,000 participants revealed that reenrollment has improved portfolio diversification for 81% of participants by defaulting them into Vanguard Target Retirement Funds, the plans' QDIA.

How reenrollment helps
Reenrollment aims to help sponsors and participants in three key areas:

Portfolio diversification. Too many Vanguard DC plan participants hold either a portfolio with zero equity or conservative equity allocations. These portfolio decisions can prove costly over time if not corrected. Reenrollment can help correct such errors and provide balance to participants' portfolios.

Participant inertia. Vanguard research shows that many participants choose to avoid investment decisions when it comes to their retirement plans. This passive approach can be risky when a participant has an extreme asset allocation. Reenrollment can turn the tide on participant inertia by making inaction a positive option. By directing current and future holdings into a QDIA, reenrollment can help improve portfolio diversification without any required action from participants.

Fiduciary protection. The PPA introduced provisions limiting plan sponsors' liability for investment losses when participants' assets are directed to a QDIA. To qualify for fiduciary protection, you must designate a QDIA and notify participants at least 30 days before the plan's reenrollment date of their right to opt out of the transfer. (In June 2012, the United States Court of Appeals for the Sixth Circuit upheld the ability to reenroll participants in accordance with QDIA regulations in Bidwell v. University Medical Center, Inc.)

"Vanguard's plan-sponsor clients can use our Plan Analytics data to pinpoint diversification opportunities," Ms. Kranick said. "Whether it's portfolios that aren't well-diversified, that are too conservative, or that are overallocated in company stock, reenrollment can help get your participants to a more balanced retirement portfolio."

Reenrollment can be employed at any time, but Vanguard clients most frequently leverage this strategy when:

  • Appropriate diversification is lacking. In this situation, you could reenroll either all participants or a subset of the population that requires attention.
  • There is a plan conversion (that is, a plan is being moved from one recordkeeper to another). Rather than "mapping" investments to similar funds when the money moves to a new recordkeeper, consider reenrollment to ensure more diversified portfolios after the move.
  • There are changes to your investment menu. This may be a good time to direct funds into your plan's QDIA.

Vanguard's expertise and highly controlled processes help ensure a smooth reenrollment experience for sponsors and participants. To discuss whether reenrollment might be right for your plan, contact your Vanguard representative or visit

Small business owner retirement plans, the bad and the good

By Jerry Kalish
May 20, 2013

Let’s take them one at a time.

The bad: Accordingly to a recent Gallup Pew Research Center survey, 67% of small business owners worry they won’t be able to put away enough money for retirement.

Moreover, a recent report by Jules Lichtenstein, Senior Economist with the Small Business Administration, Financial Viability and Retirement Assets: A Look at Small Business Owners and Private Sector Workers, finds that business owners are less likely to have a retirement plan than people who work for them.

Here are some of the findings:

  • Only 36% of business owners own IRAs.
  • Only 2% of self-employed individuals have retirement plans.
  • Only 18% of business owners participate in a 401(k) plan.

You can see that “only” is a lonely number.

So why haven’t business owners done a better job preparing for retirement? The reasons are many, but one factor is the misconceptions business owners have about retirement plans.

Here are some of the objections I hear from business owners – with an appropriate response:

  • “Retirement plans are too expensive to set-up and administer.” The 401(k) marketplace provides a wide range of choices, business models, and delivery methods. The business owner has a choice to have a plan is both cost-effective and easy to maintain.
  • “I have to make a contribution every year.” Not exactly. A 401(k)/profit sharing by its very nature generally allows the business owner to make contributions determined each year on a discretionary basis.
  • “I have to provide the same contribution to the employees as for me.” Not necessarily. There are allocation methods such as New Comparability which may permit a larger contribution for the owner than for the other employees.
  • “The tax laws will limit my ability to maximize my 401(k) contribution if not enough employees participate.” Again, not necessarily. A 401(k) Safe Harbor Plan may permit the business owner to automatically meet the 401(k) test at a reasonable cost for the other employee.

Here’s the really good part: You can help!

DOL Releases Fiduciary Tips for Selecting Target Date Funds
by Thomas R. Hoecker and Kevin J. Hogan

In recent years, target date funds (TDFs) have become a popular investment option for many 401(k) plan participants. By investing in a mix of stocks, bonds and other investments, often through investments in other mutual funds, TDFs are designed to provide a one-stop, long-term investment strategy tied to a participant’s anticipated or “target” retirement date. Generally, TDFs invest heavily in stocks and other riskier assets in earlier years and then shift to less risky assets as the target retirement date draws near. This automatic shift in the asset allocation, which is known as the fund’s “glide path,” relieves the participant of the often confusing chores of selecting the proper asset allocation and rebalancing investments.

Some TDFs use a “to retirement” glide path, while others use a “through retirement” glide path. The “to retirement” glide path will reach its most conservative point at the target retirement date, whereas the “through retirement” glide path will not reach its most conservative point until some years after the target retirement date.

With the growing popularity of TDFs, the Department of Labor (DOL) recently released a set of guidelines, which can be found here, to help plan fiduciaries in selecting and monitoring TDFs. A brief summary of the DOL’s guidelines follows:

Establish a process for comparing and selecting TDFs. As with any other investment option, plan fiduciaries should engage in an objective process to obtain information that will allow them to evaluate the prudence of any TDF offered under the plan. Information to be considered should include fund performance and investment fees and expenses.

Establish a process for the periodic review of selected TDFs. Plan fiduciaries are required to periodically review the TDFs offered by the plan. The review process should include examining whether there have been any important changes to the investment options since they were selected such as whether the TDFs investment strategy or management team has changed significantly.

Understand the fund’s investments – the allocation in different asset classes (stocks, bonds, cash), individual investments and how these will change over time. Plan fiduciaries should understand the principal strategies and risks of the fund including the TDF’s glide path.

Review the fund’s fees and investment expenses. Plan fiduciaries should understand both the amount and types of fees. If the TDF invests in other funds, plan fiduciaries should also consider the fees and expenses for the underlying funds.

Inquire about whether a custom or non-proprietary target date fund would be a better fit for your plan.
Many TDFs invest exclusively in the other mutual funds offered by the sponsor of the TDF. Custom, non-proprietary funds may offer advantages to plan participants by diversifying their exposure to funds managed by fund managers other than the TDF provider. Custom, non-proprietary TDFs are typically only available to larger plans and any additional costs or administrative tasks should be considered.

Develop effective employee communications.
Plan fiduciaries must consider any disclosures required by law, but should also provide appropriate information to employees about the TDFs as a retirement investment option.

Take advantage of available sources of information to evaluate the TDF and recommendations you received regarding the TDF selection.
There are several commercially available sources of information and services to assist plan fiduciaries in their decision-making and review process. Information also is available from the SEC here and here.

Document the process.
Plan fiduciaries should document both the selection and review process.

Plan fiduciaries are not required to follow the DOL guidelines, but they provide a good checklist of what the DOL considers to be prudent conduct in selecting and monitoring TDFs