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Sponsor News - February 2014

8 things to know about fiduciary liability

By Frank J. Bitzer and Nicholas W. Ferrigno Jr.
July 22, 2013
Regulators are soon expected to unveil a new fiduciary standard that will dramatically change how financial professionals do business.
Broker-dealers and those who work with Individual Retirement Accounts would be held to the same fiduciary standards as their 401(k) plan brethren, which would overturn 40 years of business practices that allowed these individuals to recommend investments in which they receive a commission.
Because a stricter fiduciary standard will doubtlessly increase compliance costs, all agree that it's critical that advisors know the rules of the game.

Amid all of the teeth-gnashing, here's a look at eight questions that are central to the debate:

1. Is a fiduciary liable for losses to a plan for failing to investigate and evaluate a proposed investment?

Not necessarily. A fiduciary’s failure to investigate and evaluate an investment decision alone is not sufficient to make him liable for losses to a plan. Instead, efforts to hold the fiduciary liable for a loss attributable to an inadequate investment decision must demonstrate a causal link between the failure to investigate and evaluate and the harm suffered by the plan.

The cases that hold a trustee liable for losses for failing to investigate and evaluate the merits of an investment have based the trustee’s liability on findings of fact that clearly established the unsoundness of the investment decision at the time it was made. If a court determines that a trustee failed to investigate a particular investment adequately, it will examine whether, considering the facts that an adequate and thorough investigation would have revealed, the investment was objectively imprudent.

“[T]he determination of an objectively prudent investment is made on the basis of what the trustee knew or should have known; and the latter necessarily involves consideration of what facts would have come to his attention if he had fully complied with his duty to investigate and evaluate.” It is the imprudent investment, rather than the failure to investigate and evaluate, that is the basis of liability.

2. Is the prudent person rule subject to the business judgment rules?
No. It is not a business judgment rule that applies to the question of prudence in the management of an ERISA plan, but rather a prudent person standard.

3. Is a fiduciary an insurer of plan investments?
No. “[T]he prudence rule does not make the fiduciary an insurer of the plan’s assets or of the success of its investments. ERISA does not require that a pension fund take no risk with its investments. Virtually every investment entails some degree of risk, and even the most carefully evaluated investments can fail while unpromising investments may succeed.

“The application of ERISA’s prudence standard does not depend upon the ultimate outcome of an investment, but upon the prudence of the fiduciaries under the circumstances prevailing when they make their decision and in light of the alternatives available to them.” The fiduciary duty of care requires prudence, not prescience.

In addition, the mere fact that a plan’s investment portfolio declines in value or suffers a diminution of income does not by itself establish imprudence. Market values are untrustworthy indicia of value especially in times of economic decline. In that respect, whether a trustee is liable for losses to the plan depends upon the circumstances at the time when the investment is selected and not upon subsequent events. Thus, if at the time an investment is made, it is an investment a prudent person would make, there is no liability if the investment later depreciates in value absent a failure to monitor its performance.

4. Can a successor fiduciary be liable for the investment acts of its predecessor?
Yes. If the selection of plan investments by a predecessor fiduciary constitutes a breach of duty or a prohibited transaction, a successor fiduciary has a duty to dispose of these investments upon assuming her responsibilities as fiduciary. A fiduciary has a continuing duty to advise the plan to divest of unlawful or imprudent investments, and its failure to do so gives rise to a new cause of action each time the fund was injured.

5. Is a fiduciary’s subjective good faith a defense to a breach of fiduciary duty?
No. The fact that a fiduciary may have acted in good faith is not a defense to a breach of fiduciary duties, because the sincerity of a fiduciary’s belief that his actions are in the best interests of the plan is essentially irrelevant to a determination of the prudence of the fiduciary’s conduct. Thus, good faith alone is not recognized as a defense to a breach of fiduciary duties.

6. Does the prudence requirement obligate a fiduciary to seek the assistance of an expert?
It depends. Although ERISA does not require a fiduciary to seek professional assistance in making plan investments, where a trustee does not possess the education, experience and skill required to make a decision concerning the investment of a plan’s assets, he has an affirmative duty to seek independent counsel in making the decision. The failure to do so is imprudent and constitutes a violation of ERISA Section 404(a)(1)(B).

7. Can a fiduciary avoid liability by relying on the professional advice of others?
Although fiduciaries are not expected by the courts to duplicate their advisers’ investigative efforts, fiduciaries are required to “review the data a consultant gathers, to assess its significance and to supplement it where necessary.” In addition, “[a]n independent appraisal is not a magic wand that fiduciaries may simply wave over a transaction to ensure that their responsibilities are fulfilled. It is a tool and like all tools, is useful only if used properly.”

8. Do plan losses create a presumption of a breach of duty?
No. The test of prudence under the prudent man rule is one of conduct, and not a test of the result of performance of the investment. The focus of the inquiry is how the fiduciary acted in his selection of the investment, not whether his investments succeeded or failed.

More Small Businesses Offering Retirement Plans

July 24, 2013 ( – More small business owners are offering and investing in 401(k) plans now than five years ago.

According to a nationwide survey of small business owners by ShareBuilder 401k, nearly one-quarter (24%) of small businesses now offer a 401(k) plan (compared to 10% in 2008). Eighty-nine percent of small business owners with more than one employee that offer a 401(k) plan said it is an important factor for attracting and retaining the best talent.

Additionally, 50% of those who offer a 401(k) plan believe offering a plan is their responsibility as a business owner. Of the 28% of businesses with a 401(k) plan that either stopped offering a match or lowered their match over the past five years, 56% have since reinstated it.

The majority of small business owners (58%) said their own current retirement savings is higher than it was five years ago. Nearly two-thirds (65%) now feel confident they are saving enough for retirement, compared to 44% five years ago. Eighty-two percent of all small business owners view 401(k)s as an effective approach to saving for retirement.

"Though the Great Recession had a negative impact on many Americans' retirement plans, it appears it was also a wake-up call when it comes to planning for the long term," said ShareBuilder 401k President Stuart Robertson. "A record percentage of small businesses are reporting ownership of a retirement plan—a sign that more small business owners are prioritizing their own and their employees' need to save for the future."

The survey also found the two biggest reasons more small businesses are not offering a plan to be "not enough employees to make it worthwhile" (reported by 48% of respondents) and "can't afford to offer a company match" (at 23%).

The comparative data used for the survey comes from a similar survey of small business owners commissioned by ShareBuilder 401k called the "2008 Small Business Annual Retirement Trends" report. Both this year's survey and the 2008 research included responses from 500 small businesses from across the United States with 50 or fewer employees.

The Five Big Lies of Retirement Planning

July 24, 2013
CPA, CFP®, Vice President of Financial Planning, Schwab Center for Financial Research

Key points

What passes for conventional wisdom when it comes to retirement planning often amounts to little more than wishful thinking.
Here we expose five big myths of retirement planning.

Helpful information for people of all ages who are planning for retirement.

When it comes to retirement planning, there's no shortage of conventional wisdom, even if there is a shortage of actual savings. But often what passes for wisdom amounts to little more than wishful thinking. So take off those rose-colored glasses! Recognize the five big lies of retirement planning—and make sure they don't undermine your own retirement.

You'll only need 70%–80% of your pre-retirement income.

Work-related costs go away when you retire, and your kids are hopefully financially independent. But other expenses can take their place, such as health care (particularly if you retire before 65, the age when Medicare kicks in), increased travel and leisure, etc. And, if you refinanced your home recently for a longer term, you may still be paying off your mortgage for some time to come. The old 70–80% income rule of thumb may still work for some folks, but it's probably better to assume you'll need to replace 100% of your pre-retirement income (less whatever you were saving for retirement). Consider this: Despite roughly half of retirees finding they actually spend as much or more in the early stages of retirement than they did before they retired, only 11% of current workers expect to spend more in retirement, with nearly 60% expecting to spend less.1

When you retire, you'll be in a lower tax bracket.
Even workers in higher brackets may find that Social Security income, pensions, taxable portfolio income and retirement account distributions combine to keep them in the same or an even higher bracket in retirement. In addition, marginal tax rates are at relatively low historical levels. As recently as the 1980s, the top federal bracket was a whopping 70%! Even if your taxable income level remains the same, higher tax rates in the future could boost your tax liability. Unless you have good reason to believe you'll pay lower taxes in retirement, why not plan on the same bracket when you retire? If it turns out your tax bill is lower after all, you'll be that much better off.

You can always just keep working.

Part-time or even full-time work at something you enjoy can be a fulfilling way to generate extra retirement income and social interaction. But, that presumes both you and the job market for seniors remain healthy. The Employment Benefits Research Institute's 2013 Retirement Confidence Survey found that almost half of retirees left the workforce earlier than planned due to health problems, company downsizing and workplace closure. Hopefully, you won't be forced out of the job market prematurely, but wouldn't it be better to plan on working longer because you want to, and not because you have to?

The stock market will save you.

Hopefully, the 2000–2002 bear market and the 2008 financial meltdown did away with any notion that the stock market can do your saving for you. For long-term planning, it's smart to plan on mid-single-digit stock returns and (despite today's extraordinarily low interest rates) about half that for bonds. Also, don't assume the same return every year. Market returns (even real estate) fluctuate from year to year. Your planning should consider a range of outcomes to help assess the likelihood of meeting your goals.

There's always Social Security.
With Social Security, it's especially hard to separate truth from fiction. According to some, the status quo is fine. Others see bankruptcy as imminent. The Social Security Administration projects that the current system is sound through 2036, but beginning in 2037 benefits could be reduced by 22% and could continue to be reduced annually.2 One scenario we might see, besides benefit reductions and tax increases, is means testing, which could result in a middle-class squeeze: The wealthy aren't eligible but are fine on their own, and the needy are entitled to receive full benefits, but those stuck in the middle get something less than hoped for. Wouldn't it be preferable to save a little more for the future—even if it means spending a little less now—so you can treat any Social Security payments as icing on your retirement cake, rather than the main course?

Don't be a "Gloomy Gus"

A small dose of skepticism can be healthy when it comes to conventional wisdom, but avoiding the Pollyanna label doesn't mean you need to become a hard-core cynic. After all, the stock market has rallied considerably since the depths of the 2008 financial crisis. And it's doubtful that every last penny of Social Security will dry up or that every single corporate and public pension will fail. Stay balanced—don't be overly optimistic and run the risk of failing to meet your goals because your plan depends on everything going just right, but don't be overly pessimistic and sacrifice more of your lifestyle than is necessary.

Reality check: Spend less, save more
No other factor comes close to helping to achieve retirement success as the amount that you're able to save. The flip side of that, of course, is how much you spend. Living below your means before retirement has a double benefit—it allows you to save more for the future and reduces the size of the nest egg required to maintain your standard of living. The alternative means growing accustomed to a lifestyle of spending you won't be able to support when you stop working. Spend less and save more, and you won't need to pin your hopes on wishful thinking.

Debate over fees clouds real issue

Investment analysts hotly debate whether actively managed mutual funds are worth the expense, but some say the controversy clouds the real issue: Americans aren't saving enough.

By Lisa Gillespie
July 25, 2013

A year after the federal government enacted 408(b)(2) regulations on defined contribution plan fee disclosure, debates continue to rage over whether actively managed mutual funds are better than passive funds for plan participants' retirement readiness. But many experts believe those debates are distractions from the real issue: Whatever their investment elections, workers simply aren't saving enough for retirement.
In fact, retirement confidence remains at a record low, according to the Employee Benefit Research Institute's annual Retirement Confidence Survey, which reported earlier this year that 28% of Americans - the highest level in the survey's two-decade history - are not at all confident about being able to afford a comfortable retirement.

"Wall Street has built an empire on the idea that all active funds should be in a portfolio, and there are a lot of people who have good strategies, but it doesn't work all the time," says Chad Parks, founder and CEO of The Online 401(k), a company that offers 401(k) plans to small businesses.

He calls the active vs. passive management debate the "Achilles heel of the 401(k) industry."

On the one hand are those who believe in the passive approach, who say cost matters and you can't beat the market. On the other are those who believe that fees paid for active management expertise are worth it.

Mendel Melzer, an adviser with the Institutional Retirement Income Council, a nonprofit think tank focused on retirement plan income security issues, doesn't think plan sponsors have to decide one way or the other. Rather, they should provide a diversified set of options to participants that span active and passive management, domestic and international funds, and fixed income and equity funds. He says active management has an added value in some asset classes and styles, while passive management has done a better job in others.
"The increased focus on fees doesn't invalidate active management," Melzer said. "Rather, it means that any active management strategy should also have low fees and that net returns over full market cycles should exceed the returns on passive benchmarks."

Tom Reese is of the passive management school of thought. As a consulting actuary and member of Conrad Siegel Actuaries' marketing committee, and an investment adviser representative for Conrad Siegel Investment Advisors, Inc., he specializes in retirement plan consulting, administration and employee communication for daily valuation plans, as well as investment advisory services for retirement plans. He said his firm has analyzed historical fund performance data and found that index funds' passive approach gives investors the best odds in the long run.

He says there are a small number of active managers who outperform the market, but it's not the same managers consistently beating the market and investors can't predict who that will be. Active managers are under a lot of pressure to outperform the market to offset their fees. He says investing for retirement is a long-term process, and active management is more about outperforming other funds in the short term.
"Advocates of active management claim that it brings significant value. They can provide statistics showing a short time frame when they beat the marketplace and explain how you're getting value with the extra fee," Reese says. "The particular time frame they show will clearly prove they beat the market, but they're not showing longer periods of time needed for long-term investment."

Steve Anderson, executive vice president of Schwab Retirement Plan Services, says that plan sponsors must look at the underlying expense structures of the investments. Enrolling an employee in low-cost investments, like index funds, rather than more expensive actively managed funds, he says, could mean nearly $115,000 more at retirement.

Anderson puts most of his faith in a professionally managed approach that uses data to choose appropriate investments for plan participants. His firm looks at figures such as age, savings rate, account balance, salary, gender and Social Security age to place employees in an appropriate investment portfolio.

"We're big believers in using a managed account that is personalized ... those tend to be fee-based, but you have a more personalized asset allocation," Anderson said.

'Little interest' in fees

The Department of Labor issued participant disclosure regulations last year, requiring plan administrators to make specific disclosures to employees participating in 401(k), 403(b) and other defined contribution plans that allocate investment responsibility to participants.
Even then, less than 1% of plan participants called Schwab to ask what their fees meant, says Anderson. There was "very little interest in the part of participants," he says.

It's no secret that plan participants span the spectrum of investment acumen.

"Some fully understand the difference [between active and passive management], while others don't even understand the difference between an equity fund and a bond fund," Melzer says, adding that this makes picking a qualified default investment alternative all the more important.

QDIAs set up additional protections for plan fiduciaries as long as the default investment option is a mix of investments that takes into account the individual's age or retirement date, or is a professionally managed account that allocates contributions among existing plan options to provide an asset mix that takes into account the individual's age or retirement date.

Anderson says his firm sees around 10% to 15% of employees who are engaged and who actually look at their asset allocation, but the other 85% to 90% "really want and need professional help, because they don't have the time or knowledge to oversee a career's worth of savings."

He believes employees want help with investment decisions about what funds to go with, which is why he advocates for managed accounts that incorporate auto-features.

"If you can marry those with low-cost funds so that you're not paying more than you need to, and provide the professional management service, then you have the convergence of the best of both worlds," Anderson says.

Choice overload

Greg Kasten, founder of Unified Trust, a retirement planning and wealth management practice that manages $3 billion in assets, says investment class "choice overload" leads most employees to freeze when having to make a decision.

"If I give too many choices, you take the safest choice, and the safest choice is to do nothing," he says. For every three funds over 15 on an investment menu, plan sponsors get 1% less participation, Kasten says.

He believes part of the solution to this choice paralysis lies in giving plan participants a predetermined answer that "X" is how much they'll need for retirement, and then providing them with the funds and asset allocation that might be able to help them reach their goal.

The argument over fees, he believes, detracts from the real issue: Only one in four plan participants is currently on track to retire on time. Debating the merits of active and passive management based on fees "would make you believe that the funds cost too much. It's the minority of the problem that participants face, though," he says.

The majority of employees do not understand the fundamental difference between actively managed funds and low-cost index funds. This information is too complicated and confusing for most employees, according to Reese.

"It's more important that the plan fiduciary understands the difference, since they're helping determine the fund menu," Reese says. Fiduciaries need to understand the various fee structures and what is in the best interest for everyone in the plan. "They should not expect employees to figure out which funds are best for them."

And while participants most likely don't understand the difference between active and passive management, sometimes fiduciaries don't either, believing that that the higher-cost actively managed funds must be a better and more successful option.

"It's difficult to educate fiduciaries on long-term statistics for index funds, because many are emotionally invested in active management. These fiduciaries may have been with an active manager during a time period when they did beat the marketplace and stick with them because of that," Reese says.

Seven Reasons Plan Sponsors Need Retirement Plan Advisors

Fiduciaries to retirement plans are looking for advisors’ support

There are seven main functions that a retirement plan advisor must perform to satisfy plan sponsors, according to a white paper released by Strategic Benefit Services. SBS is a retirement plan and employee benefit consulting firm.

1. Assisting and educating on fiduciary responsibilities. Advisors need to help their sponsor clients meet their fiduciary duties. The paper noted that sponsors’ main motivation in hiring an advisor is to mitigate the risk of legal action being taken against them. “Often, fiduciaries’ main concern and motivation for hiring a Plan Advisor is avoidance of legal action that can be brought against them as individuals,” according to the paper.

Educating sponsors on their responsibilities as fiduciaries is an important function for retirement plan advisors, especially regarding defined benefit plans. “Plan Advisors who are hired by defined benefit plans that fall under ERISA serve their clients well by educating them on their fiduciary role and by establishing fully documented procedures to ensure compliance.”

2. Helping establish a suitable investment policy statement. Advisors must help sponsors establish investment policies and procedures for sponsor clients. SBS suggested writing these policies in a way that leaves room for fiduciaries to use their best judgment given each case. “Rigid investment policies that are not followed could be used against the fiduciaries in a court of law,” according to the paper.
Having a well-written policy isn’t enough, though. Advisors should also review the IPS at least every two years, or any time significant regulatory changes are made.

3. Managing requests for proposals from service providers. A third reason sponsors hire a retirement plan advisor is for help with requests for proposals for service providers. An advisor should step in when a sponsor need support from other providers like custodians, the report noted. Advisors’ in-depth knowledge of the industry makes them ideal candidates to draft proposals. In addition to identifying qualified firms and analyzing their responses, advisors should also facilitate the transition to the new provider.

4. Selecting an investment manager
. Similarly, sponsors seek out advisors to help them with investment manager selection. Using the criteria listed in the IPS, the advisor identifies potential managers and provides a list of finalists. After the sponsor selects a manager, the advisor provides quarterly due diligence.

5. Replacing poorly performing managers. In the event that a manager fails to live up to the criteria required by the IPS, advisors should determine whether the manager needs to be replaced right away or if there are other reasons for underperformance that don’t justify finding and selecting a new manager.

SBS noted that if a manager is placed under review, it should be made clear that it’s a temporary status while the advisor reviews what needs to be done as quickly as possible.

6. Providing performance reports. Performance reports should include typical information like market commentary, manager status reports, a summary of investment performance and disclosure of investment fees.

Furthermore, the performance report should also include for investments made by the plan participants the dollar amount in each option and the percentage of the entire plan. For fiduciary-directed portfolios, performance reports should include a comparison of the current and target asset allocations and an analysis of which components influenced performance.

7. Conducting ongoing due diligence. Finally, these functions need to be performed on an ongoing basis throughout their relationship with the sponsor so that fiduciaries can stay up-to-date on regulatory and market changes.