Be Careful with Litigation Risk in a COVID-19 World
Investment committees charged with the oversight of their company’s 401(k) retirement plan may be wondering about their duties given recent financial market turmoil. While no one can predict the duration or severity of the current stock market correction – let alone the virus outbreak that precipitated it – there are proactive steps investment committees can take today to ensure they are managing their fiduciary responsibilities while offering employees a pathway to retirement.
ERISA rules do not hold employer’s responsible for investment outcomes, but the law does say plan sponsors are required to monitor their investment menu. Thus, it is the process not the outcome which is subject to scrutiny. Nevertheless, negative investment outcomes tend to draw litigation attention.
We recommend committees include the following five topics. If you haven’t had a meeting lately, an off-cycle meeting may be helpful to assess the status of your plan and the well-being of your participants.
1. Determine if Your Plan Should Adopt Provisions within the CARES Act.
The recently enacted CARES Act contains provisions plan sponsors may wish to adopt for their company’s retirement plan. As these provisions are optional, the first step is for committee members to conduct a thorough assessment with the assistance of their services providers.
If adopted, the legislation would allow participants to withdraw up to $100,000 as an in-service distribution, provided certain criteria are met. The participant must be “experiencing adverse financial consequences” due to COVID-19, or facing a personal/household COVID-19 diagnosis. There are also a number of tax benefits to the participant for this in-service distribution, including no 10% premature distribution penalty, no mandatory 20% withholding and the recognition of income from the distribution over three years. Finally, the amount withdrawn is eligible to be repaid over three years.
The coronavirus-driven shutdown of the U.S. economy has created a dire need for liquidity and the CARES Act opens up retirement plan assets as a source of emergency funds for everyday Americans. But short-term needs shouldn’t eclipse long-term goals and planning, which is why plan committees should carefully consider participant messaging on savings habits and decision making.
It can be understandably difficult to find time for preparing and distributing this content when other human resources (HR) and benefits activities related to the pandemic are more pressing. That is why having a good advisory team ready and able to assist can prove to be very valuable.
Participants may be tempted to access retirement balances based on phony and misleading offers during this time. Sponsor resources that educate participants on the damage cash-outs can inflict on their income in retirement can prevent them from being taken in by false promises. Already radio advertisements and solicitations are on the rise encouraging people to withdraw up to $100,000 from their retirement funds, as per the CARES Act, and invest in alternative investments as a way to earn back money lost in the market downturn.
Carefully consider the pros and cons of adopting these provisions as it relates specifically to your firm. Having a trusted advisor help you weigh in on your options and support your program with a solid employee education program may help maintain the integrity of your plan without compromising retirement readiness.
In addition, the CARES Act can provide added flexibility to a plan’s loan provisions. Specifically, the customary borrowing limits of 50% of a vested balance not to exceed $50,000 would be increased to 100% and $100,000, respectively. Also, any payments that would otherwise be owed on the plan loan through 2020 may be delayed for up to one year.
2. Monitor Participant Behavior.
Ask 401(k) service providers for data regarding the behavior of your plan participants during the market correction. Specific information should include the number of website visits and call center inquiries and how these metrics compare to historical norms.
Beyond help-seeking behaviors, it is also important to assess any adverse actions taken by participants. Record-keepers should provide data regarding the number of participants who have lowered their contributions or stopped contributing, as well as transfers from stock investments to bond investments and money market alternatives.
Another area to investigate are steps taken by employees invested in the plan’s qualified default investment alternative (QDIA). These investments are designed to offer a single asset allocation solution for participants who are generally satisfied if their plan selects their asset allocation for them. Inquire if participants are either transferring out of the QDIA or holding investments in addition to the QDIA.
3. Follow the Investment Policy Statement.
While having an Investment Policy Statement (IPS) is optional, it is widely considered a best practice among investment committees. This document provides a road map for the selection of investment options made available to plan participants and how these investments will be monitored over time. Investments that fail their plan’s IPS criteria are typically put on “watch” for one to two quarters and may be eventually replaced.
It is likely that many managers will suffer significant losses in the first quarter of 2020, but that does not necessarily mean these managers should be fired. In fact, most IPSs assess managers’ performance over a three- or five-year period and emphasize relative rather than absolute performance. Nonetheless, it is highly advisable for committees to understand the reasons behind their managers’ recent performance, taking into account any additional exogenous events that may have occurred recently, such as a portfolio manager change or merger with another organization.
4. Assess the Breadth of Fixed Income Alternatives.
Ensuring participants have sufficient options to truly diversify their 401(k) savings is one way to help mitigate the negative impact of market corrections. To help participants build an asset allocation that meets their needs, it is important to offer fixed income alternatives that can act as a buoy in times of market stress and help stabilize overall portfolio valuations.
While many plans offer a broad array of equity alternatives, some offer a limited selection of fixed income alternatives. Typically, these include a money market fund or stable value alternative and a manager tied to the U.S. Barclay’s Intermediate-Term Aggregate Bond Index. These two options are important building blocks to constructing a fixed income portfolio but may not offer participants enough diversity. As a supplement to the Core Bond category, many investment committees have added a multi-sector and/or world bond option. Generally, these options provide more return potential than a core bond option but also have additional risk.
The recent market moves have been challenging, particularly for plan participants nearing retirement and younger savers who have never experienced a significant and potentially sustained long-term stock market decline. The good news is that investment committees can take steps to guide plan participants through this difficult environment.
5. Now is the Time for Employee Education.
According to the American Psychological Association, money has been the biggest cause of stress among Americans. Nearly 75% of adults reported being stressed about finances and with the Covid-19 pandemic, it is believed financial stress has been rising exponentially. Even those who have not been directly impacted are worried about their future and the impact this may have on their jobs, their income and their retirement savings. There has never been a more important time for employers to boost their employee education program.
The lack of financial literacy in America is affecting the health of millions of workers. Nearly 80% of workers live paycheck-to-paycheck according to CareerBuilder, which means many are buried in debt. Total U.S. consumer debt is nearing $14 trillion, according to NerdWallet, and credit card debt has risen almost 37% in the past five years. Employees need help managing debt, saving for retirement and navigating volatile markets.
An investment is education may not only help you better fulfill your fiduciary duties; it could help promote retirement readiness and reduce financial stress in the workplace. A good employee education program may enable you to boost productivity, reduce absenteeism and reduce litigation risks while at the same time ensuring your messaging is consistent with your plan objectives and promotes the right culture. At Longevity Capital Management LLC we have developed the Employee Retirement University to help employers build financial literacy within their workforce. Not only could education help provide liability relief, but it may also reduce financial stress and thus, boost productivity and help your employees transition into retirement while you can focus on reducing wages and employee costs.
The bottom line is your employees need the best help they can get and now more than ever is the time to consider how you can seek to boost benefits that are of value, cost-efficient and effective, while ensuring you are follow a prudent due diligent process as the steward of your 401(k).
If you would like to learn about our comprehensive service model to support plan sponsors, please contact us for a complimentary demonstration.
This information was developed as a general guide to educate plan sponsors, but it is not intended as authoritative guidance or tax or legal advice. Each plan has unique requirements, and you should consult your attorney or tax advisor for guidance on your specific situation. In no way does advisor assure that, by using the information provided, plan sponsor will be in compliance with ERISA regulations.
No investment strategy, including asset allocation, assures a profit or protects against loss.