Defined contribution (DC) plans have come a long way since their inception in the 1970s, especially in the United States. Plan sponsors no longer rely solely on traditional investment beliefs when constructing asset lineups for participant-directed DC plans. Instead, they now intentionally consider the unique characteristics and needs of their participants.
Crafting a diversified investment structure is a crucial step in thoughtful DC plan investment design. Before choosing specific investment vehicles, it is essential to follow a structured approach from an asset class perspective.
Regulatory Foundation & Guidance for Investment Menu Structure
- The Employee Retirement Income Security Act of 1974 (ERISA) requires plan fiduciaries to act prudently and diversify plan investments.
- ERISA mandates greater asset class diversification to provide opportunities for participants to mitigate investment risks.
- Prescriptive requirements and principles-based care standards guide plan fiduciaries in building a solid investment structure.
- ERISA section 404(c) offers protection to DC plan fiduciaries from participant investment choices.
Today, it is rare for an investment structure to feature only three options. Many plan fiduciaries understand the benefits of offering a broader range of investments for participants. Target Date Funds (TDFs) are looked upon favorably and considered as Qualified Default Investment Alternatives (QDIA) under the Pension Protection Act of 2006.
Crafting a Robust Investment Structure
A structured process for investment design is pivotal in fulfilling fiduciary responsibilities under ERISA. The design process is multi-step and requires engagement from a plan sponsor’s retirement plan committee, often spearheaded by a qualified retirement plan advisor.
A Sample Process in Seven Steps
- Identify a purpose & objectives statement: Companies need to define the philosophy behind their DC plan’s objectives to inform the investment structure.
- What percent of participants are enrolled in managed account services and/or self-directed brokerage accounts?: Participant profiles should influence the investment structure.
- Develop a participant group profile: Understanding participant demographics is key to structuring a suitable investment lineup.
- Review the number of asset class options: The selection of asset classes should align with the plan’s objectives and participant profiles.
- Avoid complicated investment menu design: Simplicity is key in creating an accessible investment structure.
- Review historical performance prior to asset class selection: Analyze historical performance to inform asset class choices.
- Update the organization’s investment policy statement: The Investment Policy Statement should reflect permissible asset classes in the plan.
Putting the Participant Group Profile into Practice
- Participant Group A should consider asset classes such as domestic equity, fixed income, and TDFs.
- Participant Group B may benefit from asset classes tailored to predominantly early-career employees, including domestic equity and targeted TDFs.
In conclusion, a structured investment design process is crucial for plan sponsors to tailor investment lineups that meet the needs of DC plan participants. By following a thoughtful approach, sponsors can confidently navigate the complex landscape of DC plan investment design and fulfill their fiduciary duties effectively.
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