Getting people to invest in their workplace retirement plan is only half the battle. The more the industry does to improve participation rates, the more it opens plan sponsors up to risks.
In its research, Willis Towers Watson has found that 90% of retirement plans now offer automatic enrollment and 93% of plans are using target-date funds as their qualified default investment alternative, or the account that automatic deferrals are defaulted into.
“While that’s all wonderful, having a large dollars flowing into a target-date series creates a new wrinkle of risk for plan sponsors,” says Marina Edwards, a senior consultant in the Benefits Advisory and Compliance group of Willis Towers Watson’s retirement practice in Chicago.
She says that it isn’t out of the realm of possibility that plan sponsors could be sued based on their fiduciary selection of a QDIA. Plan participants could come back and say that a plan sponsor breached their fiduciary duty if their target-date outcomes are not as good as expected.
“If that were to happen, would you be prepared to defend that lawsuit?” she asks.
Keeping those types of risk in mind, Edwards says that plan sponsors need to make sure they have documentation in their files about how they reviewed, selected and monitor the TDFs they offer and whether or not their investment strategy fits well with participant demographics.
She points out that the Department of Labor has issued guidelines on how to pick and monitor a QDIA, and plan sponsors should review that in context of their own plan participants. It is also important to focus on the glide path — the amount of risk taken on in the plan either to or through retirement — tied to QDIAs for they are not all set up the same. Plan sponsors need to make sure their committee has properly evaluated those differences and make sure they have an ongoing dialogue to maintain the target-date series they have chosen.
The Department of Labor specifies that a QDIA can be one of four types:
· A product with a mix of investments that takes into account the individual’s age or retirement date, such as a target-date fund or life-cycle fund.
· An investment service that allocates contributions among existing plan options to provide an asset mix that takes into account the individual’s age or retirement date, such as a professionally managed account.
· A product with a mix of investments that takes into account the characteristics of the group of employees as a whole, rather than each individual, like a balanced fund.
· A capital preservation product for only the first 120 days of participation.
A QDIA must either be managed by an investment manager, plan trustee, plan sponsor or a committee comprised primarily of employees of the plan sponsor that is a named fiduciary or be an investment company registered under the Investment Company Act of 1940, according to the DOL. In general, QDIAs are not supposed to invest participant contributions in employer securities.
Another popular plan design option is offering a Roth 401(k) or in-plan Roth conversions, Edwards says.
The Roth option
With most people falling into a lower tax bracket until 2025, thanks to tax reform that was passed at the end of last year, now is a good time to take advantage of a Roth feature. Most 401(k) dollars go into a retirement account pre-tax and are taxed when they are withdrawn at retirement. Edwards recommends that plan participants have a mix of both pre-tax and after-tax retirement funds to achieve tax diversification within their 401(k) plan.
“It gives you a choice of which bucket to pull from in retirement when you are unsure what the tax brackets will be,” she says.
She adds that Willis Towers Watson is working with recordkeepers to stress the importance of tax diversification within 401(k) plans and educating them on how they can convert some of their dollars to Roth without taking a full distribution.
Right now, if participants want to convert 401(k) dollars to a Roth, they have to take the money out, pay taxes on it and then reenroll the money in a Roth.
Many plan sponsors are now considering automatically enrolling plan participants into a Roth option.
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