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ERISA Fidelity Bond versus Fiduciary Liability Insurance

Plan sponsors often ask, “Is an ERISA fidelity bond the same thing as fiduciary liability insurance?” The answer is no, they are not the same. The two insure different people and have different requirements under the terms of ERISA.

An ERISA fidelity bond is required under ERISA Section 412. Its purpose is to protect the plan, and therefore the participants. It does this by ensuring that every fiduciary of an employee benefit plan, and every person who handles funds or other property of the plan, be bonded. This protects the plan from risk of loss due to fraud or dishonesty on the part of the bonded individuals. The amount of the fidelity bond is 10 percent of the plan assets (with a $1,000 minimum) and is capped at $500,000 (or $1,000,000 for plans with company stock).

Fiduciary liability insurance protects the fiduciaries (not the plan or participants) from a breach of their fiduciary responsibilities with respect to the plan. Remember that fiduciaries may be held personally liable for losses incurred by a plan as a result of their fiduciary failures. Unlike a fidelity bond, fiduciary liability insurance is not required under ERISA. The Department of Labor may ask whether the plan fiduciaries have insurance in the event of an investigation. It’s important that fiduciary liability insurance explicitly covers “ERISA” claims. Review of any policy, including E&O policies, should look for language that may void the coverage in the event a plan has ever been out of compliance (something virtually all plans experience at some point in their existence).

Complying With ERISA 404(c)

According to ERISA, plans intending to comply with 404(c) must provide that participants: Have the opportunity to choose from a broad range of investment alternatives (which are adequately diversified); may direct the investment of their accounts with a frequency which is appropriate; and can obtain sufficient information to make informed investment decisions. The plan sponsor must provide annual written notification to participants with its intent to comply with 404(c), and be able to provide the following:

·         Information about investment instructions (including contact information of the fiduciary responsible for carrying out participant investment instructions);

·         Notification of voting and tender rights;

·         Information about each investment alternative; and

·         A description of transaction fees and investment expenses.

Compliance with section 404(c) of ERISA protects plan fiduciaries from liability for losses that result from the investment decisions made by participants. Conversely, failure to comply with 404(c) could result in liability for losses due to poor investment decisions made by plan participants. To comply with some of the important requirements of 404(c), we encourage our clients to review and execute a formal 404(c) Policy Statement and Employee Notice and send the Notice at least annually to all employees. Contact your plan consultant if you have any questions.

Index Funds – Passive or Passive Aggressive?

One of the largest misconception about index funds is that their only distinguishing feature is their fees. It’s not uncommon to hear, “index funds are just holding the stocks or bonds in the index, so we don’t need to pay attention to them.” This assumption, however, is an oversimplification. Many investors don’t realize that all index funds are not created equally.

A key difference between indexes and index funds is that index funds are exactly that – funds. Index funds manage obstacles that indexes themselves don’t face. The largest is that funds actually must transact in securities whereas indexes do not.

As an example, when Standard and Poor’s recently added Coty (COTY) to the S&P 500 Index to replace Diamond Offshore Drilling (DO), S&P simply recalculated the index values based on the closing prices of the securities on the effective date. Index funds that track the S&P 500, however, had to sell out of their positions in DO and purchase COTY, PLUS rebalance the weightings of any remaining securities that were impacted by the change.  Trading in these securities exposed the funds to transaction costs such as commissions and market impact. Additionally, funds face the risk that their realized trade prices on the securities may be different than the values used to calculate the index, creating a difference in performance. In this example, the impact of these factors is generally small.

Where the impact is more meaningful is in areas such as fixed income and international equities where liquidity in the securities tends to be significantly lower, there are more securities in the indexes, and changes are more frequent. The Barclays Aggregate Index, for example, has over 8,500 securities in it, with many of them not trading every day. In addition, the index rebalances on a monthly basis, so managers tracking this index must constantly adjust the fund.

Index funds must also efficiently manage flows in and out of the funds, dividends and interest payments, mergers, tax consequences and securities lending – all challenges that the underlying indexes do not face.

Fortunately, most index managers are adept at keeping their funds in-line with their benchmarks, so the impact of these factors on fund performance is generally small – small, but important. Just like active funds, evaluating index funds requires careful analysis beyond fees and should also include performance and risk. The index fund metrics in the Scorecard System™ incorporate all of these, providing a complete picture of the factors that produce the most effective index funds.

No Beneficiary Designation. Who Gets The Money?

According to a recent Wall Street Journal article, retirement plans and IRAs account for about 60 percent of the assets of U.S. households investing at least $100,000.¹ Both state and federal laws govern the disposition of these assets, and the results can be complicated, especially when the owner of the account has been divorced and remarried. Therefore, it is important for plan fiduciaries of qualified retirement plans to understand their role regarding beneficiary designations and the regulations that dictate.

Under ERISA and the Internal Revenue Code, in the case of a defined contribution plan that is not subject to the qualified joint and survivor annuity rules², if a participant is married at the time of death, the participant’s spouse is automatically the beneficiary of the participant’s entire account balance under the plan. A participant may designate someone other than his or her spouse as the beneficiary only with the spouse’s notarized consent.

If the owner of a retirement plan account is single when he or she dies, the assets go to the participant’s designated beneficiary, no matter what his or her will states. In addition, the assets will be distributed to the designated beneficiary regardless of any other agreements including even court orders. If the participant fails to designate a beneficiary, the terms of the plan document govern the disposition of the participant’s account. Some plan documents provide that in the absence of a beneficiary designation the participant’s estate is the beneficiary, while others provide for a hierarchy of relatives who are the beneficiaries. Because of the variances in plan documents, it is important that fiduciaries review the terms of their plan document when faced with determining who the beneficiary is in the absence of the participant’s designation.

The beneficiary determination can become complicated when a retirement plan participant divorces. Where retirement benefits are concerned, both the Employee Retirement Income Security Act (ERISA) and the Internal Revenue Code contain provisions requiring plans to follow the orders of state courts overseeing domestic disputes that meet certain requirements. These orders are referred to as “qualified domestic relations orders” (QDROs).

Until recently, the federal courts have failed to adopt a reliable and uniform set of rules for adjudicating disputes among beneficiaries with competing claims. Some courts, adopting a strict reading of ERISA, simply pay the benefit based on the express terms of the plan; while others, with a nod to such concepts of “federal common law,” look to documents extraneous to the plan (e.g., the divorce decree, a waiver, or some other document) to make the call. In Kennedy v. Plan Administrator for DuPont Savings and Investment Plan, the U.S. Supreme Court settled the matter, coming down squarely on the side of the plan document.

The facts in Kennedy are straightforward: A plan participant married and designated his wife as his beneficiary.  The plan participant and his wife subsequently divorced. Under the terms of the divorce decree, the participant’s spouse surrendered her claim to any portion of the benefits under the participant’s retirement plan. As sometimes happens, the participant neglected to change his beneficiary designation under the plan to reflect the terms of the divorce. As a result, his ex-spouse remained designated as his retirement plan beneficiary. Upon the death of the participant, the plan administrator, following the terms of the plan document and the beneficiary designation, paid the participant’s account to the ex-spouse. Predictably, the participant’s heir (his daughter in this instance) sued on behalf of the estate. The Supreme Court ruled that under the terms of the plan document, the designated beneficiary receives the participant’s death benefits, and in this case, the ex-wife was the designated beneficiary entitled to the participant’s account.

Another common example occurs following a divorce, when a plan participant designates his or her children as beneficiaries. If the participant later remarries, and dies while married to the second spouse, the second spouse is automatically the participant’s beneficiary unless he or she consents to the participant’s children being designated as the beneficiaries.

There are steps that plans can take to make the beneficiary process less prone to error. For example, a plan document can provide that divorce automatically revokes beneficiary designations with respect to a divorced spouse. It also behooves plans to review their communications materials to help ensure that participants are made aware of the rules that apply to the designation of beneficiaries.

Many plans that have had to deal with issues like these have decided to take inventory of their current beneficiary designations on file and attempt to remediate any deficiencies directly with the participants. Some have also requested their recordkeeper to insert a note in participants’ quarterly statements reminding them to confirm their beneficiary designation is current and accurate. Both are good ideas.

As a plan sponsor you have the best wishes of your participants in mind and helping ensure their beneficiary designations are in order is another way to protect them and help ensure their intentions are carried out. Consider distributing this month’s accompanying participant memo that reminds participants of the importance of keeping their beneficiary designations up to date.

¹Family Feuds: The Battles Over Retirement Accounts

²This commentary addresses only plans that are not subject to the qualified joint survivor annuity (QJSA) rules. Typically, retirement plans are designed not to be subject to the QJSA rules by meeting the following requirements: (1) upon death, 100 percent of the participant’s vested account balance is payable to the surviving spouse; (2) the participant does not elect a life annuity; and (3) the participant’s account balance does not include any assets subject to the QJSA rules, such as a transfer from a money purchase pension plan. Please contact your consultant for questions related to defined benefit pension plans and money purchase pension plans subject to the QJSA rules.

May Any Employee Join the Retirement Committee?

Upon first blush, to the extent an employee from the general populace can and wishes to make a contribution as a committee member, there seems to be no reason why they shouldn’t participate on the committee. In practice, most committees consist of executives from finance (preferably the CFO), benefits and human resources. Due to the potential personal liability exposure, if there is interest from other lay people who wish to represent the vote of the participant base, they are best served participating as a non-voting member with no discretionary capabilities. This type of person should be identified and documented as a non-voting member assuming there is no intent to take on fiduciary status and the potential liability attached to all retirement committee members.

Consider Millennial Workers when Designing Plan Fund Lineups

Millennials are the largest demographic cohort in the nation, U.S Census Bureau data shows. And up to 80 percent are already saving in their employer-sponsored retirement plans, according to a 2015 report from Bank of America Merrill Lynch.

The newest generation of workers—which the Pew Research Center defines as those born between 1981 and 1997—has exhibited distinctive attitudes and behaviors that plan sponsors and their advisors must consider when designing menus. Plan administrators, too, must rethink some long-held beliefs about participant behavior.

For starters, millennials tend to be more risk averse and gravitate toward conservative investments that they believe will be less exposed to bouts of volatility. Millennials also tend to be highly educated and research-oriented. Given these inclinations, plan sponsors should consider providing education about the benefits of long-run investing, since they have just begun their accumulation phase.

The number of millennial plan participants is likely to rise, particularly if the U.S. economy—and the job market— continue their slow but steady recoveries.

Investment Lineups

Employers with growing millennial populations should adjust their lineups to accommodate this generation’s more conservative sensibilities. Current research—including a study published by the retirement and trust unit of Wells Fargo—suggests that millennials may be inclined to choose managed options with customizable and adjustable glidepaths. Forward-thinking sponsors would do well to get ahead of the curve by looking widely across all age groups within their plans, making sure all cohorts have access to these types of solutions.

Plans geared toward millennials can offer a menu that includes conservative balanced funds, a mix of core funds and, for an added measure of diversification, funds in non-core asset classes, such as emerging markets and small-cap equities. The mix can also include a risk-managed option to help young investors build up their balances and gain experience with markets until they feel comfortable assuming greater risk levels.

About a third of millennials say that they find socially responsible investing “very appealing,” and another 59 percent say it’s “somewhat appealing,” according to a June 2016 survey by Legg Mason and Naissance. Options that include some socially responsible element stand a good chance of aligning with millennials’ social and environmental learnings.

Communication and Education

A targeted communications effort can help satisfy millennials’ appetite for understanding the different possibilities available for a given financial transaction. These materials should explain the types of investment choices available through the plan. For instance, plan sponsors can teach millennials about Roth 401(k) options, which allow them to contribute to their plans on an after-tax basis, so they don’t have to pay taxes when they cash out. That can help save total taxes, since millennials are typically in a lower tax bracket when they make initial contributions than when they are ready to pull assets from these accounts.

As millennials enter the workforce and age through it, plan sponsors and their financial advisors will need to adapt their retirement plans to suit this growing cohort. A well-considered and robust investment lineup, supported by strong communications, can help plan sponsors provide an appealing, competitive retirement plan that retains younger workers and helps them invest their way toward a more secure retirement.

This is an excerpt of Macquarie Investment Management’s article Millennial Workers Require Special Plan Sponsor Menu Design.

When Participants Retire, Should their QDIA Retire as Well?

Many retirement plan sponsors are increasingly recognizing the benefits of allowing retired employees to leave assets in the defined contribution (DC) plan. This arrangement can be a win-win for both plan sponsors and participants. Fat retiree balances may improve plan economics, allowing plan sponsors to negotiate lower fees. And participants can take advantage of funds that are overseen by fiduciaries, often available at lower costs.

Those passively enrolled generally have their contributions invested by default in the plan’s qualified default investment alternative (QDIA). In light of this, plan sponsors and their advisors may ask: The plan’s QDIA may be appropriate for younger workers, but is it the best choice for retired participants? For that matter, what about near-retirees and other participants who may have different risk profiles?

There are a number of individual investment types to consider to help support the needs of participants, both near retirement and already retired. For example, plan sponsors may want to consider adding risk-managed, multi-asset allocation funds designed to deliver both growth and income as a starting point. It could be supplemented with a fixed income fund to support the more immediate financial needs of retirees and for more risk-averse investors. Retirees with higher risk profiles — those who don’t need to tap their assets immediately — may want more access to equities, perhaps in specialized areas like small-cap and emerging market funds, to help infuse more diversity into the growth portion of their portfolios that won’t be tapped until later in retirement.

While target-date funds are designed to be all-in investments, their one-size-fits-all approach may simply not work for different circumstances. An Aon Hewitt study¹, which found that slightly less than half (49.7 percent) of investors were using target-date funds “correctly” as their sole retirement investment, suggests some retirement investors may have valid reasons for partial target date use.

For example, the study noted, two 50-year-old participants may have different financial circumstances. One might have a defined benefit (DB) plan, a child who has completed college, and a house that’s paid off. The other might not be eligible for a DB plan, has children just starting college, and has significant mortgage payments. These two participants may need different retirement portfolios, but a target-date fund would treat them in identical fashion. With that in mind, it may not be surprising that as participants age there’s a decrease in the percentage of those using target date funds for their full portfolio.

Asking the right questions

Advisors can help plan sponsors stay ahead of the trends by analyzing their pre-retiree and retiree populations now to answer these questions:

  • When will most retirees across the population likely need to tap their plan assets?

  • Do the current QDIAs meet those needs?

  • Should new retiree-focused investments be designated?

  • Does the fund lineup need to be expanded to meet the diverse needs of retirees?

  • What is the plan’s approach to educating near-retirees on this issue, and possibly tying it to other financial wellness efforts?

Educational resources and managed account services targeted to pre-retirees and retirees can help these participants implement strategies that make sense for their own situations and their retirement years.

¹Aon Hewitt, Target-Date Funds: Who is Using Them and How Are They Being Used? November 2016.

Mutual funds are sold by prospectus only. Before investing, investors should carefully consider the investment objectives, risks, charges and expenses of a mutual fund. The fund prospectus provides this and other important information. Please contact your representative or the Company to obtain a prospectus. Please read the prospectus carefully before investing or sending money.

This is an excerpt of Macquarie Investment Management’s article, “When participants retire, should their QDIA retire as well?”

Do You Send Participant Notices Via Email? Should You?

The number of notices and disclosures required to retirement plan participants has increased while methods to access information changed drastically. Many people receive their news and information on electronic devices through apps and social media. What remains the same is the Department of Labor’s (DOL’s) guidance about permissible methods to provide notices electronically. There is a disconnect between how people are accustomed to receiving information (electronically) and what is permissible under ERISA.

What Disclosures May be Distributed Electronically under the DOL Safe Harbor?

A comprehensive guidance – and safe for plan fiduciaries – is the safe harbor for electronic delivery provided in DOL regulations.  The safe harbor includes the documents required to be furnished by ERISA including, but not limited to:

  • Summary plan description

  • Summary of material modification

  • Summary annual report

  • Individual benefit statements

  • Participant fee disclosure

  • Investment-related information required for ERISA section 404(c) compliance

  • Qualified default investment alternative (QDIA) notices (both initial and annual)

  • Information regarding participant loans

  • Any information that must be provided upon request by participants/beneficiaries

The list does not include safe harbor plan notice. That annual notice falls under the jurisdiction of the IRS, not the DOL, and thus is not included in the DOL’s safe harbor.

Who May Receive Documents Electronically?

There are two categories of individuals who may receive disclosures electronically:

  1. Participants who work at a computer

  2. Participants that do not work at a computer may still receive emailed notices provided that:

  • the participant consents

  • prior to consent, the participant is given a summary of documents and informed that consent is revocable

How Must Employers Distribute Notices Electronically under the Safe Harbor?

Employers must be conscious of how they provide required disclosures.  Many use their company website to post them.  While this is allowable, the following additional rules must be met:

  • The document must be easily accessible from the company website’s home page

  • Access should be restricted by password

  • A prominent notice should appear on the home page stating that the document contains important information regarding plan rights

  • Notice of each posting must be provided

  • Documents should remain on the website for a reasonable period of time

Regardless of the specific electronic method employed, plan sponsors must ensure confidentiality and that delivery results in actual document receipt.

Should Employers Consider Electronic Distribution of Notices?

Absolutely! Technology is inescapably pervading every facet of our lives. While there are a few requirements to abide by, there are vast benefits to electronic delivery including cost savings (no more paper/postage to purchase, labor savings, etc.), environmental consciousness, quicker dissemination of information, higher likelihood of readership and overall more efficient retirement plan operation. Ask your plan advisor to add “electronic participant notice distribution” to your next retirement committee meeting agenda.

~Joel Shapiro, JD, LLM, Senior Vice President of ERISA Compliance at RPAG