Welcome to the Evolution of Defined Contribution Plans
Defined contribution (DC) plans have come a long way since their introduction in the 1970s in the United States. As these plans have evolved, so has the approach to designing investment lineups for participant-directed DC plans. Plan sponsors are now focusing on creating unique investment structures that cater to the specific characteristics and needs of their participants, rather than relying on common investment beliefs.
Creating a Thoughtful Investment Structure
In this article, we will explore the process of designing a diversified investment structure from an asset class perspective. A key aspect of this process is to carefully craft an investment lineup that considers the diverse needs of participants before selecting specific investment vehicles.
Regulatory Foundation & Guidance
The Employee Retirement Income Security Act of 1974 (ERISA) mandates that plan fiduciaries must act prudently and diversify investments to minimize risk. By providing greater asset class diversification, plan sponsors can offer more opportunities for participants to manage their investment risks effectively.
Under ERISA, plan fiduciaries must meet prescriptive requirements for creating an investment structure that aligns with the best interests of participants. Even for plans not subject to ERISA, many sponsors choose to follow ERISA guidelines as best practice.
ERISA section 404(c) stipulates that DC plan fiduciaries must offer a minimum of three diversified investment options to provide participants with different risk-return characteristics. However, in practice, most plans offer a more extensive range of investment options to better serve participant needs.
Crafting a Robust Investment Structure
Designing a comprehensive investment structure involves a multi-step process that engages the plan sponsor’s retirement plan committee. A qualified retirement plan advisor can lead this process, ensuring that the structure meets fiduciary responsibilities.
A Sample Process in Seven Steps
1. Identify a purpose & objectives statement: Define the company’s philosophy regarding the DC plan’s purpose and objectives to guide investment structure decisions.
2. Participant Enrollment: Determine the percentage of participants enrolled in managed account services or self-directed brokerage accounts.
3. Develop a participant group profile: Analyze participant demographics and investor types to understand the plan’s unique characteristics.
4. Review the number of asset classes: Determine the appropriate number of asset classes based on participant needs and objectives.
5. Avoid complicated menu design: Keep the investment menu design simple and streamlined to facilitate participant decision-making.
6. Review historical performance: Evaluate the historical performance of asset classes considered for inclusion in the lineup.
7. Update the organization’s IPS: Ensure that the Investment Policy Statement aligns with the desired asset classes and investment structure.
Putting the Participant Group Profile into Practice
By examining different participant group scenarios, plan sponsors can tailor investment structures to meet the diverse needs of participants effectively.
Empowering Plan Sponsors
By following a structured investment design process, plan sponsors can make informed decisions about investment lineup selection that align with participant needs and fiduciary responsibilities.
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Professional Learning for CFA Institute Members
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All views expressed in this post are the author’s opinion and should not be considered as investment advice. The material presented is of a general nature and does not constitute legal, tax, or accounting advice. For specific advice, consult a professional advisor.
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