401(k) Plan Sponsor Pitfall #1: Poor Investment Choices Lead to Lawsuits
As a plan sponsor, it is your fiduciary responsibility to provide investments that are in the participants’ best interest. If you need help conceptualizing this, ask yourself this question, what’s the point of Sally putting her money into a 401(k) if she can’t make a decent return on her investment? Sally wants her money to make more money. If she did not want that, then she would just use her savings account with a 0.0005 percent interest rate as way to fund her retirement.
Many plan sponsors have neglected their duties when it comes to providing a high-performing 401(k) plan; and many workers are beginning to notice. In the past two years, there have been over two dozen lawsuits filed by workers related high fees and bad investment choices. Recently, Pioneer Natural Resources USA, Inc. was sued (Barrett v. Pioneer Natural Resources USA, Inc.) for breaching their fiduciary duties the following ways:
- Failing to make sure the plan was reasonable;
- Failing to remove low performing money market funds; and
- Failing to offer institutional class shares for mutual funds.
Additionally, in 2017, American Airlines agreed to a $22 million settlement for a lawsuit in which participants sued them for breaching fiduciary responsibilities by selecting and retaining high-cost mutual funds.
So how can you avoid a lawsuit whilst helping Sally take advantage of her 401(k) plan? Get rid of bad investments and, most importantly, monitor plan fees. Below are investment types that you should generally avoid:
- Money Market Funds These investments are essentially cash with virtually no return. Investors will sometimes gravitate to this type of investment because it feels safe. No matter how low plan fees are, this investment’s return will, at most, cover plan fees. Switching out money market funds for stable value funds will not only keep the most conservative participant comfortable, but it will also generate a higher return.
- Funds in an annuity wrapper These are funds offered through insurance company annuity contracts and come with more fees than your average investment. These investements have sexy add-ons, like guaranteed death benefits and minimum income payouts, each add-on is a reason to tack on additional fees. These types of funds tend to be a waste of money for your typical investor. You should avoid adding investments that only benefit a minority of your plan participants.
- Actively managed funds: Around 84% of actively managed funds underperform their benchmark. In addition, their fees are generally higher than passively managed funds, due to the increase of work performed by the investment managers.