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Pooled employer plans (PEPs) are the latest 401(k) rage, but they can be an asset or a liability. The difference is in their qualified default investment alternative (QDIA). A PEP with a safe QDIA is an asset, but a risky QDIA is a liability.
This article defines PEPs as follows:
Pooled Employers Plans were born out of Congressional efforts to make employer-sponsored retirement plans available to more workers to help solve the retirement savings crisis. The SECURE Act, signed into law at the end of 2019, essentially created PEPs to address/solve a pair of longstanding issues that kept Multiple Employer Plans from achieving widespread adoption: the “one bad apple” rule and “common nexus” requirement.
The concern is that some small employers might not look into everything before making the decision to join a PEP, or in choosing which one to join.
According to the Groom Law Group “Many PEP providers anticipate requiring individual plan sponsors to select the investment manager of their choice. To not permit this structure could potentially stifle the options available in the PEP market that may make PEPs more attractive to employers. The department should confirm that this practice is consistent with the statute.”
In other words, sponsoring employers will find that they own the liability for fund selections made by the pooled plan provider (PPP). This liability can and should be segmented between defaulted and self-directed beneficiaries; employers choose risk on behalf of defaulted beneficiaries whereas self-directed participants choose their own risk.
Levels of fiduciary responsibility
ERISA Section 404c requires at least three investment options for self-directed beneficiaries: low, middles and high risk. In addition, recent successful lawsuits necessitate the use of the lowest cost funds. These are simple and straightforward responsibilities.
Responsibilities to defaulted beneficiaries are more complex and have not yet been tested in court. All defaulted beneficiaries have one characteristic in common – they are financially unsophisticated. Accordingly, the duty of care is like the responsibility to young children to protect them against harm. Plan sponsors are responsible for harm done to defaulted beneficiaries that could have been avoided. This is a higher level of standard than applies to self-directed beneficiaries.
Employer choices
PEP sponsors should opt for safe investments for their defaulted beneficiaries because they don’t need the headaches of causing investment losses, especially when that affects employee morale and wellbeing. Sponsors own those losses. In other words, employers should require safe defaults in their choice of a PEP.
The Pension Protection Act of 2006 requires three qualified default investment alternatives (QDIAs): a balanced account, a managed account or a target date fund (TDF). TDFs are by far the most popular choice, growing to $3 trillion, which is about a third of the $9 trillion in 401(k) plans.
The 2006 Act specifically excluded the then common practice of cash or stable value, because it was believed that this was too safe for young participants. But the pendulum might have swung too far to the risky side for older beneficiaries.
Swimming in the safe end of the pool
Employers should require a safe QDIA in their PEP selection.
A safe balanced fund would not be the standard 60/40 stock/bond mix; it lost more than 30% in the last correction in 2008. Also, bonds are very risky because interest rates are being manipulated under the government’s zero interest rate policy (ZIRP). A safe balanced fund would be at least 70% in cash and low-risk investments. This would probably be too safe for young beneficiaries, but appropriate for those nearing retirement.
Managed accounts can be the best QDIA if they are discussed in face-to-face engagements with a skillful investment advisor, but this is seldom the case. Most managed accounts are automated systems that confuse more than help unsophisticated defaulted beneficiaries. Some mistakenly believe that a “managed” balanced account is a QDIA, where the account provider essentially times the markets. The validity of this claim will likely be challenged in the next market correction.
As discussed in this article, there are two distinct groups of target date funds: safe and risky. The differences are at the target date for people near retirement. The “safe” group is invested 70% in safe (guaranteed) assets at the target date while the “risky” group is 90% in risky assets, namely 55% in equities plus 35% in risky long-term bonds.
Conclusion
PEPs will be a big deal because they make it easy for small employers. But those employers need to be very careful in their selection because there’s no benefit to swimming in the deep end of the pool. The risk is not worth taking.
Ron Surz is co-host of the Baby Boomer Investing Show and president of Target Date Solutions and Age Sage, and CEO of GlidePath Wealth Management.
Read more articles by Ron Surz
Advisor Perspectives welcomes guest contributions. The views presented here do not necessarily represent those of Advisor Perspectives.
