Plan sponsors can be overwhelmed by the choices presented to them when it’s time to choose the design of their plan. The options can be divided into three parts to help the plan sponsor choose the best fit. The categories include Participant Services, Plan Features, and Investment Menu Design.
Participant services include optional services such as hardship and unforeseeable emergency withdrawals, loans, and investment advice.
Hardship withdrawal provisions, found in 401(k) and 403(b) plans are designed to address specific circumstances in which the funds withdrawn would make a significant impact on the plan participant’s life and should be used only when a plan loan will not suffice. Unforeseeable emergency loans, found in 457(b) plans, carry stricter provisions, denoted on page one in the Plan Design section of the NAGDCA Best Practices Guide.
Plans may offer two types of loans, general purpose loans (with terms up to 5 years) or principal residence purchase loans (with terms up to 15 years). Best practices for loans include restrictions on the number of loans a participant may take at one time and clear guidance to plan participants on the rules and features of loans, including repayment requirements. Plan sponsors should consider that while plan participants may find it comforting to know they can access their funds in an emergency, there will be ongoing administrative responsibility that comes with allowing loans as the plan sponsor is responsible for facilitating repayment of the loan. Plan sponsors should consider setting rules that strike a balance between meeting participant needs and ensuring that the plan is used primarily as a retirement savings vehicle.
Plan sponsors have many options for giving investment advice to their plan participants, including offering a managed account service via the plan recordkeeper or providing access to investor centers. All advice solutions should be transparent with respect to how participants receive counseling on areas such as rollovers, financial planning in retirement, purchases or services like annuities, as well as any associated compensation received by those providing the advice to plan participants.
Plan features, such as rollovers, Roth options, automatic plan features, and employer match, can have a significant impact on the saving decisions made by participants.
Plan sponsors have many choices in regard to permitting rollovers into their plans from other plans, but should be aware of issues that could arise from different types of rollovers. For example, if 401(k) or 403(b) money is rolled into a 457(b) plan, the recordkeeper must maintain separate recordkeeping for those funds because the money continues to maintain the characteristic of the plan from which it was rolled over.
Most governmental plans are able to now allow post-tax Roth participant contributions and it is considered best practice to do so to provide an additional tax-advantaged saving opportunity to plan participants and help them better manage their tax burden during retirement. With opportunities for both tax deferred savings and tax-free accumulation, participants may need additional information to understand the different tax rules associated with each option.
Research has shown that outcomes from automatic plan features such as automatic enrollment and automatic contribution escalation include higher participation rates and higher contribution rates. Similarly, an employer match results in a higher participation rate and may result in other positive outcomes, such as the participant having more incentive to be engaged in their savings plan.
Investment Menu Design
Investment menu design can prove challenging for plan sponsors; from fiduciary requirements to fees to fund choices, there is no shortage of decisions to be made.
The Federal Department of Labor (DOL) has issued formal guidance indicating that use of an Investment Policy Statement (IPS) is consistent with fulfilling the duty of prudent plan management and the IPS is often a critical document in plan audits by the DOL. The IPS should set guidelines for several aspects of the plan, and should include an Executive Summary/Purpose of the IPS as well as Roles/Responsibilities of the plan’s key players including staff and board members, among others.
In designing the Core Investment Menu, best practice dictates that a plan sponsor keep it streamlined and simple for plan participants; too many choices can cause “decision paralysis” and actually lower participation.
When choosing domestic equity, core menus are often built around active and passive management, market capitalization, growth and value styles, or combinations of these approaches. When choosing foreign and/or international equity, the plan sponsor can consider the same categories used for domestic equity, or focus on funds that are benchmarked to, or represent, a broadly diversified global equity index.
Plan sponsors may also choose from domestic intermediate fixed income (bonds) for lower-risk options for conservative investors; capital preservation, such as money market mutual funds or FDIC-Insured products, for those interested in minimizing market risk; non-traditional asset classes, such as real estate and commodities; pre-diversified target-date or target-risk funds for those interested in an easy to use pre-packaged “diversified” investment option; and a self-directed brokerage, for individuals interested in gaining access to investment options that are not reviewed or approved by plan fiduciaries, but may suit a participant’s specific needs.
Other plan design considerations include account structure and the fees associated with mutual funds, managed account fees, and fee transparency.
For more information regarding Plan Design and other Best Practices, check out NAGDCA's Best Practices Guide at NAGDCA.org.