The Frugal Fiduciary Small Business 401(k) Blog
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Index funds not only offer 401(k) participants superior returns to comparable actively-managed funds net of fees, they are a clear and simple way for 401(k) sponsors to meet their investment-related fiduciary responsibilities. Sponsors need only select three or more prudent investments that allow plan participants to sufficiently diversify their accounts. Index funds are indisputably “prudent” by meeting their investment objective for market-correlated returns at reasonable fees.
Investment in equity index funds – and other passively-managed investments designed to track a market index – is exploding. According to a Morningstar study, these investments took in a record $504.8 billion in 2016. That’s in contrast to actively-managed funds, which are designed to outperform an index. These funds experienced outflows of $340.1 billion in 2016.
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When a small business sponsors a 401k plan, several investment-related decisions must be made by fiduciaries. Dramatically different fees and expenses can result from this decision-making, so fiduciaries should know their options in order to make “prudent” decisions on behalf of plan participants – an obligation under ERISA. Otherwise, personal liability can result.
Most 401k plans today offer a low risk investment option designed to maintain a constant net asset value. This option is usually a money market or stable value fund. Recently, the Securities Exchange Commission (SEC) made changes to the rules that govern money market mutual funds (MMFs). These changes are intended to increase MMF transparency as well as give investors additional protection during periods of extraordinary market stress, when redemptions in some MMFs can increase significantly. These changes are effective October 14, 2016.
During the 4th quarter of each year, most 401k sponsors are distributing notices to participants that disclose certain plan information about the upcoming year – the safe harbor 401k notice is an example. Most sponsors try to coordinate the distribution of these notices with their plan’s annual fee disclosure notice, which is required under ERISA 404a-5 (“404a-5 notice”). The 404a-5 notice discloses certain plan expenses (administration, individual and investment-related) to 401k participants. First required in 2012, its purpose is to help 401k participants make informed plan choices.
Selecting competent service providers is the most important - and most confusing - fiduciary duty of a 401k sponsor. Why? Services offered by 401k providers can vary dramatically in breadth, depth and price. This variability makes it difficult for 401k sponsors to match appropriate services to plan needs. Many small business 401k plans pay for superfluous services participants do not use. These excess services are often expensive, dragging down participant investment returns and creating potential personal fiduciary liability for the 401k sponsor. If you sponsor a 401k plan, I recommend following a two-step process to ensure your plan does not pay fees for services your participants will not use: 1) understand the services that compose a 401k plan and 2) determine which of these services require professional assistance to deliver. Once this process is complete, you’ll be ready to shop for professional service providers.