Retirement plan risks cannot be avoided, but they can be managed in order to minimize their impact on plan participants and sponsors. Employers and sponsors that offer defined contribution (DC) plans have a fiduciary responsibility to measure, manage and mitigate the various factors and risks that could affect those plans.
Protecting a retirement savings plan and its assets requires effective governance. The need was particularly intensified in recent years by several employee class action lawsuits scrutinizing employer governance of 401(k) and other defined contribution plans (e.g., 403(b) and 457).
Risks to Address
Minimizing your risks as a plan sponsor starts with understanding common defined contribution plan risks. Here are the major risk factors plan sponsors and participants should address in order to maintain effective governance over a retirement savings plan and its assets:
Market & Investment Risks
- Investment or market is the most apparent risk to defined contribution plans. Stocks are typically most susceptible to market risk. However, all types of investments can lose value based on factors including economic conditions, elections and natural disasters.
- Interest rate addresses value changes in retirement plans due to rising (or falling) interest rates. This is most associated with bonds; their prices typically fall when interest rates go up, and vice versa. The broader stock market also reacts to changes in interest rates.
- International investments carry additional risks from currency fluctuations, political or economic upheavals, and other issues associated with investing outside the U.S.
- Inflation affects participants because rising prices require more assets over time and necessitate larger withdrawals during retirement.
- Fund selection makes a difference in asset accumulation. Many plan sponsors ensure that the plan has a diverse selection of funds across asset classes. However, the management style, risk management approach and strength of the team behind each fund can all increase the risk of the plan.
Governance & Outcomes Risks
- Fees can be a major risk, especially as they have played a central role in several recent class-action lawsuits. New fee disclosure regulations and a 2015 U.S. Supreme Court decision against Edison International for offering funds with higher fees than comparable funds have heightened awareness of the importance of fees among plan sponsors.
- Low participation is a risk for tax-advantaged plan participants, particularly company management. Low participation can result in failed discrimination tests (and possibly the loss of tax-qualified status) if participation is weighted toward highly compensated employees.
- Income replacement is a huge risk for all plan participants, even those who have contributed throughout their working life. The primary goal for retirement savings plans is to constitute the participant’s post-employment income. However, due to the vagaries of economic downturns, contribution choices, large expenses and other issues, many retirees face the prospect of inadequate savings for income replacement.
- Regulatory compliance risk is constantly rising due to the rise in lawsuits and regulations such as the Department of Labor fiduciary rule in 2017 or the Supreme Court decision regarding fund fees.
Minimize Plan Sponsor Risk
Plan sponsors can work with a Registered Investment Advisor (RIA) or consultant to gain a deeper understanding of the risks and ways to mitigate them. Here are the key concepts to consider:
- Strong plan governance is part of a sponsor’s fiduciary responsibility. An effective governance structure needs to be in place to manage plan administration. A functioning governance structure will ensure issues and required changes are recognized and acted upon.
- Sound asset management is necessary, in part to avoid potential lawsuits. For defined contribution plans, plan sponsors need to pay particular attention to fees, ensuring that they are “reasonable and fair” when choosing investment options.
- Retirement planning education is necessary for plan sponsors and advisors. Participants should receive ongoing education, such as newsletters, informational meetings, tailored online resources to measure retirement readiness and meetings with a financial professional. These efforts boost participation and ensure employees understand the need for diversification, rebalancing and other risk management strategies.
Plan sponsors are responsible for appointing qualified individuals or partners such as RIAs to oversee and govern their retirement plans with them. PlanPILOT is an RIA that partners with clients as a fiduciary to control the risks involved with operating defined contribution retirement plans and to help deliver the plan’s intended benefits. We customize and design services based on client needs. PlanPILOT is not affiliated with any investment fund or retirement plan record keeper, so our advice to clients is unbiased and targeted specifically to each firm.
For more information on the main focal points of reducing risk in retirement plans, check out our white paper on Retirement Plan Governance. If you would like to speak to a PlanPILOT consultant about our retirement plan consulting services, call us at (312) 973-4911 or email email@example.com.