Compass Newsletter - Articles

“Pros and Cons” of Allowing Retirement Plan Participants to Self-Direct the Investment of their Accounts, after the Pension Protection Act of 2006

By Clark B. Williams
(Winter 2008-2009)

This article is for business owners and who sponsor qualified retirement plans for their employees.

Generally, sponsors of qualified retirement plans have “fiduciary” responsibility for the investment of the accounts of their participants. This means that the sponsor must exercise reasonable care to invest the plan assets prudently and in a diversified manner.

However, there are two important exceptions to this rule.

The first exception is for plans in which a bank, insurance company, or other “registered investment advisor” that handles the investments, has expressly acknowledged its “fiduciary” status to the plan. In that case, the business owner is relieved of responsibility, even if named as trustee in the plan, and only the registered investment advisor has responsibility. This is particularly appropriate where the investments are “pooled” for all participants and professionally managed. If that is your situation, you should ask your investment manager to acknowledge, in writing, that it is serving as a “fiduciary” with respect to the plan. In our experience, many investment managers will do this if asked, but they will not volunteer.

The second exception is for plans that allow their participants to “selfdirect” their investments. Federal law provides that if participants are given a broad range of investment choices, and if they are educated about their choices and about investments generally, the employer is not responsible for the choices that the participants make. However, the employer still must be prudent in choosing the “lineup” of investment choices. And if the participant is not given appropriate information and education, the employer can be responsible for the participant’s poor investment choices.

The Pension Protection Act of 2006 (PPA) changed the equation to some degree. PPA imposes additional responsibilities on employers who offer selfdirected investments to their plan participants. Under PPA, participants who have the ability to direct the investment of their own plan accounts must now be provided with quarterly statements. These statements must contain the following information:

  • Total account balance.
  • Information on “integration with Social Security,” if applicable.
  • The value of each investment to which assets have been allocated.
  • An explanation of any limitations or restrictions to self-direction.
  • An explanation of the importance to long-term retirement security for a balanced and diversified portfolio.
    A reference to a Department of Labor website for sources of information on individual investing and diversification.
  • These requirements are in addition to “individual benefit statements” that must be provided to participants annually, as has always been required.

Most investment companies are taking responsibility to amend their quarterly participant investment statements to comply with PPA’s new requirements. Nevertheless, we suggest that you contact your investment provider to inquire and to assure compliance. The Department of Labor is authorized by law to impose a penalty of up to $100 per day for noncompliance. If your investment provider is not able to assure compliance with these requirements, we can provide you with the information specific to your plan that will help you comply with the new law. Ultimately, compliance with this law is your responsibility.

In conclusion, the PPA increases the “hassle factor” for plans which offer “self-directed” investments. For some employers, these new requirements may tip the scales in favor of a “pooled” investment system. We have found that in many plans, participants do not actively avail themselves of the opportunity to self-direct the investments. And for other employers, the process of educating and informing participants of their investment choices, and administering those choices, has become too time-consuming, expensive and distracting. On the other hand, a “pooled” investment system is simpler, easier and less expensive to administer, as well as less of an overall hassle.

The employer controls the decision of whether or not to offer self-directed investments. If your plan offers self-directed investments, and if the additional requirements under PPA seem burdensome, please contact us to help you consider whether and how to switch to a pooled investment system.