An Investment Policy Statement (IPS) is a critical piece of documentation for your company’s 401(k) plan. Although not required under the Employee Retirement Income Security Act (ERISA), it is strongly recommended that each employer operating a 401(k) plan have an IPS in place.
A well-written IPS can protect plan fiduciaries by providing explicit guidelines to follow for operating the plan. Think of it as a strategic business plan for your 401(k) that guides the plan fiduciaries through their process of selecting and monitoring investments, as well as defining fiduciary roles and responsibilities. This would include:
- Initial selection criteria—risk, return, style analysis, correlation, etc.
- Identification of asset classes to be used in the plan
- Performance benchmarks
- Process for removal/replacement of investments
- Identification of fiduciary roles and committee members
- Objectives of the plan
- Evaluation of plan fees and revenue sharing
Many employers we talk with either do not have an IPS, or they have one that is terribly out-of-date and not reflective of the current state of the plan.
One of the most recent high-profile court cases involving 401(k) plans, Tussey vs. ABB Inc., demonstrated just how important it is to follow the plan’s IPS. This case generally revolved around plan fees and revenue sharing.
The plan’s IPS stated, among other things, that…
- Revenue sharing would be used to offset plan fees
- A fund’s 3- and 5-year performance should be judged to determine if the fund was to be replaced, and
- That the plan would select share classes with the lowest cost to the participant
The court found that the criteria stated above were not followed and, as a result, ABB was ordered to pay a substantial fine — over $13 million. Several appeals have been filed regarding this case, but the potential for penalty is apparent.
The ABB 401(k) plan is a sizeable one, with over $1 billion in assets. You would think a plan of this size would have a very sophisticated plan committee and enough oversight to avoid these types of breaches. So, it should come as no surprise that many of the smaller companies we talk to generally have no idea how the investments in their 401(k) menu were initially selected.
This is one area of plan oversight and governance that you do not want to leave to chance. If you don’t have an IPS, or the one you have is not current, or not being followed, it would be well worth your time to discuss the matter with a competent third party expert or investment advisor. Outsourcing this function to a 3(38) fiduciary can benefit the plan committee and the plan participants.