While not legally required by the Department of Labor, an Investment Policy Statement is widely held to be an essential document for plan sponsors.
The Investment Policy Statement (IPS) provides well-defined criteria and principles that facilitates prudent oversight of the retirement plan, and consistent, informed decision-making that keeps plan sponsors and the investment committee on track with the plan’s goals and processes. Perhaps most importantly, the IPS evidences the plan sponsor’s fidelity to its fiduciary obligation, which, as built into ERISA and DOL regulations, is to act in the best interest of the plan’s participants ahead of its own. As such, an IPS serves as both a roadmap to plan success and a guardrail to prevent plan derailment.
Given its critical role in the smooth running of an organization’s retirement plan, it should be carefully crafted, routinely reviewed and updated, and adhered to diligently.
Specifically, an IPS should include/cover the following:
Plan Purpose: An explanation of the reason for the plan and the introduction of the document as a resource for investment selection and monitoring.
Investment Objectives: Documents the number of investment options, fund/asset categories to be included and other investment-related goals.
Investment Monitoring: Specifies review frequency (e.g., quarterly or annually) and review criteria, including any changes in investment style, trading frequency and/or management.
Asset Classes: Directs the selection—mandatory or recommended—of asset classes to be included in the plan.
Investment Selection/Performance Measurement: Identifies the characteristics to be considered for investment and investment management selection and investment performance, such as long-term returns, volatility and expense ratios; provides guidance—versus mandates—for the investment committee.
Default fund: Instructs whether investment contributions lacking participant instruction are/aren’t invested into a default investment alternative. A qualified default investment alternative (QDIA), one that complies with DOL regulations, can reduce plan sponsor fiduciary lability and help participants save.
Participant Education: Mandates the requirements for participant education to increase the likelihood of employee understanding of investment fundamentals and plan operation.
An IPS should be reviewed yearly to assess its continued viability and ensure it is being followed by the plan sponsor and committee members, and any changes should be documented in writing.
Key to obtaining the benefits of an IPS is diligent plan sponsor adherence. As author Blaine Aikin writes in a recent InvestmentNews article, “the only thing worse than not having an IPS is having one that is not followed.” According to Aiken, who describes two recent lawsuits against plan sponsors—Tussey versus ABB and White versus Chevron—to emphasize his point, failure to adhere to procedures documented in their IPS enabled the participants of these plans to allege “breach of fiduciary responsibility associated with the selection, monitoring and replacement of investment options when performance faltered.” The lesson to be learned from these cases, according to Aiken: “Draft carefully, be prepared to follow what the IPS says you are going to do, and document your decisions.”
Despite the apparent soundness of Aiken’s advice, the need for an IPS is not apparent to all plan sponsors, specifically those with smaller plans. While 83% of 830 plan sponsor respondents have an IPS, far fewer small plans have one, according to the most recent 401(k) Benchmarking Survey conducted by Deloitte Consulting LLP with the International Foundation of Employee Benefit Plans and the International Society of Certified Employee Benefit Specialists; just 68% of plans with $10 million or less in assets have an IPS. Callan estimates 90% of defined contribution plans have an IPS and notes that larger plans are more likely to develop an IPS than smaller plans. That said, less than two-thirds of plans have reviewed their investment policy statements in the last 12 months, according to Callan.
A survey of plan advisors conducted by Russell Investments found that more than 50% of surveyed advisors do not create an IPS for their clients and that a nearly equal amount reported being asked to take an action that diverged from the agreed-upon IPS.
The most common objection to an investment policy statement is the notion that it’s a compliance burden; failure to abide by the terms of the IPS make the plan sponsor vulnerable to a law suit. This “predicament” is easily eradicated with an IPS containing only those provisions the plan sponsor and investment committee is able to adhere to. Any provisions they deem unable to fulfill should be reconsidered and all governing documents, including the IPS, brought into alignment.
The fundamental and overarching reason to have an IPS is maintaining the fiduciary standard, which is all about process. Questions as to whether fiduciary responsibility was maintained are not “answered” by investment results. Rather they’ll be answered by what decisions were made and how. In cases where questions are raised, plan sponsors have been asked to demonstrate the existence of a consistently followed decision-making process. An IPS both provides the documentation and enables the ability to maintain a consistent process.
It also creates “institutional memory for the plan sponsor, as committee members or trustees come and go,” notes Nathan Boxx of Fort Pitt Capital Group in a 401kSpecialist blog post. “Committee members can read the document and be brought immediately up to speed on the ‘why’ and ‘how’ of the investment strategy.”
Unless you’ve hired a 401(k) advisor who is functioning as a 3(38) fiduciary for your plan, the fiduciary responsibilities are yours. Should you wish to eliminate the work imposed by these responsibilities, a plan advisor with solid defined contribution plan experience can provide the help you seek.
The following sources were used in this article: