Is Your 401(k) Plan Too Complicated?
DOES YOUR 401(K) PLAN OFFER TOO MANY INVESTMENT OPTIONS?
Recent cases against university-sponsored retirement plans include allegations that these plans are complicating the investment decisions of participants because the plans offer too many investment choices.
As alleged in one complaint, the plans provide so many options that participants are left with a "virtually impossible burden" of deciding where to invest their retirement funds.
HOW DOES YOUR 401(K) PLAN STACK UP?
The university plans involved in litigation that may go to the U.S. Supreme Court offered hundreds of investment options (240 in one plan and 180 in another). While other issues are involved, including allegations of poor performance and excessive fees, the lower courts have been reluctant to resolve the issue of how many options might too many.
However, there are cases (Hecker and Renfro in the Seventh Circuit) which hold that plans with 26 and 73 investment options do not violate applicable ERISA requirements.
SO, WHAT IS THE SWEET SPOT?
Notably, Northwestern University, a defendant in litigation that may be accepted for review by the U.S. Supreme Court, reduced its retirement plan investment options to "about 40" after plaintiffs filed suit. The stated purposes of this reduction included enabling "simpler decision-making by participants."
So, it probably makes sense to keep the number of plan investment options well below one hundred even though record keepers may offer the availability of several hundred investment funds.
IS THERE A BETTER NUMBER FOR YOUR PLAN?
Plan administrators might want to put themselves in the shoes of their typical 401(k) participant and conclude that fewer investment options would be better. You may determine that your sweet spot is somewhere between ten and forty mutual funds (plans with a "brokerage window" option are a different animal and necessarily offer direct investment in thousands of stocks and bonds).
Regardless of how many investment options are provided in your 401(k) plan, make sure that its investment array includes low-cost index funds. As one court observed, "the average investor will do better investing in low-cost index funds than attempting to select individual stocks or actively-managed mutual funds." Such an investment option also provides a defense to any claim that your plan is providing high-risk mutual funds that charge excessive administrative fees (see here for details).
And bear in mind that courts have determined that low-cost index funds are prudent retirement plan investments—as a matter of law.
Andrew S. Williams | Benefits Bulletin