Evaluation of K⁴ Plan Goals

A White Paper

by Fred Reish and Debra Davis

When making decisions about the plan, ERISA requires fiduciaries to engage in a prudent process. That is, fiduciaries must conduct an investigation to obtain the relevant information and then make a reasoned decision based on that information. Courts have interpreted this duty to require that fiduciaries take into consideration the type of plan and needs of the plan and its participants. Among the factors for fiduciaries to consider is that, for participant-directed 401(k) plans, participants must make decisions regarding the funding -- through deferrals -- of a significant portion, if not all of, their benefits, as well as decisions about investing these amounts.

A reasonable interpretation of ERISA's requirements is that fiduciaries should engage in a prudent process to determine what kinds of services a hypothetical knowledgeable person (that is, ERISA's prudent person) would provide to participants who are responsible for making the funding and investing decisions. In order to be confident that they have satisfied this requirement, fiduciaries will want to evaluate the needs of the participants and to provide services to assist them with the deferral and investing decisions.

Fiduciaries are held to the standard of a prudent person acting under the prevailing circumstances. Services that help participants with investment and deferral decisions have not been generally available at reasonable cost. However, these services are not more accessible to plans. Under the prevailing circumstances standard, fiduciaries need to consider services based on what is currently available in the marketplace.

K⁴ Plan Goals helps participants with these decisions by generating suggested solutions to enable them to determine the appropriate amounts of deferrals and to invest properly to accumulate adequate retirement age, deferral rate and risk tolerance, to create a realistic solution that participants are likely to implement and adhere to. Based on our observation of fiduciary and industry practices, this methodology exceeds the current standards of fiduciary compliance; it is a "best practice." As a result, fiduciaries who use programs such as K⁴ Plan Goals have exceeded ERISA's fiduciary standards for helping participants with their deferral and investing decisions.

For participants who do not direct the investment of their accounts, fiduciaries my be able to obtain relief (sometimes called a fiduciary "safe harbor") under ERISA section 404(c). In order to receive this relief, fiduciaries will need to invest the accounts of participants who default (that is, who do not select their investments) in "qualified default investment alternatives" (of "QDIA"). Upon the issuance of final regulations by the U.S. Department of Labor, we anticipate that the services provided by K⁴ Plan Goals can be used for this purpose.

Our conclusion is that, the services provided by K⁴ Plan Goals materially help fiduciaries satisfy the requirements under ERISA's prudent man rule to consider the needs of participants and to provide suitable services for deferrals and investing.

Factual Description

This statement of facts is based on our review of the materials provided to us by Klein Decisions regarding K⁴ Plan Goals and our participation in a demonstration of its capabilities.

K⁴ Plan Goals is a web-based application designed to assist participants with determining their appropriate deferral rates and investment allocations based on their retirement goals. Klein Decision will license the Program to service providers to retirement plans, including investment providers, third party administrators (TPAs), broker-dealers, software providers and registered investment advisors (RIAs) ("Service Providers"). The Service Providers can then include the Program in the services they offer to their client plans. It is contemplated that participants will be given explanatory materials and that the Program will include features such as pop-up boxes and a help guide to assist participants with its usages.

The Program asks participants to consider at what age they want to retire, how much they want to save each year for retirement and how comfortable they are with risk (that is, their risk tolerance). Unlike many other programs, K⁴ Plan Goals uses a series of questions to analyze the participant's degree of flexibility regarding each of these factors. For example, the Program asks the participant for both their target retirement age and a retirement age that would be satisfactory.

The Program also determines the relative importance of each of these factors for the participant. This is accomplished through a series of follow-up questions about the significance of each of the factors to the participant. For example, the Program asks a participant to rate the importance of retiring at his target retirement age compared to the satisfactory age he entered. A scale from "extremely important" to "not important" is used for this purpose.

A participant's responses to these questions are not always consistent. As a result, the Program asks trade-off questions to further analyze the participant's preference. For example, the Program may ask the participant to rate on a sliding scale, whether it is more important to retire at the target retirement age or to the retire with the target level of retirement income. The participant's response to these questions allows the Program to determine a "Satisfaction Score" for any combination of retirement age, retirement income, savings rate and portfolio risk between the participant's target and satisfactory levels.

K⁴ Plan Goals also conducts a Monte Carlo simulation to determine the probability of "success" for many combinations of retirement age, retirement income, savings rate and portfolio risk that fall at or between the participant's target and satisfactory levels. Other income such as social security or a pension may be included in the calculations. Minimum standards for success are defined by the Service Provider. For instance, the Service Provider may determine that a successful scenario should have at least a 75% probability of the participant not outliving her assets for given levels of retirement age, retirement income, savings rate and portfolio risk. Candidate scenarios for presentation to the participant are these that exceed this minimum success level.

The Program uses asset allocation portfolios designed by the Service Providers. The Program incorporates these portfolios into its system. It uses the risk and return information provided by the Service Providers to generate solutions based on the needs and preference expressed by the participant. The Program can also use age-based lifecycle funds (also referred to as "target maturity funds") and risk-based lifestyle funds (including balanced funds) for this purpose. Klein anticipates that the investments used in the portfolios and the funds will not invest in employer securities, other than through a mutual fund or similar pooled investment vehicle, and will not impose financial penalties or otherwise restrict the ability of a participant to transfer out of the investment.

Klein Decisions has indicated that these portfolios and funds (the "Investments") are created by using generally accepted investment principles, such as modern portfolio theory. As a result, the Investments are diversified in order to minimize the risk of large losses. The fiduciaries, in connection with their advisers, select the Investments to be offered in each plan.

K⁴ Plan Goals suggest one or more top ranked scenarios that incorporate the preference of the participant (Satisfaction Score) and the probability of not outliving the participant's assets (Success Rate). The top scenarios are those that maximize the combination of satisfaction and success, subject to the minimum standard for success described above. For example, the Program may display a scenario that reflects the target retirement date and a satisfactory level of retirement income as well as a scenario that reflects a retirement date that is slightly older then the target retirement date and is closer to the target retirement income. The Program's scenarios my include automatic increases in a participant's deferral rate if allowed by the plan document.

The Program is focused on providing scenarios that the participant is likely to adhere to. The top scenarios not only reflect the participant's preferences, but also score the participant's anticipated level of satisfaction. For example, a scenario that includes the participant's target retirement age and target savings rate would have a high satisfaction score if the participant indicated that these factors were important to him.

K⁴ Plan Goals is designed to be easy to use. It can be pre-populated with information about the participant by the Service Provider. The participant can revise that information on the Service Provider's web site and then check a box to implement the Program's suggested changes. Alternatively, customized copies can be distributed to participants at employee meetings and participants can make handwritten changes to the pre-populated information. The designated person at the Service Provider or plan sponsor, such as a Human Resources representative, would make the changes online for participants and give them updated versions. Participants could respond as to whether they wanted the Program's suggested changes implemented and then have the changes implemented for them.

The Program can be used to update suggested scenarios. For example, if a plan changes its investments or a participant changes their preferences, the Program can be rerun to obtain an updated analysis. Plan may also want to re-run the Program periodically to see if any changes need to be made to the participant's strategy. For example, a participant my be able to retire earlier or defer less if their investments perform better than anticipated.

If you would like to download the complete white paper, please fill out the form on this page.