Chapter 14.3 Flashcards
ERISA
Enacted in 1974 to protect the retirement assets of participants in private sector employee benefit plans.
Rules that ERISA imposes on qualified plans includes:
- Disclosure: Plans must regularly provide participants with important information about plan features and funding
- Standards: Minimum standards are required for participation, vesting, and providing promised benefits
- Accountability: Fiduciaries are required to be accountable
- Remedies: Participants may pursue legal action for fiduciary breaches
- Guarantees: Payment of certain defined benefits is guaranteed through the Pension benefit guaranty corporation
Fiduciary
Defined as anyone who has the power to exercise discretionary authority or control over a plan’s management or assets or who is paid a fee or any form of compensation for investment advisory services
Fiduciary responsibility for ERISA
ERISA contains fiduciary provisions to protect plans from mismanagement and misuse.
- Fiduciary responsibility and accountability is required. Fiduciaries must act solely in the interest of the plan participants and beneficiaries using care, skill, prudence, and diligence. Those who violate conduct rules may be held liable for losses to the plan.
- The fiduciary must select, monitor, remove and replace a diverse selection of alternative investments appropriate for plan participants. However, fiduciaries could transfer responsibility for any losses resulting from participants decisions by designating the plan as a self-directed plan.
Investment Policy Statement
A written statement that provides plan fiduciaries who are responsible for investments with guidelines concerning investments and management decisions. ERISA interpretations have deemed the creation and maintenance of such a policy to be consistent with the fiduciary obligations required for qualified plans. Therefore, a fiduciary may be found to have breached their duties if they do not maintain an investment policy statement.
What should an investment policy statement clearly describe?
- The client’s or participant’s investment goals and objectives
- A statement of purpose and responsibilities
- Guidelines for review
- Risk tolerance and liquidity requirements
- Recommended allocations among asset classes as to minimize the risk or large losses
- Expected returns and expected range of returns
- Time horizon
Investment Policy Statements do not need to Contain:
- Specific criteria for selecting securities for the investment portfolio
- Compensation arrangements for the IA. Compensation arrangements are included in the investment advisory contract
- Summary plan description - which is a document describing the features of an employer sponsored plan
- Tax treatment of specific investments held in the plan
- *A test used to determine if any investment is proper for any plan is the “amount of risk” involved in the investment
- *If the plan’s guidelines allow it, covered call writing and transactions in index options can be done
Prohibited Transactions according to ERISA
A fiduciary shall NOT:
- Deal with the assets of the plan in its own interest or for its own account
- Act in any transaction involving the plan on behalf of a party whose interests are adverse to the interests of the plan, its participants, or its beneficiaries.
- Receive any consideration for its own personal account from any party dealing in connection with a transaction involving the assets of the plan.
A fiduciary shall NOT cause the plan to engage in a transaction, if he knows or should know that such transaction constitutes a direct or indirect:
- Sale, exchange, or leasing of property between a pension plan and a party in interest
- Lending of money or other extension of credit between a pension plan and a party in interest
- Furnishing of goods, services, or facilities between a pension plan and a party in interest
- Transfer to, or use by or for the benefit of, a party in interest, of any assets of a pension plan
- Acquisition, on behalf of a pension plan, of any employer security or employer real property unless ERISA requirements are met
- Use of plan assets for the benefit of “disqualified persons,” which includes the participant’s immediate family, including the participant’s parents.
Safe Harbor Provisions
Refers to the protection from liability given to the employer/sponsor of a self-directed plan if the employee/participant makes imprudent investment decisions and loses money. There are specific requirements under Section 404(c) for these plans.
What must plan participants do under the Safe Harbor provisions?
- Have the ability to choose between at least 3 categories of investments which are diversified. The 3 plans must differ when it comes to risk levels and expected return in relation to that risk
- Be provided with a certain level on investor education and disclosures related to various factors that affect investments such as:
- Time Horizon
- Anticipated levels of return
- The risk/reward relationship
- The benefits of proper diversification
- Realistic goals and objectives for such a plan
- Be informed that they may make changes to their chosen plan on a regular basis and no less than quarterly. Those who offer these plans:
- Are prohibited from offering as one of the 3 investment choices, a plan that is comprised of securities of the company
- Must ensure that participants have access to the proper disclosures and investor education related to that material
- Must ensure that the options available to participants are properly diversified and that the features and risk levels are properly disclosed
Defined Benefit Plans
Computed using a predetermined formula. Benefits are calculated based upon compensation, years of service, and age.
**High salaried employees near retirement benefit the most.
Exception to RMD’s from a 401k
RMD’s can be delayed until retirement if you continue to be employed by the plan sponsor beyond age 70.5 and you do not own more than 5% of the company
Department of labor requires that a plan administrator furnish investment-related information for each option offered under a plan to the plan participant when?
Prior to or on the date the participant directs their investment and at least annually thereafter.
**Firms are not required to file the information with FINRA
Profit Sharing Plan
A plan by which a company shares it’s profits with it’s employees. This plan is designed to give employees incentive to be productive.
- The determination to contribute as well as the size of any annual contributions is made by the employer
- The contribution is dependent on company profits
- All funds in the plan are tax-sheltered
**Deductible allowances may not be carried forward to the next tax plan year
