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Tuesday, June 02, 2015

What the Supreme Court’s Ruling on 401k Plans Means for You

The Supreme Court just heard a participant-brought lawsuit, Tibble v. Edison, against a company over its 401k_Lawsuits_on_the_Rise401k plan and high-cost investments.  At issue was whether or not the plan sponsor had an on-going duty to ensure prudent investment choices in its 401k lineup.  The court found, in a rare unanimous decision, that they did. 

The focus of the case was quite narrow actually:  Was it OK for a plan sponsor, with a legal obligation to look out for its plan participants (thus, a fiduciary), to condone an actively-managed mutual fund in a high-cost share class when lower-cost share classes were available?  The answer was no.   The Court also addressed the "statute of limitations" for prudent investment decision-making in a plan, but to us that is by far the less impactful part of the decision.

Here's the big deal for plan sponsors.  The vast majority of plans do exactly what this decision indicates you shouldn't do—condone higher-cost share classes on your actively-managed funds.  While you've likely been led there covertly by commissioned sales people (advisors), this case declares that you need to understand the concept and know the cost factors, because it's your problem, not theirs.

While higher-cost share classes are present in most plans, the better and much bigger question is why there are still any actively-managed funds in your 401k.   If the goal is lower cost and more effective investments for participants (which the Court has ruled it is), then the evidence says that all plans should use index funds with better, more persistent returns at about 1/5 the cost of actively-managed funds.

 A cursory review of the body of participant-brought lawsuits shows that complaints about high cost are present in all of them.  Most of them are NOT focused on the narrow issue of share classes—but the presence (or lack thereof) of index funds and lower overall cost.  If this case had been about these broader issues—and it's just by chance that it wasn't—the Court's opinion would effectively render actively-managed funds obsolete!  That day is rapidly approaching—and it's good news for participants and for every plan sponsor that takes action to fix his plan before he's sued or otherwise compelled to do it.  High-cost share classes cost participants additional money but otherwise deliver the same return as the lower cost version (s).  Actively-managed funds cost participants far more than index funds and underperform them 80% of the time!  Do we really need a court to help us see this is the better course?

Stay tuned for our next blog: A 401k Plan the Supreme Court Would Love!

Click below for some light reading in the meantime.

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Posted by at 3:30 PM