Investment Policy Statement (IPS)


Plan sponsors have important obligations as ERISA fiduciaries to a retirement plan. They must follow ERISA’s high standards of conduct as they administer the plan and safeguard participants’ assets. The key to managing ERISA fiduciary responsibilities is developing and following prudent plan governance practices. Adopting policies and procedures to make certain they are handling plan assets properly and making prudent decisions will help plan sponsors demonstrate that they have met their fiduciary responsibilities.

This is the fifth in a series of posts about plan governance best practices for plan sponsor fiduciaries. Read the first post in the series here.

Five Fiduciary Responsibilities

    1. Act solely in the best interests of the plan participants
    2. Carry out duties prudently
    3. Diversify investments
    4. Follow the terms of the plan document
    5. Pay only reasonable plan expenses

 

The prudent selection of a retirement plan’s investment menu is one of the most important fiduciary responsibilities for a plan sponsor. Once the menu of investments has been selected, most 401(k) plans allow participants to decide how their contributions should be allocated among the available investments. In recent years, plan participants have brought multiple lawsuits. These lawsuits allege that plan sponsors breached their fiduciary duties because they failed to monitor the appropriateness of plan investments or because they offered investments with excessive fees when lower cost options were available. To help ensure that plan investment selection is prudent and that the chosen investment alternatives continue to be appropriate for the plan, many plan sponsors adopt an Investment Policy Statement (IPS). Conducting an annual investment and fee analysis following the criteria described in an IPS can help plan sponsors manage their investment fiduciary requirements.

 

Investment Due Diligence

Firstly, ERISA requires plan fiduciaries to offer investments that:

IPS

ERISA does not require plan fiduciaries to always pick the best performing investment options. As with other fiduciary responsibilities, procedural prudence is key to managing investment responsibilities. Setting investment objectives, developing a due diligence process to evaluate investments, and keeping records of due diligence activities are the primary elements of a prudent process.

Evaluating investment options can be challenging. Especially considering the broad range of investments, fee structures, and revenue sharing options available to retirement plans. Most plan sponsors engage a financial advisor to help design a prudent investment selection process. Financial advisors can also help build an investment menu that is diversified and appropriate for plan participants. Plan sponsors also look to their financial advisors for support in setting investment objectives, benchmarking performance and fees against comparable investments, and documenting the due diligence process.

 

Creating an Investment Policy Statement

While not required by ERISA, creating an IPS has become a best practice for plan sponsors. An IPS is a written policy that defines the plan’s investment philosophy, and the criteria and process for selecting and monitoring investments. This helps provide the structure for conducting periodic investment reviews and for assessing plan fees. Documenting key investment decisions relative to the criteria described in the IPS can help demonstrate how plan sponsors are meeting their fiduciary responsibilities to prudently select and monitor plan investments.

 

If a plan has an IPS, all investment decisions must align with the terms of the IPS. Failure to follow the IPS may be considered a breach of fiduciary responsibility. For this reason, some plan fiduciaries elect not to adopt a formal IPS. The IPS should be reviewed periodically and may need to be updated for changes in investment products available to the plan. Additionally, it might need updates for changes in plan demographics or business objectives.

 

IPS Components

Many plan sponsors tap into their financial advisor to help draft the IPS for the plan. Following is a list of some of the components that may be in an IPS:

Investment philosophy

Describes the plan sponsor’s general investment objectives for the plan and participants, including the goals, expectations, and risk tolerance

Roles and responsibilities

Identifies who will be responsible for choosing and monitoring investment alternatives. Ex. the plan sponsor, the plan sponsor and an investment advisor who shares fiduciary investment responsibility, or an investment manager who has discretionary responsibility for plan investments

Types of investments

Defines the types or asset classes of investments permitted for the plan (should include flexibility regarding the types and number of investments allowed so the fiduciary can add or remove options as the plan’s needs and market conditions change)

Criteria for selecting and monitoring investments

Describes the performance and fee criteria that investments must meet to remain on the investment menu

Criteria for changing or replacing investments

Explains the metrics or standards that will trigger putting an investment on a watch list, as well as when an investment must be removed

Performance review timing and method

Sets guidelines as to how frequently investments will be reviewed (e.g., annually). Furthermore, it specifies the process for measuring investment performance and fees such as benchmarking against comparable investments or an index

404(c) and default Investments

States whether the plan intends to delegate certain investment responsibilities to participants in compliance with ERISA Section 404(c). Or, whether the default investment is intended to be a Qualified Default Investment Alternative (QDIA)

 

Start Here

Consequently, plan sponsors who elect to adopt an IPS typically rely on their financial advisor to help them

  • Define the investment objectives of the plan,
  • Specify investment selection criteria in the IPS, and
  • Adhere to the standards set forth in the IPS when monitoring and benchmarking investments.

Finally, if you don’t have an IPS, your financial advisor can help evaluate whether an IPS would be beneficial for you.