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Risk & Compliance: 10 Tips for Building a Socially Responsible Retirement Plan

By Net Assets posted 07-26-2021 11:25 AM

  

Human Resources |

Sustainable investing based on environmental, social justice and ethical corporate governance principles can mean higher returns and a better fiduciary future.

Article by Doug Lynam, LongView Asset Management

From the July/August 2021 Net Assets magazine

Can you remember a bookmark moment in your life so profound that there will always be a “before” and “after” that moment?

My bookmark moment occurred when a good friend and colleague asked if I would help with her retirement plan. At the time, I was the math department chair and economics teacher at an elite private school — and also a Benedictine monk.

When we opened her account statement, I was shocked. Tracy was 64 years old, had served as a private school teacher for over 30 years and had only saved $15,000. Then, she asked me when she could expect to retire. Tracy is one of the strongest women I have ever known, but as I explained the gravity of her financial situation, she broke down.

I wanted to know how this tragedy had happened. So I began discussing retirement planning with my colleagues and discovered that many of them were in no better position than Tracy.

The unpleasant truth is private school retirement plans are often outdated or broken. For example, in 2016, there were 12 class-action lawsuits against Ivy League colleges for having poorly designed retirement plans.

The most important thing I learned is that helping teachers save for retirement is not a math problem — it is a psychological problem. Most of us have emotional issues with money to some degree, which lead us to regrettable financial mistakes.

This discovery sparked three questions: What would be an optimal retirement plan? Could it be built? Could it be socially responsible?

My encounter with Tracy changed the course of my life. After much soul-searching, I decided to leave the monastery after 20 years of service, gave up teaching and became an investment advisor.

The most important thing I learned is that helping teachers save for retirement is not a math problem — it is a psychological problem. Most of us have emotional issues with money to some degree, which lead us to regrettable financial mistakes.

Unfortunately, most retirement plans fail to take psychological behavior into account and assume we are rational and will always act in our own best interests. Or worse, plan designers tragically assume that teachers are financially literate and understand how investing works.

Fiduciary Duty

Building a robust retirement plan requires school administrators keep one core regulatory principle in mind: fiduciary duty. Fiduciary duty means the plan must be designed in the best interests of employees and their beneficiaries.

However, many private schools are unaware or have forgotten that they, as the fiduciary, are legally responsible for designing and maintaining their retirement plan. Instead, many schools mistakenly assume that the company they use for recordkeeping is a fiduciary.

As a result, plans may continue for decades with little oversight and fail to keep abreast of advancements in technology and psychology that can make retirement plans more robust and sustainable.

Equally important is strong retirement plans greatly benefit both schools and employees. Significant long-term cost savings can accrue by enabling senior faculty with high salaries to retire when they choose instead of prolonging their employment due to financial concerns.

When a teacher cannot retire when they are eligible, everyone suffers — teacher, administration, staff and students.

When a teacher cannot retire when they are eligible, everyone suffers — teacher, administration, staff and students.

10 Tips

Here are 10 tips to ensure your retirement plan is effective, socially responsible and compliant with best practices in plan design.

  1. Set up annual auto-enrollment. The biggest mistake many employees make is starting too late to invest for retirement. If educators delay investing, the negative impact on their eventual retirement savings can be dramatic, as Tracy discovered. An effective solution is annual auto-enrollment, which signs up every employee on their first day of eligibility and re-enrolls them each year if they opt out.
  2. Institute auto-escalation. Younger employees typically struggle to contribute to their retirement plan and often start with a low savings rate. Auto escalation increases employees’ contribution rates each year by a predetermined amount, typically 1%. This annual increase can continue until the contribution rate reaches a predetermined target (e.g., 10% to 20% of pre-tax income), helping employees save adequately for retirement.
  3. Offer a strong default investment. When employees are automatically enrolled in a plan and do not make an investment choice, they default into the plan’s Qualified Default Investment Alternative (QDIA). Ensure the QDIA is a target date fund, or something similar, that has an age-based asset allocation that automatically rebalances over time. Asset allocation is one of the most important pieces of building a robust portfolio and is something plan participants often struggle with. A good QDIA takes the guesswork out of asset allocation, and in my experience over 90% of plan participants stick with the QDIA, so make sure yours is excellent.
  4. Use open architecture. Your plan should be open architecture, using the best funds available, not just those your recordkeeper manages. For example, if your recordkeeper sells proprietary investment products, and your plan is full of those proprietary products, and your recordkeeper also provides your financial advice, you do not have a world-class retirement plan. Instead, you have a bundle of conflicts of interest. Avoid proprietary products, annuities and financial advice from your recordkeeper unless they are a fiduciary to your plan.
  5. Pay attention to fees. What is the total cost to participants? Excessive recordkeeping, fund fees and add-ons can torpedo any retirement plan. The average expense ratio should never be much more than 1% in total, and larger plans should have lower fees because of the economy of scale.
  6. Offer individualized participant counseling. Taking the time to fit each teacher with the right investment portfolio can make a life-changing difference. Employees need and want help planning for retirement, but ensure the person offering the advice is a fiduciary and not a sales rep.
  7. Avoid annuities. Annuities are insurance products and often do not fit the criteria of good long-term investments. Most employees should not be purchasing annuities with restrictive surrender fees until they are at retirement, if at all. So most annuity products should not be prominently featured in your plan.
  8. Outsource fiduciary duty. Get outside help if you cannot do all the work yourself due to lack of time or resources. Few schools or colleges have the in-house expertise to manage all the moving parts of their plan.
  9. Benchmark. Regularly benchmarking performance and fees ascertains if your plan is competitive and fees are reasonable. If you don’t know how your funds and fees stack up compared to their appropriate benchmarks, you have a dangling legal liability.
  10. Use environmentally and socially responsible investments. Over 2,200 studies have proven that sustainable investing based on environmental, social and corporate governance (ESG) criteria can result in higher returns with less risk than conventional investing. ESG considerations are now another crucial factor for all investors to consider — just like large cap, small cap, growth or value metrics.

Investing in the Future

I believe you should protect the future you are investing in. If we are wise, ESG considerations will become a core part of fiduciary duty under the law. The children we are sending into the future deserve nothing less.

The last tip is good news for conscious investors but terrific news for the health of our planet. As a bonus, participation and contribution rates often go up when employees know their investments help build a better world.

In 2018, I built the first socially responsible QDIA for any school or college. There were no off-the-shelf ESG target-date products available at the time, so we had to design our own.

That situation has changed. The first ERISA-compliant ESG target-date mutual fund series launched three years ago, the Natixis Sustainable Future Funds, and more companies are bringing them to market soon. As further proof that ESG investing can be profitable, three of the Natixis Sustainable Future Funds took top spots among all target-date funds in a recent Morningstar ranking.

A word of caution: in 2020, the Department of Labor ruled that employees’ financial interests are the only factors to consider when selecting investments, especially in a QDIA. The sustainable investments you pick must still meet the fiduciary standard of prudence and balance risk versus return. Pure “impact” investments, which intentionally place social good above expected returns, are not suitable for retirement plans.

In summary, design your plan so that participants are on track to a secure retirement — even if they do nothing. Use inertia, anxiety and self-doubt to the advantage of employees, not as unforgivable flaws punished by poverty in old age.

I believe you should protect the future you are investing in. If we are wise, ESG considerations will become a core part of fiduciary duty under the law. The children we are sending into the future deserve nothing less.

Doug Lynam is a partner at LongView Asset Management in Santa Fe, New Mexico, and is the author of “From Monk to Money Manager: A Former Monk’s Financial Guide to Becoming A Little Bit Wealthy — And Why That’s Okay.” Profiled in numerous media outlets such as The New York Times, Kiplinger’s, CNBC, and Entrepreneur, Doug is a self-proclaimed “Suffering Prevention Specialist,” and a columnist and speaker.
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