pooled employer plan

Don’t Swim in the Deep End of the Pool: Pooled Employer Plans (PEPs) Can Be Dangerous

  • PEPs are the latest 401(k) rage, but employers will find that a PEP can be an asset or a liability. The difference is the Qualified Default Investment Alternative (QDIA). 
  • A PEP with a Safe QDIA is an asset.
  • A PEP with a Risky QDIA is a liability.
  • Don’t choose a liability    

This article introduces Pooled Employer Plans (PEPs) as follows:

Pooled Employers Plans were born out of Congressional efforts to make employer-sponsored retirement plans available to more workers to help solve the retirement savings crisis. The SECURE Act, signed into law at the end of 2019, essentially created PEPs to address/solve a pair of longstanding issues that kept Multiple Employer Plans from achieving widespread adoption: the “one bad apple” rule and “common nexus” requirement.

The concern is that some small employers might not look into everything before making the decision to join a PEP, or in choosing which one to join.

According to the Groom Law GroupMany PEP providers anticipate requiring individual plan sponsors to select the investment manager of their choice. To not permit this structure could potentially stifle the options available in the PEP market that may make PEPs more attractive to employers. The department should confirm that this practice is consistent with the statute.”

In other words, sponsoring employers will find that they own the liability for fund selections made by the pooled plan provider (PPP). This liability can and should be segmented between defaulted and self-directed beneficiaries because employers choose risk on behalf of defaulted beneficiaries whereas self-directed participants choose their own risk.


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Levels of fiduciary responsibility

ERISA’s Section 404c requires at least 3 investment options for self-directed beneficiaries: low, middle, and high risk. In addition, recent successful lawsuits necessitate the use of the lowest-cost funds. These are fairly simple and straightforward responsibilities.

Responsibilities to defaulted beneficiaries are more complex and have not yet been tested in court. All defaulted beneficiaries have one characteristic in common — they are financially unsophisticated. Accordingly, the Duty of Care is like our responsibility to our young children, which is to protect them against harm.   Plan sponsors are responsible for the harm done to defaulted beneficiaries that could have been avoided.  This is a higher level of standard than applies to self-directed beneficiaries.


Employer choices

PEP sponsors should opt for safe investments for their defaulted beneficiaries because they don’t need the headaches of causing investment losses, especially the effects of investment losses on employee morale and financial well-being. Sponsors own these losses. In other words, employers should require safe defaults in their choice of a PEP.

The Pension Protection Act of 2006 specifies three Qualified Default Investment Alternatives (QDIAs): a balanced account, a managed account, or a target-date fund (TDF). TDFs are by far the most popular choice, growing to $3 trillion which is about a third of the $9 trillion in 401(k) plans. 

Please note that the 2006 Act specifically excluded the then-common practice of cash or stable value, because it was believed that this was too safe for young participants. But the pendulum might have swung too far to the risky side for older beneficiaries.


Swimming in the safe end of the pool

Employers should require a safe QDIA in their PEP selection. 

A safe balanced fund would not be the standard 60/40 stock/bond mix; it lost more than 30% in the last correction in 2008. Also, bonds are currently very risky because interest rates are being manipulated by the Fed and that will not last forever.

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