Plan Investments – Pension and Profit Sharing

Employer Responsibility and Potential Liability

Unlike 401k plans, which almost always utilize self-directed participant investment accounts, pension and profit sharing plan assets are usually invested by the employer, often with the assistance of a financial advisor. Because the employer is investing money that will ultimately belong to other people, he or she needs to be more diligent in their oversight than if they were investing their own money.

Pension Plan Investments

With defined benefit and cash balance plans, the employer assumes all investment risk. They are responsible for paying the promised retirement benefits regardless of the plan’s investment performance. Plans of this type are subject to an annual actuarial valuation, so at least in theory the employer should know well in advance if there is going to be a funding problem. In today’s financial environment, this might not always be the case. Over the past several years, the interest paid on conservative investments, such as money market funds, CDs and investment grade bonds has ranged between very little and none. As a result more money, including pension money has found its way into the stock market.

The problem with the stock market is that when things go bad, they go bad quickly. In late 2008 and early 2009, the S&P 500 lost nearly half its value in only a few months. This is why hiring the right financial advisor is important. Whoever you hire, whether an individual or institution, should understand modern portfolio theory, have the ability to determine the direction of the primary market trend and, equally important, have experience managing pension plan assets. In addition to controlling overall market risk, the liquidity needs of the plan must be addressed. For example if 3 people in a 10 person defined benefit plan will reach retirement age next year, plan assets will need to be more liquid than otherwise would be the case.

Many banks, trust companies and brokerage firms have departments that specialize in managing pension assets. Their fees can be substantial but depending on the number of participants and the amount of money involved, it could be worth it.

Profit Sharing Plan Investments

Because no benefits are guaranteed, profit sharing plans are more forgiving in terms of the plan’s investment returns. Still, however, plan assets must be invested responsibly by following the “prudent man” rule. The prudent man rule is a legal concept that described how fiduciaries are to invest plan assets on behalf of plan participants. The complete definition of the prudent man rule can be found on Wikipedia but what the rule boils down to is to pay attention and use common sense. A balanced portfolio of investment grade bonds and blue chip dividend paying stock would probably meet this definition. Investing all assets in a single penny stock would not.

A good financial advisor can help here as well. He or she may not be able to always deliver spectacular gains but should be able to protect you from catastrophic losses.