Many governments offer tax deferred retirement savings plans to their employees. Typically, they are in the form of 457 deferred compensation plans, or similar plans, to which employees can make voluntary contributions subject to IRS limits or in the form of a 401 defined contribution plan to which governments make direct or matching contributions to benefit individual employees. In operating these plans, members of governing bodies and other decision makers act as fiduciaries.
An investment policy is a governing document in which the governing board and other key stakeholders formally set broad policy parameters. Detailed guidance about implementation and oversight of the investment program may be contained in the investment policy or other documents, such as investment procedure manuals and agreements with third parties. GFOA’s Best Practice Investment Policy recommends that all governments establish a comprehensive written investment policy, which should be adopted by the governing body.
GFOA recommends that the governing bodies of the tax deferred retirement savings plans establish and adhere to a formal investment policy governing the selection and monitoring of investments made available by the plan. Such a policy should be viewed as a long-term governing document and should be reviewed at least annually and updated as deemed appropriate.
The development of an investment policy must be made within the framework of the legal restrictions set forth in federal, state, provincial and local laws as well as those established by common law and fiduciary standards. Among those standards are a duty to govern the plan solely in the interest of plan participants, a duty to administer the plan in accordance with policies, and a duty to make a diversified range of investments available for plan participants. GFOA recommends that the investment policy address at least the following elements in addition to those outlined in GFOA’s Best Practice Investment Policy:
- Statement of purpose: Articulating the rationale for having the policy, as well as the investment goals for the plan;
- Fiduciary standards: Identifying the standard of prudence that the decision makers are expected to meet in carrying out their responsibilities (e.g., prudent person or prudent expert), including the selection and retention of a discretionary investment advisor or selection of investment options1 and costs of funds and services used by the plan;
- Scope of investment options: Identifying the investment options available to plan participants2;
- Qualified Default Investment Alternative(s): Identifying the plan’s Qualified Default Investment Alternative(s) (QDIAs) to provide an appropriate default investment fund for plan participants who do not select investment options;
- Monitoring procedures: Identifying the frequency (no less than annually) and manner in which the entity conducts a thorough assessment of the plan, including regulatory compliance, cost of investment options, changes in investment structure, style, and process; and considerations for making changes in investment options;3
- Liquidity requirements: Specifying liquidity requirements should the plan sponsor choose to terminate a stable value fund,4 including the circumstances under which a fee or an impediment can be imposed by the fund stable value provider; and
- Participant education and outreach: Identifying the frequency of, responsibilities for, and results of participant education and outreach.5
Certain investments and services need additional policy guidance on how they are evaluated. These include:
- Target-date or target-risk funds: Evaluating alternatives for their potential to meet the interests of the plan participant population on a cost effective basis, especially when they serve as the plan’s QDIA.6
- Retirement income features or annuity funds: Evaluating whether available funds that deliver a guaranteed benefit at a certain point in time in the future are cost effective and will meet the interest and risk tolerance of the plan participant population; and
- Brokerage options7: Evaluating whether the plan participants could benefit from a brokerage option that provides access to funds outside of the lineup selected by the plan’s governing body.
1 Some governments make investment selections and others hire a manager to identify those selections.
2 See GFOA Best Practice, Asset Allocation for Defined Contribution Plans.
3 See GFOA Best Practice, Monitoring and Disclosure of Fees for Defined Contribution Plans.
4 A stable value fund is comprised of a diversified, fixed-income portfolio that is insulated from interest rate movements.
5 See GFOA Best Practice, Participant Education Guidance for Defined Contribution Plans.
6 See GFOA Best Practice, Defined Contribution Retirement Plan Design.
7 If available to plan participants, the policy should identify the responsibility of communicating that brokerage options are not monitored by the plan sponsor.