Many public agency 457(b) plans offer a stable value fund investment option. When a plan moves to a new 457(b) plan recordkeeper, the plan’s investment lineup will usually change. In those cases where the lineup includes a stable value fund, the plan’s investment advisor and the plan administrator must be keenly alert to the potentially negative impact on the values of plan participant accounts when moving out of that stable value fund. This matter needs to be reviewed and considered well before the plan can be moved to a new recordkeeper.
Stable value funds are typically offered by insurance companies, but can also be offered through a collective trust arrangement, or in the form of a mutual fund. They generally consist of high quality, diversified fixed income portfolios, such as highly rated government or corporate debt, asset-backed securities, mortgage-backed securities and cash equivalents with maturities that may extend out two to four years.
Stable value funds can offer principal protections (typically backed by the insurance company issuer), stable share prices (prices do not go up, but also do not lose value), and rates of return that are much higher than those of money market funds.
In the retirement plan arena, stable value fund issuers often include a minimum interest rate guarantee to attract investors. Again, these rate guarantees typically are backed by the financial strength of the issuer. Such rate guarantees may be made or reset by the fund issuer on an annual or semi-annual basis. In rarer instances, a rate guarantee may exist for the life of the annuity contract.
As one can imagine, it would make little sense for the stable value fund issuer to offer and pay higher than market rates of interest while allowing retirement plan investors to move freely in and out of such funds. Because of the “durational” risk the issuers take on, they restrict the withdrawal of funds, both at the participant level and at the plan level:
- While participants generally are free to liquidate their stable value fund option with a plan and move to another investment option, they usually are not allowed to move directly to a similar option, such as a money market or a bond fund. This type of restriction, requiring the participant to first invest in a stock or sector fund before moving to a competing option, is referred to as an “equity wash.”
- Restrictions on withdrawals at the plan level usually take one of two forms. In some cases, the underlying investment contract provides for a “market value adjustment,” which allows the issuer to pay out less than the current “book value” of the stable value fund to reflect the fact that the issuer has been crediting participant accounts with a higher than market rate of return. In other cases, the investment contract gives the issuer a “put” option – that is, the right to hold onto the stable fund investments (at the plan level) for up to 12 months from the date notice is given.
If your plan offers a stable value fund and you are thinking about eventually changing recordkeepers, it is essential to review and understand the terms of that investment contract to learn whether an attempted migration of your stable value fund could be subject to a market value adjustment or a put option.
Either way, a negative adjustment to the value of participant accounts or the inability to move the stable value fund money (at the plan level) for up to a year are things that deserve your attention and some careful planning with your investment adviser.
Jeff Chang is a partner at Best Best & Krieger LLP. He has four decades of experience skillfully evaluating benefit and retirement plan compliance to achieve maximum outcomes for public agency clients throughout California. He can be reached at firstname.lastname@example.org or (916) 329-3685.