DOL Issues Final Regulations on Qualified Default Investment Alternatives
November 21, 2007
The Department of Labor has issued final regulations on Qualified Default Investment Alternatives ("QDIAs") under participant-directed individual account plans (such as 401(k) plans). As you may recall, the Pension Protection Act of 2006 made a number of changes to the laws governing pension and 401(k) plans. One of those changes was to encourage 401(k) plan sponsors to use automatic enrollment arrangements by providing plan fiduciaries with a safe harbor from liability if certain default investments are required under the plan. By using the safe harbor, plan fiduciaries will reduce their exposure to liability if a participant's account is invested in a default investment option and that investment option incurs losses (or does not earn as much as other investment options).
Here are some of the highlights of the final regulations on QDIAs:
- Scope of Fiduciary Relief. Relief is available to the plan fiduciary of an individual account plan if loss or breach results from an investment in a QDIA. However, the fiduciary remains obligated to select and monitor prudent investment option(s) that will be deemed to be the default investment option under the plan (although the final regulations make clear that the fiduciary is not obligated to select the "most prudent" investment option). Also, the fiduciary safe harbor does not extend to transactions prohibited under ERISA Section 406 (such as those involving self-dealing), conflicts of interest, and other improper influences.
- Safe Harbor Requirements. For the safe harbor to apply, the following six requirements must be met:
- Assets must be invested in the QDIA because the participant failed to direct the investment of his or her assets despite having had the opportunity to do so.
- The plan must provide adequate notice to the participant of the QDIA arrangement (see below for a brief discussion of the notice requirements).
- The plan fiduciary must provide the participant with specific information relating to the QDIA, including the prospectus, proxy materials, and information about the QDIA's annual operating expenses.
- The defaulting participant must be permitted to transfer out of the QDIA with the same frequency afforded other participants, but at least once every three months.
- The participant must not be subject to fees or expenses imposed by the QDIA for 90 days from the date of the participant's first contribution, though ongoing fees and expenses related to the operation of the QDIA are permitted. After 90 days, fees and expenses may be imposed for any transfers or withdrawals from the QDIA to the same extent that fees and expenses would otherwise be charged to participants who elect to invest in the QDIA.
- The plan must offer a broad range of investment alternatives. The alternatives must: (a) be diversified; (b) be distinct with respect to risk and return; and (c) enable the participant to achieve a portfolio with risk and return within the range appropriate for a like participant.
- Investment Option That Qualify as QDIAs. For an investment option to qualify as a QDIA, the following four requirements must be met:
- The QDIA may not hold or acquire employer securities unless the employer securities are: (i) held or acquired by a regulated financial institution; or (ii) acquired as a matching contribution from the plan sponsor or at the direction of the participant.
- The QDIA may not impose any restrictions, fees, or expenses in violation of the regulations (see safe harbor requirements above).
- The QDIA must be managed by an investment manager, a plan trustee, a plan sponsor who is a named fiduciary, or a registered investment company.
- The QDIA must use specific types of investment fund products, including either:
Any of these three types of funds may be offered through variable annuity contracts, trust funds, or other pooled investment funds.
- A life-cycle or targeted-retirement-date fund, which consists of a mix of equity and fixed income exposures based on the participant's age, target retirement date, or life expectancy.
- A managed account, where an investment management service allocates a participant's assets among equity and fixed income exposures based on the participant's age and target retirement date.
- A balanced fund, which consists of a mix of equity and fixed income exposures consistent with the target risk appropriate for the plan participants in the aggregate.
- Capital Preservation Investments. While capital preservation funds, such as stable value and money market funds, are generally excluded from the definition of a QDIA, an individual account pension plan may initially default undirected account assets into a capital preservation investment for up to 120 days after the participant's first elective contribution. After 120 days, the plan must then default into one of the investment options noted above. In addition, investments in stable value funds made before December 24, 2007, the effective date of the regulations, are "grandfathered" under the regulations.
- How QDIAs Apply to Situations Beyond Automatic Enrollment. Under the final regulations, fiduciary relief applies whenever a participant has had the opportunity to direct the investment of assets in her account but fails to do so. This means that, for example, should a participant fail to provide investment direction following the elimination of an investment alternative, the plan fiduciary may avail itself of the relief provided by the regulations and invest the participant's account in a QDIA until the participant provides a different direction.
- Notice Requirements and Transition. To qualify for the safe harbor, an initial notice must be provided to the participant either: (a) at least 30 days before her or she becomes eligible to participate in the individual account plan; (b) at least 30 days before his or her assets are invested in the QDIA; or (c) before or at the time of plan eligibility if the plan provides participants with a 90-day window to withdraw automatic contributions without penalty. An annual notice must also be provided at least 30 days before each subsequent plan year.
Each notice must include the following information: (a) the circumstances giving rise to the investment of a participant's assets in a QDIA; (b) a description of the QDIA; (c) a description of the participant's right to direct the investment in his or her plan account and to divest his or her QDIA holdings and invest the proceeds in any of the plan's other investment alternatives; and (d) directions on how to obtain information on the other investment alternatives.
The IRS recently published a sample notice that plan sponsors can use as a starting point for preparing the applicable notice. The notice may not be provided by including it in the plan's summary plan description.