The Pension Protection Act of 2006 (“PPA”) amended ERISA to provide fiduciary relief for certain default investments when plan participants do not provide investment direction. The DOL has now issued final regulations, which will take effect on December 24, 2007, under which plan sponsors may enjoy a “safe harbor” from certain fiduciary liability. The final regulations provide that participants and beneficiaries in individual account plans will be treated as exercising control over the assets in their accounts if, in the absence of their investment directions, the plan invests in a “qualified default investment alternative” (“QDIA”). Provided that the plan invests in a QDIA, the plan fiduciary will not be liable for any investment losses that are the direct and necessary result of investing all or part of a participant’s or beneficiary’s account in any QDIA.
QDIA OPTIONS
The proposed regulations limited a QDIA to one of only three types of investment products, portfolios, or services:
• a life-cycle or targeted-retirement-date fund or account;
• a balanced fund; or
• a professionally managed account.
The final regulations add two additional options to that list:
(1) a capital preservation product or fund (e.g., a money market fund), but only for the 120-day period after the participant’s first deferrals into the plan; and
(2) stable value products and funds, but only for investments made before December 24, 2007.
The short-term capital preservation fund QDIA is intended to accommodate employers who implement an automatic enrollment feature. It provides a short-term investment alternative for the period of time during which an automatically enrolled participant may elect to withdraw amounts contributed to his or her account. Investing such amounts in a short-term QDIA would likely guarantee that, should the participant opt to reverse his or her automatic enrollment, the amount to be refunded would include the full amount deducted from the participant’s paycheck, along with a small investment gain.
Despite protests from the insurance industry, the DOL declined to add stable value funds as a permanent QDIA option. The final regulations do, however, include a special “grandfather” rule for defaults into certain of those funds that occur before December 24, 2007. This means that fiduciaries may obtain safe harbor protection for old investments in stable value funds without transferring those accounts to another QDIA. This concession to the insurance industry should alleviate concerns about the financial disruption that could have been caused if a large volume of stable value investments had been liquidated and moved to other QDIAs.
The final regulations require that each of the QDIA options have at least some exposure to both equity and fixed income investments, regardless of the age or retirement date of the participant. Thus, some life cycle and targeted retirement date funds might not constitute QDIAs under these standards. Moreover, the final regulations give plan sponsors more flexibility with respect to the managed account safe harbor. The rules permit plan sponsors either to choose prepackaged QDIAs sponsored by fund companies or advisors, or to create their own, custom QDIAs, which might include the plan’s core investment options.
When selecting a QDIA, the plan’s fiduciaries need not evaluate which of the safe harbor options is the most prudent for the plan. As long as the regulations’ other requirements are satisfied, selecting any of those investment types will satisfy the fiduciaries’ duties. Nevertheless, the fiduciaries still must act prudently when selecting and monitoring the specific fund used as the default vehicle.
NOTICE REQUIREMENT
In order to obtain fiduciary relief, the final regulations require that an initial notice be provided to participants and beneficiaries either (1) at least 30 days before the date of plan eligibility or at least 30 days before the first QDIA investment; or (2) on or before the date of plan eligibility, provided the participant has the opportunity to make a permitted withdrawal under Code Section 414(w). The notice must be provided as a separate notice; it cannot be combined in an SPD or SMM. Additionally, an annual notice must be provided at least 30 days before the start of each plan year. A plan fiduciary that fails to provide the initial notice upon plan eligibility or the first investment may still obtain the safe harbor relief with respect to later contributions, once the initial notice is provided. Each initial and annual notice must explain (1) if applicable, the circumstances under which elective deferrals will be made on the participant's behalf, the deferral percentage, and the participant's right to elect not to have the deferrals made (or to elect to have them made at a different percentage); and (2) the right of participants and beneficiaries to direct the investments of assets in their accounts. The DOL recognized that many plans will not have sufficient records to tell which participants defaulted into a particular fund, and which affirmatively elected that fund. Accordingly, once the initial notice is provided, all existing participants who are invested in the default fund will be treated as having been defaulted into it.
FEES AND EXPENSES
Unlike the proposed regulations, which prohibited financial penalties on transfers for the duration of the QDIA investment, the final regulations prohibit restrictions, fees, and expenses only for transfers (or withdrawals) made during the first 90 days of the QDIA investment. Thereafter, defaulted participants and beneficiaries may be subject to the same restrictions, fees, and expenses on transfers that apply to participants and beneficiaries who elected to invest in that QDIA. The final regulations also clarify that fees and expenses charged on an ongoing basis for the QDIA’s operation (including investment management, distribution, service, or 12b-1 fees) are not fees or expenses for transfer purposes.
OTHER ALTERNATIVES
The regulations confirm that a QDIA safe harbor is not the only means by which a fiduciary might satisfy his or her fiduciary duties to participants who fail to provide investment directions. The DOL acknowledged that the use of non-QDIA default investments may also be prudent in certain circumstances. Nevertheless, the rationale for choosing a non-QDIA option should be well documented. Plan sponsors wishing to take advantage of the safe harbor fiduciary relief provided by the regulations also should review their processes carefully.