The Pension Protection Act of 2006 (PPA) made several changes intended to facilitate automatic enrollment plans, including new ERISA Section 404(c)(5), which provides fiduciary relief for certain default investments under participant-directed individual account plans. The DOL has now issued its proposed implementing regulations. The regulations will be effective 60 days after the final regulations – expected early in 2007 – are published.
The proposed regulations offer plan fiduciaries protection from liability if, in the absence of investment directions from the participant or beneficiary, the plan invests in a “qualified default investment alternative” (QDIA). Although the proposed regulations will have the most pronounced effect on plans that have automatic enrollment features, they will also apply in any other situation where participants have failed to make an election for their plan investments. Thus, even plan sponsors who do not intend to implement automatic enrollment should take a close look at the proposed regulations.
Fiduciary relief is granted only if the following five conditions are met:
- the participant or beneficiary must have had an opportunity to direct investments but failed to exercise such opportunity;
- the participant or beneficiary must receive a notice of the QDIA at least 30 days before the first QDIA investment and at least 30 days before each subsequent plan year;
- the participant or beneficiary must receive any material provided to the plan relating to the QDIA (for example, account statements, prospectuses, and proxy voting materials);
- the participant or beneficiary, consistent with the plan’s terms but at least quarterly, must be permitted to transfer all or part of the assets invested in the QDIA to any other plan investment option without financial penalty; and
- the plan must offer a broad range of investment options, as defined in the regulations under ERISA Section 404(c).
If the above conditions are met, plan fiduciaries will not be liable for any loss or fiduciary breach associated with investing a participant’s or beneficiary’s account in a QDIA. The plan fiduciary is, however, still responsible for prudently selecting and monitoring the QDIA.
According to the proposed rules, a QDIA must use one of three types of investment products:
- an investment fund or model portfolio that is designed to provide varying degrees of long-term appreciation and capital preservation through a mix of equity and fixed income exposures based on the participant’s age, target retirement date, or life expectancy (a “life-cycle” or “targeted-retirement-date” fund);
- an investment fund or model portfolio that is designed to provide long-term appreciation and capital preservation through a mix of equity and fixed income exposures consistent with a target level of risk appropriate for participants in the plan as a whole (a “balanced” fund); or
- an investment management service in which the investment manager allocates the assets of a participant’s individual account to achieve varying degrees of long-term appreciation and capital preservation through a mix of equity and fixed income exposures offered through investment alternatives available under the plan, based on the participant’s age, target retirement date, or life expectancy (a “managed account”).
Historically, many plan sponsors have chosen conservative default funds that focus on preservation of capital and low risk of loss, such as stable value or money market funds, in an effort to minimize potential fiduciary liability. The proposed regulations do not recognize these conservative investment vehicles as a QDIA. Thus, plan sponsors who currently designate such funds as the default investment alternative should consider whether to switch to a default that qualifies as a QDIA.
The notice of the QDIA must be written in a manner calculated to be understood by the average plan participant and must contain the following information:
- the circumstances under which the participant’s or beneficiary’s account may be invested in a QDIA;
- the QDIA’s features, including its investment objectives, risk and return characteristics, and fees and expenses;
- the right to direct the investment of the assets invested in the QDIA to any other plan investment option; and
- the place where participants and beneficiaries can obtain information about the plan’s other investment options.
The notice can be provided in an SPD, an SMM, or a separate notice. Some commentators have expressed concern regarding the 30-day advance notice as applied to newly hired employees or transferred employees. In such instances, it may not be possible to give 30 days advance notice before the first investment in the QDIA. We will have to wait and see whether the final regulations address this issue.