After much delay, the Department of Labor (DOL) has issued fi nal regulations setting forth the conditions for fi duciary relief when plan assets are invested in a qualified default investment alternative (QDIA) in the absence of participant direction. The fi nal regulations are generally effective on December 24, 2007. The fi nal regulations follow in large part the previously proposed regulations but add a transition provision for stable value funds and permit capital preservation vehicles to be used on a short-term basis.
CONDITIONS FOR FIDUCIARY RELIEF
While the fi nal regulations do not relieve a fi duciary from general fi duciary responsibilities, including the duties of prudently selecting and monitoring QDIAs and avoiding prohibited transactions, there is relief for losses resulting from investment in a default investment alternative provided each of the following six conditions are met:
1) Default Investment Alternative Must Be a QDIA. The assets must be invested on behalf of participants or benefi ciaries in a default investment alternative that satisfi es the requirements of a QDIA, discussed further below.
2) Existence of Opportunity to Self-Direct Investment. The participant or benefi ciary whose assets are invested in a QDIA must have had the opportunity to direct the investment of his or her assets, but failed to do so.
3) Initial and Annual Notice Must Be Provided. Participants and benefi ciaries must receive information regarding the investments that may be made on their behalf. Both an initial and an annual notice are required, as discussed below.
4) QDIA Material Provided to Plan Must Be Furnished. Certain material provided to the plan relating to the investment in a QDIA must be provided to the participant or benefi ciary and should consist of the same information that is provided to those participants who elected to direct their investments into the investment serving as the QDIA. This includes items such as prospectuses and proxy voting material.
5) Transferability Requirements Must Be Satisfied. A participant or beneficiary must be given the ability to move assets out of a QDIA to any other investment available under the plan. This opportunity must be afforded with the same frequency given participants and benefi ciaries who direct their own investments, subject to a minimum frequency of at least once in a three-month period.
In addition, any transfer or permissible withdrawal by the participant or beneficiary within the 90-day period, starting on the date of the participant’s fi rst elective contribution or other fi rst investment in a QDIA, must not be subject to any restrictions, fees or expenses, such as surrender charges or liquidation or redemption fees. The only allowable fees are those charged on an ongoing basis for the operation of the investment, such as investment management fees and “12b-1” fees, and not those charged solely because of the decision to transfer assets out of the QDIA.
After the end of the 90-day period, no fees, restrictions or expenses may be imposed for any transfer or permissible withdrawal from a QDIA that would not be applicable to a participant or benefi ciary who elected to invest in the QDIA.
6) Broad Range of Investment Alternatives Must Be Offered. The fi nal condition requires that the plan offer participants and benefi ciaries a broad range of investment alternatives within the meaning of the regulations promulgated under Section 404(c) of the Employee Retirement Security Act of 1974 (ERISA).
QDIA: INVESTMENTS THAT “QUALIFY”
In order to qualify as a QDIA, the investment option must:
1) not hold or permit the acquisition of employer securities (except in limited circumstances);
2) permit the transfer of the investment from the QDIA to any other investment alternative available under the plan (see the discussion of transfers above);
3) be either (a) managed by an investment manager, a trustee that satisfi es the ERISA definition of investment manager or a plan sponsor that is a named fiduciary under ERISA; (b) an investment company registered under the Investment Company Act of 1940 (e.g., a mutual fund); or (c) an investment product or fund that satisfi es the capital preservation requirements described below; and, 4) be one of the specifi ed types of investment fund products, model portfolios or investment management services described below.
Available Types of Investments. As under the proposed regulations, there are generally three types of investments that may qualify as QDIAs. Each type of investment must be designed to provide varying degrees of long-term appreciation and capital preservation through a mix of equity and fi xed-income investments, and must be diversifi ed to minimize the risk of large losses. Types of investments which may qualify include:
1) A fund product or portfolio with a strategy is tied to a participant’s age, target retirement date or life expectancy and becomes more conservative over time (e.g., a “life-cycle” or “target retirement date” fund or account). 2) A fund product or portfolio with a target level of risk appropriate for the plan’s participants as a whole (e.g., a “balanced” fund). 3) An investment management service provided by a plan fi duciary that allocates contributions among existing plan options and takes into account the participant’s age, target retirement date or life expectancy and becomes more conservative over time (e.g., a “managed account”).
In addition to these three basic types of investments, the final regulations permit capital preservation vehicles, such as money market or stable value funds, to be used as a short-term investment for not more than 120 days after a participant’s fi rst elective contribution. A capital preservation vehicle is an acceptable QDIA if it is designed to preserve principal and provide a reasonable rate of return, whether or not guaranteed, and is offered by a state or federally regulated fi nancial institution.
Drinker Biddle Comment:
The new opportunity for using a capital preservation vehicle allows the risk of loss to be minimized during the period when employees are most likely to opt out of participation in an automatic enrollment arrangement. However, the use of such a vehicle will require a transfer of assets to one of the other investment options after 120 days and, therefore, creates additional administrative burdens on the plan sponsor.
The final regulations also provide that a stable value fund will be a QDIA with respect solely to assets invested in such fund before December 24, 2007, provided the fund is designed to guarantee principal and a rate of return consistent with that earned on intermediate investment grade bonds, no fees or surrender charges are imposed when a participant or benefi ciary transfers out of the fund and the principal and rates of return are guaranteed by a state or federally regulated fi nancial institution.
As noted above, the fi duciary seeking relief must provide participants and benefi ciaries whose accounts are invested in a QDIA with certain information about the nature of the default investment and their right to elect other investment options. Initially, this notice must be distributed at least 30 days before the date of plan eligibility or the fi rst investment in the QDIA. The fi nal regulations provide a limited exception to this 30- day advance notice requirement. In particular, for a plan with an automatic enrollment feature, the notice may be provided on or before the date of plan eligibility if the plan includes the special Pension Protection Act (PPA) rule permitting automatically enrolled participants to withdraw their pre-tax contributions during the fi rst 90 days of participation (i.e., the participant can “unwind” the automatic enrollment without paying the penalties that might otherwise be incurred with such distributions). In addition, the notice must be distributed at least 30 days before the beginning of each subsequent plan year.
Drinker Biddle Comment:
The DOL’s intention is that QDIA fi duciary relief is available in a broad range of instances when a participant or benefi ciary has failed to make an investment election – not just automatic enrollment. For example, it might be appropriate to send this notice to employees who are about to become eligible for employer profit-sharing contributions and have not previously elected to make pre-tax deferrals. Plan sponsors should evaluate their plan terms and administration to assess when these notices should be distributed.
At a minimum, each notice must include the following information:
1) the circumstances in which a participant’s or benefi ciary’s account may be invested in a QDIA, including, if applicable, an explanation of any automatic enrollment feature;
2) an explanation of the right of participants and beneficiaries to direct the investment of assets in their individual accounts;
3) a description of the QDIA, including its investment objectives, any risk and return characteristics, and fees and expenses related to the QDIA;
4) a description of the right to transfer assets invested in a QDIA to any other investment alternative under the plan, including a description of any related restrictions, fees or expenses; and,
5) an explanation of where the participants and benefi ciaries can obtain investment information concerning the other investment alternatives available under the plan.
Drinker Biddle Comment: The description of any automatic enrollment feature should include the circumstances under which elective contributions will be made on behalf of a participant, the percentage of such contributions, and the right of the participant to elect not to have such contributions made on the participant’s behalf (or to elect to have such contributions made at a different percentage). This will ensure that the QDIA notice also satisfi es the notice requirement for ERISA preemption of any state wage laws that would otherwise prohibit an automatic enrollment arrangement.
Under the final regulations, it is no longer permissible to include this notice in the plan’s summary plan description (SPD) or a summary of material modifi cations updating that SPD. However, the QDIA notice may be included in the notice required to be distributed by plans intending to satisfy the Internal Revenue Service’s nondiscrimination requirements through the PPA automatic enrollment safe harbor. In addition, the DOL recognizes that the QDIA notice may be distributed with other materials being sent to participants and benefi ciaries. Electronic distribution is permitted when it is consistent with the same electronic disclosure requirements applicable to other similar required disclosures.
PREEMPTION OF STATE WAGE LAWS
The final regulations also clarify that state wage laws are preempted for all automatic enrollment arrangements, including those which do not use a QDIA as the default investment.
DECISIONS FOR PLAN SPONSORS
In order to comply with the new regulations, plan sponsors must take the following actions:
1) determine whether the plan’s current default fund qualifi es as one of the three permitted types of QDIAs. If not, a decision will have to be made as to which other investment option offered by the plan should serve as the new QDIA;
2) if a qualifying stable value fund served as the default investment option before December 24, 2007, decide whether to retain that fund as the QDIA for pre-December 24, 2007, investments or to transfer funds to the new QDIA;
3) decide whether to use a capital preservation fund as the QDIA for the initial 120 days after a participant’s fi rst elective contribution;
4) make appropriate changes to plan documents, including the SPD;
5) prepare the required initial and annual notices; and,
6) communicate with participants concerning any changes made to the plan’s default investments.