On October 24, 2007, the Department of Labor published the final regulation providing guidance on fiduciary relief for plan fiduciaries that select certain default investment options for their participant directed individual account plans. This regulation implements the relief provided under section 404(c)(5) of ERISA which was created by the Pension Protection Act of 2006.
Section 404(c)(5) of ERISA insulates plan fiduciaries from fiduciary risk if the plan fiduciaries comply with the general prudence standards under ERISA in selecting and monitoring plan investments and they select certain default investments for the investment of accounts of participants and beneficiaries who have failed to make investment directions. A plan fiduciary that prudently selects and monitors the default investments and complies with the final regulation will not be liable for any loss, or by reason of any breach, that occurs as a result of the default investment.
Under the final regulation, if a plan fiduciary prudently selects and monitors the plan’s investments, invests accounts of participants and beneficiaries from whom no investment directions were given in a “qualified default investment alternative” (or “QDIA”) and meets certain other conditions of the final regulation, the plan fiduciary will not be liable for any loss on account of the investment in the QDIA. The final regulation also affords fiduciary relief to plan fiduciaries for their default investment in a QDIA under a plan’s automatic enrollment arrangement as well as other default investment events, such as in the case of plan mergers or changes in service providers. The final regulation becomes effective on December 24, 2007.
Immediate Action Required
- Plan fiduciaries should immediately evaluate the current default investment option for their plan to determine whether the current default investment option qualifies as a QDIA.
- If a plan’s current default investment option does not qualify as a QDIA, the plan fiduciaries should immediately select a default investment option which does qualify as a QDIA by December 24, 2007, in order to maximize the fiduciary relief available under the final regulation.
- If a plan’s existing default investment option does qualify as a QDIA or, in the case where the plan fiduciaries select a default option which qualifies as a QDIA by the effective date of the regulation, the plan fiduciaries should avail themselves of the fiduciary relief as of the effective date of the final regulation by issuing the required notice to plan participants and beneficiaries by November 24, 2007.
- If the required initial notice is not provided for a QDIA by November 24, 2007, plan fiduciaries should provide the initial notice to participants and beneficiaries as soon as possible after November 24, 2007 because the fiduciary relief under the final regulation will become effective 30 days after the initial notice is distributed.
- Life cycle (or targeted retirement date) funds, balanced funds and managed accounts qualify as QDIAs.
- Stable value funds and money market funds do not qualify as QDIAs. However, investments in such funds prior to December 24, 2007 are grandfathered, and plan fiduciaries are afforded fiduciary relief as to those prior investments subject to certain conditions being satisfied.
- The fiduciary relief becomes, and continues to be, effective if plan participants and beneficiaries receive certain notices within certain time periods prescribed by the final regulation. Generally, the final regulation requires the notices to be distributed 30 days in advance of the default investment.
- Distribution of the required notice may not be satisfied through disclosure in the plan’s summary plan description or a summary of material modifications. However, the notice may be included as part of other plan communications, such as the plan’s quarterly statements, or as part of any other required notices such as automatic enrollment or other safe harbor type notices.
- The final regulation does not specifically provide any guidance related to the Pension Protection Act’s provisions related to section 404(c)(4) of ERISA which provided fiduciary relief for the “mapping” of investment choices from one investment option to another.
Requirements for Fiduciary Relief
Plan fiduciaries must satisfy the following six conditions in order to receive fiduciary relief under ERISA section 404(c)(5) for the default investment of an account of a participant or beneficiary for which no investment directions were made:
1. The assets of the account of the participant or beneficiary must be invested in a QDIA (which is further discussed below).
2. The participant or beneficiary must have been given the opportunity to direct the investment of his or her account, but failed to do so.
3. The participant or beneficiary must be provided with a notice in advance of the investment of his or her account in a QDIA and be provided with an annual notice in advance of each subsequent plan year. The notice requirements are discussed more fully below.
4. The plan fiduciary must provide a description of the QDIA and certain materials and information about the QDIA (e.g., prospectuses, account statements, and information related to investment objectives, risks and returns) to the participant or beneficiary. Information related to fees and expenses with respect to the QDIA must also be included.
5. The participant or beneficiary on whose behalf assets are invested in a QDIA must be given the opportunity to direct the investment of his or her account as frequently as those who elected to invest in the QDIA, but at least quarterly. Additionally, no fees or expenses (including surrender charges, liquidation or exchange fees, or redemption fees) may be imposed during the first 90 days of a participant’s or beneficiary’s initial investment in the QDIA. However, ongoing fees and expenses for the operation of the QDIA may be charged. After the 90-day period, fees and expenses may be imposed for any transfers or withdrawals from the QDIA on the same basis that fees and expenses are otherwise charged to participants and beneficiaries who had made affirmative elections to invest in the QDIA.
6. The plan must offer a broad range of investment alternatives sufficient to satisfy the regulations under ERISA section 404(c).
Which Investment Products are QDIAs?
Plan fiduciaries may use the following types of investment products as QDIAs and avail themselves of the fiduciary relief under the final regulation:
1. Life Cycle or Target Retirement Date Funds. These investment fund products or model portfolios are designed to provide varying degrees of long-term appreciation through a mix of equity and fixed income exposures based on the participant’s age, target retirement date or life expectancy (but are not required to take into account risk tolerances, investments or other preferences of an individual participant). It is important to note that a life cycle or target retirement date fund would not qualify as a QDIA if the fund had only equity investments.
2. Balanced Index Fund. This investment fund product or model portfolio is diversified to minimize the risk of large losses and 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 the plan’s participants as a whole.
3. Managed Account Fund. A managed account fund involves an investment management service that allocates assets to achieve 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 – such investments typically become more conservative as the participant’s or beneficiary’s age increases.
4. Variable Annuities or Similar Contracts. Any of the QDIAs described above may be offered through variable annuity or similar contracts as well as through common or collective trust funds or pooled investment funds.
Although capital preservation funds (including stable value funds or money market funds) are not generally considered QDIAs under the final regulation, fiduciary relief is available in the following limited circumstances to plan fiduciaries to accommodate limited investments in capital preservation funds:
1. Investment up to First 120 Days. An investment in a stable value or money market fund is permitted and fiduciary relief is available for the first 120 days of plan participation, provided an employee may elect to withdraw from participation. After 120 days, the plan fiduciaries must redirect the investment of the participant’s account to a QDIA in order to continue fiduciary relief under the final regulation. The 120-day time frame is intended to provide plans that allow an employee a withdrawal election, a reasonable amount of time following the end of the 90-day withdrawal period provided in Code Section 414(w) to effectuate a transfer of investments to a QDIA.
2. Pre-Effective Date Investment. Investment in a stable value or money market fund before December 24, 2007 is “grandfathered” under the final regulation. Plan fiduciaries who selected these funds as the default investment are granted fiduciary relief for the pre-effective date investment only if :
- The pre-effective date investment is designed to guarantee principal and a rate of return generally consistent with that earned on intermediate investment grade bonds, while providing liquidity for withdrawals by participants and beneficiaries, including transfers to other investment alternatives; and
- There are no fees or surrender charges imposed in connection with withdrawals initiated by a participant or beneficiary.
It is important to note that stable value or money market funds for purposes of the “first 120-day exception” are not required to guarantee a rate of return, while stable value or money market funds for the “pre-effective date exception” do require a guaranteed return. A typical stable value or money market fund does not guarantee a rate of return, and therefore plan sponsors should examine their fund descriptions if they desire to rely on this exception.
Fiduciary Prudence in the Selection and Monitoring of QDIAs
Plan fiduciaries must prudently select and monitor a plan’s QDIA just as they are required by the general fiduciary rules under ERISA to prudently select and monitor any other investment option under the plan. Under the final regulation, any QDIA is deemed to be appropriate for a participant or beneficiary who does not provide investment directions with respect to his or her account balances. Therefore, a plan fiduciary is not required to determine which of the QDIAs is the most prudent for a participant or beneficiary.
The final regulation specifically states that it is not intended to be the exclusive means by which a plan fiduciary may satisfy his or her responsibilities under ERISA with respect to investment of assets on behalf of a participant or beneficiary who fails to give investment directions. Investments which do not meet the requirements of a QDIA may still be prudent investments for some participants or beneficiaries. Furthermore, investments which themselves do not qualify as QDIAs under the final regulation, may be part of an investment portfolio of a QDIA.
The final regulation requires that a participant or beneficiary must be provided with notice in advance of an investment of his or her account in the QDIA and annual notice prior to each subsequent plan year.
- Initial Notice. The initial notice generally must be provided to the participant or beneficiary at least 30 days in advance of the date of plan eligibility, or at least 30 days in advance of any first investment in a QDIA. Alternatively, if the plan has an automatic enrollment feature, the initial notice may be given on or before the date of plan eligibility, provided the participant has the opportunity to opt out of plan participation.
- Annual Notice. An annual notice must be provided at least 30 days in advance of each subsequent plan year.
- Notice Content. The initial notice and annual notice must be written in a manner calculated to be understood by the average plan participant and must include:
- A description of the circumstances under which the participant’s or beneficiary’s account may be invested in a QDIA;
- If applicable, a description of the automatic enrollment provisions under the plan and the participant’s right to opt out of participation or change the percentage of his or her contribution;
- An explanation of the right of the participant or beneficiary to direct the investment of assets in his or her individual account;
- A description of the QDIA, including the investment objectives, risk and return characteristics (if applicable), and fees and expenses attendant to the investment alternative;
- A description of the right of the participant or beneficiary to direct the investment of his or her account to any other investment alternative under the plan, including a description of any restrictions, fees or expenses in connection with such transfer; and
- Information about where the participants and beneficiaries can obtain investment information concerning the other investment alternatives available.
- Distribution of Notices. The final regulation provides that the notices may not be included in a summary plan description or summary of material modifications. However, the notices may be distributed with other materials (e.g., a safe harbor 401(k) notice, or automatic enrollment notice) being provided to participants and beneficiaries. Additionally, plans that wish to distribute the notices electronically may rely on previous guidance issued by the Department of Labor and the Internal Revenue Service relating to the use of electronic media to distribute notices.
- No Model Notice. The final regulation does not include a model notice. However, the Department of Labor has indicated that it will continue to explore whether model notice language will be issued in the future.
How quickly plan fiduciaries avail themselves of the fiduciary relief provided under the final regulation and transition their plan depends on whether the plan’s current default investment is a QDIA. The following action items will enable plan fiduciaries to determine what steps should be taken in order to fully take advantage of the fiduciary relief afforded by the final regulation as quickly as possible:
- Plans with a Current QDIA. If the plan’s current default investment qualifies as a QDIA, an initial notice should be provided to current participants and beneficiaries by November 24, 2007 in order to have the maximum fiduciary relief beginning on the effective date of the final regulation. Thereafter, to continue fiduciary relief under the final regulation, the plan fiduciaries must satisfy the general requirements for the initial and annual notices required under the final regulation.
- Plans with a Current Non-QDIA. If the plan’s default investment option does not qualify as a QDIA, the plan fiduciaries should select an investment option which does qualify as a QDIA by the effective date of the final regulation and provide the initial notice to participants and beneficiaries as soon as possible. Fiduciary relief under the final regulation will then become effective 30 days after the initial notice is distributed. Thereafter, to continue fiduciary relief , the plan fiduciaries must satisfy the general requirements for initial and annual notices under the final regulation.
- Plans with a Current Capital Preservation Fund. Subject to the exceptions noted above, the final regulation grants fiduciary relief for investments made in these types of funds prior to December 24, 2007. However, future investment in these funds are not afforded fiduciary relief. Therefore, plan fiduciaries should select a QDIA for default investments made on and after December 24, 2007 and provide the initial notice to participants and beneficiaries as soon as possible. The fiduciary relief will then become effective 30 days after the initial notice is distributed. Thereafter, to continue fiduciary relief under the final regulation, the plan fiduciaries must satisfy the general requirements for initial and annual notices under the final regulation.