The Department of Labor (“DOL”) recently issued final regulations extending fiduciary relief with respect to investment performance to qualified default investment alternatives (“QDIAs”). A default investment option is the investment option in which assets are invested in a 401(k) plan (or other qualified retirement plans permitting participant investment direction) if the participant does not provide affirmative investment direction. By following the new regulations, a plan sponsor can limit fiduciary liability with respect to a QDIA.
The final regulations are effective December 24, 2007. However, plan sponsors who wish to obtain the earliest fiduciary relief possible must issue notices required by the final regulations to plan participants on or before November 24, 2007, otherwise, fiduciary relief will not be available until 30 days after plan participants are provided with the required notice.
If a plan sponsor does not avail itself of QDIA protection, arguably there is no increase in fiduciary liability. The plan sponsor is merely giving up the opportunity to reduce exposure to fiduciary liability.
The final regulations expand the fiduciary relief otherwise available under ERISA Section 404(c). Generally, under ERISA Section 404(c), if a plan participant exercises control over the assets in his or her qualified retirement plan account by directing the investment of such assets among the plan’s available investment alternatives, no fiduciary will be liable under ERISA for any investment loss that results solely from the participant’s investment direction.1
Prior to the Pension Protection Act of 2006, the DOL’s position was that fiduciary relief under ERISA Section 404(c) was not available when a plan participant failed to give any investment direction and the participant’s account was invested in a default investment option under the plan. Many practitioners believed that courts would be reluctant to impose fiduciary liability for default investment funds because the participant effectively made a choice to invest in the default fund by not registering an alternate investment election. While this belief is likely still valid, a plan fiduciary who follows the final regulations will have a greater likelihood of fiduciary protection for default investments.
A participant’s failure to affirmatively direct his or her plan assets arises frequently in plans with automatic enrollment or negative election features, but could also arise following the elimination or change of an investment option, a rollover from another qualified plan, a change in service provider, the death or divorce of a participant where the beneficiary or alternate payee leaves assets in the plan, or in the context of a plan merger.
Conditions for Obtaining Fiduciary Relief
This advisory discusses the specific requirements for obtaining fiduciary relief. Among these is a notice requirement (discussed in detail below). To obtain the earliest relief possible, plan fiduciaries should focus on the notice requirements and consider giving this notice as soon as prudently possible. While fiduciaries are still responsible for prudent selection of investment options (i.e., the selection of the default investment option itself), the final regulations provide fiduciary relief for investment outcomes if each of the following six conditions are satisfied.
1. Assets must be invested in a qualified default investment alternative (defined below).
2. The participant must be given an opportunity to direct the investment of assets in his or her account, but fails to do so.
3. Advance notice of the plan’s default investment provisions must be provided to the participant before the first investment in the QDIA and each year thereafter.
4. Investment materials (e.g., prospectuses) for the QDIA otherwise required for ERISA Section 404(c) protection must be provided to the participant.
5. Participants must be permitted to transfer assets from the QDIA to other investment alternatives under the plan at least as frequently as affirmative investments in the QDIA, but at least quarterly. In addition, for the first 90 days of investment in the QDIA, fees such as surrender charges, liquidation or redemption fees or similar fees may not be imposed on default investments in the QDIA. Ongoing operational fees, such as investment management fees, 12b-1 fees, transfer agent fees and similar administrative expenses not based on the decision to transfer out of the QDIA, are permitted.
6. The plan must offer a broad range of other investment alternatives.
Qualified Default Investment Alternatives
The final regulations set forth three general categories of investment options that will constitute a QDIA. These include:
1. A product or model portfolio with a mix of equity and fixed income exposures that takes into account the participant’s age or target retirement date (e.g., a life-cycle or target-retirement-date fund).
2. A product or model portfolio with a mix of equity and fixed income exposures that is designed with a target level of risk appropriate to the group of plan participants as a whole (e.g., a balanced fund).
3. An investment management service that allocates the participant’s investments among existing investment options under the plan (e.g., a professionally managed account).
The final regulations confirm that a QDIA can be offered through insurance company variable annuity or similar contracts as well as common or collective trust funds or pooled investment funds. Capital Preservation Funds (e.g., Stable-Value or Money Market Funds) The final regulations provide that a capital preservation product such as a stable-value fund or money market fund designed to preserve principal generally will not constitute a QDIA. However there are two exceptions:
1. A capital preservation fund can constitute a QDIA, but only for the first 120 days after a participant’s first elective contribution to the plan, provided the participant is permitted to opt out of participation and withdraw his or her contribution within the 90-day opt-out period under Code Section 414(w). In order to maintain investment in a QDIA, a participant’s investments must be transferred to a different QDIA before the end of the 120-day period.
Comment. This capital preservation QDIA option may be useful for plans with automatic contribution arrangements that permit participants to “opt out” within the first 90 days of participation because the capital preservation option will minimize risk of loss during this period. However, the requirement to make an automatic transfer within 120 days may be burdensome, administratively, and many recordkeeping platforms do not presently have this capability.
2. The final regulations provided a sort of grandfathered treatment for plans that have used stable-value funds as their default investments in the past. Contributions defaulted to these investments prior to December 24, 2007, may be treated as having been made to a QDIA under the final regulations. There is no fiduciary relief for default contributions to these funds after December 24, 2007 (other than the 120 day relief noted above).
Comment. This grandfather relief does not apply to typical money market funds since the fund must guarantee a rate of return generally consistent with intermediate investment grade bonds to receive the relief. Plan fiduciaries should review the terms of their stable-value fund to determine whether it meets all the requirements for grandfather relief.
Two types of notice to participants are required under the final regulations. Participants must receive an initial written notice of the plan’s default investment provisions and an annual notice issued at least 30 days before each plan year thereafter. The notice may not be provided as part of a summary plan description or summary of material modifications, but may be combined with other notices, such as one of the 401(k) safe harbor plan notices or an automatic enrollment notice. Until further guidance is issued, the notice can be delivered electronically under either the DOL or IRS regulations on electronic delivery.
The initial notice must generally be provided at least 30 days in advance of the date of plan eligibility or 30 days in advance of the participant’s first default investment in the QDIA. Plans with automatic enrollment features that permit participants to “opt out” within the first 90 days (in accordance with Code Section 414(w)) may give the notice as late as the participant’s date of plan eligibility.
Comment. Plans with immediate eligibility generally cannot satisfy the 30-day advance notice requirement. Such plans should consider adding an opt out feature under Code Section 414(w) in order to obtain full fiduciary relief under the final regulations.
Comment. If a plan currently uses a default investment option that will satisfy the QDIA requirements, the initial notice to current plan participants should be provided by November 24, 2007, in order to obtain the earliest possible fiduciary relief. This notice will also satisfy the annual notice requirement for 2008 for calendar-year plans.
Comment. If the initial notice is not provided by November 24, 2007, for current participants or is not provided timely for a participant’s initial contributions and investments, fiduciary relief will still apply for default investments in a QDIA 30 days after the initial notice is properly given after the effective date of the regulations. For example, if a plan sponsor is unable to provide the notice until April 1, 2008, fiduciary relief should apply for default investments made on and after May 1, 2008.
Both the initial and annual notice must contain the following information:
- a description of when and to what extent assets may be invested in a QDIA
- a statement of the participant’s right to affirmatively direct investments
- a description of the QDIA, including investment objectives, risk and return characteristics, fees and expenses
- a statement of the participant’s right to transfer assets from the QDIA to other investment options under the plan, including a description of any restrictions, fees or expenses associated with such transfer
- an explanation of where additional information concerning the other investment options under the plan may be obtained