When the U.S. Department of Labor (DOL) issued final rules and guidance on Qualified Default Investment Alternatives (QDIA) last year, the goal was to encourage automatic enrollment initiatives in 401(k) retirement plans by alleviating employers’ fears regarding potential liability arising from the default investment options given to participants who are not active in directing their own investments. Generally, plan sponsors have some relief from potential liability stemming from a participant’s investment decisions when participants exercise control over the assets in their account, as long as the requirements of Section 404(c) of the Employee Retirement Income Security Act of 1974 (“ERISA) are met. However, prior to issuance of the new QDIA rules, ERISA § 404(c) relief generally was not available in the situation in which a participant failed to provide any investment direction. Employers were therefore concerned about potential liability when directing participant investments without any input from the participant. Many employers had chosen to direct such investments into conservative money-market funds or stable value funds, with low investment returns but little risk or volatility. However, it had become apparent based upon comments and concerns expressed in recent years by the U.S. Department of Labor that such investments may not be sufficient for purposes of meeting the fiduciary duty imposed by ERISA in overseeing the investment of plan assets. On the other hand, employers have been concerned with investing in riskier options for fear that such investments would subject them to potential liability if losses were incurred. With the issuance of the QDIA rules, however, there is now a safe harbor from such legal liability, as long as employers direct default investments into approved types of investments and otherwise follow the final DOL rules.
What is a QDIA?
The final U.S. Department of Labor rules lay out the requirements for an investment option to be considered a Qualified Default Investment Alternative or QDIA. The goal behind the rules is to ensure that default investment alternatives meet the long-term retirement needs of participants without exposing the investments to excessive risk. The following four investment alternatives are described in the regulations for purposes of the type of investment options that will satisfy the requirements of a QDIA: two of the options are individually-based alternatives, one is group-based and the other is a short-term investment alternative permitted for ease of administration.
An age or retirement date based product such as a life-cycle or targeted-retirement-date fund;
An option that allocates an individual’s contributions among existing plan products to achieve a mix of investments that account for an individual’s age or retirement date such as a professionally-managed account;
A product which focuses on the characteristics of a group and not an individual to ensure an appropriate asset mix such as a balanced fund; and
A product whose goal is capital preservation and which is used for only the first 120 days in the event that employees decide to opt-out of participation after being automatically enrolled through an automatic contribution arrangement.
Safe Harbor
In general, to obtain the protection of the final rules’ safe harbor from fiduciary liability for investment results, the following requirements must be satisfied:
Assets must be invested in a QDIA (as described briefly above).
Assets generally cannot be invested in employer securities.
Participants and beneficiaries must have been given an opportunity to provide investment direction even though they have not taken advantage of that opportunity.
Typically, a notice containing specific information required by the regulations must be furnished to participants and beneficiaries in advance of the first investment in the QDIA and annually thereafter.
Material, such as investment prospectuses, provided to the plan for the QDIA must be furnished to participants and beneficiaries.
Participants and beneficiaries must have the opportunity to direct investments out of a QDIA as frequently as from other plan investments, but in any event no less than quarterly.
There are limitations on the fees that can be imposed on a participant who opts out of participation in the plan or who decides to direct his or her investments after being invested in a QDIA.
The plan must offer a “broad range of investment alternatives” as defined in the regulations.
2008 Guidance and Corrections
The Department of Labor (DOL) issued final guidance as well as corrections to the QDIA rules in April of this year. The scope of the rules was clarified to confirm that the QDIA rules apply not only to 401(k) plans, but also to 403(b) plans that are subject to ERISA. In addition, the final guidance provides that QDIA notice requirements may be combined with the required notices for a 401(k) or 403(b) qualified automatic contribution arrangement and may be met using more than one document. For example, until further guidance is issued, prospectuses can be used for the description of the QDIA, its fees and charges. Notices are also permitted to be distributed electronically, though the pass-through of investment materials is barred. In addition, the final rules provide transitional relief for those plan sponsors who have adopted stable value products as their default investment prior to passage of the final regulations. These alternatives are grandfathered as to contributions invested in the stable value products prior to the effective date of the final rule, December 24, 2007; however, it should be noted that any contributions after that date are not grandfathered. Another important point to note in the DOL’s recently issued QDIA guidance is that a plan may have more than one QDIA but each QDIA must be diversified “so as to minimize the risk of large losses.” Likewise, another important point to consider is that the final rules permit a committee that is comprised primarily of employees to manage and oversee a QDIA, provided that the committee is a “named fiduciary.” In such a case, plan documents must specify the committee’s role as a plan fiduciary and allow for in-house management of the QDIA. The final guidance also clarifies other technical rules applicable to QDIA investments and the safe harbor requirements. Therefore, a close reading of the recently issued guidance and corrections to the final regulations is recommended.
What do You Need to Do?
Defined contribution plan sponsors should examine their investment alternatives and investment policies to ensure compliance with the final rules and thereby obtain the fiduciary protection offered for default investment alternatives. In addition, plan sponsors may want to consider whether to adopt an automatic contribution arrangement as part of a 401(k) or 403(b) plan now that the rules are finalized. Previously, some employers and plan sponsors had been reluctant to initiate automatic contribution arrangements for fear of State law conflicts with wage deduction and withholding laws. However, the finalized QDIA rules specifically provide that ERISA preempts any State law that would prohibit or restrict automatic contribution arrangements, regardless of whether such arrangements actually qualify for the above-described safe harbor. Finally, an important overall comment to keep in mind is that although QDIAs give fiduciaries some much needed breathing room for default investment alternatives, the final regulations do not absolve employers and plan sponsors from their duty to prudently select and monitor QDIAs in light of the final regulatory requirements and corrections and general ERISA fiduciary duty principles.
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