On September 27, 2006, the Department of Labor (“DOL”) issued proposed regulations implementing provisions of the recently enacted Pension Protection Act of 2006 (“PPA”) relating to default investment of plan assets in individual account plans (e.g., Internal Revenue Code section 401(k) plans). The proposed rules shield fiduciaries of individual account plans from liability for automatic enrollment and default investment plan design features, provided the safe harbor conditions are met.
PPA section 624(a) amended the Employee Retirement Income Security Act of 1974 (“ERISA”) by adding Section 404(c)(5), under which a participant who had the opportunity but does not provide investment directions is treated as exercising control over his or her account with respect to assets that the plan invests in a qualified default investment alternative (“QDIA”). When it was enacted on August 17, 2006, the PPA directed the Department of Labor to issue default investment regulations. This article provides a summary of the proposed regulations.
Scope of Fiduciary Relief
The regulations provide that a fiduciary of an individual account plan that allows participants to direct the investment of assets in their accounts is not liable for any loss that is the direct and necessary result of investing all or part of a participant’s or beneficiary’s account in a QDIA. Further, fiduciaries are not liable for investment decisions in connection with the management of a QDIA.
Nevertheless, the proposed regulations do not relieve fiduciaries from their duties to prudently select and monitor a QDIA or from liability resulting from a failure to satisfy these duties, including liability for any resulting losses. Additionally, investment managers are not relieved from their fiduciary duties under ERISA or from liability for failing to satisfy these duties.
The proposed regulation also does not provide relief from the prohibited transaction provisions of ERISA section 406 or from any liability for violating those provisions.
Plan Fiduciary’s Required Actions
In order to qualify for fiduciary relief under the proposed regulations, a plan fiduciary must take the following actions:
- Invest assets in a QDIA;
- Provide affected participants and beneficiaries an opportunity to direct the investment of assets in their accounts;
- Furnish affected participants and beneficiaries with a notice at least 30 days in advance of the first investment and within a reasonable period of time of at least 30 days in advance of each subsequent plan year;
- Give affected participants and beneficiaries any material provided to the plan relating to their investments in a QDIA (e.g., account statements, prospectuses and proxy voting materials);
- Provide affected participants and beneficiaries the opportunity, consistent with the plan’s terms (but not less frequently than once within a three month period), to transfer assets to any other investment alternative available under the plan without financial penalty; and
- Offer a “broad range of investment alternatives” as defined by 29 CFR §2550.404(c)-1(b)(3).
Notice Requirements
The notice must be written in a manner calculated to be understood by the average plan participant. It can be provided in the plan’s summary plan description, summary of material modifications, or a separate notification. The notice must contain the following information:
- A description of the circumstances under which assets in the individual account of an affected participant or beneficiary may be invested in a QDIA;
- A description of the QDIA, including a description of the investment objectives, risk and return characteristics (if applicable) and fees and expenses;
- A description of the affected participants’ and beneficiaries’ rights to direct investment of those assets to any other investment alternative under the plan without financial penalty; and
- An explanation of where affected participants and beneficiaries can obtain investment information concerning the other investment alternatives under the plan.
In its proposal overview, the DOL noted that similar notice requirements are contained in Section 401(k)(13)(E) of the Internal Revenue Code, and that it anticipates that both notice requirements could be satisfied in a single notice.
Qualified Default Investment Alternatives
To be considered a QDIA, five requirements must be satisfied under the proposed regulations:
- The investment alternative must not hold or permit the acquisition of employer securities, with two exceptions. The first exception applies to securities held or acquired by an investment company registered under the Investment Company Act of 1940, or by a similar pooled investment vehicle regulated by a state or federal agency and independent of the plan sponsor. Employer securities acquired as a matching contribution from the employer or plan sponsor or acquired prior to management by the investment management service are the second exception to this prohibition.
- A QDIA also must not impose financial penalties or otherwise restrict an affected participant’s or beneficiary’s ability to transfer his or her investment to any other investment alternative under the plan.
- A QDIA must be managed by an investment manager as defined in Section 3(38) of ERISA or by an investment company registered under the Investment Company Act of 1940.
- A QDIA must be diversified as to minimize the risk of large losses.
- The QDIA must constitute one of the three types of investment products described below.
Permissible Types of Investment Products
- A life-cycle or targeted-retirement-date fund or account, 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. These products change their asset allocations and risk levels over time to become more conservative with increasing age. Asset allocation decisions are not required to take into account risk tolerances, investments or an individual participant’s preferences.
- A balanced fund 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 to the plan participants as a whole. Asset allocation decisions are not required to take into account the age, risk tolerances, investments or other preferences of an individual participant.
- An investment fund management service, which allocates assets to an affected participant’s or beneficiary’s 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, these allocations are based on the participant’s age, target retirement date or life expectancy. Like the life-cycle or targeted-retirement- date fund, the asset allocation of the investment fund management service is not required to take into account risk tolerances, investments or an individual participant’s preferences.The DOL noted in its proposal overview that although the fiduciary relief provided is conditioned on the use of certain investment alternatives, the limitations “should not be construed to indicate that the use of investment alternatives not identified in the proposed regulation” as QDIAs would be imprudent. Investments in money market funds and stable value products, for example, may be prudent for some participants or beneficiaries, according to the Department.
