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Compensation Planning & Employee Benefits

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Final Regulation Issued Concerning Protection of Trustees and Other Plan Fiduciaries in Connection with Default Investment Funds

November 2007

The Department of Labor has issued a final regulation, effective on December 24, 2007, that offers important protection to fiduciaries with respect to default investment funds. The final regulation allows, for the first time, a trustee or other fiduciary of an individual account plan that permits participants to select investments not to be liable with respect to the investments in a “qualified default investment alternative” or QDIA. Previously, there was no such insulation from fiduciary liability with respect to a default investment fund. It is very important to note that a fiduciary who has responsibility for selecting and monitoring a QDIA remains liable if the selection and retention of the qualified default investment alternative is, itself, a breach of fiduciary duty. That is, the fiduciary must be prudent when selecting and monitoring the performance of the QDIA.

A plan is not required to avail itself of the fiduciary protection offered by the regulation. If the plan does not, fiduciaries will be in the same position as they were before the regulation takes effect: they will have fiduciary liability as though they had chosen the investments of the default fund themselves. We presume that most plans and plan fiduciaries will wish to protect themselves by conforming to the regulation’s rules.

In order to qualify from relief from fiduciary liability, the following conditions must be met:

  1. The default fund must be a QDIA.
  2. The participant or beneficiary, having had the opportunity to select the investment of the assets in his or her plan account, must not have done so in whole or in part.
  3. Certain notice rules must be met. With respect to a plan that does not have automatic enrollment, a notice must be given at least 30 days before the participant is eligible to participate in the plan or at least 30 days before the first investment in the qualified default investment alternative. With respect to a plan that has automatic 401(k) enrollment that meets certain requirements, the notice must be given on or before the date on which the participant becomes eligible to participate. In addition, a notice must be given to participants and beneficiaries at least 30 days before the beginning of each plan year. The notice must be a separate notice and not part of a summary plan description or summary of material modifications.
  4. Certain materials, specified in the regulation, must be provided to the participant or beneficiary regarding the default investment feature, the right to select investments, a description of the QDIA, the right to select other investment alternatives, and where additional information may be obtained about other investment alternatives.
  5. The participant or beneficiary must be permitted to transfer QDIA assets to other investment alternatives under the plan with the same frequency that he or she can change investments if he or she had chosen to invest in the QDIA, but not less frequently than once in any three-month period. There is also a restriction on imposing penalties, such as surrendered charges, liquidation or exchange fees, redemption fees and similar expenses charged in connection with the liquidation of, or transfer from the QDIA, within 90 days of the first investment in the QDIA, or in the case of an automatic enrollment 401(k) plan, within 90 days of the first 401(k) contribution.
  6. The plan must offer a broad range of investment alternatives from which a participant or beneficiary can select.

The regulation imposes significant restrictions on what default investment alternative will constitute a QDIA.

  1. With some exceptions, a QDIA cannot acquire or hold securities of the plan sponsor and affiliates.
  2. The participant or beneficiary must have the ability to move funds out of the QDIA, as described above.
  3. The QDIA must be managed by a professional investment advisor who meets certain requirements of the Employee Retirement Income Security Act of 1974 (ERISA), a trustee that meets certain requirements of ERISA or the plan sponsor who is a “named fiduciary” under ERISA. Alternatively, the QDIA must be an investment company registered under the Investment Company Act of 1940 (such as a mutual fund) or certain investment products for funds described in paragraphs 4(d) and (e) below.
  4. The QDIA must:
    1. Be a fund product or model portfolio that, applying accepted investment theories, provides a diversified investment portfolio designed to provide varying degrees of long-term appreciation and capital preservation based on a participant’s age, target retirement date or life expectancy. An example of such a fund or portfolio is a “life-cycle” or “targeted-retirement-date” fund.
    2. An investment fund product or model portfolio that, applying accepted investment theories, provides a diversified investment portfolio designed to provide long-term appreciation and capital preservation with a target level of risk appropriate for participants and beneficiaries in the plan as a whole. An example is a “balanced” fund.
    3. An investment management service with respect to which a fiduciary, applying generally accepted investment theories, allocates the assets of participants’ individual accounts to achieve varying degrees of long-term appreciation and capital preservation through a diversified portfolio based on the participant’s age, target retirement date, or life expectancy. An example is a “managed account.”
    4. Available only for the first 120 days after a 401(k) contribution is made, is a state- or federally- regulated financial institution that has an investment product or fund designed to preserve principal and provide a reasonable rate of return. This QDIA is available only with respect to certain 401(k) plans that provide for automatic enrollment in 401(k) contributions. An example is a money market fund.
    5. With respect only to assets invested prior to December 24, 2007, an investment product or fund designed to guarantee principal and a rate of return generally consistent with that earned on intermediate investment grade bonds, with certain other conditions. An example is a guaranteed income fund or GIC.

It is very important to note that while a plan may offer investment alternatives in money market funds, stable value products and other capital preservation investment vehicles, such investment alternatives generally will not qualify as a QDIA, except in limited circumstances described in paragraphs 4(d) and (e) above. We are aware that many plans have used default investment funds in these categories that will not generally qualify as QDIAs under the final regulation.

Because the final regulation is effective on December 24, 2007, and many plans have a calendar year plan year, plan sponsors and fiduciaries should consult immediately with their investment service providers to obtain the appropriate notices to provide plan participants and beneficiaries.

If you have any questions, please contact a member of our Compensation Planning & Employee Benefits Group.