DOL Issues Regulation Changing Plan Default Investments

October 24, 2007

Summary

The U.S. Department of Labor (DOL) issued the final regulation related to Qualified Default Investment Alternatives (QDIA) on October 24, 2007 in 401(k) and other defined contribution retirement plans that permit participants to direct the investment of their accounts. The permitted types of QDIAs are life cycle, managed account options and balanced funds, but stable value and other capital preservation funds are given only short term QDIA status. The regulation provides fiduciary relief for covered plans when the participant or beneficiary does not make an affirmative investment election, provided the specified QDIA are used. The new regulation will become effective on December 24th. While these regulations apply to Employee Retirement Income Security Act of 1974 (ERISA) plans, non-ERISA plans such as 457 plans have generally viewed the principles contained in ERISA as "best practices." Recognizing that some plan sponsors adopted stable value products as their default investment prior to passage of the Pension Protection Act of 2006 (PPA) and of this final regulation, the new regulation provides a transition rule. The regulation "grandfathers" these arrangements by providing relief for contributions invested in stable value products prior to the effective date of the final rule. However, the transition rule does not provide relief for future contributions to stable value products.

Background

The PPA removed impediments to employers adopting automatic enrollment, including employer fears of legal liability for market fluctuations and the applicability of state wage withholding laws. These impediments prevented many employers from adopting automatic enrollment, or led them to invest workers' contributions in low-risk, low-return "default" investments. The PPA directed DOL to issue a regulation to assist employers in selecting default investments that best serve the retirement needs of workers who do not direct their own investments.

Summary of Qualified Default Investment Alternatives

The final regulation does not identify specific investment products — rather, it describes mechanisms for investing participant contributions. This is to ensure that an investment qualifying as a QDIA is appropriate as a single investment capable of meeting a worker's long-term retirement savings needs.

The types of QDIAs are:

1. A product with a mix of investments that takes into account the individual's age or retirement date (such as a life-cycle or targeted-retirement-date fund);
2. An investment service that allocates contributions among existing plan options to provide an asset mix that takes into account the individual's age or retirement date (such as a professionally managed account);
3. A product with a mix of investments that takes into account the characteristics of the group of employees as a whole, rather than each individual (such as a balanced fund).

Capital preservation products are also identified, but only as short-term options for the first 120 days of participation.

Elements for Safe Harbor Relief

The final regulation provides the following conditions that must be satisfied in order to obtain safe harbor relief from fiduciary liability for investment outcomes:

• Assets must be invested in a "qualified default investment alternative" as defined in the regulation.
• Participants and beneficiaries must have been given an opportunity to provide investment direction, but have not done so.
• A notice generally must be furnished to participants and beneficiaries in advance of the first investment in the QDIA and annually thereafter. The rule describes the information that must be included in the notice.
• Material, such as investment prospectuses, provided to the plan for the QDIA, must be furnished to participants and beneficiaries.
• The plan must offer a "broad range of investment alternatives" as defined in the Department's regulation under section 404(c) of ERISA.

For more information about the QDIA Regulation visit ICMA-RC's Pension Protection Act coverage under our Plan Rules Section