For retirement plans that permit participants to direct investment of their accounts, the choice of a default investment for participants who fail to exercise control over their accounts has long been an issue of concern. Historically, plan fiduciaries were not afforded fiduciary protection under ERISA § 404(c) unless a participant exercised actual control over his or her account. Thus, plan fiduciaries could be held liable for losses generated by default investments if a court concluded that the default investment was imprudent. In the last several years, concern over the selection of the default investment has grown as the number of plans with automatic 401(k) enrollment programs increased. Although default investments are often associated with automatic enrollment, they exist other contexts, such as with plan mergers or non-elective (e.g., profit sharing) contribution arrangements.
Proposed regulations recently issued by the Department of Labor under the Pension Protection Act of 2006 (“PPA”) offer employers a road map for creating a “qualified default investment alternative” (“QDIA”) that carries ERISA § 404(c) protection. Participants who fail to direct investment will be deemed to have exercised control over their accounts for ERISA § 404(c) purposes if the conditions of the QDIA regulations are satisfied. The QDIA can be one of three investment types – a “life cycle” or target retirement date fund, a balanced fund or a professionally managed account. There are numerous additional conditions for establishing and maintaining a QDIA, including prior and recurring notice, disclosure and diversification requirements. We cannot list all of those conditions in this short update. You should consult with your legal counsel to discuss specifics. Below we offer you a list of just a few of the items you should be thinking about now in order to implement a QDIA:
- Identify advisors that can help with the selection of the QDIA and identify the fiduciary that will make the selection of the QDIA.
- Discuss with trustee and record keeper their requirements for implementing a QDIA.
- Assess whether any fund now offered potentially qualifies as a QDIA.
- Develop a time line for implementation of a QDIA.
- Determine whether the QDIA will be used only for future contributions or also for existing balances not previously directed (and assess the ability of the existing records to identify existing balances not previously directed).
- Prepare a communications program that will inform affected (and perhaps not affected) participants about the QDIA and what amounts will be mapped over to the QDIA.
- Establish a system to inform new participants about the QDIA if they fail to direct.
- Set up system to give annual (or perhaps more frequent) notices about the QDIA.
- Determine whether any document amendments are required to implement the QDIA.
Even if you do not intend to establish a QDIA, you should still give serious consideration to the choice of default investment currently in place under your plan. To minimize their fiduciary liability exposure, plan sponsors have often chosen a conservative default investment that preserves capital, such as money market or stable value funds. One of the objectives of the PPA is to encourage plan sponsors to select default investment funds that produce long-term capital appreciation while preserving capital. In the preamble to its proposed regulations, the DOL states that when money market and stable value funds “become the exclusive investment of participants or beneficiaries, it is unlikely that the rate of return generated by those funds over time will be sufficient to generate adequate retirement savings for most participants and beneficiaries.” In our view, there are fundamental questions about the prudence of using a conservative capital preservation vehicle as a default investment alternative under a retirement plan.
Originally appeared in Dorsey's Benefits and Compensation Update