Labor Department Issues Final Qualified Default Investment Alternative Regulations

October 24, 2007

On October 23, the Labor Department issued final regulations setting forth the standards applicable to qualified default investment alternatives ("QDIAs"). If the regulations’ requirements are satisfied, a fiduciary of a defined contribution plan that permits participants to direct investment of their accounts generally will be relieved of liability for losses experienced by participants whose account is invested in the QDIA due to the participant’s failure to elect another investment alternative.

Background. The Pension Protection Act of 2006 directed the Labor Department to issue guidance implementing fiduciary relief for QDIAs. The relief is similar to that provided to plan fiduciaries under section 404(c) of ERISA with respect to participant-directed investments. The Department issued proposed regulations in September 2006, and the final regulations adopt the proposed rules with some modifications. The rules provide a "safe harbor" form of relief, but are not the exclusive way for fiduciaries to satisfy their ERISA fiduciary duties. For example, a default investment that is not a QDIA (e.g., a "stable value" product) may be a prudent default investment, but would have to be justified under ERISA’s general standards.

Scope of Relief. Under the final rules, fiduciaries are relieved from liability for losses that are the "direct and necessary result" of investments in QDIAs. However, the regulations do not relieve plan fiduciaries from their duties to prudently select and monitor any QDIA under the plan or from any liability that results from a failure to satisfy these duties. In addition, the person who manages the QDIA may be an ERISA fiduciary, and is not relieved from fiduciary responsibility in that event.

Conditions for Relief. All of the following requirements must be satisfied for QDIA relief to apply:

     Participant Opportunity. The participant must have been provided the opportunity to direct investment of his or her account but did not.

     Notice Requirement. At least 30 days prior to plan eligibility or before the date of the first investment in a QDIA, the participant must be provided a notice that satisfies various requirements. Alternatively, if the participant is "defaulted" into the plan pursuant to the automatic contribution rules under the Pension Protection Act and is given 90 days to withdraw the contributions pursuant to Section 414(w) of the Internal Revenue Code, the notice may be provided at any time on or prior to plan eligibility. In addition, a notice must be provided at least 30 days before the commencement of each subsequent plan year. The notice generally must be in a separate document (e.g., it may not be included in the plan’s summary plan description) and must address various specified items, such as a description of when amounts will be invested in the QDIA and the fees and expenses under the QDIA.

     Provision of Materials. Materials that generally are required to be provided to participants under Section 404(c) of ERISA, such as mutual fund prospectuses, must be provided to participants invested in the QDIA.

     Ability to Transfer to Other Investments. A participant on whose behalf assets are invested in a QDIA must be permitted to transfer the assets, in whole or in part, to any other investment available under the plan, as frequently as participants who elected to invest in the fund that serves as the QDIA. In all events, transfers must be permitted at least quarterly. Importantly, there can be no penalties for such a transfer or withdrawal — including, for example, redemption fees — for 90 days following the participant’s first investment in the QDIA. Thereafter, restrictions, fees and expenses may be imposed to the extent that they are applicable to plan participants who elected to invest in the product that serves as the QDIA. 

     Broad Range of Investment Alternatives. The plan must offer a broad range of investment alternatives. The standard under section 404(c) of ERISA applies here as well. Plans that offer a variety of mutual funds or other similar types of investments generally will satisfy this standard.

     Investment Must Be a QDIA. The investment alternative must satisfy various requirements. Key requirements include:

• Subject to limited exceptions, it must not invest in securities of the plan sponsor.
• It must be managed by an ERISA investment manager, a trustee that meets specified requirements, or the plan sponsor.
• It must constitute one of the following:
  • A product or model portfolio that is diversified so as to minimize the risk of large losses and is 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. Such products and portfolios change their asset allocations and associated risk levels over time with the objective of becoming more conservative with increasing age. Examples include "life-cycle" or "targeted-retirement-date" funds or accounts.
  • A product or model portfolio that is diversified so as to minimize the risk of large losses and 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 for participants of the plan as a whole. (Note that this will require the plan sponsor or the other responsible fiduciary to make this "level of risk" determination.) For purposes of this rule, asset allocation decisions for such products and portfolios are not required to take into account the age, risk tolerances, investments or other preferences of any individual participant. An example of such a fund or portfolio is a "balanced" fund.
  • An investment management service with respect to which a fiduciary allocates the assets of a participant’s individual 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, based on the participant’s age, target retirement date or life expectancy. Such portfolios are diversified so as to minimize the risk of large losses and change their asset allocations and associated risk levels for an individual account over time with the objective of becoming more conservative. Asset allocation decisions are not required to take into account risk tolerances, investments or other preferences of any individual participant. An example of such a service is a "managed account."
  • Products that are designed to preserve principal and provide a reasonable rate of return, such as stable value funds, can be QDIAs, but only for 120 days after the participant’s first elective contribution is invested in the QDIA. In addition, such products are "grandfathered" as QDIAs with respect to amounts invested therein before the date the final regulations become effective. Thus, these types of vehicles can serve as QDIAs, but there are substantial limitations, and as a practical matter there will need to be "second" QDIAs that apply after the first 120 days if this alternative is chosen.

Effective Date/Steps for Plan Sponsors. The final regulations become effective on December 23, 2007. In recent years, many plan sponsors have changed their default investments to alternatives that should qualify as QDIAs, and away from stable value, money market and other products. Plan sponsors should review their default investment alternatives and, if they decide to comply with the conditions for QDIA relief, ascertain that the investments meet the requirements to qualify as QDIAs and distribute required participant notices.