Choose Your Designated Hitter

On October 24, the final regulations for qualified default investment alternatives (QDIAs) under participant-directed individual account plans were published in the Federal Register after completion by the Department of Labor (DoL). Plan fiduciaries will not be liable for investment outcomes for QDIA-eligible investments to which participants are defaulted under the new guidelines (see “Safe Harbor Requirements,” page 63). Although the final regulations are much like those proposed in September of 2006, the DoL made some important changes in response to concerns raised by industry professionals and plan sponsors. 

The final DoL regulations keep the three basic default investment option types outlined in the proposed regulations (see PLANADVISER, Fall 2006): lifecycle funds that take into account an individual’s age or retirement date; professionally managed accounts that allocate an individual’s contributions among existing plan options based on age or retirement date; or a product such as a balanced fund that has a mix of investments and takes into account the characteristics of the group of employees as a whole.

The DoL also expanded the list of eligible managers of QDIAs to include plan sponsors and trustees. This, along with the broad definitions of QDIAs in the rule, allows for portfolios of funds offered in the plan selected by an adviser to the plan to qualify as a QDIA. In this instance, the plan sponsor would take on the fiduciary responsibility of managing the fund, says Bradford Campbell, Assistant Secretary for the Employee Benefit Security Administration (EBSA) at the Department of Labor. 

The DoL acknowledged that it received many comments that plan sponsors were concerned about the potential for giving the participant who asks for his money back less than what was taken out of the paycheck. So, there is now a fourth type of QDIA. The law allows for stable-value funds to be used as a short-term capital preservation option; a plan may default into this option for up to 120 days, but then must move those funds into one of the long-term QDIAs.  

One significant change in the final regulation is a transition rule by which contributions that were defaulted into stable-value funds prior to the effective date of the regulation can receive the protections accorded QDIAs. The rule limits these capital preservation investments to those that bind the plan sponsor under a contract requiring participant direction or a distributable event before funds can be moved or else a penalty will be assessed.  

Fred Reish, Managing Director and Partner of the Los Angeles-based law firm of Reish Luftman Reicher & Cohen believes the DoL got it right with the grandfather provision, saying that plan sponsors he has consulted immediately embraced long-term QDIA for new defaulted money, but didn’t want to upset their established arrangements with the existing default option.  

However, some clients are questioning whether they want to move participants who are already in a stable-value default fund, says Douglas G. Prince, Managing Director, Stifel Nicolaus & Company. If so, advisers and clients need to start addressing the problems they could have in this process and the cost to get money out of the funds.  

There are still questions about the participant notices, the first of which were required to be out by November 24. The regulation as originally proposed required notice be given to participants 30 days prior to eligibility for plan participation, but some commenters said this would not work for plans with immediate eligibility. Consequently, the final rule adds that notice may also be given 30 days prior to the initial investment into the default fund, and includes the option to provide concurrent notice in cases where 30 days prior to the initial investment is not feasible. The 30-day notice relief is conditioned on the participant being able to withdraw funds that were defaulted without penalty. 

A sample notice was released on November 15 for plan sponsors looking to satisfy the requirements of the IRS’s proposed regulations for qualified automatic contribution arrangements (QACAs) and eligible automatic contribution arrangements (EACAs). 

Prince notes sponsors and advisers are asking who is going to be responsible for sending the notices. Most assume bundled providers will take care of the notices for plans they service, but Prince said no word confirming that assumption has been received, so there is some confusion. Richard C. Delaney, Partner at PensionTrend Investment Advisers, LLC, also says there is a question of whether the recordkeeping system can distinguish between who is defaulted into a QDIA and who chose the investment on his own in order to recognize to whom to send annual notices. In many cases, recordkeepers might not have that capability, so the notices can be sent to everyone in that investment option.  

What Now? 

However, even with the revisions to the proposed regulations, there are still many questions about applicability. The DoL is currently working on a Q&A document to assist in implementing the regulations. 

According to Prince, advisers should be helping clients look at the default funds they have in place to see if they are already QDIA-eligible, find out what fund redemption fees are charged, check on limitations recordkeepers might have in administering the various provisions of the rule, and analyze the demographics of their participant groups to select the best QDIA, since the regulations stipulate that age must be considered in the selection.  

Delaney says separate educational meetings will be held on the managed funds the firm has available to participants, which generally will be the QDIAs it offers. “The only way we are really going to accomplish getting participants into QDIAs is to re-enroll everyone, start with new enrollment forms, and talk to participants about enhancements and new regulations and the PPA [Pension Protection Act],’ Delaney explains. He adds that this will give participants another chance to affirm their investments. 

“I think this will have a tremendous impact on the 401(k)—maybe more than anything else in recent history,’ Delaney noted. “It gives us a start on almost a whole new ball game on how to run and manage a 401(k) plan properly.’  

Safe Harbor Requirements 

• In order to obtain the safe harbor relief from fiduciary liability for investment outcomes, plan sponsors must satisfy the following conditions: 
• 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. A sample notice, applicable to auto-enrollment and contribution programs, was published by the IRS in November. 
• Material, such as investment prospectuses, provided to the plan for the QDIA must be furnished to participants and beneficiaries. 
• Participants and beneficiaries must have the opportunity to direct investments out of a QDIA as frequently as from other plan investments, but at least quarterly. 
• The rule limits the fees that can be imposed on participants who opt out of participation in the plan or who decide to direct their investments.  
• The plan must offer a “broad range of investment alternatives’ as defined in the DoL’s regulation under section 404(c) of ERISA.