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DOL Issues Final 401(k) Default Rules
Stable-value funds excluded, but 'grandfathered' 

By Stephen Miller and Allen Smith  10/24/2007

On Oct. 23, U.S. Secretary of Labor Elaine L. Chao unveiled a final rule establishing "safe harbor" qualified default investment alternatives (QDIAs), making it easier for employers to automatically enroll workers in their 401(k) and other defined contribution plans. (The DOL also created this fact sheet regarding the rule, and the Employee Benefit Research Institute issued its own information sheet .)

The final rule was published in the Oct. 24, 2007, edition of the Federal Register and takes effect 60 days after that date.

The regulation, which resulted from the Pension Protection Act (PPA), is projected to increase retirement savings in 401(k)-type plans by as much as $134 billion by 2034. The rule implements PPA provisions providing relief to plan fiduciaries who invest the assets of participants who do not provide investment direction (such as automatically enrolled workers).

The QDIAs described in the rule are intended to encourage the investment of employee assets in investment vehicles appropriate for long-term retirement savings.

Three Options

The regulation sanctions as default investments these three options:

    • Target-date (or "lifecycle") funds, which have asset allocations that shift gradually over time, based on an investor's age.

    • Balanced funds, which typically have a fixed blend of stocks and bonds.

    • Professionally managed accounts, a diversified portfolio of funds managed by an outside adviser.

While the final rule provides limited protection from employee lawsuits based on the performance of the default funds, it does not absolve fiduciaries of the duty to prudently select and monitor the investments they choose even if they fall within the QDIA safe harbor.

Toni Pilzner

SHRM Video 
Default Investment Options

Toni Pilzner, ERISA attorney with Butzel Long, on practicing due diligence when selecting default investments.
-- View this video


Left Out: Stable Value Funds

Roughly two-thirds of 401(k) plans offer stable-value funds as an investment option, according to the Stable Value Investment Association. Stable-value funds generally pay returns that are just a few percentage points higher than the average money market fund, but with no risk to the invested capital.

The insurance industry (the primary vendor of stable-value funds) and some employer groups had lobbied hard for the inclusion of these funds as a QDIA option. But others had argued that employers might feel pressured to then select stable-value funds as their plan's automatic default, since it would be perceived as the "safest" option (albeit one with the lowest long-term potential for capital growth).

'Grandfathered' Relief for Stable-Value Default Investments
About 11 percent of 401(k) assets are invested in stable-value funds or similar guaranteed investment contracts. That amounts to roughly $300 billion, according to a recent study by the Investment Company Institute and the Employee Benefit Research Institute.

Recognizing that many automatic enrollment 401(k) plans have used stable-value funds or money market funds as their default option, the Labor Department said employers who defaulted workers' investments into stable-value funds prior to the new regulation going into effect will get legal protections against being sued for having put their employees into an investment that some now say isn't a suitable long-term retirement savings option. That is, plans apparently can keep any money invested in stable-value funds by default before the effective date of the final rule in the stable-value funds. The transition rule, however, does not provide relief for future contributions to stable-value products.

Long-Term Savings

“The new default options will be an essential element in the success of automatic enrollment plans to help workers achieve retirement security,” said Assistant Secretary of Labor Bradford P. Campbell. “This regulation will ensure that workers in qualified default alternatives are automatically invested in a mix of fixed income, equity and other assets appropriate for long-term retirement savings.”

Notice and Opt-Out Requirements
Other key provisions in the final QDIA rule of which HR professionals and benefit managers should take note include new requirements that:

    • The annual participant notice of fund defaults can no longer simply be included in the annual summary plan description (SPD), and instead must be provided to participants separately in an effort to reduce the likelihood that it will be overlooked.

    • The opportunity for participants to opt-out of automatic enrollment and retrieve their defaulted monies from the plan must be without penalty. Any fund that imposes a redemption fee within the first 90 days of investing will not qualify as a QDIA, according to the DOL.

The DOL explained in the preamble to the final rule that there must be a separate annual notice of fund defaults because a separate notice "will reduce the likelihood of a participant or beneficiary missing or ignoring information about his or her plan participation and the investment of his or her assets."

Paul Hamburger, an attorney with McDermott Will & Emery in Washington, D.C., told SHRM Online that he found the DOL's explanation for why the annual notice of fund defaults must be separate "astounding." He said that it is "almost an implicit acknowledgment that no one reads the SPD" and points to a larger "fault in the whole system" of notices.

But Hamburger said the DOL provided employers with a helpful example of how to provide an initial notice if it is not possible to provide an initial notice at least 30 days in advance of plan eligibility. In these circumstances, "the fiduciary may obtain relief for later contributions with respect to which the 30-day advance notice requirement is satisfied," the DOL explained in the regulations' preamble. The preamble essentially says "'here's another way to do this that will work,' which is unusual," Hamburger remarked. He recommended that plan administrators familiarize themselves with the final rule's preamble, which he said "is almost more valuable than the regulation."

The final rule also prohibits fees during the first 90 days of a defaulted participant's or beneficiary's investment in a QDIA. Steven Friedman, an attorney with Littler Mendelson in New York, described the QDIA final rule's fee provisions as a harbinger of much more regulation of 401(k) fees in the future. He said employers consequently should ensure that:

    Employees have appropriate disclosures about fees.

    Employers pay for products appropriate for their employees and do not pay too much.

The final rule's 90-day prohibition on fees does not, however, apply to expenses that are charged on an ongoing basis to operate the investment (e.g., investment management fees, distribution and/or service or so-called "12b-1" fees) or administrative-type fees (e.g., for legal, accounting, transfer agent expenses).

-- Allen Smith

Stephen Miller is manager of SHRM Online’s Benefits Discipline. Allen Smith, J.D., is manager of SHRM Online’s Legal Issues.

Related Articles:

DOL Issues Technical Corrections, Guidance for Default Investment Rule, SHRM Online Benefits Discipline, May 2008

Study Supports Use of 'Lifestyle' Type FundsSHRM Online  Benefits Discipline, October 2007

Hitting the Target with Target-Date Funds, SHRM Online Compensation & Benefits Focus Area, August 2007

All Lifecycle Funds Are Not Created Equal: How to Choose Wisely, SHRM Online Benefits Discipline, February 2007

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