Default Investments: Great Expectations
One of the sections of the Pension Protection Act (“PPA”, P.L. 109-280) believed to be most important for purposes of augmenting retirement savings, is the default investment piece. This section of the law is intended to provide a plan sponsor with some degree of relief from liability for any losses due to investment selections made on behalf of plan participants. With the demise of defined benefit plans, and arguably, the weakening of Social Security, it is more and more incumbent upon individuals to save for retirement. To this end, the law encourages employer/plan sponsors to place as many individuals in retirement plans as possible.
A defined contribution plan, including a 401(k), 403(b), and a 457 plan, can include a provision that says an eligible individual will be automatically enrolled in the plan, and money will be invested in a selection of investment options, unless the individual opts out, or actively elects his/her own investment choices. The Department of Labor (DOL) has selected this section of the PPA to issue its first set of proposed regulations, which suggests to us, how important this section of the law is to the DOL.
According to the proposed regulations, a plan fiduciary would be relieved from liability for any losses due to investment market performance, as long as certain conditions are met. It is important to remember that the plan fiduciary would not be relieved from the prudent selection and monitoring of investment choices.
Qualified Default Investment Alternatives
To be entitled to fiduciary relief, the plan would establish a qualified default investment alternative (QDIA). The QDIA would have to satisfy several criteria.
1. The QDIA must be:
- A life-cycle, or a targeted-retirement-date-fund;
- A balanced fund; or
- A professionally managed account.
In no event could the QDIA use participant money to purchase employer securities, with one exception. The exception is that participant money could be used if the employer security is listed on an index in which the default option invests.
The investment choices must be managed either by an investment manager, or a registered investment company.
2. The participant must have the right to personally invest his/her own plan assets.
3. The participant receives a notice containing the following information about the QDIA:
- A description of the circumstances under which assets in the individual account may be invested;
- A description of the QDIA including investment objectives, risk and return characteristics, and fees and expenses.
- A description of the right to direct the investment of assets to any other investment alternative under the plan without financial penalty; and
- An explanation of where the participant can obtain investment information concerning any other investment alternatives available under the plan.
The notice must be provided to the participant at least 30 days prior to the initial investment, and at least 30 days prior to the beginning of each plan year. The notice could be provided in the form of a summary plan description, a summary of material modification or similar communication.
4. The participant must be provided all investment materials, such as prospectuses, proxy voting material, and account statements.
5. A QDIA must be allowed to transfer investments, in accordance with plan terms applicable to all participants. The plan must allow transfers at least once every three months, and all transfers must be without financial penalty.
6. The QDIA must offer the opportunity to invest in a broad range of investment alternatives, with varying risk and return characteristics. The intent of this provision is to ensure that the investment alternatives allow an opportunity for reasonable investment growth. The investment alternative must allow sufficient diversification to minimize the risk of large losses.
These regulations are to become effective 60 days after they are finalized. The default election section of the PPA becomes effective January 1, 2007. The expediency with which the DOL issued these proposed regulations suggests that they will be finalized in an efficient manner. The comments from the DOL certainly indicate that there is great expectation that these regulations will encourage retirement savings.
The information contained in this Benefit Beat is not intended to be legal, accounting, or other professional advice, nor are these comments directed to specific situations.
As required by U.S. Treasury rules, we inform you that, unless expressly stated otherwise, any U.S. federal tax advice contained in this Benefit Beat is not intended or written to be used, and cannot be used, by any person for the purpose of avoiding any penalties that may be imposed by the Internal Revenue Service.