CUNA Regulatory Comment Call
October 25, 2006
Default Investments for Automatic Enrollment in 401(k) Plans
- The U.S. Department of Labors (DOLs) Employee Benefits Security Administration has issued proposed regulations implementing the provisions of the Pension Protection Act of 2006 (Act) that would make it easier for fiduciaries of 401(k) plans and other participant-directed defined contribution (retirement) plans to adopt automatic enrollment and default investment plan design features. This proposal would apply to credit union sponsors of 401(k) plans.
- Under the proposed regulation, a fiduciary would not be liable for any loss as a result of automatically investing a participants account in a qualified default investment alternative (QDIA is defined in the proposal), provided certain conditions are met. The fiduciary, however, would remain liable for the selection and monitoring of a QDIA.
- These rules will apply not only in situations involving 401(k) plans with automatic enrollment features, but also in cases where investments are added or eliminated in conjunction with a change in service provider.
- The aim of the Act and the proposal is to boost participation in retirement savings plans. DOL estimates that the proposal will increase aggregate 401(k) plan account balances by between $45 billion and $90 billion.
- DOL anticipates that the proposed regulations will have two major economic consequences. First, default investment will be directed toward higher-return instruments raising average account performance and automatic enrollment provisions will become more common, increasing plan participation. Second, it is possible that the proposed regulation will have additional indirect consequences which could affect future retirement income levels.
- The DOL is required under the Act to finalize the proposed regulations by February 17, 2007. The final regulations will take effect 60 days after they are published in the Federal Register.
- Comments are due to the DOL by November 13, 2006. Please send your comments to CUNA by November 3, 2006. Please feel free to fax your responses to CUNA at 202-638-7052; e-mail them to Deputy General Counsel Mary Dunn at email@example.com or to Senior Regulatory Counsel Catherine Orr at firstname.lastname@example.org; or mail them to Mary or Catherine in c/o CUNA's Regulatory Advocacy Department, 601 Pennsylvania Avenue, NW, 6th Floor - South Building, Washington, DC 20004. You may also contact us at 800-356-9655, ext. 6743, if you would like a copy of the proposed rule, or you may access it here.
- Under the Employee Retirement Income Security Act of 1974 (ERISA), a plan fiduciary who invests plan assets on behalf of plan participants and beneficiaries may be held liable for investment losses incurred as a result of its investment decisions, if those decisions are found to be imprudent or otherwise in violation of ERISAs fiduciary standards.
- Under current law, fiduciaries of individual account plans are relieved of this potential liability if the investment is made at the direction of the participant or beneficiary and the plan meets certain other requirements. The Act amended ERISA to extend this relief to investments in default funds on behalf of participants and beneficiaries who fail to provide investment direction. The Act also directed the DOL to publish regulations implementing this relief.
DESCRIPTION OF THE PROPOSAL
Conditions for Fiduciary Relief
- The proposed regulations establish a safe harbor under which a participant or beneficiary who does not provide investment directions with respect to their account will be deemed to have exercised investment control over the account. If certain requirements are met, plan fiduciaries will not be liable for any investment loss resulting from such investment.
- The proposal establishes the following conditions for fiduciary relief:
- The assets invested on behalf of the participant or beneficiary must be invested in a QDIA.
- There are five requirements for a QDIA:
(1) A QDIA may not impose financial penalties or otherwise restrict the ability to transfer investments from one investment alternative to any other investment.
(2) A QDIA must either be managed by an investment manager or a registered investment company.
(3) A QDIA must be diversified in order to minimize the risk of large losses.
(4) A QDIA must not invest participant contributions directly in employer securities. (The QDIA may not be nor include employer securities unless held in a mutual fund or other regulated pooled investment vehicle pursuant to stated investment objectives and independent of the plan sponsor. In addition, if the QDIA is a managed account, it may include employer securities acquired as a matching contribution or acquired prior to management of the account by the investment management service.)
(5) In terms of investment characteristics, the QDIA must be either:
- An investment fund product or model portfolio that provides varying degrees of long-term appreciation and capital preservation through a mix of equity and fixed income exposures based on the participants age, target retirement date (which may be the plans normal retirement date) or life expectancy, e.g., a life-cycle or target retirement approach. Asset allocation decisions may be based only on age and need not take into account any other participant-specific characteristics. The investment fund product or model portfolio may be a fund of funds or a stand-alone vehicle; or
- An investment fund product or model portfolio (a fund of funds or stand-alone vehicle) of diversified exposures with a target level of risk exposure appropriate for the participant population as a whole, e.g., a balanced fund approach. Asset allocation decisions may be based on the demographics of the participant population as a whole (which may change over time, leading the plan fiduciary to change or add to its selection of the QDIA), and need not take into account any participant-specific characteristics; or
- An investment management service under which the investment manager allocates the participants account among diversified exposures based on the participants age, target retirement date or life expectancy, e.g., an age-based managed account approach. Asset allocation decisions may be based solely on age and need not take into account of any other participant-specific characteristics.
Opportunity to Make Investment Instruction
- Participants and beneficiaries must have been given the opportunity to provide investment direction, but failed to do so.
- A notice must be furnished to participants and beneficiaries at least 30 days in advance of the first investment into the QDIA (initial notice), and at least 30 days in advance of each subsequent plan year (annual notice).
- The notice may be furnished in a summary plan description, summary of material modifications, or a separate communication.
- The notice must be written in a manner calculated to be understood by the average plan
participant and explain:
- The circumstances under which assets will be invested in a QDIA.
- The investment objectives, risk and return characteristics, and fees and expenses of the QDIA.
- The rights of the participants and beneficiaries to make transfers out of the QDIA.
- Where participants and beneficiaries may obtain information on the other investment alternatives available under the plan.
QDIA Materials Furnished to Participants and Beneficiaries
- Any materials provided to the plan by the QDIA (e.g., statements, prospectuses, proxy materials) must be provided to participants and beneficiaries.
Frequency of Transfers Out of the QDIA
- Participants and beneficiaries must have the opportunity to make transfers out of the QDIA with the same frequency that transfers are available with respect to other plan investments, but no less frequently than quarterly, and without financial penalty.
- The plan must satisfy the broad range of investment alternatives requirement applicable to ERISA 404(c) plans. Generally, this requirement will be satisfied if the plan offers at least three investment alternatives that are diversified and have materially different risk and return characteristics. A plan need not otherwise meet the requirements applicable to 404(c) plans to take advantage of the QDIA relief.
- The Act amends ERISA to provide for civil penalties of up to $1,100 a day for each violation.
- Implementing regulations will be developed in a separate rulemaking by DOL.