Default Investment Alternatives Under Participant Directed Individual
Account Plans; Final Rule
[10/24/2007]
Volume 72, Number 205, Page 60451-60480
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[Federal Register: October 24, 2007 (Volume 72, Number 205)]
[Rules and Regulations]
[Page 60451-60480]
From the Federal Register Online via GPO Access [wais.access.gpo.gov]
[DOCID:fr24oc07-22]
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Part III
Department of Labor
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Employee Benefits Security Administration
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29 CFR Part 2550
Default Investment Alternatives Under Participant Directed Individual
Account Plans; Final Rule
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DEPARTMENT OF LABOR
Employee Benefits Security Administration
29 CFR Part 2550
RIN 1210-AB10
Default Investment Alternatives Under Participant Directed
Individual Account Plans
AGENCY: Employee Benefits Security Administration.
ACTION: Final rule.
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SUMMARY: This document contains a final regulation that implements
recent amendments to title I of the Employee Retirement Income Security
Act of 1974 (ERISA) enacted as part of the Pension Protection Act of
2006, Public Law 109-280, under which a participant in a participant
directed individual account pension plan will be deemed to have
exercised control over assets in his or her account if, in the absence
of investment directions from the participant, the plan invests in a
qualified default investment alternative. A fiduciary of a plan that
complies with this final regulation will not be liable for any loss, or
by reason of any breach, that occurs as a result of such investments.
This regulation describes the types of investments that qualify as
default investment alternatives under section 404(c)(5) of ERISA. Plan
fiduciaries remain responsible for the prudent selection and monitoring
of the qualified default investment alternative. The regulation
conditions relief upon advance notice to participants and beneficiaries
describing the circumstances under which contributions or other assets
will be invested on their behalf in a qualified default investment
alternative, the investment objectives of the qualified default
investment alternative, and the right of participants and beneficiaries
to direct investments out of the qualified default investment
alternative. This regulation will affect plan sponsors and fiduciaries
of participant directed individual account plans, the participants and
beneficiaries in such plans, and the service providers to such plans.
DATES: This final rule is effective on December 24, 2007.
FOR FURTHER INFORMATION CONTACT: Lisa M. Alexander, Kristen L. Zarenko,
or Katherine D. Lewis, Office of Regulations and Interpretations,
Employee Benefits Security Administration, (202) 693-8500. This is not
a toll-free number.
SUPPLEMENTARY INFORMATION:
A. Background
With the enactment of the Pension Protection Act of 2006 (Pension
Protection Act), section 404(c) of ERISA was amended to provide relief
afforded by section 404(c)(1) to fiduciaries that invest participant
assets in certain types of default investment alternatives in the
absence of participant investment direction. Specifically, section
624(a) of the Pension Protection Act added a new section 404(c)(5) to
ERISA. Section 404(c)(5)(A) of ERISA provides that, for purposes of
section 404(c)(1) of ERISA, a participant in an individual account plan
shall be treated as exercising control over the assets in the account
with respect to the amount of contributions and earnings which, in the
absence of an investment election by the participant, are invested by
the plan in accordance with regulations prescribed by the Secretary of
Labor. Section 624(a) of the Pension Protection Act directed that such
regulations provide guidance on the appropriateness of designating
default investments that include a mix of asset classes consistent with
capital preservation or long-term capital appreciation, or a blend of
both. In the Department's view, this statutory language provides the
stated relief to fiduciaries of any participant directed individual
account plan that complies with its terms and with those of the
Department's regulation under section 404(c)(5) of ERISA. The relief
afforded by section 404(c)(5), therefore, is not contingent on a plan
being an ``ERISA 404(c) plan'' or otherwise meeting the requirements of
the Department's regulations at Sec. 2550.404c-1. The amendments made
by section 624 of the Pension Protection Act apply to plan years
beginning after December 31, 2006.
On September 27, 2006, the Department, exercising its authority
under section 505 of ERISA and consistent with section 624 of the
Pension Protection Act, published a notice of proposed rulemaking in
the Federal Register (71 FR 56806) that, upon adoption, would implement
the provisions of ERISA section 404(c)(5). The notice included an
invitation to interested persons to comment on the proposal. In
response to this invitation, the Department received over 120 written
comments from a variety of parties, including plan sponsors and
fiduciaries, plan service providers, financial institutions, and
employee benefit plan industry representatives. Submissions are
available for review under Public Comments on the Laws & Regulations
page of the Department's Employee Benefits Security Administration Web
site at http://www.dol.gov/ebsa.
Set forth below is an overview of the final regulation, along with
a discussion of the public comments received on the proposal.
B. Overview of Final Rule
Scope of the Fiduciary Relief
Paragraph (a)(1) of Sec. 2550.404c-5, like the proposal, generally
describes the scope of the regulation and the fiduciary relief afforded
by ERISA section 404(c)(5), under which a participant who does not give
investment directions will be treated as exercising control over his or
her account with respect to assets that the plan invests in a qualified
default investment alternative. Paragraph (a)(2) of Sec. 2550.404c-5,
also like the proposal, makes clear that the standards set forth in the
regulation apply solely for purposes of determining whether a fiduciary
meets the requirements of the regulation. These standards are not
intended to be the exclusive means by which a fiduciary might satisfy
his or her responsibilities under ERISA with respect to the investment
of assets on behalf of a participant or beneficiary in an individual
account plan who fails to give investment directions. As recognized by
the Department in the preamble to the proposal, investments in money
market funds, stable value products and other capital preservation
investment vehicles may be prudent for some participants or
beneficiaries even though such investments themselves may not generally
constitute qualified default investment alternatives for purposes of
the regulation. The Department further notes that such investments,
while not themselves qualified default investment alternatives for
purposes of investments made following the effective date of this
regulation, may nonetheless constitute part of the investment portfolio
of a qualified default investment alternative.
Paragraph (b) of Sec. 2550.404c-5 defines the scope of the
fiduciary relief provided. Paragraph (b)(1) of the proposal provided
that, subject to certain exceptions, a fiduciary of an individual
account plan that permits participants and beneficiaries to direct the
investment of assets in their accounts and that meets the conditions of
the regulation, as set forth in paragraph (c) of Sec. 2550.404c-5,
shall not be liable for any loss, or by reason of any breach under part
4 of title I of ERISA, that is the direct and necessary result of
investing all or part of a
[[Page 60453]]
participant's or beneficiary's account in a qualified default
investment alternative, or of investment decisions made by the entity
described in paragraph (e)(3) in connection with the management of a
qualified default investment alternative. The Department has revised
paragraph (b)(1) of the final regulation to clarify that a fiduciary of
an individual account plan that permits participants and beneficiaries
to direct the investment of assets in their accounts and that meets the
conditions of the regulation, as set forth in paragraph (c) of Sec.
2550.404c-5, shall not be liable for any loss under part 4 of title I,
or by reason of any breach, that is the direct and necessary result of
investing all or part of a participant's or beneficiary's account in
any qualified default investment alternative within the meaning of
paragraph (e), or of investment decisions made by the entity described
in paragraph (e)(3) in connection with the management of a qualified
default investment alternative. The phrase ``any qualified default
investment alternative'' in the final regulation is intended to make
clear that a fiduciary will be afforded relief without regard to which
type of qualified default investment alternative the fiduciary selects,
provided that the fiduciary prudently selects the particular product,
portfolio or service, and meets the other conditions of the regulation.
Some commenters asked whether the relief provided by the final
regulation covers a plan fiduciary's decision regarding which of the
qualified default investment alternatives will be available to a plan's
participants and beneficiaries who fail to direct their investments. As
long as a plan fiduciary selects any of the qualified default
investment alternatives, and otherwise complies with the conditions of
the rule, the plan fiduciary will obtain the fiduciary relief described
in the rule. The Department believes that each of these qualified
default investment alternatives is appropriate for participants and
beneficiaries who fail to provide investment direction; accordingly,
the rule does not require a plan fiduciary to undertake an evaluation
as to which of the qualified default investment alternatives provided
for in the regulation is the most prudent for a participant or the
plan. However, the plan fiduciary must prudently select and monitor an
investment fund, model portfolio, or investment management service
within any category of qualified default investment alternatives in
accordance with ERISA's general fiduciary rules. For example, a plan
fiduciary that chooses an investment management service that is
intended to comply with paragraph (e)(4)(iii) of the final regulation
must undertake a careful evaluation to prudently select among different
investment management services.
Application of General Fiduciary Standards
The scope of fiduciary relief provided by this regulation is the
same as that extended to plan fiduciaries under ERISA section
404(c)(1)(B) in connection with carrying out investment directions of
plan participants and beneficiaries in an ``ERISA section 404(c) plan''
as described in 29 CFR 2550.404c-1(a), although it is not necessary for
a plan to be an ERISA section 404(c) plan in order for the fiduciary to
obtain the relief accorded by this regulation. As with section
404(c)(1) of the Act and the regulation issued thereunder (29 CFR
2550.404c-1), the final regulation does not provide relief from the
general fiduciary rules applicable to the selection and monitoring of a
particular qualified default investment alternative or from any
liability that results from a failure to satisfy these duties,
including liability for any resulting losses. See paragraph (b)(2) of
Sec. 2550.404c-5.
Several commenters asked the Department to provide additional
guidance concerning the general fiduciary obligations of these plan
fiduciaries in selecting a qualified default investment alternative.
The selection of a particular qualified default investment alternative
(i.e. a specific product, portfolio or service) is a fiduciary act and,
therefore, ERISA obligates fiduciaries to act prudently and solely in
the interest of the plan's participants and beneficiaries. A fiduciary
must engage in an objective, thorough, and analytical process that
involves consideration of the quality of competing providers and
investment products, as appropriate. As with other investment
alternatives made available under the plan, fiduciaries must carefully
consider investment fees and expenses when choosing a qualified default
investment alternative. See paragraph (b)(2) of Sec. 2550.404c-5.
Paragraph (b)(3) of the final regulation has been modified to
reflect changes to paragraph (e)(3)(i) regarding persons responsible
for the management of a qualified default investment alternative's
assets. Paragraph (b)(3) of Sec. 2550.404c-5 makes clear that nothing
in the regulation relieves any such fiduciaries from their general
fiduciary duties or from any liability that results from a failure to
satisfy these duties, including liability for any resulting losses. As
proposed, paragraph (b)(3) was limited to investment managers. The
final regulation, at paragraph (e)(3)(i) of Sec. 2550.404c-5, broadens
the category of persons who can manage the assets of a qualified
default investment alternative, thereby requiring a conforming change
to paragraph (b)(3). The changes to paragraph (e)(3)(i) are discussed
in detail below.
Finally, the regulation also provides no relief from the prohibited
transaction provisions of section 406 of ERISA or from any liability
that results from a violation of those provisions, including liability
for any resulting losses. Therefore, plan fiduciaries must avoid self-
dealing, conflicts of interest, and other improper influences when
selecting a qualified default investment alternative. See paragraph
(b)(4) of Sec. 2550.404c-5.
Application of Final Rule to Circumstances Other Than Automatic
Enrollment
Several commenters requested clarification on the extent to which
the fiduciary relief provided by the final regulation will be available
to plan fiduciaries for assets that are invested in a qualified default
investment alternative on behalf of participants and beneficiaries in
circumstances other than automatic enrollment. Consistent with the
views expressed concerning the scope of the relief provided by the
proposed regulation, it is the view of the Department that nothing in
the final regulation limits the application of the fiduciary relief to
investments made only on behalf of participants who are automatically
enrolled in their plan. Like the proposal, the final regulation applies
to situations beyond automatic enrollment. Examples of such situations
include: The failure of a participant or beneficiary to provide
investment direction following the elimination of an investment
alternative or a change in service provider, the failure of a
participant or beneficiary to provide investment instruction following
a rollover from another plan, and any other failure of a participant to
provide investment instruction. Whenever a participant or beneficiary
has the opportunity to direct the investment of assets in his or her
account, but does not direct the investment of such assets, plan
fiduciaries may avail themselves of the relief provided by this final
regulation, so long as all of its conditions have been satisfied.
Conditions for the Fiduciary Relief
Like the proposal, the final regulation contains six conditions for
relief. These
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conditions are set forth in paragraph (c) of the regulation.
The first condition of the final regulation, consistent with the
Department's proposal, requires that assets invested on behalf of
participants or beneficiaries under the final regulation be invested in
a ``qualified default investment alternative.'' See Sec. 2550.404c-
5(c)(1). This condition is unchanged from the proposal.
The second condition also is unchanged from the proposal. The
participant or beneficiary on whose behalf assets are being invested in
a qualified default investment alternative must have had the
opportunity to direct the investment of assets in his or her account
but did not direct the investment of the assets. See Sec. 2550.404c-
5(c)(2). In other words, no relief is available when a participant or
beneficiary has provided affirmative investment direction concerning
the assets invested on the participant's or beneficiary's behalf.
The third condition continues to require that participants or
beneficiaries receive information concerning the investments that may
be made on their behalf. As in the proposal, the final regulation
requires both an initial notice and an annual notice. The proposed
regulation required an initial notice within a reasonable period of
time of at least 30 days in advance of the first investment. A number
of commenters explained that requiring 30 days' advance notice would
preclude plans with immediate eligibility and automatic enrollment from
withholding of contributions as of the first pay period. Commenters
argued that plan sponsors should not be discouraged from enrolling
employees in their plan on the earliest possible date.
The Department agrees that plan sponsors should not be discouraged
from enrolling employees on the earliest possible date. To address this
issue, the Department has modified the advance notice requirements that
appeared in the proposed regulation. For purposes of the initial
notification requirement, the final regulation, at paragraph (c)(3)(i),
provides that the notice must be provided (A) at least 30 days in
advance of the date of plan eligibility, or at least 30 days in advance
of any first investment in a qualified default investment alternative
on behalf of a participant or beneficiary described in paragraph
(c)(2), or (B) on or before the date of plan eligibility, provided the
participant has the opportunity to make a permissible withdrawal (as
determined under section 414(w) of the Internal Revenue Code of 1986
(Code)).
With regard to the foregoing, the Department notes that, unlike the
proposal, the final regulation measures the time period for the 30-day
advance notice requirement from the date of plan eligibility to better
coordinate the notice requirements with the Code provisions governing
permissible withdrawals. The Department also notes that if a fiduciary
fails to comply with the final regulation for a participant's first
elective contribution because a notice is not provided at least 30 days
in advance of plan eligibility, the fiduciary may obtain relief for
later contributions with respect to which the 30-day advance notice
requirement is satisfied.
In addition, while retaining the general 30-day advance notice
requirement, the final regulation also permits notice ``on or before''
the date of plan eligibility if the participant is permitted to make a
permissible withdrawal in accordance with 414(w) of the Code. In this
regard, the Department believes that if participants are not going to
be afforded the option of withdrawing their contributions without
additional tax, such participants should be given notice sufficiently
in advance of the contribution to enable them to opt out of plan
participation.
The Department notes that the phrase in paragraph (c)(3)(i)--``or
at least 30 days in advance of any first investment in a qualified
default investment alternative''--is intended to accommodate
circumstances other than elective contributions. For example, although
fiduciary relief would not be available with respect to a fiduciary's
investment of a participant or beneficiary's rollover amount from
another plan into a qualified default investment alternative if the 30-
day advance notice requirement is not satisfied, relief may be
available when a fiduciary invests the rollover amount into a qualified
default investment alternative after satisfying the notice requirement
in paragraph (c)(3)(i)(A) as well as the regulation's other conditions.
Finally, the phrase--``in advance of the date of plan eligibility *
* * or any first investment in a qualified default investment
alternative''--is not intended to foreclose availability of relief to
fiduciaries that, prior to the adoption of the final regulation,
invested assets on behalf of participants and beneficiaries in a
default investment alternative that would constitute a ``qualified
default investment alternative'' under the regulation. In such cases,
the phrase--``in advance of the date of plan eligibility * * * or any
first investment''--should be read to mean the first investment with
respect to which relief under the final regulation is intended to apply
after the effective date of the regulation.
The timing of the annual notice requirement contained in the final
regulation has not changed from the proposal. Notice must be provided
within a reasonable period of time of at least 30 days in advance of
each subsequent plan year. See Sec. 2550.404c-5(c)(3)(ii). One
commenter requested that the Department eliminate the annual notice
requirement. The Department retained the annual notice requirement
because the Pension Protection Act specifically amended ERISA to
require an annual notice. Further, the Department believes that it is
important to provide regular and ongoing notice to participants and
beneficiaries whose assets are invested in a qualified default
investment alternative to ensure that they are in a position to make
informed decisions concerning their participation in their employer's
plan. Several commenters supported the furnishing of an annual reminder
to participants and beneficiaries that their assets have been invested
in a qualified default investment alternative and that participants and
beneficiaries may direct their contributions into other investment
alternatives available under the plan.
Paragraph (c)(3), as proposed, provided that the required
disclosures could be included in a summary plan description, summary of
material modification or other notice meeting the requirements of
paragraph (d), which described the content required in the notice. Some
commenters expressed concern that permitting the notice requirement to
be satisfied though a plan's summary plan description or summary of
material modification may result in participants overlooking or
ignoring information relating to their participation and the investment
of contributions on their behalf. The Department is persuaded that,
given the potential length and complexity of summary plan descriptions
and summaries of material modifications, the furnishing of the required
disclosures through 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 the assets in his or her
account in a qualified default investment alternative. Accordingly, the
final regulation, at paragraph (c)(3), has been modified to eliminate
references to providing notice through a summary plan description or
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summary of material modifications. The Department notes that the notice
requirements of ERISA section 404(c)(5)(B) and this regulation, and the
notice requirements of sections 401(k)(13)(E) and 414(w)(4) of the
Code, as amended by the Pension Protection Act, are similar.
Accordingly, while the final regulation provides for disclosure through
a separate notice, the Department anticipates that the notice
requirements of this final regulation and the notice requirements of
sections 401(k)(13)(E) and 414(w)(4) of the Code could be satisfied in
a single disclosure document. Further, the Department notes that
nothing in the regulation should be construed to preclude the
distribution of the initial or annual notices with other materials
being furnished to participants and beneficiaries. In this regard, the
Department recognizes that there may be cost savings that result from
distributing multiple disclosures simultaneously and, to the extent
that distribution costs may be charged to the accounts of individual
participants and beneficiaries, efforts to minimize such costs should
be encouraged.
The fourth condition of the proposed regulation required that,
under the terms of the plan, any material provided to the plan relating
to a participant's or beneficiary's investment in a qualified default
investment alternative (e.g., account statements, prospectuses, proxy
voting material) would be provided to the participant or beneficiary.
See proposed regulation Sec. 2550.404c-5(c)(4). Several commenters
asked the Department to clarify whether the phrase ``under the terms of
the plan'' would require plan amendments to explicitly incorporate the
proposed rule's disclosure provision. Commenters suggested that
paragraph (c)(4) of the proposal could be read to require that the
disclosure provisions be described in the formal plan document, and the
commenters suggested that it is unclear what documents would suffice to
meet this condition. The phrase ``under the terms of the plan'' was
merely intended to ensure that plans provide for the required pass-
through of information. Taking into account both the fact that a pass-
through of information is a specific condition of the regulation and
the comments on this provision, the Department has concluded that the
phrase is confusing and not necessary. Accordingly, the phrase ``under
the terms of the plan'' has been removed from paragraph (c)(4) of the
final regulation. See Sec. 2550.404c-5(c)(4).
Commenters also requested clarification as to the material intended
to be included in the reference to ``material provided to the plan'' in
paragraph (c)(4). Specifically, commenters inquired whether material
provided to the plan includes information within the custody of a plan
service provider or the fiduciary responsible for selecting a qualified
default investment alternative, and whether ``material provided to the
plan'' includes aggregate, plan-level information received by the plan.
Commenters also asked for clarification regarding the manner in which
information shall be ``provided to the participant or beneficiary'' in
paragraph (c)(4) of the proposed regulation. A number of commenters
suggested that the final regulation permit disclosure of information
upon request; others recommended that the disclosure requirement should
be satisfied by including a statement in the notice required by
paragraph (c)(3) of the proposed regulation that provides direction to
a participant or beneficiary regarding where he or she can find
information about the qualified default investment alternatives. Other
commenters asked whether plans could make materials available to a
participant or beneficiary instead of affirmatively providing materials
to them.
Other commenters suggested that a participant or beneficiary on
whose behalf assets are invested in a qualified default investment
alternative should not be required to be furnished more material than
is required to be furnished to those individuals who direct their
investments. In this regard, commenters recommended that the Department
apply the same standard set forth in the section 404(c) regulation for
the pass-through of information to both participants who fail to direct
their investments and participants who elect to direct their
investments.
The Department believes that participants who fail to direct their
investments should be furnished no less information than is required to
be passed through to participants who elect to direct their investments
under the plan. The Department also believes there is little, if any,
basis for requiring defaulted participants to be furnished more
information than is required to be passed through to other
participants. For this reason, the Department has adopted the
recommendation of those commenters that the pass-through disclosure
requirements applicable to section 404(c) plans be applied to the pass-
through of information under the final regulation. The Department,
therefore, has modified paragraph (c)(4) to provide that a fiduciary
shall qualify for the relief described in paragraph (b)(1) of the final
regulation if a fiduciary provides material to participants and
beneficiaries as set forth in paragraphs (b)(2)(i)(B)(1)(viii) and
(ix), and paragraph (b)(2)(i)(B)(2) of the 404(c) regulation, relating
to a participant's or beneficiary's investment in a qualified default
investment alternative. The Department notes that, as part of a
separate regulatory initiative, it is reviewing the disclosure
requirements applicable to participants and beneficiaries in
participant-directed individual account plans and that, to the extent
that the pass-through disclosure requirements contained in Sec.
2550.404c-1 are amended, the language of paragraph (c)(4), as modified,
will ensure such amendments automatically extend to Sec. 2550.404c-5.
The Department notes, in responding to one commenter's request for
clarification, that the plan's obligation to pass through information
to participants or beneficiaries would be considered satisfied if the
required information is furnished directly to the participant or
beneficiary by the provider of the investment alternative or other
third-party.
The fifth condition of the proposal required that any participant
or beneficiary on whose behalf assets are invested in a qualified
default investment alternative be afforded the opportunity, consistent
with the terms of the plan (but in no event less frequently than once
within any three month period), to transfer, in whole or in part, such
assets to any other investment alternative available under the plan
without financial penalty. See proposed regulation Sec. 2550.404c-
5(c)(5). This provision was intended to ensure that participants and
beneficiaries on whose behalf assets are invested in a qualified
default investment alternative have the same opportunity as other plan
participants and beneficiaries to direct the investment of their
assets, and that neither the plan nor the qualified default investment
alternative impose financial penalties that would restrict the rights
of participants and beneficiaries to direct their assets to other
investment alternatives available under the plan. This provision was
not intended to confer greater rights on participants or beneficiaries
whose accounts the plan invests in qualified default investment
alternatives than are otherwise available under the plan. Thus, if a
plan provides participants and beneficiaries the right to direct
investments on a quarterly basis, those participants and beneficiaries
with investments in a qualified default investment alternative need
only be afforded the opportunity to direct their
[[Page 60456]]
investments on a quarterly basis. Similarly, if a plan permits daily
investment direction, participants and beneficiaries with investments
in a qualified default investment alternative must be permitted to
direct their investments on a daily basis.
The Department received many comments requesting clarification on
this requirement, most often concerning what the Department considers
to be a financial penalty. Commenters asked whether investment-level
fees and restrictions, as opposed to fees or other restrictions that
are imposed by the plan or the plan sponsor, would be considered
impermissible restrictions or ``financial penalties.'' Commenters
explained that fees and limitations that are part of the investment
product are beyond the control of the plan sponsor and should not be
considered financial penalties for purposes of the final regulation.
The comment letters provided many examples of investment-level fees or
restrictions that commenters believed should not be considered
punitive, including redemption fees, back-end sales loads, reinvestment
timing restrictions, market value adjustments, equity ``wash''
restrictions, and surrender charges.
In response to these and other comments, the Department has
modified and restructured paragraph (c)(5) of the final regulation to
provide more clarity with respect to limitations that may or may not be
imposed on participants and beneficiaries who are defaulted into a
qualified default investment alternative. As modified and restructured,
paragraph (c)(5) of the final regulation includes three conditions
applicable to a defaulted participant's or beneficiary's ability to
move assets out of a qualified default investment alternative.
The first condition, as in the proposal, is intended to ensure that
defaulted participants and beneficiaries have the same rights as other
participants and beneficiaries under the plan regarding the frequency
with which they may direct an investment out of a qualified default
investment alternative. In this regard, paragraph (c)(5)(i) provides
that any participant or beneficiary on whose behalf assets are invested
in a qualified default investment alternative must be able to transfer,
in whole or in part, such assets to any other investment alternative
available under the plan with a frequency consistent with that afforded
participants and beneficiaries who elect to invest in the qualified
default investment alternative, but not less frequently than once
within any three month period. The Department received no substantive
comments on this provision and it is being adopted unchanged from the
proposal.
The second and third conditions, at paragraphs (c)(5)(ii) and
(iii), relate to limitations (i.e., restrictions, fees, etc.) other
than those relating to the frequency with which participants may direct
their investment out of a qualified default investment alternative,
which are addressed in paragraph (c)(5)(i). Unlike the proposal, which
limited the imposition of financial penalties for the period of a
defaulted participant's or beneficiary's investment, the regulation, as
modified, precludes the imposition of any restrictions, fees or
expenses (other than investment management and similar types of fees
and expenses) during the first 90 days of a defaulted participant's or
beneficiary's investment in the qualified default investment
alternative. At the end of the 90-day period, defaulted participants
and beneficiaries may be subject to the restrictions, fees or expenses
that are otherwise applicable to participants and beneficiaries under
the plan who elected to invest in that qualified default investment
alternative. While the condition on restrictions, fees and expenses is
limited to 90 days, the condition, as explained below, is broad in its
application, thereby providing defaulted participants and beneficiaries
an opportunity to redirect or withdraw their contributions. Also, the
Department believes that restrictions or fees on qualified default
investment alternatives are more likely to be waived if this period is
shortened to 90 days. The 90-day period is defined by reference to the
participant's first elective contribution as determined under section
414(w)(2)(B) of the Code, thereby enabling participants, if their plan
permits, to make a permissible withdrawal without being subject to the
10 percent additional tax under section 72(t) of the Code.
Specifically, paragraph (c)(5)(ii) of the regulation provides that
any transfer or permissible withdrawal described in paragraph (c)(5)
resulting from a participant's or beneficiary's election to make such a
transfer or withdrawal during the 90-day period beginning on the date
of the participant's first elective contribution as determined under
section 414(w)(2)(B) of the Code, or other first investment in a
qualified default investment alternative on behalf of a participant or
beneficiary described in paragraph (c)(2), shall not be subject to any
restrictions, fees or expenses (except those fees and expenses that are
charged on an ongoing basis for the investment itself, such as
investment management and similar fees, and are not imposed, or do not
vary, based on a participant's or beneficiary's decision to withdraw,
sell or transfer assets out of the investment alternative).
Accordingly, no restriction, fee, or expense may be imposed on any
transfer or permissible withdrawal of assets, whether assessed by the
plan, the plan sponsor, or as part of an underlying investment product
or portfolio, and regardless of whether or not the restriction, fee, or
expense is considered to be a ``penalty.'' This provision, therefore,
would prevent the imposition of any surrender charge, liquidation or
exchange fee, or redemption fee. It also would prohibit any market
value adjustment or ``round-trip'' restriction on the ability of the
participant or beneficiary to reinvest within a defined period of time.
As long as the participant's or beneficiary's election is made within
the applicable 90-day period, no such charges may be imposed even if,
due to administrative or other delays, the actual transfer or
withdrawal does not take place until after the 90-day period.
Paragraph (c)(5)(ii)(B) makes clear that the limitations of
paragraph (c)(5)(ii)(A) do not apply to fees and expenses that are
charged on an ongoing basis for the operation of the investment itself,
such as investment management fees, distribution and/or service fees
(``12b-1'' fees), and administrative-type fees (legal, accounting,
transfer agent expenses, etc.), and are not imposed, or do not vary,
based on a participant's or beneficiary's decision to withdraw, sell or
transfer assets out of the investment alternative. In response to a
request for a clarification, the Department further notes that to the
extent that a participant or beneficiary loses the right to elect an
annuity as a result of a transfer out of a qualified default investment
alternative with an annuity feature, such loss would not constitute an
impermissible restriction for purposes of paragraph (c)(5)(ii) inasmuch
as the annuity feature is a component of the investment alternative
itself.
Paragraph (c)(5)(iii) of the final regulation provides that,
following the end of the 90-day period described in paragraph
(c)(5)(ii)(A), any transfer or permissible withdrawal described in
paragraph (c)(5) shall not be subject to any restrictions, fees or
expenses not otherwise applicable to a participant or beneficiary who
elected to invest in that qualified default investment alternative.
This provision is intended to ensure that defaulted participants and
beneficiaries are not subject to restrictions, fees or penalties that
would serve to create a greater disincentive for defaulted participants
and beneficiaries, than for other participants and
[[Page 60457]]
beneficiaries under the plan, to withdraw or transfer assets from a
qualified default investment alternative.
The Department notes that the final rule does not otherwise address
or provide relief with respect to the direction of investments out of a
qualified default investment alternative into another investment
alternative available under the plan. See generally section 404(c)(1)
of ERISA and 29 CFR 2550.404c-1.
The last condition of paragraph (c) of the regulation adopts,
without modification from the proposal, the requirement that plans
offer participants and beneficiaries the opportunity to invest in a
``broad range of investment alternatives'' within the meaning of 29 CFR
2550.404c-1(b)(3).\1\ See Sec. 2550.404c-5(c)(6). The Department
believes that participants and beneficiaries should be afforded a
sufficient range of investment alternatives to achieve a diversified
portfolio with aggregate risk and return characteristics at any point
within the range normally appropriate for the pension plan participant
or beneficiary. The Department believes that the application of the
``broad range of investment alternatives'' standard of the section
404(c) regulation accomplishes this objective. The Department received
no substantive objections to this provision and, as indicated, is
adopting the provision without change.
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\1\ 29 CFR 2550.404c-1(b)(3) provides that ``[a] plan offers a
broad range of investment alternatives only if the available
investment alternatives are sufficient to provide the participant or
beneficiary with a reasonable opportunity to: (A) Materially affect
the potential return on amounts in his individual account with
respect to which he is permitted to exercise control and the degree
of risk to which such amounts are subject; (B) Choose from at least
three investment alternatives: (1) each of which is diversified; (2)
each of which has materially different risk and return
characteristics; (3) which in the aggregate enable the participant
or beneficiary by choosing among them to achieve a portfolio with
aggregate risk and return characteristics at any point within the
range normally appropriate for the participant or beneficiary; and
(4) each of which when combined with investments in the other
alternatives tends to minimize through diversification the overall
risk of a participant's or beneficiary's portfolio; * * *''
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Notices
As discussed above, relief under the final regulation is
conditioned on furnishing participants and beneficiaries advance
notification concerning the default investment provisions of their
plan. See Sec. 2550.404c-5(c)(3). The specific information required to
be contained in the notice is set forth in paragraph (d) of the
regulation.
As proposed, paragraph (d) of Sec. 2550.404c-5 required that the
notice to participants and beneficiaries be written in a manner
calculated to be understood by the average plan participant and contain
the following information: (1) A description of the circumstances under
which assets in the individual account of a participant or beneficiary
may be invested on behalf of the participant and beneficiary in a
qualified default investment alternative; (2) a description of the
qualified default investment alternative, including a description of
the investment objectives, risk and return characteristics (if
applicable), and fees and expenses attendant to the investment
alternative; (3) a description of the right of the participants and
beneficiaries on whose behalf assets are invested in a qualified
default investment alternative to direct the investment of those assets
to any other investment alternative under the plan, including a
description of any applicable restrictions, fees, or expenses in
connection with such transfer; and (4) an explanation of where the
participants and beneficiaries can obtain investment information
concerning the other investment alternatives available under the plan.
A few commenters suggested expanding the content of the notice to
include procedures for electing other investment options, a description
of the right to request additional information, a description of any
right to obtain investment advice (if available), a description of fees
associated with the qualified default investment alternatives,
information about other investment options under the plan, etc. While
the Department did not adopt all of the changes suggested by the
commenters, the Department has modified the notice content requirements
to broaden the required disclosures. As modified, the Department
intends that the furnishing of a notice in accordance with the timing
and content requirements of this regulation will not only satisfy the
notice requirements of section 404(c)(5)(B) of ERISA but also the
notice requirements under the preemption provisions of ERISA section
514 applicable to an ``automatic contribution arrangement,'' within the
meaning of ERISA section 514(e)(2).
ERISA section 404(c)(5)(B)(i)(I) provides for the furnishing of a
notice explaining ``the employee's right under the plan to designate
how contributions and earnings will be invested and explaining how, in
the absence of any investment election by the participant, such
contributions and earnings will be invested.'' ERISA section 514(e)(1)
provides for the preemption of State laws that would directly or
indirectly prohibit or restrict the inclusion in any plan of an
automatic contribution arrangement. Section 514(e)(3) provides that a
plan administrator of an automatic contribution arrangement shall
provide a notice describing the rights and obligations of participants
under the arrangement and such notice shall include ``an explanation of
the participant's right under the arrangement not to have elective
contributions made on the participant's behalf (or to elect to have
such contributions made at a different percentage)'' and an explanation
of ``how contributions made under the arrangement will be invested in
the absence of any investment election by the participant.''
In addition to broadening the required disclosures, the Department
revised the disclosures relating to restrictions, fees and expenses to
conform the notice requirements to the changes in paragraph (c)(5)
relating to restrictions, fees or expenses. As modified, paragraph (d)
of the final regulation provides that the notices required by paragraph
(c)(3) shall include: (1) A description of the circumstances under
which assets in the individual account of a participant or beneficiary
may be invested on behalf of the participant or beneficiary in a
qualified default investment alternative; and, if applicable, an
explanation of the circumstances under which elective contributions
will be made on behalf of a participant, the percentage of such
contribution, and the right of the participant to elect not to have
such contributions made on his or her behalf (or to elect to have such
contributions made at a different percentage); (2) an explanation of
the right of participants and beneficiaries to direct the investment of
assets in their individual accounts; (3) a description of the qualified
default investment alternative, including a description of the
investment objectives, risk and return characteristics (if applicable),
and fees and expenses attendant to the investment alternative; (4) a
description of the right of the participants and beneficiaries on whose
behalf assets are invested in a qualified default investment
alternative to direct the investment of those assets to any other
investment alternative under the plan, including a description of any
applicable restrictions, fees or expenses in connection with such
transfer; and (5) an explanation of where the participants and
beneficiaries can obtain investment information concerning the other
investment alternatives available under the plan.
Other commenters suggested that the Department provide a model
notice.
[[Page 60458]]
Because applicable plan provisions and qualified default investment
alternatives may vary considerably from plan to plan, the Department
believes it would be difficult to provide model language that is
general enough to accommodate different plans and different investment
products and portfolios and that would allow sufficient flexibility to
plan sponsors. Accordingly, the final regulation does not include model
language for plan sponsors. However, the Department will explore this
concept in the future in coordination with the Department of Treasury
concerning the similar notice requirements contained in sections
401(k)(13)(E) and 414(w) of the Code.
Commenters also requested guidance concerning the extent to which
the final regulation's notice requirements could be satisfied by
electronic distribution. The Department currently is reviewing its
rules relating to the use of electronic media for disclosures under
title I of ERISA. In the absence of guidance to the contrary, it is the
view of the Department that plans that wish to use electronic means by
which to satisfy their notice requirements may rely on either guidance
issued by the Department of Labor at 29 CFR 2520.104b-1(c) or the
guidance issued by the Department of the Treasury and Internal Revenue
Service at 26 CFR 1.401(a)-21 relating to the use of electronic media.
Qualified Default Investment Alternatives
Under the final regulation, as in the proposal, relief from
fiduciary liability is provided with respect to only those assets
invested on behalf of a participant or beneficiary in a ``qualified
default investment alternative.'' See Sec. 2550.404c-5(c)(1).
Paragraph (e) of Sec. 2550.404c-5 sets forth four requirements for a
``qualified default investment alternative.''
The first requirement, at paragraph (e)(1), addresses investments
in employer securities. As indicated in the preamble to the proposal,
while the Department does not believe it is appropriate for a qualified
default investment alternative to encourage investments in employer
securities, the Department also recognizes that an absolute prohibition
against holding or investing in employer securities may be
unnecessarily limiting and complicated. Accordingly, the proposal, in
addition to establishing a general prohibition against qualified
default investment alternatives holding or permitting acquisition of
employer securities, provided two exceptions to the rule. While, as
discussed below, the Department did receive comments generally
requesting different or expanded exceptions to the general prohibition,
the Department has determined it appropriate to adopt paragraph (e)(1)
without modification from the proposal.
The two exceptions to the general prohibition are set forth in
paragraph (e)(1)(ii). The first exception applies to employer
securities held or acquired by an investment company registered under
the Investment Company Act of 1940, 15 U.S.C. 80a-1, et seq., or a
similar pooled investment vehicle (e.g., a common or collective trust
fund or pooled investment fund) regulated and subject to periodic
examination by a State or Federal agency and with respect to which
investment in such securities is made in accordance with the stated
investment objectives of the investment vehicle and independent of the
plan sponsor or an affiliate thereof.
Several commenters suggested that the exception to investments in
employer securities should extend to circumstances when the plan
sponsor delegates investment responsibilities to an ERISA section 3(38)
investment manager and with respect to which the plan sponsor has no
discretion regarding the acquisition or holding of employer securities.
The Department did not adopt this suggestion because in such instances
the investment manager may be following the investment policies
established by the plan sponsor, and, while the plan sponsor may not be
directly exercising discretion with respect to the acquisition or
holding of employer securities, the plan sponsor might indirectly be
influencing such decision through an investment policy that requires
the investment manager to acquire or hold various amounts of employer
securities. In the Department's view, limiting the exception to
regulated financial institutions avoids this type of problem.
Another commenter suggested that the Department limit qualified
default investment alternatives to a 10% investment in employer
securities. The Department did not adopt this suggestion because it
believes that a percentage limit test would effectively require that a
plan sponsor or other fiduciary monitor on a daily, if not more
frequent, basis the specific holdings of the qualified default
investment alternative and fluctuations in the value of the assets in
the qualified default investment alternative to determine compliance
with a percentage limit. Such a test would, in the Department's view,
result in considerable uncertainty as to whether at any given time the
intended designated qualified default investment alternative actually
met the requirements of the regulation. The Department believes that
the approach it has taken to limiting employer securities provides both
flexibility and certainty.
The second exception is for employer securities acquired as a
matching contribution from the employer/plan sponsor or at the
direction of the participant or beneficiary. This exception is intended
to make clear that an investment management service will not be
precluded from serving as a qualified default investment alternative
under Sec. 2550.404c-5(e)(4)(iii) merely because the account of a
participant or beneficiary holds employer securities acquired as
matching contributions from the employer/plan sponsor, or acquired as a
result of prior direction by the participant or beneficiary; however,
an investment management service will be considered to be serving as a
qualified default investment alternative only with respect to assets of
a participant's or beneficiary's account over which the investment
management service has authority to exercise discretion.
In the case of employer securities acquired as matching
contributions that are subject to a restriction on transferability,
relief would not be available with respect to such securities until the
investment management service has an unrestricted right to transfer the
securities. Although an investment management service would be
responsible for determining whether and to what extent the account
should continue to hold investments in employer securities, the
investment management service could not, except as part of an
investment company or similar pooled investment vehicle, exercise its
discretion to acquire additional employer securities on behalf of an
individual account without violating Sec. 2550.404c-5(e)(1).
In the case of prior direction by a participant or beneficiary, if
the participant or beneficiary provided investment direction with
respect to employer securities, but failed to provide investment
direction following an event, such as a change in investment
alternatives, and the terms of the plan provide that in such
circumstances the account's assets are invested in a qualified default
investment alternative, the final regulation continues to permit an
investment management service to hold and manage those employer
securities in the absence of participant or beneficiary direction.
Although the investment management service may not acquire additional
employer securities using participant
[[Page 60459]]
contributions, the investment management service may reduce the amount
of employer securities held by the account of the participant or
beneficiary.
One commenter suggested that the exception be extended to qualified
default investment alternatives other than the investment management
service described in paragraph (e)(4)(iii). An employer securities
match can only constitute part of a qualified default investment
alternative if the fiduciary selects an investment management service
as the qualified default investment alternative, because only in the
investment management service context is the responsible fiduciary
undertaking the duty to evaluate the appropriate exposure to employer
securities for a particular participant or beneficiary and undertaking
the obligation to sell employer securities until the participant's or
beneficiary's account reflects that appropriate exposure. Accordingly,
the Department declines to adopt the commenter's suggestion to expand
the second employer securities exception to other qualified default
investment alternatives. The Department further notes that this
regulation does not provide relief for the acquisition of employer
securities by an investment service.
The second requirement, at paragraph (e)(2), is intended to ensure
that the qualified default investment alternative itself does not
impose any restrictions, fees or expenses inconsistent with the
requirements of paragraph (c)(5) of Sec. 2550.404c-5. While the
provision has been redrafted for clarity, it is substantively the same
as in the proposal and, therefore, is being adopted without substantive
change.
The third requirement, at paragraph (e)(3), addresses the
management of a qualified default investment option. As proposed, the
regulation required that a qualified default investment alternative be
either managed by an investment manager, as defined in section 3(38) of
the Act, or an investment company registered under the Investment
Company Act of 1940. Several commenters suggested that requiring a
qualified default investment alternative to be managed by an investment
manager, or to be an investment company, is too restrictive.
A number of commenters noted that section 3(38) of ERISA excludes
from the definition of the term ``investment manager'' named
fiduciaries, as defined in section 402(a)(2) of ERISA \2\ and
trustees.\3\ With regard to named fiduciaries, commenters pointed out
that a number of employers serve as named fiduciaries and manage their
plan investments in-house, resulting in reduced administrative and
investment management costs. Commenters also noted that implementation
of the requirement as proposed would eliminate the ability of plan
sponsors who are named fiduciaries to directly manage a qualified
default investment alternative, use asset allocation models, develop
asset allocations themselves, or engage investment consultants (who may
or may not be fiduciaries) to assist in the development of asset
allocations. Other commenters, however, suggested that the final
regulation retain the requirement that only investment managers within
the meaning of section 3(38) of ERISA or registered investment
companies be permitted to manage qualified default investment
alternatives. Commenters suggested that investment management decisions
should be made by investment professionals who are investment managers
within the meaning of section 3(38) of ERISA; they asserted that
requiring a 3(38) manager is safer and more prudent than other
alternatives, and such requirement is administratively feasible.
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\2\ Section 402(a)(2) of ERISA provides that the term ``named
fiduciary'' means a fiduciary who is named in the plan instrument,
or who, pursuant to a procedure specified in the plan, is identified
as a fiduciary by a person who is an employer or employee
organization with respect to the plan, or by such an employer and
such an employee organization acting jointly.
\3\ Section 3(38) defines the term ``investment manager'' to
mean any fiduciary (other than a trustee or named fiduciary, as
defined in section 402(a)(2))--(A) who has the power to manage,
acquire, or dispose of any asset of a plan; (B) who (i) is
registered as an investment adviser under the Investment Advisers
Act of 1940 [15 U.S.C. 80b-1 et seq.]; (ii) is not registered as an
investment adviser under such Act by reason of paragraph (1) of
section 203A(a) of such Act [15 U.S.C. 80b-3a(a)], is registered as
an investment adviser under the laws of the State (referred to in
such paragraph (1)) in which it maintains its principal office and
place of business, and, at the time the fiduciary last filed the
registration form most recently filed by the fiduciary with such
State in order to maintain the fiduciary's registration under the
laws of such State, also filed a copy of such form with the
Secretary; (iii) is a bank, as defined in that Act; or (iv) is an
insurance company qualified to perform services described in
subparagraph (A) under the laws of more than one State; and (C) has
acknowledged in writing that he is a fiduciary with respect to the
plan.
---------------------------------------------------------------------------
With regard to permitting plan sponsors to manage a qualified
default investment alternative, the Department is persuaded that a plan
sponsor's willingness to serve as a named fiduciary responsible for the
management of the plan's investment options in conjunction with the
potential cost savings to plan participants that can result from such
management, is a sufficient basis to expand the regulation to permit
plan sponsors that are named fiduciaries to manage a qualified default
investment alternative. This modification is reflected in paragraph
(e)(3)(i)(C).
A number of commenters also indicated that, under the proposal,
investment consultants engaged by plan sponsors would have to assume
fiduciary responsibility for asset allocations in order to obtain
relief under the proposal. These commenters suggested that requiring an
investment consultant to assume fiduciary responsibility for asset
allocation would increase costs for the provision of such consulting
services, and that these costs inevitably would be passed along to
participants. Commenters also asserted that the use of asset allocation
models is well-established and is often an effective way to lower costs
and to provide a clean structure and process for the formation,
selection and monitoring of all elements of a prudent default
investment alternative. The commenters also noted that many plan
sponsors develop generic asset allocations and select particular funds,
tailored to a particular plan, with the input of an investment
consultant who may be an investment adviser under the Investment
Advisers Act of 1940. With regard to these comments, the Department
continues to believe that when plan fiduciaries are relieved of
liability for underlying investment management/asset allocation
decisions, those responsible for the investment management/asset
allocation decisions must be fiduciaries and those fiduciaries must
acknowledge their fiduciary responsibility and liability under the
ERISA. The Department notes, however, that plan sponsors who serve as
named fiduciaries of a qualified default investment alternative may, to
the extent they consider it prudent, engage investment consultants,
utilize asset allocation models (computer-based or otherwise), etc. to
carry out their investment management/asset allocation
responsibilities. Accordingly, the Department does not believe the
regulation in this regard should to any significant degree alter the
availability or cost of such services.
With regard to the exclusion of trustees from the ``investment
manager'' definition, commenters suggested that the final regulation
make clear that bank trustees of collective investment funds are
permitted to manage a qualified default investment alternative. In this
regard, commenters noted that the definition of ``investment managers''
recognizes that banks and other
[[Page 60460]]
institutions can be investment managers, citing ERISA section
3(38)(B)(ii) and (iii), and should not be foreclosed from managing a
qualified default investment alternative solely on the basis that the
institution might otherwise serve as a trustee. These commenters noted
that, similar to investment managers, banks as trustees of collective
funds have fiduciary responsibility and liability under ERISA with
respect to the funds they maintain. The Department is persuaded that an
entity that meets the requirements of section 3(38)(A), (B) and (C)
should not be precluded from assuming fiduciary responsibility and
liability for the underlying investment management/asset allocation
decisions of a qualified default investment alternative solely because
that entity serves in a trustee capacity for the plan.\4\ The
Department has modified the final regulation accordingly. This
modification is reflected in paragraph (e)(3)(i)(B).
---------------------------------------------------------------------------
\4\ This position is consistent with the Department's long-held
view that the parenthetical language of section 3(38) was merely
intended to indicate that in order for a person to be an investment
manager for a plan, that person must be more than a mere trustee or
named fiduciary. See Advisory Opinion No. 77-69/70A
---------------------------------------------------------------------------
In response to a request from one commenter, the Department
confirms that the provisions of the regulation do not preclude a
qualified default investment alternative from having more than one
fiduciary (e.g., investment manager) responsible for the investment
management/asset allocation decisions of the investment alternative, as
would be the case in an arrangement utilizing a ``fund of funds''
approach to designing a qualified default investment alternative.
As with the proposal, the regulation permits a qualified default
investment alternative to be an investment company registered under the
Investment Company Act of 1940. See paragraph (e)(3)(ii) of Sec.
2550.404c-5.
In addition to the foregoing, paragraph (e)(3) has been expanded to
include certain capital preservation products and funds described in
paragraph (e)(4)(iv) and (v) of Sec. 2550.404c-5. These products and
funds are discussed below.
The last requirement for a qualified default investment alternative
conditions relief on the use of specified types of investment fund
products, model portfolios or services. See Sec. 2550.404c-5(e)(4). In
the proposal, the Department identified three categories of investment
alternatives that it determined appropriate for achieving meaningful
retirement savings over the long-term for those participants and
beneficiaries who, for one reason or another, do not elect to direct
the investment of their pension plan assets. After careful
consideration of all the comments concerning the nature and type of the
investment alternatives that should be included as qualified default
investment alternatives under the regulation, the Department, as
discussed below, has decided to retain the three proposed categories of
investment alternatives, essentially unchanged from the proposal, as
the type of alternatives appropriate for default investments under the
regulation. However, in recognition of the fact that some plan sponsors
may find it desirable to reduce investment risks for all or part of
their workforce following employees' initial enrollment in the plan,
the Department has added a limited capital preservation option that
would constitute a qualified default investment alternative under the
regulation for purposes of contributions made on behalf of a
participant for a 120-day period following the date of the
participant's first elective contribution. See paragraph (e)(4)(iv). In
addition, the Department has modified the regulation to include a
``grandfather''-like provision pursuant to which stable value products
and funds will constitute a qualified default investment alternative
under the regulation for purposes of investments made prior to the
effective date of the regulation. See paragraph (e)(4)(v).
As noted above, the three categories of investment alternatives set
forth in the proposal are being adopted essentially unchanged from the
proposal. One organizational change appearing in the final regulation
involves the inclusion of diversification language in each of three
categories, rather than as a separate requirement of general
applicability as in the proposal (see paragraph (e)(4) of proposed
regulation Sec. 2550.404c-5). This change accommodates the addition of
the capital preservation investment alternatives mentioned above that
may not, given the nature of the investment, satisfy a diversification
standard.
Some commenters expressed concern that the Department's approach to
defining qualified default investment alternatives takes into account
only products currently available in the marketplace and that the
defining of qualified default investment alternatives should be based
on more general criteria. These commenters emphasized that the
regulation should not stifle creativity in the development of the next
generation of retirement products. While the Department does provide
examples of products, portfolios and services that would fall within
the framework of the various definitions of products, portfolios and
services set forth in the regulation, these examples are provided
solely for the purpose of providing the benefits community with
guidance as to what might be included within the defined categories and
are not intended in any way to limit the application of the definitions
to such vehicles. The Department believes that, on the basis of the
information it has at this time and the comments on the proposal
generally, the approach it is taking to defining qualified default
investment alternatives for purposes of the regulation is sufficiently
flexible to accommodate future innovations and developments in
retirement products.
A number of commenters requested clarification concerning
application of the regulation to possible qualified default investment
alternatives that are offered through variable annuity contracts.
Commenters explained that variable annuity contracts typically permit
participants to invest in a variety of investments through one or more
separate accounts (or sub-accounts within the separate account) that
would qualify as qualified default investment alternatives under the
regulation. Commenters also requested confirmation that the
availability of annuity purchase rights, death benefit guarantees,
investment guarantees or other features common to variable annuity
contracts would not themselves affect the status of a variable annuity
contract that otherwise met the requirements for a qualified default
investment alternative. Consistent with providing flexibility and
encouraging innovation in the development and offering of retirement
products, model portfolios or services, the Department intends that the
definition of ``qualified default investment alternative'' be construed
to include products and portfolios offered through variable annuity and
similar contracts, as well as through common and collective trust funds
or other pooled investment funds, where the qualified default
investment alternative satisfies all of the conditions of the
regulation. For purposes of identifying the entity responsible for the
management of the qualified default investment alternative in such
arrangements pursuant to paragraph (e)(3) of Sec. 2550.404c-5, it is
the view of the Department that such a determination is made by
reference to the entity (e.g., separate account, sub-account, or
similar entity) that is responsible for carrying out the day-to-day
investment management/asset allocation responsibilities. Finally, with
regard to such products and portfolios,
[[Page 60461]]
it is the view of the Department that the availability of annuity
purchase rights, death benefit guarantees, investment guarantees or
other features common to variable annuity contracts will not themselves
affect the status of a fund, product or portfolio as a qualified
default investment alternative when the conditions of the regulation
are satisfied. A new paragraph (e)(4)(vi) was added to the regulation
to clarify these principles.
A number of commenters submitted questions or comments concerning
the specific investment alternatives described in the regulation.
The first investment alternative set forth in the regulation, at
paragraph (e)(4)(i), is an investment fund, product or model portfolio
that applies generally accepted investment theories, 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 (such as normal retirement
age under the plan) or life expectancy. Consistent with the proposal,
the description provides that such products and portfolios change their
asset allocation and associated risk levels over time with the
objective of becoming more conservative (i.e., decreasing risk of
losses) with increasing age. Also like the proposal, the description
makes clear that asset allocation decisions for eligible products and
portfolios are not required to take into account risk tolerances,
investments or other preferences of an individual participant. An
example of such a fund or portfolio may be a ``life-cycle'' or
``targeted-retirement-date'' fund or account.
The reference to ``an investment fund product or model portfolio''
is intended to make clear that this alternative might be a ``stand
alone'' product or a ``fund of funds'' comprised of various investment
options otherwise available under the plan for participant investments.
As noted in the proposal, the Department believes that, in the context
of a fund of funds portfolio, it is likely that money market, stable
value and similarly performing capital preservation vehicles will play
a role in comprising the mix of equity and fixed-income exposures.
Several commenters asked the Department to clarify whether a plan
fiduciary must, or may, consider demographic or other factors in
addition to a participant's age or target retirement date when
selecting an investment product intended to satisfy the first category
of qualified default investment alternatives. For example, commenters
suggested that a plan fiduciary may wish to take into account an
employer-provided defined benefit plan or an employer stock
contribution when selecting the plan's default investment product.
Although the final regulation does not preclude consideration of
factors other than a participant's age or target retirement date in
these circumstances, the regulation is clear that such considerations
are neither required nor necessary as a condition to a fiduciary
obtaining relief under the regulation. The Department intended to
provide plan fiduciaries with certainty that they have complied with
the requirements of the regulation; accordingly, as long as a plan
fiduciary satisfies its general obligations under ERISA when selecting
any qualified default investment alternative, the fiduciary will not
lose the relief provided by the regulation if he or she selects a
product, portfolio or service described in the regulation.
One commenter requested clarification concerning the status of
``lifestyle'' funds. ``Lifestyle'' funds were defined as being similar
to ``lifecycle'' funds, except that the allocation in a given lifestyle
fund does not change over time to become more conservative. That is,
the investment manager of a lifestyle fund invests the fund's assets to
achieve a predetermined level of risk, such as ``conservative,''
``moderate,'' or ``aggressive.'' While it does not appear that a
lifestyle fund, as defined by the commenter, would by itself satisfy
the requirements for a product or portfolio within the meaning of
paragraph (e)(4)(i), such a fund could, in the Department's view,
constitute part of a qualified default investment alternative within
the meaning of paragraph (e)(4)(i). Similarly, nothing in the final
regulation precludes an investment manager from allocating a portion of
a participant's assets to such a fund as part of a qualified default
investment alternative within the meaning of paragraph (e)(4)(iii). It
is also possible that a lifestyle fund, as defined by the commenter,
might be able to constitute an investment within the meaning of
paragraph (e)(4)(ii), an example of which is a ``balanced'' fund.
With respect to the language requiring that the investment fund,
product or model portfolio provide varying degrees of long-term
appreciation and capital preservation through ``a mix of equity and
fixed income exposures,'' one commenter inquired whether the Department
intended to exclude funds that had no fixed income exposure, which,
according to the commenter, might be appropriate for young individuals
many years away from retirement. While the Department believes that
such an investment option may be appropriate for individuals actively
electing to direct their own investments, the Department believes that
when an investment is a default investment, the investment should
provide for some level of capital preservation through fixed income
investments. Accordingly, the final regulation, like the proposal,
continues to require that the qualified default investment
alternatives, defined in paragraph (e)(4)(i), (ii) and (iii), be
designed to provide degrees of long-term appreciation and capital
preservation through a mix of equity and fixed income exposures.
The second investment alternative set forth in the regulation, at
paragraph (e)(4)(ii), is an investment fund product or model portfolio
that applies generally accepted investment theories, 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. For purposes of
this alternative, asset allocation decisions for such products and
portfolios are not required to take into account the age of an
individual participant, but rather focus on the participant population
as a whole. An example of such a fund or portfolio may be a
``balanced'' fund. As with the preceding alternative, the reference to
``an investment fund product or model portfolio'' is intended to make
clear that this alternative might be a ``stand alone'' product or a
``fund of funds'' comprised of various investment options otherwise
available under the plan for participant investments. In the context of
a fund of funds portfolio, it is likely that money market, stable value
and similarly performing capital preservation vehicles will play a role
in comprising the mix of equity and fixed-income exposures for this
alternative.
Although commenters generally supported inclusion of a balanced
investment option as a qualified default investment alternative, a
number of commenters had questions or expressed concern regarding the
requirement that the investment alternative define its investment
objectives by reference to ``a target level of risk appropriate for
participants of the plan as a whole.'' Commenters indicated that having
to take into account the ``participants of the plan as a whole'' would
result in uncertainty as to whether the plan sponsor properly matched
the chosen fund to its participant population. In
[[Page 60462]]
addition, commenters asserted that the on-going monitoring necessary
for the plan fiduciary to ensure the continued appropriateness of the
match would likely result in unnecessary burdens and costs. One
commenter explained that balanced funds as a group hold approximately
60-65% percent of their portfolios in equity investments,\5\ and that
the typical balanced fund would be somewhat more conservatively
invested than most targeted-retirement-date funds; hence, the commenter
argued that balanced funds are an appropriate default for all workers.
The commenter further noted that periodic monitoring, while adding
unnecessary costs, will likely never produce an impetus for changing to
a different balanced fund option. After careful consideration of the
comments, the Department has decided to retain the requirement that,
for purposes of paragraph (e)(4)(ii), the selected qualified default
investment alternative reflect ``a target level of risk appropriate for
participants of the plan as a whole.'' The Department recognizes that,
to the extent that a particular investment fund product or model
portfolio does not itself consider or adjust its balance of fixed
income and equity exposures to take into account a target level of risk
appropriate for the participants of the plan as a whole, plan
fiduciaries will retain that responsibility. The Department believes
that, as a practical matter, this responsibility would be discharged by
the fiduciary in connection with the prudent selection and monitoring
of the investment fund product.\6\ Specifically, fiduciaries would take
into account the diversification of the portfolio, the liquidity and
current return of the portfolio relative to the anticipated cash flow
requirements of the plan, the projected return of the portfolio
relative to funding objectives of the plan, and the fees and expenses
attendant to the investment.\7\
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\5\ Investment Company Institute, Quarterly Supplementary Data
for Quarter Ending June 30, 2006.
\6\ See paragraph (b)(2) of 29 CFR 2550.404c-5.
\7\ See 29 CFR 2550.404a-(b).
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Unlike the first alternative, which focuses on the age, target
retirement date (such as normal retirement age under the plan) or life
expectancy of an individual participant, the second alternative
requires a fiduciary to take into account the demographics of the
plan's participants, and would be similar to the considerations a
fiduciary would take into account in managing an individual account
plan that does not provide for participant direction. A number of
commenters asked the Department to clarify the demographic factors that
should be considered by the fiduciary. The Department understands that
the only information a plan fiduciary may know about its participant
population is age. Thus, when determining a target level of risk
appropriate for participants of a plan as a whole, a plan fiduciary is
required to consider the age of the participant population. However, a
plan fiduciary is not foreclosed from considering other factors
relevant to the participant population, if the fiduciary so chooses.
The third alternative set forth in the regulation, at paragraph
(e)(4)(iii), is an investment management service with respect to which
an investment manager 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 (such as
normal retirement age under the plan) or life expectancy.\8\ Such
portfolios change their asset allocation and associated risk levels
over time with the objective of becoming more conservative (i.e.,
decreasing risk of losses) with increasing age. Similar to the first
two alternatives, these portfolios must be structured in accordance
with generally accepted investment theories and diversified so as to
minimize the risk of large losses. The final regulation also clarifies
that, as with the other alternatives described in the regulation, asset
allocation decisions are not required to take into account risk
tolerances, other investments or other preferences of an individual
participant. An example of such a service may be a ``managed account.''
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\8\ Although investment management services are included within
the scope of relief, the Department notes that relief similar to
that provided by this regulation is available to plan fiduciaries
under the statute. Specifically, section 402(c)(3) of ERISA provides
that ``a person who is a named fiduciary with respect to control or
management of the assets of the plan may appoint an investment
manager or managers to manage (including the power to acquire and
dispose of) any assets of a plan.'' Section 405(d)(1) of ERISA
provides that ``[i]f an investment manager or managers have been
appointed under section 402(c)(3), then * * * no trustee shall be
liable for the acts or omissions of such investment manager or
managers, or be under an obligation to invest or otherwise manage
any asset of the plan which is subject to the management of such
investment manager.'' The Department included investment management
services within the scope of fiduciary relief in order to avoid any
ambiguity concerning the scope of relief available to plan
fiduciaries in the context of participant directed individual
account plans.
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One commenter requested clarification that, with regard to a
participant's account holding employer securities with restrictions on
transferability, the investment management service could serve as
qualified default investment alternative for purposes of all other
assets in the participant's account with respect to which the managed
account has investment discretion. As discussed earlier, the mere fact
that the account of a participant or beneficiary holds employer
securities acquired as matching contributions from the employer/plan
sponsor, or acquired as a result of prior direction by the participant
or beneficiary, will not preclude an investment management service from
serving as a qualified default investment alternative. However, an
investment management service will be considered to be serving as a
qualified default investment alternative only with respect to the
assets of a participant's or beneficiary's account over which the
investment management service has authority to exercise discretion. If
the investment management service does not have the authority to
exercise discretion over investments in employer securities, the
investment management service will not be a qualified default
investment alternative with respect to those securities. See discussion
of paragraph (e)(1)(ii) of Sec. 2550.404c-5, above.
Another commenter expressed concern that requiring the manager of a
managed account qualified default investment alternative to be an
investment manager may prevent plan sponsors from using existing
managed account programs, such as that addressed in Advisory Opinion
2001-09A (the ``SunAmerica Opinion''). The Department believes these
concerns are addressed by the modifications to paragraph (e)(3)(i)(C),
pursuant to which plan sponsors who are named fiduciaries may manage
qualified default investment alternatives.
Many commenters expressed concern that the Department did not
include capital preservation, in particular stable value, products as
qualified default investment alternatives on a stand alone basis. These
commenters pointed out that stable value funds are utilized by a large
number of plans as default investment funds. These funds are often
chosen by plan sponsors because they provide: Safety of principal;
bond-like returns without the volatility associated with bonds;
stability and steady growth of principal and earned income; and
benefit-responsive liquidity, so that plan participants may transact at
``book value.'' Commenters supporting stable value funds argued that
stable value funds are superior to money market
[[Page 60463]]
funds and other cash-equivalent products because stable value
investments earn higher rates of return than money market funds and
other cash-equivalent products. A number of these commenters also
suggested that stable value funds are appropriate for plans with
different demographics, including, for example, plans that cover
younger, higher turnover employees who are likely to elect lump sum
payments, or plans that cover older, near-retirement employees.
Commenters in support of the inclusion of stable value products
also indicated that stable value funds have relatively low costs
compared to life-cycle, targeted-retirement-date and balanced funds,
particularly those that use a ``fund of funds'' structure. These
commenters expressed the view that, because stable value returns are
comparable to intermediate corporate bond returns, the premium, if any,
of equity investments over stable value investments has been
overstated. Many of the commenters argued that the exclusion of stable
value funds would unduly discourage plan sponsors from using stable
value funds as a default option, to the detriment of plan participants.
These commenters argued that limiting default investment alternative
choices discourages plans from implementing automatic enrollment. In
addition, some commenters suggest that if participants whose account
balances are invested in qualified default investment alternatives
react negatively to volatile equity performance by opting out of plan
participation when losses occur, the regulation may ultimately decrease
retirement savings, and the potential gains expected from funds with
higher historical long-term performance records will not materialize.
Some of the comments supporting the inclusion of capital preservation
products also argued that the Congress, in referencing ``a mix of asset
classes consistent with capital preservation or long-term capital
appreciation, or a blend of both'' in section 624 of the Pension
Protection Act, intended the Department to include capital preservation
products as a separate stand alone qualified default investment
alternative.
The Department also received comments in support of its
determination that capital preservation products, such as money market
funds, stable value funds and similarly performing investment vehicles,
should not themselves constitute qualified default investment
alternatives under the regulation.
After careful consideration of the comments addressing this issue
and assessment of related economic impacts, the Department has
determined, except as otherwise discussed below, not to include capital
preservation products, such as money market or stable value funds, as a
separate long-term investment option under the regulation. As a short-
term investment, money market or stable value funds may not, in the
Department's view, significantly affect retirement savings. The
Department recognizes, however, that such investments can, and in many
instances will, play an important role as a component of a diversified
portfolio that constitutes a qualified default investment alternative.
It is the view of the Department that investments made on behalf of
defaulted participants ought to and often will be long-term investments
and that investment of defaulted participants' contributions and
earnings in money market and stable value funds will not over the long-
term produce rates of return as favorable as those generated by
products, portfolios and services included as qualified default
investment alternatives, thereby decreasing the likelihood that
participants invested in capital preservation products will have
adequate retirement savings.
The Department also is concerned that including capital
preservation and stable value products as a qualified default
investment alternative for future contributions on behalf of defaulted
participants may impede, or even reverse, the current trend away from
the use of such products as default investments. The Department
understands that, because account balances invested in capital
preservation products are unlikely to show a nominal loss, a number of
employers, if given a choice between capital preservation products and
more diversified investment options, may be more likely to opt for
capital preservation products because they are perceived as presenting
less litigation risk for employers. If so, inclusion of a capital
preservation option without limitation may increase utilization of
capital preservation products as default investments and, thereby,
increase the number of participants likely to have inadequate
retirement savings, as compared with savings that would be generated
through investments in the established qualified default investment
alternatives.
Lastly, the Department is concerned that inclusion of a capital
preservation product as a qualified default investment alternative,
without limitation, may be perceived by participants and beneficiaries
as an endorsement by the government, by virtue of its inclusion in the
regulation, or as an endorsement by the employer, by virtue of its
selection as the qualified default investment alternative, as an
appropriate investment for long-term retirement savings. Although the
Department recognizes that such perceptions on the part of some
participants and beneficiaries might be addressed with investment
education and investment advice, the Department nonetheless is
concerned that, overall, the potentially adverse effect on long-term
retirement savings may be significant.
In light of these concerns, the Department, as indicated above, has
not included a capital preservation investment alternative as a long-
term stand alone investment option for future contributions under the
final regulation. The Department, however, has added two exceptions to
the regulation that accommodate limited investments in capital
preservation products as qualified default investment alternatives. The
first exception is at paragraph (e)(4)(iv). In general, this exception
treats investments in capital preservation products or funds as an
investment in a qualified default investment alternative for a 120-day
period following a participant's first elective contribution (as
determined under section 414(w)(2)(B) of the Code).
Specifically, paragraph (e)(4)(iv)(A) recognizes, subject to the
limitations of paragraph (e)(4)(iv)(B), as a qualified default
investment alternative an investment product that is designed to
preserve principal and provide a reasonable rate of return, whether or
not guaranteed, consistent with liquidity. The product description and
applicable standards are similar to the standards adopted for purposes
of automatic rollovers of mandatory distributions at 29 CFR 2550.404a-
2. The Department believes it is appropriate to include capital
preservation products as a limited-duration qualified default
investment alternative to afford plan sponsors the flexibility of
utilizing a near risk-free investment alternative for the investment of
contributions during the period of time when employees are most likely
to opt out of plan participation. The use of capital preservation
products in these circumstances will enable plan sponsors to return
contributed amounts to participants who opt out without concern about
loss of principal. In this regard, the limitation set forth in
paragraph (e)(4)(iv)(B) provides that capital preservation products
described in paragraph (e)(4)(iv)(A) shall, with respect to any given
participant, be treated as a qualified default investment
[[Page 60464]]
alternative for a 120-day period following the participant's first
elective contribution (as determined under section 414(w)(2)(B) of the
Code). At the end of the 120-day period, capital preservation products
would cease to be a qualified default investment alternative with
respect to any assets of the participant that continue to be invested
in such products. In order to avail itself of the relief afforded by
the regulation, the plan fiduciary must redirect the participant's
investment in the capital preservation product to another qualified
default investment alternative prior to the end of the 120-day period.
As previously stated, such alternative may include an appropriate
capital preservation component in the context of a diversified
portfolio.
The 120-day time frame is intended to provide plans that allow an
employee to elect to make a permissible withdrawal, consistent with
section 414(w) of the Code, a reasonable amount of time following the
end of the 90-day period provided in section 414(w)(2)(B) (i.e., the
period during which employees may elect to make a permissible
withdrawal) to effectuate a transfer of a participant's assets to
another qualified default investment alternative.
The second exception relating to capital preservation products and
funds is at paragraph (e)(4)(v). This exception, unlike the first, is
intended to be limited to stable value products and funds with respect
to which plan sponsors are typically limited by the terms of the
investment contracts from unilaterally reinvesting assets on behalf of
participants who fail to give investment direction without triggering a
surrender charge or other fees that could directly and adversely affect
participant account balances. Under the exception, stable value
products and funds will be treated as a qualified default investment
alternative solely for purposes of investments in such products or
funds made prior to the effective date of this regulation. The
Department believes that this ``grandfather''-type provision
accommodates the concerns of commenters regarding the utilization of
stable value products and funds by plan sponsors as their default
investment option in the absence of guidance concerning fiduciary
responsibilities attendant to default investments generally, guidance
like that provided by this regulation. At the same time, by limiting
the exception to pre-effective date contributions, plan sponsors are
encouraged to assess whether and under what circumstances they wish to
avail themselves of the relief provided under the regulation by
utilizing a qualified default investment alternative that extends to
participant contributions made after the effective date of this
regulation. It is important to note, however, that, as indicated in the
regulation itself, the standards applicable to qualified default
investment alternatives set forth in the regulation are not intended to
be the exclusive means by which a fiduciary might satisfy his or her
responsibilities under the Act with respect to the investment of assets
in the individual account of a participant or beneficiary. Accordingly,
fiduciaries may, without regard to this regulation, conclude that a
stable value product or fund is an appropriate default investment for
their employees and use such product or fund for contributions on
behalf of defaulted employees after the effective date of this
regulation.
It also is important to note with regard to both of the exceptions
discussed above that the relief afforded by the regulation for
investments in the covered products or funds on behalf of defaulted
participants is contingent on compliance with all the requirements of
the regulation.
Finally, the Department disagrees with commenters' assertion that
the Department's decision not to include capital preservation products
as a qualified default investment alternative is inconsistent with
Congressional intent. The Department believes that Congress, in
enacting section 624 of the Pension Protection Act, provided the
Department broad discretion in framing a regulation that would permit
the Department to include or exclude capital preservation products as a
separate qualified default investment alternative. The Department also
notes that, pursuant to section 505 of ERISA, the Secretary may
prescribe such regulations as are necessary or appropriate to carry out
the provisions title I of ERISA.
C. Miscellaneous Issues
Transition Issues
A number of commenters raised issues concerning the status of
existing default investments and transfers to default investments that
would meet the requirements of the regulation. Specifically, commenters
requested guidance on what steps should be taken to ensure that a
plan's current default investments, which also meet the requirements of
the regulation, will be treated as qualified default investment
alternatives after the effective date of the regulation. Other
commenters requested guidance on what steps should be taken when a plan
is moving from default investments that do not meet the requirements of
the regulation to qualified default investment alternatives. In both
scenarios, commenters noted that plans often will not have the records
necessary to distinguish participants who were defaulted into a default
investment from those who affirmatively elected to invest in that
investment. Some commenters requested retroactive relief for
investments that would not otherwise constitute qualified default
investment alternatives because a plan's determination to transfer
assets out of such investments could trigger a market value adjustment
or similar withdrawal penalty.
To ensure that an existing or a new default investment constitutes
a qualified default investment alternative with respect to both
existing assets and new contributions of participants or beneficiaries,
plan fiduciaries must comply with the notice requirements of the
regulation. It is the view of the Department that any participant or
beneficiary, following receipt of a notice in accordance with the
requirements of this regulation, may be treated as failing to give
investment direction for purposes of paragraph (c)(2) of Sec.
2550.404c-5, without regard to whether the participant or beneficiary
was defaulted into or elected to invest in the original default
investment vehicle of the plan. Under such circumstances, and assuming
all other conditions of the regulation are satisfied, fiduciaries would
obtain relief with respect to investments on behalf of those
participants and beneficiaries in existing or new default investments
that constitute qualified default investment alternatives.
Several commenters requested guidance on the effective date of the
regulation. While section 404(c)(5) of ERISA is effective for plan
years beginning after December 31, 2006, relief under section 404(c)(5)
is conditioned on, among other things, the investment of a
participant's contributions and earnings ``in accordance with
regulations issued by the Secretary.'' See section 404(c)(5)(A).
Accordingly, relief under section 404(c)(5) is conditioned on
compliance with the provisions of this final regulation, which provide
relief only for investments on behalf of participants and beneficiaries
who were furnished a notice in accordance with paragraphs (c)(3) and
(d) of Sec. 2550.404c-5 and who did not give investment directions to
the plan after the effective date of the regulation. Although the
regulation only provides relief for investments in qualified default
investment alternatives when participants and beneficiaries do
[[Page 60465]]
not give investment directions after the effective date of the
regulation, compliance with the notice requirements may be achieved by
providing notice in accordance with the regulation before its effective
date.
With regard to the possible assessment of market value adjustments
or similar withdrawal penalties that may result from a fiduciary's
decision to move assets to a qualified default investment alternative,
the Department reminds fiduciaries that such decisions must be made in
compliance with ERISA's prudence and exclusive purpose requirements.
These decisions cannot be based solely on a fiduciary's desire to take
advantage of the limited liability afforded by this regulation, without
regard to the financial consequences to the plan's participants and
beneficiaries. In this regard, the Department notes that the final
regulation does not change the status of an otherwise prudent default
investment into an imprudent default investment. The Department has
attempted to make clear in both the preamble and the operative language
of the final regulation that the standards set forth therein are not
intended to be the exclusive means by which fiduciaries might satisfy
their responsibilities under the Act with respect to the investment of
assets on behalf of participants and beneficiaries who do not give
investment directions.
Further, as discussed above under Qualified Default Investment
Alternatives, the Department modified the regulation to provide relief
for investments made in stable value products or funds prior to the
effective date of the regulation. This modification is intended to
assist plan fiduciaries who may be limited by the terms of investment
contracts for such products or funds from unilaterally reinvesting
assets on behalf of participants who fail to direct their investments.
One commenter requested that the Department make clear that once a
participant or beneficiary directs any portion of his or her account
balance, the participant or beneficiary is considered to have directed
the investment of the entire account. The Department agrees that
investment direction by a participant or beneficiary with respect to a
portion of his or her account balance may be treated as a decision to
retain the remainder of the account balance as currently invested, thus
permitting the responsible fiduciary to consider the entire account
balance as directed by the participant or beneficiary.
A number of commenters requested that the Department clarify the
interrelationship between ERISA section 404(c)(4)(A)--the ``mapping''
provisions--and section 404(c)(5) and this regulation. The most obvious
difference between the two sections is the circumstances under which
relief is available. The relief provided by section 404(c)(4) is
limited to circumstances when a plan undertakes a ``qualified change in
investment options'' within the meaning of section 404(c)(4)(B). In
contrast, section 404(c)(5) and this regulation can apply to changes in
investment options and to the selection of initial plan investments
when participants or beneficiaries do not give investment directions.
Section 404(c)(4) applies only when the investment option from which
assets are being transferred was chosen by the participant or
beneficiary (see section 404(c)(4)(C)(iii)). Section 404(c)(5), unlike
404(c)(4), can apply to the selection of an investment alternative by
the plan fiduciary in the absence of any affirmative direction by the
participant or beneficiary. While the fiduciary relief afforded by
section 404(c)(4) and section 404(c)(5) is similar, relief under
section 404(c)(4) requires that new investments be reasonably similar
to the investments of the participant or beneficiary immediately before
the change, whereas relief under section 404(c)(5) requires investment
to be made in qualified default investment alternatives. In the context
of changing investment options under the plan, ERISA sections 404(c)(4)
and 404(c)(5) provide fiduciaries flexibility in implementing such
changes.
Preemption
Section 902 of the Pension Protection Act added a new section
514(e)(1) to ERISA providing that, notwithstanding any other provision
of section 514, title I of ERISA shall supersede any State law that
would directly or indirectly prohibit or restrict the inclusion in any
plan of an automatic contribution arrangement. Section 902 further
added section 514(e)(2) to ERISA defining the term ``automatic
contribution arrangement'' as an arrangement under which a participant:
May elect to have the plan sponsor make payments as contributions under
the plan on behalf of the participant, or to the participant directly
in cash; is treated as having elected to have the plan sponsor make
such contributions in an amount equal to a uniform percentage of
compensation provided under the plan until the participant specifically
elects not to have such contributions made (or specifically elects to
have such contributions made at a different percentage); and under
which such contributions are invested in accordance with regulations
prescribed by the Secretary of Labor under section 404(c)(5) of ERISA.
In the preamble to the proposed regulation, the Department specifically
invited comment on whether, and to what extent, regulations would be
helpful in addressing the preemption provision of section 514(e).
In response to the Department's invitation, commenters indicated
that, while the application of the preemption provisions should be
clarified, they did not believe it was necessary at this time for the
Department to prescribe regulations establishing minimum standards for
automatic contribution arrangements. Commenters also argued that ERISA
preemption should extend to all prudent investments under an automatic
contribution arrangement, not just those determined to be qualified
default investment alternatives under the Department's regulation. In
addition, commenters argued that preemption should not depend on
compliance with all the requirements of the regulation under section
404(c)(5), noting that section 514(e) has an independent notice
requirement. See section 514(e)(3).
In an effort to clarify the application of the preemption
provisions of section 514(e), the final regulation includes a new
paragraph (f). As set forth in the regulation, section 514(e) broadly
preempts any State law that would restrict the use of an automatic
contribution arrangement. After reviewing the text and purpose of
section 514(e), the Department concluded that Congress intended to
supersede the application of such laws to any pension plan that
provides for an automatic contribution arrangement, regardless of
whether such plan includes an automatic contribution arrangement as
defined in the regulation. This conclusion is reflected in paragraph
(f)(2) of the final regulation.
With the enactment of section 514(e), Congress intended to occupy
the field with respect to automatic contribution arrangements.\9\ Thus,
section 514(e) of ERISA does not merely supersede State laws
``insofar'' as any particular plan complies with this final regulation,
but rather generally supersedes any law ``which would directly or
indirectly
[[Page 60466]]
prohibit or restrict the inclusion in any plan of an automatic
contribution arrangement.'' This language stands in marked contrast to
the familiar language of section 514(a) of ERISA, which supersedes
State laws only ``insofar'' as they satisfy the ``relates to'' standard
set forth in that section.\10\
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\9\ This interpretation of section 514(e) is consistent with the
Technical Explanation of H.R. 4, the ``Pension Protection Act of
2006,'' as Passed by the House on July 28, 2006, and as Considered
by the Senate on August 3, 2006, a document prepared by the staff of
the Joint Committee on Taxation. That document states, on page 230:
``The State preemption rules under the bill are not limited to
arrangements that meet the requirements of a qualified enrollment
feature.''
\10\ Section 514(a) of ERISA provides, in pertinent part, that
``the provisions of this title and title IV shall supersede any and
all State laws insofar as they may now or hereafter relate to any
employee benefit plan * * *.'' Emphasis added.
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Additionally, Congress gave the Department discretion in section
514(e)(1) to determine whether and to what extent preemption should be
conditioned on plan compliance with minimum standards, stating that
``[t]he Secretary may prescribe regulations which would establish
minimum standards that such an arrangement would be required to satisfy
in order for this subsection [on preemption] to apply in the case of
such arrangement.'' Pursuant to this grant of discretionary authority,
the Department has concluded, at this time, that it should not tie
preemption to minimum standards for default investments. The
Department, therefore, specifically provides in paragraph (f)(4) that
nothing in the final regulation precludes a pension plan from including
an automatic contribution arrangement that does not meet the conditions
of paragraph (a) through (e) of the regulation. While relief under
ERISA section 404(c)(5) is available only to plans that comply with the
regulation, the Department has determined that it would be
inappropriate to discourage plan fiduciaries from selecting default
investments that are not identified in the regulation. State laws that
hinder the use of any other default investments would be inconsistent
with this determination, and with the discretionary authority Congress
vested in the Department over the scope of ERISA preemption.
Finally, in an effort to eliminate the need for multiple notices by
plan administrators of automatic contribution arrangements, paragraph
(f)(3) of the final regulation specifically provides that the
administrator of an automatic contribution arrangement within the
meaning of paragraph (f)(1) shall be considered to have satisfied the
notice requirements of section 514(e)(3) if notices are furnished in
accordance with paragraphs (c)(3) and (d) of the regulation.
Accordingly, satisfaction of the notice requirements under section
404(c)(5) and this regulation also will serve to satisfy the separate
notice requirements set forth in section 514(e)(3) for automatic
contribution arrangements.
Enforcement
Section 902 of the Pension Protection Act amended section 502(c)(4)
of ERISA to provide that the Secretary of Labor may assess a civil
penalty against any person for each violation of section 514(e)(3) of
ERISA. Implementing regulations will be developed in a separate
rulemaking.
D. Effective Date
This final regulation will be effective 60 days after the date of
its publication in the Federal Register.
E. Regulatory Impact Analysis
Summary
This regulation is expected to have two major economic
consequences. Default investments will be directed more toward higher-
return portfolios, boosting average investment returns, and automatic
enrollment provisions will become more common, boosting participation.
Both of these effects will increase average retirement savings,
especially among workers who are younger, have lower earnings and/or
more frequent job changes. A substantial number of individuals will
enjoy significant increases in retirement income, while a few may
experience decreases if the introduction of automatic enrollment slows
their saving or if their default investment returns are particularly
poor. The magnitude of these effects will be large in absolute terms
and proportionately large for many directly affected individuals.
The regulation's effects will be cumulative and gradual, and their
magnitude will depend on plan sponsor and participant choices. The
Department has developed low- and high-impact estimates to illustrate a
range of potential long-term effects.
By 2034 the regulation (together with the automatic enrollment
provisions of the Pension Protection Act) is predicted to increase
aggregate annual 401(k) plan contributions by between 2.6 percent and
5.1 percent, or by $5.7 billion to $11.3 billion (expressed in 2006
dollars). It is predicted to increase aggregate account balances by
between 2.8 percent and 5.4 percent, or by $70 billion to $134 billion.
Between 83 percent and 77 percent of net new 401(k) accumulations will
be preserved for retirement rather than cashed out early.
Low-impact estimates indicate that the regulation will increase
pension income by $1.3 billion per year on aggregate for 1.6 million
individuals age 65 and older in 2034, but decrease it by $0.3 billion
per year for 0.6 million. High-impact estimates suggest that pension
income will increase by $2.5 billion for 2.5 million and fall by $0.6
billion for 0.9 million. Impacts on retirement income will be larger
farther in the future, reflecting the fact that automatic enrollment
and default investing disproportionately affect young workers.
A substantial portion of the increase in retirement savings will be
attributable directly to the movement of default investments away from
stand-alone, fixed income capital preservation vehicles and toward
qualified default investment alternatives that provide for capital
appreciation as well as capital preservation. The majority of the
increase, however, will be attributable to the proliferation of
automatic enrollment.
The Department believes that the net increase in retirement savings
will translate into a net improvement in welfare. There is substantial
risk that savings will fall short relative to many workers' retirement
income expectations, especially in light of increasing health costs and
stresses on defined benefit pension plans and the Social Security
program. The regulation will help reduce that risk. An increase in
retirement savings additionally is likely to promote investment and
long-term economic productivity and growth. The Department therefore
concludes that the benefits of this regulation will justify its costs.
Executive Order 12866
Under Executive Order 12866, the Department must determine whether
a regulatory action is ``significant'' and therefore subject to the
requirements of the Executive Order and subject to review by the Office
of Management and Budget (OMB). Section 3(f) of the Executive Order
defines a ``significant regulatory action'' as an action that is likely
to result in a rule (1) having an annual effect on the economy of $100
million or more, or adversely and materially affecting a sector of the
economy, productivity, competition, jobs, the environment, public
health or safety, or State, local or tribal governments or communities
(also referred to as ``economically significant''); (2) creating
serious inconsistency or otherwise interfering with an action taken or
planned by another agency; (3) materially altering the budgetary
impacts of entitlement grants, user fees, or loan programs or the
rights and obligations of recipients thereof; or (4) raising novel
legal or policy issues arising out of legal
[[Page 60467]]
mandates, the President's priorities, or the principles set forth in
the Executive Order. This action is significant under section 3(f)(1)
because it is likely to have an annual effect on the economy of $100
million or more. Accordingly, the Department has undertaken, as
described below, an analysis of the costs and benefits of the
regulation. The Department believes that the regulation's benefits
justify its costs.
Regulatory Flexibility Act
The Department certified that the proposed regulation, if adopted,
would not have a significant economic impact on a substantial number of
small entities. 71 FR 56806, 56815 (Sept. 27, 2006). In explaining the
basis for this certification, the Department noted that 10 to 20
percent of small participant directed defined contribution plans
(28,000 to 56,000 plans) might adopt automatic enrollment programs as a
result of the regulation. Consequently, some of the employers
sponsoring such plans may have to make additional matching
contributions (up to $100 million to $300 million annually). The
Department expects that the amount of such additional contributions to
small plans would be proportionately similar to those to large plans.
The Department did not expect the proposed regulation to have any
adverse consequences for small plans or their sponsors because all the
factors at issue, including the payment of matching contributions, the
adoption of automatic enrollment programs, and compliance with the
regulation are voluntary on the part of the plan sponsor.
The Department received one comment regarding the proposed
regulation's potential effect on small entities. The commenter believes
that certain types of mutual funds that would be qualified default
investment alternatives under paragraph (e)(4)(i) (e.g., life-cycle or
target-retirement date funds) sometimes invest in other types of mutual
funds. According to the commenter, the investment advisers for the
life-cycle or target-retirement-date funds may have an incentive to
skew the fund's allocation toward sub funds that generate higher fees
than to funds that would be most appropriate for the age or expected
retirement date of the affected participants. The commenter stated that
fiduciaries of small plans wishing to use the safe harbor would need to
expend disproportionately more resources than large plan fiduciaries in
making sure that the asset allocations (and thus, the corresponding fee
structures) are not tainted by conflicts of interest. Specifically, the
commenter was concerned that unlike larger plans which could conduct
analyses of the neutrality of asset allocations in-house, small plans
would have to expend resources on using outside consultants to conduct
such analyses or face potential liability for a failure to do so. The
commenter mentioned that some funds are willing to indemnify
fiduciaries of large plans from any liability associated with choosing
such funds. The commenter suggested that the Department add measures to
mitigate the likelihood of conflicts, such as requiring that such funds
allocate assets pursuant to independent algorithms and require equal
treatment for small plan fiduciaries with regard to indemnification.
Plan fiduciaries must take into account potential conflicts of
interest and the reasonableness of fees in choosing and monitoring any
investment option for a plan, whether covered under the safe harbor or
not. This obligation flows from the fiduciary duties of prudence and
loyalty to the participants set out in ERISA section 404(a)(1). The
regulation imposes no new requirements for selecting qualified default
investment alternatives. For large or small plans, the duty to evaluate
a plan investment option exists regardless of whether the plan includes
an automatic enrollment feature or whether the fiduciary is seeking to
comply with this regulation. Thus, the Department continues to believe
that this regulation would not have a significant effect on a
substantial number of small entities.
The Department considered the commenter's suggestions. Adopting
them, however, could limit plans' choices or increase the cost of
qualified default investment alternatives. The regulation does not
prevent plan fiduciaries from taking features such as independent
algorithms into account in choosing qualified default investment
alternatives. If it determines that a widespread need for such
assistance exists, the Department may consider providing guidance for
small plans regarding prudent selection of qualified default investment
alternatives.
The Department has also considered the changes made in this
document from the proposed regulation. These changes, including the
modified notice requirement, allowing trustees and certain pla |
