The United States Department of Labor has finalized regulations mandated by the Pension Protection Act of 2006 to establish a safe harbor protecting 401(k) plan fiduciaries from liability when they select investments for participants who do not make investment elections.
There has been a long-standing safe harbor protecting fiduciaries when participants select investments from the choices available in the plan, but it does not cover investments for participants who take no action. The new regulations will help facilitate the adoption of 401(k) plans with automatic enrollment features, i.e., those plans enrolling participants who do not file election forms at a predetermined contribution rate. However, the new safe harbor is available to fiduciaries of all 401(k) plans (and any other qualified plans) that permit participants to make investment elections. It may be applied to current participants who receive proper notice, as well as to new entrants into a plan.
Why Use the Safe Harbor?
Although use of the safe harbor is not mandatory, and there may be other ways for fiduciaries to satisfy their obligations for selecting default investments, as a practical matter, the safe harbor provides the only clear guidelines for fiduciaries to protect themselves. In addition, 401(k) plans with automatic enrollment are required to use a qualified default investment alternative (QDIA) defined in these regulations if they permit automatically enrolled participants who opt out of participation to withdraw contributions or to get extra time to refund excess contributions.
Plan fiduciaries should act promptly to determine whether and how to take advantage of the safe harbor, because under the new regulations some commonly used default investments will not be safe harbor default investments in the future, and the regulations condition the safe harbor protection on giving notices and information to participants.
Effective Date of Safe Harbor
The regulations become effective on December 24, 2007. Plan sponsors who cannot be ready by December 24 do not lose the ability to use the safe harbor; however, protection will become available only when all of the requirements of the regulations have been satisfied.
The questions and answers below discuss the basic requirements in the regulations.
What are permissible QDIA's?
These are life cycle funds, target retirement date funds, balanced funds, and certain managed accounts and asset allocation services. Stable value funds, which include money market funds and guaranteed investment contracts, and most employer stock investments will not be QDIAs for contributions made on and after December 24, 2007. This is a major shift for many plans that used stable value funds as default investments, because of the low risk profile of those funds. An exception was made for the use of money market and other stable value funds as temporary investments for 120 days after the participant's first contribution under certain automatic enrollment arrangements. This was intended to cover the 90 day period when participants may withdraw contributions if they have the right to opt out of the automatic enrollment. In addition, contributions made prior to December 24 to certain investment contracts and other stable value funds are grandfathered and do not need to be reallocated.
What other requirements must be satisfied?
Fiduciaries must provide participants with notice. The initial notice must usually be provided 30 days in advance, although notice up to the date of plan eligibility may be provided by plans with certain automatic contribution arrangements. Notice is annual thereafter. The notice must be a separate document and may not be combined with the plan's summary plan description. The IRS and the Department of Labor recently issued a model notice that could be used by plans with automatic enrollment. Required fund information, such as prospectuses, must be given to participants, and there are limitations on the fees that may be imposed on participants who subsequently move their investments out of the QDIA. In addition, the plan must offer a broad range of investment alternatives.
How comprehensive is the safe harbor?
While it is comprehensive, it does not absolve fiduciaries from the duty to prudently select and monitor the QDIA and/or the managers of the managed accounts. However, the Department of Labor has made clear that the choice from among the types of available alternatives, such as whether to pick a balanced fund or a target-date fund as a QDIA, is not a fiduciary decision.
Is further guidance anticipated?
There are many unanswered questions regarding application of the regulations. In recognition of this fact, the Department of Labor has announced that it plans to issue a Q&A sheet soon.
U.S Tax (IRS Circular 230): Nothing in this communication is U.S. tax or other legal advice that is intended or written to be used, and it cannot be used, by any person to (i) avoid penalties under U.S. federal, state or local tax law, or (ii) promote, market or recommend to any person any transaction or matter addressed herein.
Carol Buckman is Counsel in the firm's New York office, practising in the Pensions and Benefits Department. Sandra Cohen is a partner in the firm's New York office practising in the Pensions and Benefits Department, with a cross-appointment to the Tax Department. Heidi I. Winzeler is Counsel in the Pensions and Benefits Department of the firm's New York office.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.