ErisaALERT 2007-04 Administrative and procedural implications of the QDIA regulations

November, 2007

Focusing on the administrative and procedural implications of the QDIA regulations

By now you have received numerous bulletins from your consultants and attorneys regarding the new qualified default investment alternative (QDIA) rules. In this ErisaALERT we will try very hard not to repeat everything you have already received, but rather focus on the practical administrative/procedural steps you should be thinking about now. Unfortunately, we must begin with a very brief synopsis of the regulations.

Brief Synopsis. PPA 2006 added ERISA§404(c)(5) which provides fiduciary relief when a participant does not give investment direction for various contributions. The relief can apply to auto enrollment contributions, rollovers into the plan, profit sharing contributions and alternative investment fund choices when a particular investment fund is removed from an existing line up. The final regulations were issued on October 24, 2007 (www.dol.gov/ebsa/regs/fedreg/final/07-5147.pdf) and are effective December 24, 2007. The regulations themselves are not very long, roughly three pages; the preamble, which often provides very meaningful information is about 25 pages and is clearly worth a read.

The QDIA regulations provide fiduciary relief if:

• Assets are invested in a QDIA as defined in the regulations.

• The participant or beneficiary on whose behalf the investment is made had the opportunity to make an investment election but didn’t.

• The participant or beneficiary is furnished a notice initially and annually thereafter.

• The participant is provided information regarding the investment that is provided to the plan,

• The participant is able to transfer out of the QDIA to another investment with a frequency consistent with that offered to other plan participants who made elections, but not less frequently than once within any 90 day period and any transfer made by the participant within the 90 day period beginning on the date of the participant’s first elective contribution isn’t subject to any restrictions, fees or expenses for the transfer out of the QDIA.

• The plan offers a broad range of investment alternatives within the meaning of DOL §2550.404c-1(b)(3).

• A QDIA must be either managed by an investment manager, plan trustee or plan sponsor who is the named fiduciary or be an investment company registered under the Investment Company Act of 1940.

• The QDIA generally may not invest in employer securities.

The regulations do not absolve fiduciaries of the duty to prudently select and monitor QDIAs.

What should you do first? You should decide whether you want to avail yourself of the protection provided by the regulations. The DOL indicates that the QDIA standards aren’t the exclusive method by which a plan fiduciary can satisfy his/her responsibilities under ERISA. So, if you have a prudent process in place for selecting and monitoring plan investments and believe your process will stand up in court, you don’t have to comply with the QDIA regulations. As a practical matter, we believe the majority of plan sponsors will avail themselves of the protection offered by the QDIA regulations.

First Action Item: Decide if you want to avail yourself of the fiduciary relief offered by the regulations.

What should you do next? Assuming you have decided to become QDIA compliant, the next thing you should do is review your current default procedures. Is your default fund:

• A life cycle or target retirement date fund?

• A model portfolio that applies generally accepted investment theories, is diversified to minimize risk of large losses, designed to provide long term appreciation 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, e.g., a balanced fund?

• An investment management service, such as a managed account, which allocates the assets of the 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 or life expectancy?

• A short term investment of not more than 120 days from the date of the participant’s first elective contribution in an investment product or fund designed to preserve principal and provide a reasonable rate of return, whether or not guaranteed consistent with liquidity, e.g., a money market fund or a stable value fund?

NOTE: If the short term QDIA fund is a stable value fund there must be no fees or surrender charges imposed in connection with withdrawals initiated by a participant or beneficiary and principal and rates of return must be guaranteed by a state or federally regulated financial institution.

If your current default fund is not a money market or stable value fund and otherwise satisfies the regulations, you should focus on the notice requirements discussed below.

If your current default fund is a money market fund or a stable value fund, review the fund’s terms to ensure that there are no fees or surrender charges imposed in connection with withdrawals initiated by a participant or beneficiary and that the principal rates of return are guaranteed by a State or federally regulated financial institution. Keep in mind that a stable value fund will only be considered a QDIA for contributions made before December 24, 2007; contributions after December 24, 2007 that are defaulted into a stable value fund will not be afforded QDIA relief. If you want the fiduciary relief, you must designate a QDIA for contributions made after December 24, 2007. Also, if your current default fund is a money market fund, it will be a QDIA only for the first 120 days after a participant’s initial contribution; thereafter, you must transfer the funds to a QDIA as described above in order to retain the fiduciary relief.

Second Action Item(s):

• Carefully read the regulations and understand the QDIA requirements;
• review the regulations taking into consideration your current default fund and existing fund line up;
• engage an “investment expert” whether internal or external to assist with the review of the funds vs the regulatory requirements
• identify a QDIA and establish procedures to transfer funds from the existing default fund; it would be a good idea to confirm that the QDIA provider understands the ramifications of the new QDIA regulations
• pay special attention to any redemption fee requirements in the prospectus of your chosen QDIA; the QDIA must satisfy the regulations regarding fees
• confirm with your recordkeeper that the recordkeeping system isn’t set up to automatically charge redemption fees for short round trip investments in the QDIA
• develop a procedure, if you don’t already have one, to monitor the fund performance
• communicate to participants.

Notify participants. In addition to selecting a QDIA, you must notify participants initially and annually thereafter.

• Content. The notice must be written in a manner calculated to be understood by the average plan participant and contain:
  • 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 QDIA; and if applicable, an explanation of the circumstances under which elective contributions will be made on behalf of a participant, the percentage of such contributions, and the right of the participant to elect not to have such contributions made on the participant’s behalf or to elect to have such contributions made at a different percentage
  • An explanation of the right of participants and beneficiaries to direct the investment in their individual accounts
  • A description of the QDIA, including a description of the investment objectives, risk and return characteristics (if applicable) and fees and expenses attendant to the investment alternative
  • A description of the right of the participants and beneficiaries on whose behalf assets are invested in a QDIA 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
  • an explanation of where the participants and beneficiaries can obtain investment information concerning the other investment alternatives available under the plan.
• Timing of the Notice. The notice must be provided:
  • 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 QDIA on behalf of a participant or beneficiary
  • on or before the date of plan eligibility provided the participant has the opportunity to make a permissible withdrawal as determined under IRC §414(w). (Recall that PPA provided that plans with automatic enrollment could elect to allow participants who were automatically enrolled to withdraw the automatic contributions within 90 days with no early withdrawal penalties)
  • within a reasonable period of time of at least 30 days in advance of each subsequent plan year.

Third Action Item: Develop and mail notices by November 24^th if you wish to avail yourself of the fiduciary relief for contributions made after December 24^th ; mail annually thereafter

NOTE: The IRS released a sample notice (http://www.irs.gov/pub/irs-tege/se111507.pdf)which combines the notice required for plans with eligible automatic contribution arrangements (EACA), qualified automatic contribution arrangements (QACA) and QDIAs. Be forewarned, that due to the individual nature of each particular plan’s default fund, plan administrators still have work to do creating a QDIA notice.

Note: This material is for the sole purpose of providing general information and does not under any circumstances constitute legal advice and should not be used as a substitute for legal advice. You should seek the advice of counsel when applying the requirements to your plans. For more information on this ErisaALERT, contact us by phone at 610-524-5351 and ask for Mary Andersen or 973-994-7539 and ask for Theresa Borzelli, Esquire, Fox Rothschild LLP.