The Department of Labor (DOL) recently issued final regulations extending fiduciary relief with respect to investment performance using qualified default investment alternatives (QDIA). The following questions and answers explain the requirements for utilizing a QDIA, including a detailed discussion of "stable value funds," often historically offered as the default fund.

Question and Answers: Qualified Default Investment Alternatives and "Stable Value Funds"

Q1. What is a QDIA?

A1. Many participants, for a number of reasons, accept sponsor-chosen default investment options instead of making positive elections. However, plan sponsors should be concerned with the fiduciary responsibility associated with sponsor-chosen investments, especially when poor long-term returns result in lower investment value and a less secure retirement. Introduced in the Pension Protection Act of 2006, the QDIA was designed to promote wider implementation of automatic 401(k) plan enrollment by protecting plan sponsors from excess fiduciary liability (but the fiduciary relief offered by a QDIA extends beyond automatic enrollment to all default investments). Investing participant assets in a default investment option that qualifies as a QDIA affords a plan sponsor the same fiduciary protection as they receive from participant-directed investments. The DOL regulations, effective December 24, 2007, define the QDIAs.

Q2. How does a plan sponsor take advantage of the fiduciary relief offered by the new DOL regulations?

A2. Assuming fiduciaries are acting in the best interest of plan participants when selecting investment options (i.e., the default investment option itself), the final regulations provide fiduciary relief for investment outcomes provided that assets are invested in a QDIA (as defined below), the participant is given an opportunity to direct the investment of assets in his or her account, and proper notice is given to participants in a timely manner (please see final Federal Register for complete regulations).

Q3. Is a plan sponsor required to invest plan participant assets in a QDIA? What if they don't?

A3. No, compliance with regulations governing QDIAs is optional. A plan sponsor is free to choose any investment they wish. However, the QDIA acts as a shield from fiduciary liability. If a plan sponsor chooses not to invest assets in a QDIA, they will assume fiduciary responsibility for any investment not directed by plan participants (e.g., default investments). Ignoring the QDIA regulations could make plan sponsors vulnerable to lawsuits and fiduciary actions from participants unhappy with the results of sponsor-chosen default investments.

Q4. Must participants be given advance notice of the plan's default investment provisions before the first investment in the QDIA and each year thereafter?

A4. Yes.

Q5. Must participants be permitted to transfer assets from the QDIA to other investment alternatives?

A5. Yes, transfers must be offered at least as frequently as other investments, but at least quarterly.

Q6. What qualifies a valid offering as a QDIA?

A6. Final regulations define three general categories of investment options that will constitute a QDIA:

1. A product or model portfolio with a mix of equity and fixed income exposures that takes into account the participant's age or target retirement date (e.g., a life-cycle or target-retirement-date fund);
2. A product or model portfolio with a mix of equity and fixed income exposures that is designed with a target level of risk appropriate to the group of plan participants as a whole (e.g., a balanced fund); and
3. An investment management service that allocates the participant's investments among existing investment options under the plan (e.g., a professionally managed account).

Q7. Does a capital preservation fund (e.g., stable value fund or money market fund) constitute a valid QDIA?

A7. Generally, no. The final regulations specify that, with exceptions outlined below, a capital preservation product such as a stable value fund or money market fund designed to preserve principal generally will not constitute a QDIA.

Q8. OK, what exceptions allow capital preservation funds to constitute a QDIA?

A8. There are two exceptions:

1. A capital preservation fund can constitute a QDIA, but only for the first 120 days after a participant's first elective contribution to the plan, provided the participant is permitted to opt out of participation and withdraw his or her contribution within the 90-day opt-out period under Code Section 414(w). (There are administrative concerns regarding this requirement, but Cowden Associates will address this issue further at a later date.) This is referred to as a limited-duration QDIA. It is designed 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.
2. Plans that used a capital preservation fund as their default fund prior to December 24, 2007 receive a grandfathered treatment of those contributions, and may consider them to be contributions to a QDIA. However, there is no fiduciary relief for default contributions to capital preservation funds after December 24, 2007 (other than the 120 day relief noted above).

NOTE: At the end of the 120-day period, capital preservation products will cease to be a QDIA 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 QDIA prior to the end of the 120-day period.

Q9. Does this grandfather relief apply to typical money market funds?

A9. No, since the fund must guarantee a rate of return generally consistent with intermediate investment grade bonds to receive the relief.

Q10. Does this grandfather relief apply to typical insurance company stable value or guaranteed funds?

A10. In most cases, yes, assuming the fund guarantees a rate of return generally consistent with intermediate investment grade bonds. If the rate is lower, it appears that the relief will not apply.

Q11. What should plan fiduciaries do to protect themselves?

A11. Plan fiduciaries should review the terms of their stable value funds to determine whether they meets all the requirements for grandfather relief. In addition, participant notices must be provided, including:

1. an initial written notice of the plan's default investment provisions issued at least 30 days prior to the participant's entry date; and
2. an annual notice issued at least 30 days before each plan year thereafter.

Q12. Can these notices be included as part of a summary plan description or summary of material modifications?

A12. No, but they may be combined with other notices, such as a 401(k) safe harbor plan notice or an automatic enrollment notice.

Q13. Can the notice be delivered via email?

A13. Yes. Unless further guidance is issued, the notice can be delivered electronically under either the DOL or IRS regulations on electronic delivery.

Q14. What do we do if our plan, which currently uses a default investment option, did not meet the November 24, 2007 deadline to issue initial notice to current plan participants?

A14. The fiduciary relief will still apply for default investments in a QDIA 30 days after the initial notice is properly given after the effective date of the regulations. For example, if a plan sponsor is unable to provide the notice until April 1, 2008, fiduciary relief will apply for default investments made on and after May 1, 2008.

Q15. What information must be included in the notice?

A15. Both the initial and annual notice must contain:

1. a description of when and to what extent assets may be invested in a QDIA;
2. a statement of the participant's right to affirmatively direct investments;
3. a description of the QDIA, including investment objectives, risk and return characteristics, fees and expenses;
4. a statement of the participant's right to transfer assets from the QDIA to other investments;
5. options under the plan, including a description of any restrictions, fees or expenses associated with such transfer; and
6. an explanation of where additional information concerning the other investment options under the plan may be obtained.

Q16. I still have some questions. How do I find out more about fiduciary relief and QDIAs?

A16. For further information, please contact Jere Cowden, President and CEO, or Jim Bartoszewicz, Executive Vice President, Defined Contribution & Investment Advisory Services. They can be reached at 412-394-9330 or toll-free at 888-889-9432. Full regulations and a QDIA Fact Sheet can also be found at the DOL website.

Note: The information contained herein is not legal or investment advice and should not be relied on for action; plan sponsors and other fiduciaries should contact legal counsel and their investment adviser prior to taking action.