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Safe Harbor Investments.

Summary paragraph: QDIAs offer fiduciary protection, so why don't all plan sponsors use them?

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When examining retirement plan design, sponsors naturally have many questions. What investments should be offered to plan participants? Are the participants legally protected? Are you, as a plan sponsor, legally protected?

A decision that speaks to all of these questions is whether to choose a qualified default investment alternative (QDIA) or a non-QDIA investment as the default investment for plan participants.

What Is a QDIA?

QDIAs are a safe harbor investment created by the Pension Protection Act (PPA) of 2006. Language in the PPA directed the U.S. Department of Labor (DOL) to issue a regulation to assist employers in selecting default investments that best serve the retirement needs of employees who entrust investing to their employer. Although QDIAs are often associated with automatic enrollment, they can be applied to any participant enrolled in the plan who has given no affirmative investment direction.

The final QDIA regulation, titled "Default Investment Alternatives Under Participant-Directed Individual Account Plans," was issued in October 2007. Updates and adjustments were released in April 2008 as a DOL fact sheet and in Field Assistance Bulletin (FAB) No. 2008-03.

The DOL has established guidelines around the kinds of investments that qualify as QDIAs. The most popular options include target-date funds (TDFs), managed accounts and balanced funds. While the regulation fails to identify specific investment products, it does describe the mechanisms, or types of products, for investing participant contributions, namely:

* A product with a mix of investments that takes into account the individual's age or retirement date-for example, a target-date fund;

* An investment service that allocates contributions among existing plan options to provide an asset mix that factors in the individual's age or retirement date-a managed account; and

* A product with a mix of investments that considers the characteristics of the group of employees as a whole, rather than each individual-a balanced fund.

The DOL regulation also allows for a capital preservation product-such as a stable value or money market fund-to be used, but only for the first 120 days of participation in the plan, after which a participant must move into one of the three QDIAs for the safe harbor to apply.

In terms of non-QDIA investments, the DOL regulation recognizes that, while "investments in money market funds, stable value products and other capital preservation investment vehicles may be prudent for some participants or beneficiaries, ... such investments themselves may not generally constitute qualified default investment alternatives."

Although most plan sponsors have changed their default investment to adhere to the QDIA regulation, nearly one in five have not. The 2012 PLANSPONSOR Defined Contribution (DC) Survey asked sponsors what was used as their plan's automatic enrollment default investment (see "Default Investment Options in Auto-enrollment Plans," above, right); 18% of sponsors (see "Use of Non-QDIA Investments - by Asset Size," at left) have non-QDIA investments: stable value funds and guaranteed investment contracts (GICs) (5.7%), money market funds (6.9%) and other (5.4%).

The Benefits of Using a QDIA

Most important, the QDIA regulation offers sponsors legal protection from fiduciary liability for investment outcomes under its safe harbor terms (see "Conditions for a QDIA Safe Harbor ( 6442494057&page=4)").

Lori Lucas, head of the Defined Contribution Consulting Practice at Callan Associates in Chicago, says that the protection offered by QDIAs often figures in their selection over non-QDIA investments. "Defaults that qualify as QDIAs can have protection under Section 404(c) of ERISA [the Employee Retirement Income Security Act], meaning that, as long as the plan sponsor defaults workers into the QDIA and follows the appropriate QDIA notifications, etcetera, then the plan sponsor is not liable for any losses in participant accounts attributable to the investment fund."

The fiduciary safe harbor is only one reason to select a QDIA; diverse investment options and increased participation also appear to be motivators. "For those plan sponsors that pick QDIAs, they are taking advantage of the safe harbor status and, if they select a target-date or lifecycle fund or managed account product, [of] the changing of asset allocations over time. These factors often make sense for their participants," says David Kaleda, principal with the Fiduciary Responsibility group at Groom Law Group in Washington, D.C.

In choosing whether or not to adopt a QDIA, plan sponsors might look at the demographics of the plan and/or participants, says Kathleen Connelly, executive vice president of Client Service at Ascensus Inc. in Dresher, Pennsylvania. "The inertia of plan participants can definitely play a role there."

Opting to utilize a QDIA does not absolve a plan sponsor of all responsibility, though. According to Howard Heller, manager of legislative and regulatory strategy at T. Rowe Price in Owings Mills, Maryland, "Even though a QDIA provides fiduciary protection for default investments, going with a QDIA doesn't totally let them off the hook. Plan sponsors are still responsible for prudently selecting and monitoring the QDIA."

Why Use Non-QDIA Investments?

Those plans that choose to use non-QDIA investments as their default forego the safe harbor protection offered by QDIAs. "Plan sponsors who include QDIAs in their plans feel that, if they are prudent in choosing their investment lineup, the use of the QDIA safe harbor and reliance on the 404(c) safe harbor for participant-directed investment gives them the most protection they can get under the law," says Kaleda. "However, those who go with a non-QDIA approach must also prudently select their plan's investment option; so they feel, if they can prove that, they are adequately protected under ERISA."

As to why some plans choose non-QDIA investments, says Lucas, "Some plan sponsors prefer a very conservative default investment fund-such as a money market or stable value fund-even though it does not afford the plan sponsor protection under Section 404(c) of ERISA. In this situation, a plan sponsor may believe that a money market or stable value fund is more appropriate for its participants as a default and, therefore, more prudent-for example, if there is a much older work force at the company. The plan sponsor may take the position that, since the money market or stable value fund is a prudent default, they do not require 404(c) protection."

However, a lack of knowledge about QDIAs can also play a role in choosing to use a non-QDIA investment. "I am still surprised by how many plan sponsors are unaware of these protections. The amount of education that a plan sponsor has on this subject definitely influences its decision on whether or not to use a QDIA with its plan," says Connelly.

Although a plan's size does not directly affect whether it goes the QDIA or non-QDIA route, she says, it can still have an impact on access to information. Smaller companies may not have the same information about QDIAs available to them that larger companies have, so the plan sponsors may make decisions based on an incomplete picture. Once they learn of the protections offered by a QDIA, she says, many switch over from their non-QDIA investments.

Still, despite the lack of safe harbor protection, says Bradford Campbell, counsel at Drinker Biddle & Reath LLP in Washington, D.C., the decision to select a non-QDIA is not necessarily imprudent. "Plans are free to select a prudent default investment that is not a QDIA. A plan can adopt automatic enrollment without using a QDIA, and some companies believe that a non-QDIA investment is prudent for them. It is really an individualized fiduciary determination." -Kevin McGuinness

The qualified default investment alternative (QDIA) regulation offers plan sponsors legal protection under its safe harbor conditions. For plan sponsors to obtain this safe harbor relief from fiduciary liability for investment outcomes, the following conditions must be met:

* Assets must be invested in a "qualified default investment alternative" as defined in the regulation;

* Participants and beneficiaries must have been given an opportunity to provide investment direction but opted not to;

* A notice must generally be given to participants and beneficiaries in advance of the first investment in the QDIA and annually thereafter. The rule describes the information that must be included in the notice;

* Material, such as investment prospectuses, provided to the plan for the QDIA must be forwarded to the participants and beneficiaries;

* Participants and beneficiaries must have the opportunity to direct investments out of a QDIA as frequently as out of other plan investments, but at least quarterly;

* The rule limits the fees that can be imposed on a participant who opts out of participation in the plan or who decides to direct his investments; and

* The plan must offer a broad range of investment alternatives as defined by the Department of Labor (DOL)'s regulation under Section 404(c) of the Employee Retirement Income Security Act (ERISA).

Also, the QDIA regulation does not absolve fiduciaries of the duty to prudently select and monitor QDIAs.

Source: U.S. Department of Labor (DOL)
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Date:Jul 1, 2013
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