DoL Releases Default Investment Option Safe Harbor

September 26, 2006 ( - US Department of Labor (DoL) officials on Tuesday released a proposed safe harbor rule covering default investment options chosen by retirement plan sponsors for auto enrollment programs and scenarios in which employees fail to submit investment instructions.

Under the proposal, employers would be protected from suits about the default investment option’s market performance, US Secretary of Labor Elaine Chao and Assistant Secretary of Labor Ann Combs said during a news media briefing. However, even if plans were to follow such a rule, Combs cautioned, plan sponsors are still liable for litigation about how the specific options were chosen within the broad categories and how they were later monitored.

The default investment safe harbor applies to all defined contribution plans permitting participants to exercise control over the investment of assets in their plan accounts – including in 401(k), 403(b), and 457 plans, the officials said. The rule said the proposal is limited to plan scenarios where an individual account’s plan assets are invested in default investment alternatives on behalf of those participants or beneficiaries who fail to give the plan investment instructions.

“Too many workers, some overwhelmed by investment choices or paperwork, are leaving retirement money on the table by not signing up for their employers’ defined contribution plan,” said Chao.  “This regulation would boost retirement savings by establishing default investments for these workers that are appropriate for long-term savings.”

As widely expected by Employee Retirement Income Security Act experts (See The Washington Winds: The ‘Death Knell’ of DB ), the approved default categories in the DoL proposal – now known as qualified default investment alternatives (QDIAs) – include:

  • lifecycle or targeted-retirement date funds,
  • balanced funds, and
  • managed accounts.

“The new default options will help workers accumulate larger nest eggs for retirement,” said Combs.  “Workers who don’t feel equipped to make investment decisions will be automatically invested in a mix of stocks and bonds appropriate for long term savings.”

According to Combs, a plan that institutes an auto enrollment feature would notify all employees who would be given a grace period of at least 30 days to either opt out or to remain enrolled and specify one or more investment options. The notice has to specify that an employee who does not respond within the specified time period will be invested in a default investment.

class=”a”> “The employee has the option to say ‘No, I don’t want to participate,’ or ‘I want to participate but I don’t want to invest my money in that option'”, Combs said.

class="a"> The proposed rule requires that a notice be furnished to participants and beneficiaries 30 days in advance of the first investment, and at least 30 days in advance of each subsequent plan year, and must include: a description of the circumstances under which assets will be invested in a QDIA; a description of the investment objectives of the QDIA; and an explanation of the right of participants and beneficiaries to direct investment of the assets out of the QDIA.

class="a"> Also:

  • Any material, such as investment prospectuses and other notices, provided to the plan by the QDIA must be furnished to participants and beneficiaries.
  • Participants and beneficiaries must have the opportunity to direct investments out of a QDIA with the same frequency available for other plan investments but no less frequently than quarterly, without having to pay a fee.
  • The plan must offer a "broad range" of investment alternatives" as defined in section 404(c) of ERISA into which an opting out participant can move.

Chao and Combs also said that QDIAs:

  • may not impose financial penalties or otherwise restrict the ability of a participant or beneficiary to transfer the investment from the qualified default investment alternative to any other investment alternative available under the plan,
  • must be either managed by an investment manager, or a registered investment company,
  • must be diversified to minimize the risk of large losses, and
  • may not invest participant contributions directly in employer securities. One exception: when the employer's stock is listed on an index in which a default option is invested.

Chao and Combs said DoL economists have estimated that the proposal could increase aggregate 401(k) plan account balances by between $45 billion and $90 billion and that auto enrolled plans could see a 90% participation rate. Combs said about 18% of plans now use auto enrollment features.

The suggested regulation represents the first such release resulting from the Pension Protection Act (PPA) signed into law by President Bush on August 17, 2006. Combs said the DoL will have to issue more than 30 rules growing out of the PPA, while the US Treasury Department and the Pension Benefit Guaranty Corporation (PBGC) will put out others.

A fact sheet about the proposal is  here . The text of the proposed rule is   here .     

Public comments on the proposed rule should be submitted to the U.S. Department of Labor, Employee Benefits Security Administration, Room N-5669,  200 Constitution Ave., N.W., Washington, D.C.  20210, Attention: Default Investment Regulation; or electronically to or .  The proposed regulation is to be published in the September 27, 2006 Federal Register.