How Automatic Are Your 401(k) Plan Investments?
Larry A. Ruff
Automatic enrollment of participants in 401(k) plans, which was encouraged by the Pension Protection Act of 2006, was designed to overcome the drawbacks of voluntary enrollment by getting more employees to save in their workplace retirement plan. Since that time, automatic enrollment for 401(k) plans has been demonstrated by Employee Benefit Research Institute research to have substantial benefits for some employees.
Besides helping your employees save for retirement, automatic enrollment addresses some retirement plan and administrative issues. For instance, it may help solve non-discrimination testing failures and reduce, or eliminate, the need to issue refunds.
But what to do about plan investments? With automatic enrollment comes a fiduciary duty to direct plan investments for those automatically enrolled participants that do not choose a place to invest their contributions. To address this concern, the Department of Labor (DOL) created a regulatory “safe harbor” in 2007 to limit plan sponsor liability for investing contributions on behalf of employees into default investments when employees do not otherwise make an election.
DOL Safe Harbor
For a plan sponsor to be eligible for the DOL safe harbor, there are several conditions that must be met to get this relief.
The DOL safe harbor also specifies four types of investment alternatives for employees’ automatic contributions, called “qualified default investment alternatives” or QDIAs. One of these is a temporary safe harbor, which will not be discussed in this article. The other three alternatives are an investment mix based on age, such as a life-cycle (or target-date) fund, balanced funds and an investment management service.
The Government Accountability Office (GAO) issued a report in August 2015, which studied QDIAs. The study looked at which default options plan sponsors selected and why; how plan sponsors monitor their default investments; and what challenges plan sponsors faced when adopting a default investment for their plan. Overall, the GAO found that clearer regulations could help plan sponsors choose investments for participants.
To no surprise, the GAO report found that most plan sponsors use target-date funds as their default. In their three surveys, target-date funds represented anywhere from 60% to 72% of default investments chosen by plan sponsors. Non-safe harbor default fund choice ranged from roughly 17% to 25% in these surveys. These plan sponsors typically chose a money-market or stable value fund as their non-safe harbor default investment. The other two safe harbors, balanced funds and managed accounts, each represented the less than 10% of default investments.
Besides participant characteristics (like age), simplicity and fiduciary protection were often cited by plan sponsors as reasons for selecting a default investment. Target-date funds tend to do a good job of meeting those three criteria, which explains why they are the predominant choice among plan sponsors for their QDIA. In spite of this, do plan sponsors really understand the safe harbor and its offered protection? Let us take a brief look.
How Safe Are We Today?
The GAO report indicated that QDIAs were specifically selected for the additional fiduciary protection they may provide under the DOL’s safe harbor. Despite the safe harbor, many plan sponsors were unsure of the extent of protection or whether each QDIA type provided the same level of protection. In fact, more than half of plan sponsors did indicate that the three main QDIA types did not offer the same level of protection. They also said that they did not know, or had no basis to judge, the level of protection provided by the safe harbor.
Due to the lack of clarity with this safe harbor rule, the GAO recommended that the DOL take the time to assess the challenges reported by plan sponsors and implement corrective actions through clarifying guidance or regulations. It remains to be seen what, if anything, the DOL might consider with respect to this report.
In the meantime, automatic enrollment is still growing as a 401(k) plan feature and continues to be administered in the marketplace. So what should a plan sponsor do to manage their fiduciary risk related to QDIA selection?
It is Really Not Automatic
It all starts with your basic fiduciary responsibilities under ERISA when choosing a default investment of any kind. Keep those basic principals in mind when establishing or changing your QDIA for your plan. Exercise much due diligence when selecting a QDIA type that aligns with your plan’s objectives and investment policy. Check off and document how you meet the safe harbor conditions under the regulation and how you choose your QDIA.
However, do not leave it alone. Continue to exercise your due diligence by reviewing and evaluating your QDIA choice annually. When events change that might impact your QDIA selection, such as a plan merger or change in funds, assess how that might impact your QDIA choice and take action, as appropriate under ERISA.
To see the entire GAO report visit http://www.gao.gov.
For more information on QDIAs contact Larry Ruff at [email protected] or call him at 312.670.7444. Visit ORBA.com to learn more about our Employee Benefit Plans Services.