Extracted from Law360
Law360, New York (February 13, 2017, 11:00 AM EST) -- At the end of the 2016, the U.S. Department of Labor issued an information letter regarding TIAA’s, a financial services company, "Income for Life Custom Portfolios" (ILCP) that concluded that the ILCP did not meet the requirements to be a qualified default investment alternative (QDIA) under the Employee Retirement Income Security Act of 1974. The ILCP, a custom target-date model that allocates investment funds to a fixed guaranteed annuity (annuity sleeve) and provides a guaranteed return element to the portfolio and the option of guaranteed lifetime income at retirement, contains certain liquidity and transferability restrictions that fail the frequency of transfer requirement described in paragraph (c)(5)(i) of the regulation.
However, noting the need for lifetime income as an “important public policy issue,” the DOL opined that a fiduciary may nevertheless be able to conclude (without regard to ERISA Section 404(c)(5) and the regulation) that this type of investment is a prudent default investment for a plan — albeit without the protections afforded by ERISA 404(c) and the regulation. Among other things, this information letter emphasizes the DOL’s support for efforts to broaden the use of lifetime income options in defined contribution plans as a supplement to and enhancement of accumulation of retirement savings.
The Pension Protection Act of 2006 (PPA) afforded certain relief to plan sponsors and fiduciaries under Section 404(c) of ERISA when a participant enrolls in a defined contribution plan (often through auto-enrollment) but fails to make an affirmative investment election. In such a case, the plan sponsor must step into that decision-making role and direct the investment of the contributions into a default investment. In order to enjoy these protections, plan fiduciaries are required to designate an investment option that satisfies the requirements of a QDIA.
In 2007, the DOL issued final regulations on what constitutes a QDIA and what steps a plan fiduciary must take to be protected from liability. Specifically, an investment option must meet five specific requirements to be a QDIA:
- It cannot hold or permit the acquisition of employer securities.
- It may not impose financial penalties or otherwise restrict a participant’s ability to transfer, in whole or in part, to another investment option available under the plan.
- It must be managed by an investment manager, as defined by ERISA, a plan sponsor that is a named fiduciary, a registered investment company or plan trustees who meet certain requirements.
- It must be diversified to minimize the risk of large losses (this diversification requirement does not apply to capital preservation products described below).
- It must be a permissible investment type — those investment funds or model portfolios that seek both long-term appreciation and capital preservation through a mix of equity and fixed-income investments, specifically a life cycle or target-date fund, a balanced fund or a managed account.
Under ERISA Section 404(c) and 29 C.F.R. § 2550.404c-5, plan fiduciaries can obtain relief from liability for participant investment losses if:
- The chosen investment is a QDIA;
- Participants fail to affirmatively direct their investments;
- Participants receive both an initial and annual notice;
- Participants defaulted into a QDIA receive the same information as participants who elect to direct their investments under the plan;
- Participants defaulted into a QDIA have the opportunity to transfer out of the QDIA, in whole or in part, at least as often as any other participant and at least once every three months;
- For the first 90 days after investments are first made in a QDIA on the participant’s behalf, any transfer out of the QDIA by the participant is not subject to restrictions, fees or expenses, except those charged on an ongoing basis for the operation of the investment itself;
- After that first 90-day period, transfers may be subject only to the same fees or restrictions that would be imposed on participants who affirmatively chose to invest in the QDIA; and
- The plan offers a broad range of investment alternatives as defined in Section 404(c) of ERISA.
In 2014, the U.S. Treasury Department issued guidance that provided that plan sponsors using target-date funds could include annuities in those funds. However, the DOL issued concurrent advice that clarified that, as with any QDIA, participants must be able to transfer assets out of the fund within a three-month period or shorter.
The DOL’s Dec. 22, 2016, Information Letter
At the end of December 2016, the DOL issued an information letter that discussed the propriety of offering a specific TIAA annuity product, the ILCP, as a default investment alternative for a participant-directed individual account plan. The ILCP, unlike traditional target-date funds, allocates investment funds to a fixed guaranteed annuity that provides a guaranteed return annuity sleeve to the portfolio. TIAA designed the ILCP to gradually increase allocation to the annuity sleeve over time, ultimately capping the portion of annuity investment at 50 percent.
The ILCP annuity sleeve was notably subject to certain liquidity restrictions. Specifically, the ILCP allowed participants to freely transfer or withdraw from the annuity without restriction for 12 months after the initial investment. However, after that period, any funds invested in the annuity were transferable to another investment option only in installments over an 84-month period. TIAA provided that during the 12-month opt-out period, the plan would periodically furnish educational materials to participants who were defaulted into the ILCP. The plan would explain the ILCP (including the annuity) and would provide additional education about the ILCP at least annually, after the opt-out period.
In order to be a QDIA, the investment must, among other things, allow participants or beneficiaries to transfer assets “in whole or in part” to any other investment alternative available under the plan within a three-month period or shorter. Because TIAA’s annuity sleeve requires participants to keep the assets in the annuity for significantly longer than three months, there was no real debate that that product “would not constitute a QDIA.”
That said, the DOL noted that the “QDIA standards are not intended to be the exclusive means by which a fiduciary might satisfy his or her responsibilities with respect to the selection of a default investment for assets in the individual account of a participant or beneficiary.”
Rather, in the DOL’s view, a fiduciary may be able to conclude, without regard to the relief available under ERISA Section 404(c)(5) and the regulation, that an investment product or portfolio is a prudent default investment for a plan. In this regard, the DOL noted that the preamble to the regulations notes that investments in stable value products of funds may be prudent for some participants or beneficiaries even though such investments themselves may not generally constitute QDIAs. Indeed, the DOL noted that its prior list of examples of possible QDIA products was not meant to be an “exclusive list of investments that could be prudent default investment alternatives.”
Proceed with Caution
The DOL expressly cautioned that whether the selection of any particular investment alternative as a default investment alternative satisfies the fiduciary duties of prudence and loyalty in ERISA Section 404(a) for any particular plan would depend on the unique “facts and circumstances.” The DOL made clear that, even though a fiduciary could prudently select an investment with lifetime income elements as a default investment under the plan, it does not mean that the fiduciary should. Rather, as with any decision to select an investment option for the plan, a fiduciary must engage in an “objective, thorough and analytical process that considers all of the facts and circumstances.” The DOL noted that it would be “important” to evaluate the demographics of the plan and make a considered decision about how the characteristics of the investment alternative align with the needs of plan participants and beneficiaries taking into account:
- The nature and duration of the liquidity restrictions;
- The level of guarantees of principal and minimum interest rates;
- Any opportunities for the guaranteed minimum interest rates;
- Any opportunities for the guaranteed minimum interest rates to be supplemented with additional credited amounts; and
- Expected lifetime income to be provided in retirement.
Further, a fiduciary should also consider whether the costs associated with the investment alternative (including the fees and investment expenses) are reasonable in relation to the benefits and administrative services to be provided. In particular, products with a lifetime income option tend to be more expensive than those without. Given the recent rise in litigation challenging fees in 401(k) plans, it is imperative that plan fiduciaries thoroughly identify, understand and evaluate the fees and expenses associated with any such investment.
The DOL also cautioned that, because the notice and disclosure provisions in the QDIA regulation were designed for default investments that would be generally liquid and transferable, a fiduciary should also consider what additional notice may need to be provided to participants, as well as the need for educating affected participants about the features of this investment alternative.
Significantly, even though the DOL has suggested that selecting an investment with a lifetime income component as a plan’s default investment alternative may be prudent, the protections afforded by ERISA 404(c) will not apply if the product does not meet all of the QDIA requirements. This means that a plan fiduciary will not be automatically insulated from liability for participants’ investment losses by selecting this investment option as the default alternative — and most fiduciaries will not want to give up such protection. That said, given the important public policy reasons cited by the DOL in its recent information letter, fiduciaries may want to consider offering a product (such as the ILCP) as a nondefault option in a plan’s investment lineup.
—By Emily Seymour Costin and David M. Mohl, Alston & Bird LLP
Emily Seymour Costin is a partner and David Mohl is an associate at Alston & Bird in Washington, D.C.
The opinions expressed are those of the author(s) and do not necessarily reflect the views of the firm, its clients, or Portfolio Media Inc., or any of its or their respective affiliates. This article is for general information purposes and is not intended to be and should not be taken as legal advice.
 See 29 C.F.R. § 2550.404c-5. In 2008, due to the large volume of questions and comments, the DOL issued additional guidance through a Field Assistance Bulletin. See FAB No. 2008-03.
 This requirement has two exceptions: (1) employer securities held or acquired by an investment company registered under the Investment Company Act of 1940 or a similar pooled investment vehicle regulated and subject to periodic examination by a state or federal agency; or (2) certain employer securities acquired with matching contributions made by the plan sponsor.
 See Treasury and IRS Notice 2014-66.
 See Department of Labor Information Letter to J. Mark Iwry, Senior Adviser to the Secretary and Deputy Assistant Secretary for Retirement and Health Policy at the Treasury Department, dated Oct. 23, 2014.
 The guidance in an information letter is limited solely to the facts presented in the specific letter.
 Letter at p. 2.
 Id., at p. 3, n. 4.
 Letter at p. 3.