The benefits of re-enrollment Documeent title on one or two lines … · 2016-03-24 · The...
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Introduction In most 401(k) plans, employers—the plan sponsors—expect the participants to invest their accounts. But the participants may lack the experience, interest or time to create an appropriate portfolio for long-term investing. While sympathetic, plan sponsors may not realize that they bear some legal responsibility for how participants use the investments offered by the plan. Both of these problems can be solved. Plan sponsors can materially improve participant investing by using a process called “re-enrollment.” 1 And by helping the participants, plan sponsors can receive enhanced fiduciary protection for themselves. (Plan sponsors have two roles with their plans. First, they are the “settlors” who establish and design the plans. This is not a fiduciary activity. Second, though, plan sponsors manage their plans and the investments in their plans. They are fiduciaries for that purpose. In this paper, we use “plan sponsor” in the latter meaning—the primary fiduciary for a plan.) “Re-enrollment” refers to a process in which participants whose accounts are invested must make a new investment election. Accounts of participants who do not re-select their investments are defaulted into the plan’s qualified default investment alternative, or QDIA (often a target-date fund or TDF). 2 This process has been used by plan sponsors for about a decade; and the data show that, given this opportunity, most participants allow their accounts to be defaulted into the TDF … and then stay there. 3 So the popular term “re-enrollment” is a misnomer; a better word might be “re-selection.” But because “re-enrollment” is the term commonly used for this process, we use that term in this paper. The re-enrollment process benefits participants by creating an opportunity for their accounts to be invested in a professionally managed, diversified vehicle. Re-enrollment benefits plan sponsors by providing them with a fiduciary safe harbor under ERISA when participants default and their accounts are invested in a plan’s QDIA. Unfortunately, the re-enrollment process is sometimes seen as being “risky” from a fiduciary perspective, difficult, and/or an invasion of participants’ prerogatives or fraught with other difficulties. These are myths that have no basis in fact—and the legal support for re-enrollment is strong and clear. This article discusses the fiduciary considerations affecting, and the legal support for, re-enrollment. The benefits of re-enrollment By Fred Reish and Bruce Ashton Drinker Biddle & Reath LLP The re-enrollment process is sometimes seen as being “risky” from a fiduciary perspective, difficult, and/or an invasion of participants’ prerogatives or fraught with other difficulties. These are myths that have no basis in fact—and the legal support for re-enrollment is strong and clear.
Transcript of The benefits of re-enrollment Documeent title on one or two lines … · 2016-03-24 · The...
IntroductionIn most 401(k) plans, employers—the plan sponsors—expect the participants to invest their accounts. But the participants may lack the experience, interest or time to create an appropriate portfolio for long-term investing. While sympathetic, plan sponsors may not realize that they bear some legal responsibility for how participants use the investments offered by the plan. Both of these problems can be solved.
Plan sponsors can materially improve participant investing by using a process called “re-enrollment.”1 And by helping the participants, plan sponsors can receive enhanced fiduciary protection for themselves. (Plan sponsors have two roles with their plans. First, they are the “settlors” who establish and design the plans. This is not a fiduciary activity. Second, though, plan sponsors manage their plans and the investments in their plans. They are fiduciaries for that purpose. In this paper, we use “plan sponsor” in the latter meaning—the primary fiduciary for a plan.)
“Re-enrollment” refers to a process in which participants whose accounts are invested must make a new investment election. Accounts of participants who do not re-select their investments are defaulted into the plan’s qualified default investment alternative, or QDIA (often a target-date fund or TDF).2 This process has been used by plan sponsors for about a decade; and the data show that, given this opportunity, most participants allow their accounts to be defaulted into the TDF … and then stay there.3 So the popular term “re-enrollment” is a misnomer; a better word might be “re-selection.” But because “re-enrollment” is the term commonly used for this process, we use that term in this paper.
The re-enrollment process benefits participants by creating an opportunity for their accounts to be invested in a professionally managed, diversified vehicle.
Re-enrollment benefits plan sponsors by providing them with a fiduciary safe harbor under ERISA when participants default and their accounts are invested in a plan’s QDIA.
Unfortunately, the re-enrollment process is sometimes seen as being “risky” from a fiduciary perspective, difficult, and/or an invasion of participants’ prerogatives or fraught with other difficulties. These are myths that have no basis in fact—and the legal support for re-enrollment is strong and clear.
This article discusses the fiduciary considerations affecting, and the legal support for, re-enrollment.
Documeent title on one or two lines in Gustan Book 24pt
The benefits of re-enrollmentBy Fred Reish and Bruce Ashton Drinker Biddle & Reath LLP
The re-enrollment process is sometimes seen as being “risky” from a fiduciary perspective, difficult, and/or an invasion of participants’ prerogatives or fraught with other difficulties. These are myths that have no basis in fact—and the legal support for re-enrollment is strong and clear.
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Fiduciary considerationsUnder ERISA, plan sponsors must prudently manage a plan’s investments.4 This includes the prudent selection and monitoring of investments offered by the plan, and the prudent investing of participant accounts.5 The latter applies to all participants, including participants who self-direct their accounts (unless the plan complies with the 404(c) conditions,6 explained later).
In an effort to help participants invest their accounts, plan sponsors may offer professionally designed investment options, including managed accounts, risk-based investments (balanced funds) or age-based investments (TDFs). But in participant-directed plans, it can be a challenge to get large numbers of participants to use those services and investments.
One of the goals of including professionally managed investments (such as TDFs) in a plan’s line-up is that participants will be encouraged to select them on their own. Unfortunately, making these investments available as an option has not had the desired result, as participants have generally not redirected their accounts into one of these options on their own—particularly if the options are added to the plan after participants have already directed their investments.7
Participant inaction can be overcome using a “reset” approach. In a reset, the plan sponsor directs that all participant accounts be moved into a professionally managed option, without letting participants opt out before the plan sponsor makes the change (though participants can move their investments after the change).8 In doing so, the plan sponsor exercises its fiduciary authority to take control over the participant accounts. A substantial percentage of participants will leave their funds in the new investment.9 However, the plan sponsor remains responsible for the investment decision; there is no insulation from fiduciary liability (though the decision might be viewed as a prudent one).
In a reset, the plan sponsor directs that all participant accounts be moved into a professionally managed option, without letting participants opt out before the plan sponsor makes the change (though participants can move their investments after the change).8 In doing so, the plan sponsor exercises its fiduciary authority to take control over the participant accounts.
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ERISA safe harborsERISA provides several forms of fiduciary protections for participant investing, referred to as “safe harbors.” These include ERISA Section 404(c), engaging an investment manager (sometimes called a “3(38) fiduciary”), and the QDIA safe harbor.10 Though 404(c) protection11 is often referred to as a “safe harbor,” it is only available if a plan complies with various disclosure and investment requirements, and if participants actually exercise control over their accounts. In the authors’ experience based on audits of plans for 404(c) compliance, plans often fail to comply with all of the requirements – rendering 404(c) protection unavailable.12
The investment manager (3(38)) safe harbor is available when an investment adviser (a bank, insurance company or registered investment adviser) is given discretion over investment management.13 In the participant investing context, a plan sponsor may select an adviser to manage participant accounts. If participants elect to use the adviser, the plan sponsor is not responsible for the investment results (provided that the plan sponsor prudently selects and monitors the investment manager).
The common thread of both the 404(c) and investment manager safe harbors is that they require participants to take action: Participants must either direct their accounts or choose to rely on the adviser the plan sponsor selects.
The QDIA safe harbor is based on participant inaction. If a participant fails to take action, fails to exercise control over his account—i.e., “defaults”—the plan sponsor must prudently invest the participant’s account. But, ERISA says that if the plan complies with specific requirements,14 including selection of a specified type of default investment (a “qualified default investment alternative” or QDIA), the plan sponsor is not responsible for the investment outcome.15 Because plan sponsors receive protection when participants fail to act, the default situation typically offers fiduciary protection for a much larger number of participants.16
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Re-enrollment If participants can invest their accounts but do not—i.e., they default—the plan sponsor must invest the money for them. So long as they comply with the QDIA requirements, plan sponsors are protected from liability for the investment under the QDIA safe harbor.17 Under the safe harbor, plan sponsors will not be liable for losses that may occur because of the default investment—though the plan sponsor still must make a prudent selection and monitor the TDF.18
Various requirements must be met for the safe harbor to apply, but the keys are the existence of a default and the investment of the participant’s account in a TDF.19 How does a “default” occur? The most common is when a newly eligible employee, whether automatically enrolled or not, fails to make an investment election. But a default can also occur through the re-enrollment process.
The QDIA safe harbor requires a plan to give participants a 30-day notice about their rights to direct their accounts and to move their accounts out of the QDIA, and about the other investment options available under the plan. In practice, plan sponsors using the re-enrollment process generally provide participants with more notice than required by the safe harbor. A common approach is to use a 60/30/7 model. That is, the first notice about the re-enrollment process is given 60 days before the effective date, another is given 30 days in advance, and a final reminder is provided seven days in advance. The 60- and 30-day notices comply with the QDIA safe harbor requirements. The objective of these extended notification steps is to ensure that participants are not taken by surprise and understand what is about to happen and their options.
To reiterate, re-enrollment allows plan sponsors to improve participant investing, while enjoying the protection of the QDIA safe harbor. This is true even for participants who have previously made an affirmative election about investing. Through re-enrollment, those participants are invited to make a new decision, which may be to leave their account where it is, to reallocate to other core options, or to be defaulted into a QDIA. Where the latter happens, a plan sponsor will have the QDIA safe harbor for those assets.
In some respects, re-enrollment may seem very much like a reset. This is true, with a major difference. In a reset, the plan sponsor has taken control of participants’ accounts and does not give them an opportunity to opt-out and make an affirmative choice of their own. But in a re-enrollment, participants have an opt-out right, which, if not exercised, leads to a default and investment of the participants’ accounts in the plan’s TDF.
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Re-enrollment supportSome plan sponsors and advisers are skeptical that through re-enrollment, plan sponsors avail themselves of the QDIA safe harbor protection. After all, the Department of Labor’s QDIA regulation does not address re-enrollment. But the re-enrollment concept is supported by language in the regulation’s preamble. Moreover, a major 2012 court decision explicitly upheld the concept.
In the preamble, the DOL discussed the application of the QDIA safe harbor to situations other than automatic enrollment. The DOL makes it clear that whenever a participant “has the opportunity to direct the investment of assets in his or her account, but does not … plan fiduciaries may avail themselves of the relief provided by this final regulation” so long as all of its conditions have been satisfied.20 That has been confirmed by informal comments by DOL officials.
Invoking the preamble language, the United States Court of Appeals for the Sixth Circuit held that fiduciaries of a re-enrolled plan were entitled to the QDIA safe harbor.21 In that case, two participants who were re-enrolled in a plan argued that QDIA protection applied only to participant accounts where there were no existing participant investment directions. The court disagreed, saying: “The DOL was clear also that the ‘opportunity to direct investment’ includes the scenario where a plan administrator requests participants who previously had elected a particular investment vehicle to confirm whether they wish for their funds to remain in that investment vehicle.” And “as a result,” the court concluded, “the plan administrator can direct those participants’ investments in accordance with the plan’s default investment policies and with the benefit of the Safe Harbor protections.” In other words, the QDIA safe harbor applies to defaults in a re-enrollment setting.
A plan sponsor that wishes to adopt such a strategy should ensure the plan document does not contain provisions inconsistent with or precluding re-enrollment.22 For example, a plan might indicate that only participants may change their investment elections. If such a provision is present, before embarking on the process, the plan document should be amended.
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ConclusionRe-enrollment addresses two concerns: Participants may not be well-invested, which can significantly affect the adequacy of their retirement savings; and under ERISA, absent a safe harbor, plan sponsors bear responsibility for ensuring that participant accounts are prudently invested. By asking participants to re-select their investment choices or have their money invested in the plan’s TDF, the plan sponsor takes a positive step to help participants, since many will allow their accounts to be defaulted into the TDF. Plan sponsors will also help themselves by taking advantage of the ERISA QDIA safe harbor.
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About the authors Fred ReishPartner, Drinker Biddle & Reath LLPFred Reish is an ERISA attorney whose practice focuses on fiduciary responsibility, retirement income and plan operational issues. He has been recognized as one of the “Legends” of the retirement industry by both PLANADVISER magazine and PLANSPONSOR magazine. Fred serves as a member of his firm’s Retirement Income Team and is a member of the Institutional Retirement Income Council (IRIC), which focuses on retirement income issues and products, and has written extensively about retirement income issues. Fred also received awards for: The 401(k) Industry’s Most Influential Person by 401kWire; one of RIABiz’s 10 most influential individuals in the 401(k) industry affecting RIAs for 2012; the Commissioner’s Award and the District Director’s Award by the IRS; the Eidson Founder’s Award by the American Society of Professionals & Actuaries (ASPPA); the Institutional Investor and the PLANSPONSOR magazine Lifetime Achievement Awards; and the ASPPA/Morningstar 401(k) Leadership Award. He has written more than 350 articles and four books about retirement plans, including a monthly column on 401(k) fiduciary issues for PLANSPONSOR magazine. Fred Co-Chaired the IRS Los Angeles Benefits Conference for over 10 years, served as a founding Co-Chair of the ASPPA 401(k) Summit, and has served on the Steering Committee for the DOL National Conference.
Bruce AshtonPartner, Drinker Biddle & Reath LLPBruce L. Ashton is a partner in the firm’s Employee Benefits & Executive Compensation Practice Group. With more than 35 years of practice, Bruce has gained wide experience representing businesses in sophisticated business transactions and employee benefits matters. Bruce has co-authored four books on employee benefits issues and a quarterly column in the Journal of Pension Benefits on IRS remedial programs, and is a frequent contributor to various tax and pension publications, including Journal of Taxation, CCH Pension Plan Guide, Journal of Pension Benefits and The ASPPA Journal.
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Endnotes 1 Based on a study of 92 mid- and large-size plan conversions, T. Rowe Price determined
that approximately 81% of the participants were defaulted into TDFs on conversion to a new provider. After three months, 96% of these participants remained invested in the TDFs and after 18 months, the percentage remained at about 93.8% (we refer to this as the rate of persistency). While similar statistics are not available for re-enrollments, we believe the persistency rates could be somewhat lower (inasmuch as, in the re-enrollment context, participants have the option of leaving their accounts invested as they previously directed, whereas this option is not available in a conversion); but at least one provider reported that after one year “87% of participants maintained a full or partial position in the target-date approach and that re-enrollment had boosted plan diversification substantially.” See “Research report: Reenrollment and target-date funds: A case study in portfolio reconstruction,” Vanguard 09/22/09.
2 Target date funds have become the most prevalent type of QDIA. As a result, in this article, TDF is the term used when referring to a plan’s qualified default investment alternative.
3 See studies referenced in footnote 1.
4 ERISA §404(a)(1)(B) and ERISA Regulation §2550.404a-1.
5 ERISA §409(a). See also Department of Labor’s Amicus Brief in Hecker v. Deere: “It is the fiduciary’s responsibility to choose investment options in a manner consistent with the core fiduciary duties of prudence and loyalty. If it has done so, section 404(c) relieves the fiduciary from responsibility for the participants’ exercise of authority over their own accounts. If, however, the funds offered to the participants were imprudently selected or monitored, the fiduciary retains liability for the losses attributable to the fiduciary’s own imprudence.”
6 ERISA Section 404(c)(1) and ERISA Regulation Section 2550.404c-1.
7 Several studies reveal that participants tend to stick with their initial investment choices and, due to inertia, do not change their investment elections, even if more choices become available. See Preamble to QDIA Regulation, 72 FR 60475, FN 40. Cites to studies showing that “Participants have been found to exhibit inertia in their investment choices, being slow to rebalance or to respond to changes in the investment options offered to them (see, e.g., Olivia S. Mitchell, Gary R. Mottola, Stephen P. Utkus, and Takeshi Yamaguchi, The Inattentive Participant: Portfolio Trading Behavior in 401(k) Plans, Pension Research Council Working Paper 2006–5 (2006) at 16, which finds a lack of rebalancing; see also Jeffrey R. Brown and Scott Weisbenner, Individual Account Investment Options and Portfolio Choice: Behavioral Lessons from 401(k) Plans (Dec. 2004).”)
8 ERISA §404(c)(4).
9 See studies referenced in footnote 1.
10 ERISA Section 404(c)(5) and ERISA Regulation Section 2550.404c-5.
11 Technically, this is not a safe harbor but a defense to a claim of breach of fiduciary duty. Since it is commonly referred to as a “safe harbor,” however (except by the DOL), that term is used here as well.
12 See ERISA Regulation §2550.404a-5.
13 See ERISA §§3(38), 402(c)(3) and 405(d).
14 ERISA §404(c)(5).
15 Bidwell v. University Medical Center, Inc., 685 F.3d 613 (6th Cir. 2012).
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16 See studies referenced in footnote 1.
17 ERISA §404(c)(5). The purpose of this safe harbor is to improve investing of defaulted participant accounts. See Preamble to QDIA Regulation, 72 FR 60463.
18 Preamble to QDIA Regulation, 72 FR 60453 and ERISA Regulation §2550.404c-5(b)(1) and (2).
19 ERISA Regulation §2550.404c-5 provides six requirements: (1) assets are invested in a qualified default investment alternative; (2) the participant had the opportunity to direct the investment of the assets in his account but did not do so; (3) the participant is furnished a notice regarding his right to direct his account, his right to move his account out of the QDIA and the other investment options available under the plan; (4) the participant receives certain information regarding the features of the QDIA; (5) the participant is given the right to transfer out of the QDIA to any other investment alternative available under the plan with appropriate frequency and without penalty; and (6) the plan offers a broad range of investment alternatives.
20 Preamble to the QDIA Regulation, 71 FR 60453.
21 Bidwell v. University Medical Center, Inc., 685 F.3d 613 (6th Cir. 2012).
22 Falcone v. DLA Piper US LLP Profit Sharing Plan and 401(k) Savings Plan Committee, No. 09-5555 (N.D. Cal. filed Nov. 23, 2009, terminated Sept. 2, 2011).
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