The Department of Labor (DOL) has offered a sneak peek at its upcoming guidance concerning 401(k) default investment options. These options come into play when participants don’t actively choose investments or when automatic enrollment features utilize a default fund. Plan sponsors are increasingly scrutinizing their default fund choices due to fiduciary responsibility concerns and the performance of these investments.
When a participant makes no selection, the plan’s fiduciaries make the investment decision for them. Because the participant isn’t actively involved, fiduciaries bear the responsibility of prudently investing those funds. Many sponsors mistakenly believe that Section 404(c) of the Internal Revenue Code shields them. Section 404(c) provides an exemption from liability for investment decisions when participants have the power to choose their own investments, transferring liability to the participant. However, this doesn’t apply when participants fail to make an active choice and are placed in a default investment.
The absence of a participant’s active decision means there’s no 404(c) defense for plan fiduciaries. ERISA mandates a reasoned and thoughtful process for evaluating risk and returns, offering diversified and prudent investment options.
The forthcoming DOL guidance offers a safe harbor to 401(k) fiduciaries regarding investment management decisions tied to default investments, protecting them from breaches directly resulting from investing a participant’s account in a qualified default investment. Investment managers and advisors don’t receive this protection and remain solely responsible for their decisions and any resulting losses.
To qualify for this safe harbor, 401(k) fiduciaries must:
* Allow participants to move their investments into an alternative account.
* Provide advance notice of the default investment.
* Invest assets in a qualified default investment, such as a lifecycle fund or managed account.
These qualified default investments must limit employer stock and allow funds to be transferred out of the default option. This new preliminary safe harbor helps alleviate some of the fiduciary burden associated with selecting default investment options.