Questions on Qualified Default Investment Alternatives

By Stephanie Bennett

One of our clients recently raised the following questions about Qualified Default Investment Alternatives (QDIAs):

1. I know that a stable value investment can be grandfathered, but can a stable value investment be used as a short-term QDIA?

2. Can amounts invested in a money market fund prior to the December 24, 2007 be grandfathered under the new QDIA regulation?

3. If a plan has participants that are defaulted in a money market, why would the plan necessarily want to move them into a QDIA since the relief provided by the regulation only extends to losses and that is less of an issue with the money market?

The QDIA regulation provides guidance on the first question. The regulation defines a short-term QDIA as:

“(iv)(A) Subject to paragraph (e)(4)(iv)(B) of this section, an investment product or fund designed to preserve principal and provide a reasonable rate of return, whether or not such return is guaranteed, consistent with liquidity. Such investment product shall for purposes of this paragraph (e)(4)(iv):

(1) Seek to maintain, over the term of the investment, the dollar value that is equal to the amount invested in the product; and

(2) Be offered by a State or federally regulated financial institution.

(B) An investment product described in this paragraph (e)(4)(iv) shall constitute a qualified default investment alternative for purposes of paragraph (e) of this section for not more than 120 days after the date of the participant’s first elective contribution (as determined under section 414(w)(2)(B) of the Code).”

Based on the definition in the regulation, we advised our client that, to the extent that a stable value investment meets that definition it qualifies. However, if there are fees or restrictions imposed on transfers within the first 90 days it poses a problem. In addition, there might be market value adjustments when the money is transferred from the short-term QDIA to a long-term QDIA by the plan sponsor, which would raise fiduciary responsibility issues.

The answer to the second question is no. The grandfather relief under the regulation is only available for stable value investments that meet the definition in the regulation. The regulation requires that, to be a grandfathered QDIA, the investment must “guarantee principal and a rate of return generally consistent with that earned on intermediate investment grade bonds.” So that rules out a money market fund.

The last question required clarification on the measure of losses in a suit for fiduciary breach. Basically, the client’s misunderstanding of the calculation of losses led him to believe that since there is minimal risk of loss with a money market fund there was also minimal risk of liability. The measure of loss for fiduciary breach is usually the difference between the performance of the actual investments and the return that would have been earned on a well-selected portfolio. We pointed out that, just because an investment will not ordinarily suffer real-world losses, it does not mean that it is prudent under ERISA for accumulating retirement benefits.

For example, in the preamble to the QDIA regulation the DOL explained: “It is the view of the Department that investments made on behalf of defaulted participants ought to and often will be long-term investments and that investment of defaulted participants’ contributions and earnings in money market and stable value funds will not over the long-term produce rates of return as favorable as those generated by products, portfolios and services included as qualified default investment alternatives, thereby decreasing the likelihood that participants invested in capital preservation products will have adequate retirement savings.”

As a word of caution, that language may serve to support future claims by plaintiffs’ attorneys regarding the prudence of investments in money markets or stable value over the long-term.

© 2008 Reish Luftman Reicher & Cohen. All rights reserved. The REPORT TO PLAN SPONSORS is published as a general informational source. Articles are general in nature and are not intended to constitute legal advice in any particular matter. Transmission of this report does not create an attorney-client relationship. Reish Luftman Reicher & Cohen does not warrant and is not responsible for errors or omissions in the content of this report.

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