Default Investment Alternatives Under Participant Directed
Individual Account Plans
[09/27/2006]
Volume 71, Number 187, Page 56805-56824
[[Page 56805]]
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Part VI
Department of Labor
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Employee Benefits Security Administration
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29 CFR Part 2550
Default Investment Alternatives Under Participant Directed Individual
Account Plans; Proposed Rule
[[Page 56806]]
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DEPARTMENT OF LABOR
Employee Benefits Security Administration
29 CFR Part 2550
RIN 1210-AB10
Default Investment Alternatives Under Participant Directed
Individual Account Plans
AGENCY: Employee Benefits Security Administration, Department of Labor.
ACTION: Proposed regulation.
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SUMMARY: This document contains a proposed regulation that, upon
adoption, would implement recent amendments to title I of the Employee
Retirement Income Security Act of 1974 (ERISA) enacted as part of the
Pension Protection Act of 2006, Public Law 109-280, under which a
participant of a participant directed individual account pension plan
will be deemed to have exercised control over assets in his or her
account if, in the absence of investment directions from the
participant, the plan invests in a qualified default investment
alternative. A fiduciary of a plan that complies with this proposed
regulation will not be liable for any loss, or by reason of any breach
that occurs as a result of such investments. The types of investments
that qualify as default investment alternatives under section 404(c)(5)
of ERISA are described in the proposal. Plan fiduciaries remain
responsible for the prudent selection and monitoring of the qualified
default investment alternative. The proposed regulation conditions
relief upon advance notice to participants and beneficiaries describing
the plan's provisions governing the circumstances under which
contributions or other assets will be invested on their behalf in a
qualified default investment alternative, the investment objectives of
the default investment alternative, and the right of participants and
beneficiaries to direct investments out of the default investment
alternative without penalty. The regulation, upon adoption, will affect
plan sponsors and fiduciaries of participant directed individual
account plans, the participants and beneficiaries in such plans, and
the service providers to such plans.
DATES: Written comments on the proposed regulation should be received
by the Department of Labor on or before November 13, 2006.
ADDRESSES: Comments should be addressed to the Office of Regulations
and Interpretations, Employee Benefits Security Administration, Room N-
5669, U.S. Department of Labor, 200 Constitution Avenue, NW.,
Washington, DC 20210, Attn: Default Investment Regulation. Commenters
are encouraged to submit comments electronically to e-ORI@dol.gov or
http://www.regulations.gov (follow instructions for submission). Comments will
be available to the public at http://www.dol.gov/ebsa and www.regulations.gov.
Comments also will be available for public inspection at the Public
Disclosure Room, N-1513, Employee Benefits Security Administration, 200
Constitution Avenue, NW., Washington, DC 20210.
FOR FURTHER INFORMATION CONTACT: Erin M. Sweeney or Lisa M. Alexander,
Office of Regulations and Interpretations, Employee Benefits Security
Administration, (202) 693-8500. This is not a toll-free number.
SUPPLEMENTARY INFORMATION:
A. Background
It is well established that many of America's workers are not
adequately saving for retirement. Part of the retirement savings
problem is attributable to employees who, for a wide variety of
reasons, do not take advantage of the opportunity to participate in
their employer's defined contribution pension plan (such as a 401(k)
plan). The retirement savings problem is also exacerbated by those
employees who enroll in their employer's plan, but do not assume
responsibility for investment of their contributions, leaving their
accounts to be invested in a conservative default investment that over
the career of the employee is not likely to generate sufficient savings
for a secure retirement.
A number of recent studies indicate that significant improvements
can be made in 401(k) plan participation and in retirement savings
levels through plan design changes. Specifically, the studies show that
adoption of automatic enrollment provisions (provisions pursuant to
which employees are automatically enrolled in the plan and must
affirmatively opt-out of plan participation) by 401(k) plans can
dramatically increase plan participation rates.\1\ However, most
surveys suggest that fewer than 20 percent of the employers sponsoring
401(k) plans have adopted an automatic enrollment provision.\2\
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\1\ Stephen P. Utkus & Jean A. Young, Lessons from Behavioral
Finance and the Autopilot 401(k) Plan, (Vanguard Center for
Retirement Res.) April 2004; Sarah Holden & Jack VanDerhei, The
Influence of Automatic Enrollment, Catch-Up, and IRA Contributions
on 401(k) Accumulations at Retirement, 283 Employee Benefit Res.
Inst. Issue Brief (2005). The issue brief indicates that the ``EBRI/
ICI model shows that prior to automatic enrollment, 66 percent of
eligible workers at year-end 2000 were participants in 401(k) plans,
while immediately after adding automatic enrollment to the model,
the participation rate rises to 92 percent of eligible employees.''
Id. at 4. See also James J. Choi, David Laibson, & Brigitte C.
Madrian, Plan Design and 401(k) Savings Outcomes, 57 National Tax J.
275 (2004); see also James J. Choi, David Laibson, Brigitte Madrian,
& Andrew Metrick, For Better or For Worse: Default Effects and
401(k) Savings Behavior (Pension Research Council, Working Paper No.
2002-2, 2001), available at http://prc.wharton.upenn.edu/prc/PRC/WP/WP2002-2.pdf
.
\2\ The incidence of automatic enrollment appears to be growing,
by one estimate from 8.4 percent of plans in 2003 to 10.5 percent in
2004 (48th Annual Survey of Profit Sharing and 401(k) Plans, (Profit
Sharing/401(k) Council of America, Chicago, Ill.), 2005, at 36), by
another from 14 percent in 2003 to 19 percent in 2005 (Survey
Findings: Trends and Experiences in 401(k) Plans 2005, (Hewitt
Associates LLC), 2005, at 1, 13). Another survey found no growth
between 2003 and 2004 (2004 Annual 401(k) Benchmarking Survey
(Deloitte Consulting LLP), 2004, at 6).
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Many of the studies also indicate that the accumulation of
retirement savings in automatic enrollment plans depends heavily on the
default investment alternative and the default contribution rate
provided under the plan.\3\ The scope of this proposal is limited to
default investment alternatives in which individual account plan assets
are invested on behalf of those participants or beneficiaries who fail
to give investment instructions. Modification of contribution rates
implicates issues beyond the jurisdiction of the Department of Labor.
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\3\ See studies cited supra note 2. See also Stephen P. Utkus,
Selecting a Default Fund for a Defined Contribution Plan (Vanguard
Center for Retirement Res.), July 2004.
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Several studies note that the contributions of automatically
enrolled participants are frequently invested in products that present
little risk of capital loss, e.g., money market funds, stable value
funds and similarly performing investment vehicles.\4\ It also appears
that many plans without automatic enrollment provisions \5\
[[Page 56807]]
utilize similar capital preservation default investment products for
those employees who enroll in the plan but fail to direct the
investment of their contributions or their employer's matching
contributions. As a short-term investment, money market or stable value
funds may not significantly affect retirement savings. Such investments
can play a useful role as a component of a diversified portfolio.
However, when such funds become the exclusive investment of
participants or beneficiaries, it is unlikely that the rate of return
generated by those funds over time will be sufficient to generate
adequate retirement savings for most participants or beneficiaries.\6\
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\4\ Of the responding plans with automatic enrollment, the
default investment option was a stable value fund for 26.9%, a money
market fund for 23.7%, a balanced fund for 29%, a life cycle fund
for 8.6%, a professionally managed account for 6.5%, and 5.4% were
reported as ``other.'' 48th Annual Survey of Profit Sharing/401(k)
Plans, supra note 2, at 37, Table 64. Other surveys indicate the use
of money market, stable value and similarly performing investment
vehicles at 58 percent (2004 Annual 401(k) Benchmarking Survey,
supra note 2, at 7, Exhibit 20) and 81 percent (Stephen P. Utkus,
Selecting A Default Fund for a Defined Contribution Plan, (Vanguard
Center for Retirement Res.), Volume 14, June 2005, at 3).
\5\ This proposal encompasses situations beyond automatic
enrollment. Examples include: failure of a participant or
beneficiary to provide investment instruction following the
elimination of an investment alternative or a change in service
provider, failure of a participant or beneficiary to provide
investment instruction following a rollover from another plan, and
any other failure of a participant or beneficiary to provide
investment instruction.
\6\ Investments in capital preservation vehicles deprive
investors of the opportunity to benefit from the returns generated
by equity securities that have historically generated higher returns
than fixed income investments.
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A frequently cited impediment to adoption of automatic enrollment
provisions in individual account plans is the assumption of fiduciary
responsibility for the investment decisions that the plan fiduciary
must make on behalf of the automatically enrolled participants. In the
case of a participant directed individual account plan designed to
comply with the requirements of ERISA section 404(c)(1), responsibility
for the result of specific investment directions rests with the
directing plan participant or beneficiary, rather than the plan sponsor
or other fiduciaries.\7\ Before enactment of the Pension Protection
Act, which became law on August 17, 2006, the Department indicated that
a participant or beneficiary would not be considered to have exercised
control when the participant or beneficiary is merely apprised of
investments that will be made on his or her behalf in the absence of
instructions to the contrary.\8\ In effect, the Department treated the
plan fiduciary's investment decision on behalf of a participant or
beneficiary as if the decision were made in connection with a
participant directed individual account plan that is not designed, or
fails, to meet the conditions for a section 404(c) plan. While some
employers, in adopting automatic enrollment provisions or otherwise
dealing with the absence of investment direction from plan
participants, have been willing to assume fiduciary responsibility for
their investment decisions, many of those employers attempt to minimize
their fiduciary liability by limiting default investments to funds that
emphasize preservation of capital and little risk of loss (e.g., money
market and stable value funds).
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\7\ See Final Regulation Regarding Participant Directed
Individual Account Plans (ERISA Section 404(c) Plans), 57 FR 46,906
(Oct.13, 1992) (codified at 29 CFR 2550.404c-1).
\8\ See Rev. Rul. 98-30, 1998-1 C.B. 1273; see also Rev. Rul.
2000-8, 2000-1 C.B. 617; see also Final Regulation Regarding
Participant Directed Individual Account Plans (ERISA Section 404(c)
Plans), 57 FR at 46924; see also Retirement Plans, Cash or Deferred
Arrangements Under Section 401(k) and Matching Contributions or
Employee Contributions Under Section 401(m) Regulations, 69 FR
78144, 78146 n. 2 (Dec. 29, 2004) (codified at 26 CFR pts. 1 & 602).
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As part of the Pension Protection Act, section 404(c) of ERISA was
amended to provide relief accorded by section 404(c)(1) to fiduciaries
that invest participant assets in certain types of default investment
alternatives in the absence of participant investment direction.
Specifically, section 624(a) of the Pension Protection Act added a new
section 404(c)(5) to ERISA. Section 404(c)(5)(A) of ERISA provides
that, for purposes of section 404(c)(1) of ERISA, a participant in an
individual account plan shall be treated as exercising control over the
assets in the account with respect to the amount of contributions and
earnings which, in the absence of an investment election by the
participant, are invested by the plan in accordance with regulations
prescribed by the Secretary of Labor. Section 624(a) of the Pension
Protection Act directed that such regulations provide guidance on the
appropriateness of designating default investments that include a mix
of asset classes consistent with capital preservation or long-term
capital appreciation, or a blend of both. In the Department's view,
this statutory language provides the stated relief to fiduciaries of
any participant directed individual account plan that complies with its
terms and with those of the Department's proposed regulation under
section 404(c)(5) of ERISA. This relief therefore, is not contingent on
a plan being an ``ERISA 404(c) plan'' or otherwise meeting the
requirements of the Department's regulations at 2550.404c-1.
Section 624(a) of the Pension Protection Act also added notice
requirements in section 404(c)(5)(B)(i) and (ii) of ERISA. Section
404(c)(5)(B)(i) requires that each participant--(I) receive, within a
reasonable period of time before each plan year, a notice explaining
the employee's right under the plan to designate how contributions and
earnings will be invested and explaining how, in the absence of any
investment election by the participant, such contributions and earnings
will be invested, and (II) has a reasonable period of time after
receipt of such notice and before the beginning of the plan year to
make such designation. Section 404(c)(5)(B)(ii) requires each notice to
be sufficiently accurate and comprehensive to appraise the employee of
such rights and obligations, and to be written in a manner calculated
to be understood by the average employee eligible to participate.
The amendments made by section 624 of the Pension Protection Act
shall apply to plan years beginning after December 31, 2006. Section
624(b) of the Pension Protection Act directed the Department to issue
final regulations under section 404(c)(5)(A) of ERISA no later than 6
months of the date of enactment of the Pension Protection Act.
In an effort to increase plan participation through the adoption of
automatic enrollment provisions, and increase retirement savings
through the utilization of default investments that are more likely to
increase retirement savings for participants and beneficiaries who do
not direct their own investments, the Department, exercising its
authority under section 505 of ERISA and consistent with section 624 of
the Pension Protection Act, is proposing to provide relief to
fiduciaries of participant directed individual account plans that
invest participant assets in certain types of default investment
alternatives in the absence of participant investment direction. The
proposed regulation is described below.
B. Overview of Proposal
Scope of the Fiduciary Relief
The proposal would, upon adoption, implement the fiduciary relief
afforded by ERISA section 404(c)(5), under which a participant, who
does not give investment directions, will be treated as exercising
control over his or her account with respect to assets that the plan
invests in a qualified default investment alternative. See Sec.
2550.404c-5(a)(1).
The relief provided by the proposed regulation is conditioned on
the use of certain investment alternatives, but the limitations of the
proposed regulation should not be construed to indicate that the use of
investment alternatives not identified in the proposed regulation as
qualified default investment alternatives would be imprudent. For
example, the Department recognizes that investments in money market
funds, stable value products and similarly performing investment
vehicles may be prudent for some participants or beneficiaries.
[[Page 56808]]
Paragraph (b) of Sec. 2550.404c-5 defines the scope of the
fiduciary relief provided. Specifically, paragraph (b)(1) provides
that, subject to certain exceptions, a fiduciary of an individual
account plan that permits participants and beneficiaries to direct the
investment of assets in their accounts and that meets the conditions of
the regulation, as set forth in paragraph (c) of Sec. 2550.404c-5,
shall not be liable for any loss under part 4 of title I, or by reason
of any breach, that is the direct and necessary result of investing all
or part of a participant's or beneficiary's account in a qualified
default investment alternative, or of investment decisions made by the
entity described in paragraph (e)(3) in connection with the management
of a qualified default investment alternative. The scope of this relief
is the same as that extended to plan fiduciaries under ERISA section
404(c)(1)(B) in connection with carrying out investment directions of
plan participants and beneficiaries in an ``ERISA section 404(c) plan''
as described in 29 CFR 2550.404c-1(a), although it is not necessary for
a plan to be an ERISA section 404(c) plan in order for the fiduciary to
obtain the relief accorded by this proposed regulation. As with section
404(c)(1) of the Act and the regulation issued thereunder (29 CFR
2550.404c-1), the proposed regulation would not provide relief from the
general fiduciary rules applicable to the selection and monitoring of a
default investment alternative or from any liability that results from
a failure to satisfy these duties, including liability for any
resulting losses. See paragraph (b)(2) of Sec. 2550.404c-5. Paragraph
(b) further makes clear that nothing in the proposed regulation
relieves an investment manager from its general fiduciary duties or
from any liability that results from a failure to satisfy these duties,
including liability for any resulting losses. See paragraph (b)(3) of
Sec. 2550.404c-5. In addition, the proposed regulation provides no
relief from the prohibited transaction provisions of section 406 of
ERISA or from any liability that results from a violation of those
provisions, including liability for any resulting losses. See paragraph
(b)(4) of Sec. 2550.404c-5.
Like other investment alternatives made available under a plan, a
plan fiduciary would be required to carefully consider investment fees
and expenses in choosing a qualified default investment alternative for
purposes of the proposed regulation. To the extent that a plan offers
more than one investment alternative that could constitute a qualified
default investment alternative, the Department anticipates that fees
and expenses would be an important consideration in selecting among the
alternatives.
Conditions for the Fiduciary Relief
The conditions for relief are set forth in paragraph (c) of the
proposal. The proposal has six conditions.
The first condition requires that assets invested on behalf of
participants or beneficiaries under the proposed regulation be invested
in a ``qualified default investment alternative.'' See Sec. 2550.404c-
5(c)(1). ``Qualified default investment alternatives'' are defined in
paragraph (e) of the proposed regulation and discussed in detail below.
The second condition provides that the participant or beneficiary on
whose behalf assets are being invested in a qualified default
investment alternative had the opportunity to direct the investment of
assets in his or her account but did not direct the assets. See Sec.
2550.404c-5(c)(2). In other words, no relief is available when a
participant or beneficiary has provided affirmative investment
direction concerning the assets invested on the participant's or
beneficiary's behalf.
The third condition requires that the participant or beneficiary on
whose behalf an investment in a qualified default investment
alternative may be made is furnished a notice within a reasonable
period of time of at least 30 days in advance of the first such
investment, and within a reasonable period of time of at least 30 days
in advance of each subsequent plan year. As described in the
regulation, the required notice can be furnished in the plan's summary
plan description, summary of material modifications, or as a separate
notification. See Sec. 2550.404c-5(c)(3). The specific content
requirements for the notice are described in paragraph (d) of the
proposed regulation and discussed in detail below.
The Department notes that a similar notice requirement is contained
in section 401(k)(13)(E) of the Internal Revenue Code (Code), as
amended by the Pension Protection Act. The Department anticipates that
the notice requirements of this proposed regulation and the notice
requirements of section 401(k)(13)(E) of the Code could be satisfied in
a single notice.
The Department further notes that the phrase--``in advance of the
first such investment [in a qualified default investment
alternative]''--is not intended to foreclose availability of relief to
fiduciaries that, prior to the adoption of a final regulation, invested
assets on behalf of participants and beneficiaries in a default
investment alternative that would constitute a ``qualified default
investment alternative'' under the regulation. In such cases, the
phrase ``in advance of the first such investment'' should be read to
mean the first investment with respect to which relief under the
proposed regulation is intended to apply after the effective date of
the regulation. The Department is proposing to make this regulation
effective 60 days after publication of the final rule in the Federal
Register.
The fourth condition of the proposed regulation requires that the
terms of the plan provide that any material provided to the plan
relating to a participant's or beneficiary's investment in a qualified
default investment alternative (e.g., account statements, prospectuses,
proxy voting material) will be provided to the participant or
beneficiary. See Sec. 2550.404c-5(c)(4).
The fifth condition requires that any participant or beneficiary on
whose behalf assets are invested in a qualified default investment
alternative be afforded the opportunity, consistent with the terms of
the plan (but in no event less frequently than once within any three
month period), to transfer, in whole or in part, such assets to any
other investment alternative available under the plan without financial
penalty. See Sec. 2550.404c-5(c)(5). This provision assures that
participants and beneficiaries on whose behalf assets are invested in a
qualified default investment alternative have the same opportunity as
other plan participants and beneficiaries to direct the investment of
their assets, and that neither the plan nor the qualified default
investment alternative impose financial penalties that would restrict
the rights of participants and beneficiaries to direct their assets to
other investment alternatives available under the plan. This provision
does not confer greater rights on participants or beneficiaries whose
accounts the plan invests in qualified default investment alternatives
than are otherwise available under the plan with respect to the timing
of investment directions. Thus, if a plan provides participants and
beneficiaries the right to direct investments on a quarterly basis,
those participants and beneficiaries with investments in a qualified
default investment alternative need only be afforded the opportunity to
direct their investments on a quarterly basis. Similarly, if a plan
permits daily investment direction, participants and beneficiaries with
investments in a qualified default investment alternative
[[Page 56809]]
must be permitted to direct their investments on a daily basis.
The Department notes that this proposal does not address or provide
relief with respect to the direction of investments out of a qualified
default investment alternative into another investment alternative
available under the plan. See generally section 404(c)(1) of ERISA and
29 CFR 2550.404c-1.
The last condition requires that the plan offer participants and
beneficiaries the opportunity to invest in a ``broad range of
investment alternatives'' within the meaning of 29 CFR 2550.404c-
1(b)(3).\9\ See Sec. 2550.404c-5(c)(6). For purposes of the proposed
regulation, the Department believes that participants and beneficiaries
should be afforded a sufficient range of investment alternatives to
achieve a diversified portfolio with aggregate risk and return
characteristics at any point within the range normally appropriate for
the pension plan participant or beneficiary. The Department believes
that the application of the ``broad range of investment alternatives''
standard of the section 404(c) regulation accomplishes this objective.
Moreover, the Department believes that virtually all individual account
plans that provide for participant direction, without regard to whether
such plans meet all the requirements for an ERISA section 404(c) plan,
likely will meet this standard without having to undertake significant
changes in available investment alternatives.
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\9\ 29 CFR 2550.404c-1(b)(3) provides that ``[a] plan offers a
broad range of investment alternatives only if the available
investment alternatives are sufficient to provide the participant or
beneficiary with a reasonable opportunity to: (A) Materially affect
the potential return on amounts in his individual account with
respect to which he is permitted to exercise control and the degree
of risk to which such amounts are subject; (B) Choose from at least
three investment alternatives: (1) Each of which is diversified; (2)
each of which has materially different risk and return
characteristics; (3) which in the aggregate enable the participant
or beneficiary by choosing among them to achieve a portfolio with
aggregate risk and return characteristics at any point within the
range normally appropriate for the participant or beneficiary; and
(4) each of which when combined with investments in the other
alternatives tends to minimize through diversification the overall
risk of a participant's or beneficiary's portfolio; * * *''
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Notices
As discussed above, relief under the proposed regulation is
conditioned on furnishing participants and beneficiaries advance
notification concerning the default investment provisions of their
plan. See Sec. 2550.404c-5(c)(3). The specific information required to
be contained in the notice is set forth in paragraph (d) of the
regulation.
Paragraph (d) of Sec. 2550.404c-5 requires that the notice to
participants and beneficiaries be written in a manner calculated to be
understood by the average plan participant and contain the following
information: (1) A description of the circumstances under which assets
in the individual account of a participant or beneficiary may be
invested on behalf of the participant and beneficiary in a qualified
default investment alternative; (2) a description of the qualified
default investment alternative, including a description of the
investment objectives, risk and return characteristics (if applicable),
and fees and expenses attendant to the investment alternative; (3) a
description of the right of the participants and beneficiaries on whose
behalf assets are invested in a qualified default investment
alternative to direct the investment of those assets to any other
investment alternative under the plan, without financial penalty; and
(4) an explanation of where the participants and beneficiaries can
obtain investment information concerning the other investment
alternatives available under the plan.
It is the view of the Department that the notice requirements of
this proposed regulation are consistent with the notice requirements
added to section 404(c)(5) of ERISA by section 624 of the Pension
Protection Act. The Department believes the required information is
sufficient to put participants and beneficiaries on notice as to the
consequences of failing to direct investment of the assets in their
account, and encourages active decisionmaking by participants and
beneficiaries. The Department invites suggestions as to whether
additional information should be considered for inclusion in the
notice.
Qualified Default Investment Alternatives
Under the proposal, relief from fiduciary liability is provided
with respect to only those assets invested on behalf of a participant
or beneficiary in a ``qualified default investment alternative.'' See
Sec. 2550.404c-5(c)(1). Paragraph (e) of Sec. 2550.404c-5 sets forth
five requirements for a qualified default investment alternative.
The first requirement is intended to limit investment in employer
securities as part of a qualified default investment alternative's
investment strategy. Subject to two exceptions, the proposal provides
that a qualified default investment alternative shall not hold or
permit the acquisition of employer securities. See Sec. 2550.404c-
5(e)(1)(i).
The first exception to this general prohibition is applicable to
employer securities held or acquired by an investment company
registered under the Investment Company Act of 1940, 15 U.S.C. 80a-1,
et seq., or a similar pooled investment vehicle regulated and subject
to periodic examination by a State or Federal agency and with respect
to which investment in such securities is made in accordance with the
stated investment objectives of the investment vehicle and independent
of the plan sponsor or an affiliate thereof. While the Department does
not believe it is appropriate for a qualified default investment
alternative to encourage investments in employer securities, the
Department also recognizes that an absolute prohibition against holding
or investing in employer securities may unnecessarily complicate the
selection and monitoring of qualified default investment alternatives
by publicly traded companies, the stock of which may be held or
acquired pursuant to an investment strategy wholly independent of the
employer. The Department believes that the foregoing exception is
sufficiently broad to accommodate publicly traded companies and pooled
investment vehicles that may invest in such companies.
The second exception is for employer securities acquired as a
matching contribution from the employer/plan sponsor or at the
direction of the participant or beneficiary. This exception is intended
to make clear that an investment management service will not be
precluded from serving as a qualified default investment alternative
under Sec. 2550.404c-5(e)(5)(iii) merely because the account of a
participant or beneficiary holds employer securities acquired as
matching contributions from the employer/plan sponsor, or acquired as a
result of prior direction by the participant or beneficiary, provided
that the investment management service has the authority to dispose of
such securities.
In the case of employer securities acquired as matching
contributions that are subject to a restriction on transferability,
relief would not be available until the investment management service
can exercise discretion over such securities, at the expiration of the
restriction. Although an investment management service would be
responsible for determining whether and to what extent the account
should continue to hold investments in employer securities, the
investment management service could not, except as part of an
investment company or similar pooled investment vehicle, exercise its
discretion to acquire additional employer securities on behalf
[[Page 56810]]
of an individual account without violating Sec. 2550.404c-5(e)(1).
In the case of prior direction by a participant or beneficiary, if
the participant or beneficiary provided investment direction with
respect to employer securities, but failed to provide investment
direction following an event, such as a change in investment
alternatives, and the terms of the plan provide that in such
circumstances the account's assets are invested in a default investment
alternative, the proposed regulation would permit an investment
management service to hold and manage those employer securities in the
absence of participant or beneficiary direction. While the investment
management service may not acquire additional employer securities using
participant contributions, the investment management service may reduce
the amount of employer securities held by the account of the
participant or beneficiary.
The second requirement provides that, except as otherwise provided
in paragraph (c)(5), a qualified default investment alternative may not
impose financial penalties or otherwise restrict the ability of a
participant or beneficiary to transfer, in whole or in part, his or her
investment from the qualified default investment alternative to any
other investment alternative available under the plan. The Department
does not believe that limits on the ability of a participant or
beneficiary to move from a qualified default investment alternative
should be permitted by the plan or the qualified default investment
alternative.
The third requirement is that a qualified default investment
alternative be either managed by an investment manager, as defined in
section 3(38) of the Act, or an investment company registered under the
Investment Company Act of 1940. The Department believes that when plan
fiduciaries are relieved of liability for underlying investment
management/asset allocation decisions, those responsible for the
investment management/asset allocation decisions must be investment
professionals who acknowledge their fiduciary responsibilities and
liability under ERISA. For this reason, the proposed regulation
requires that, except in the case of registered investment companies,
those responsible for the management of a qualified default investment
alternative be ``investment managers'' within the meaning of section
3(38) of ERISA.\10\ Inasmuch as the assets of an investment company
registered under the Investment Company Act of 1940 do include plan
assets solely by virtue of a plan's investment in securities issued by
such investment company \11\ and such investment companies are subject
to Federal and State regulation and oversight, the proposal permits an
investment company registered under the Investment Company Act of 1940
to constitute a ``qualified default investment alternative'' provided
that the other conditions of the proposed regulation are satisfied.
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\10\ Section 3(38) of ERISA defines the term ``investment
manager'' to mean ``any fiduciary (other than a trustee or named
fiduciary, as defined in section 402(a)(2) [29 U.S.C. 1102(a)(2)])--
(A) who has the power to manage, acquire, or dispose of any asset of
a plan; (B) who (i) is registered as an investment adviser under the
Investment Advisers Act of 1940 [15 U.S.C. 80b-1 et seq.]; (ii) is
not registered as an investment adviser under such Act by reason of
paragraph (1) of section 203A(a) of such Act, is registered as an
investment adviser under the laws of the State (referred to in such
paragraph (1)) in which it maintains its principal office and place
of business, and, at the time the fiduciary last filed the
registration form most recently filed by the fiduciary with such
State in order to maintain the fiduciary's registration under the
laws of such State, also filed a copy of such form with the
Secretary; (iii) is a bank, as defined in that Act [15 U.S.C. 80b-1
et seq.]; or (iv) is an insurance company qualified to perform
services described in subparagraph (A) under the laws of more than
one State; and (C) has acknowledged in writing that he is a
fiduciary with respect to the plan.''
\11\ See ERISA section 401(b)(1).
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The fourth requirement provides that a qualified default investment
alternative is diversified so as to minimize the risk of large losses.
The last requirement for a qualified default investment alternative
conditions relief on the use of one of three types of investment
products, portfolios or services. See Sec. 2550.404c-5(e)(5). In
defining qualified default investment alternatives, the Department
presumes that, in those instances when a participant or beneficiary
chooses not to direct the investment of the assets in their account,
the only objective and readily available information relevant to making
an investment decision on behalf of the participant is age. For this
reason, the investment objectives of the qualified default investment
alternatives are not required to take into account other factors, such
as risk tolerances, other investment assets, etc.
The first alternative is an investment fund product or model
portfolio that is designed to provide varying degrees of long-term
appreciation and capital preservation through a mix of equity and fixed
income exposures based on the participant's age, target retirement date
(such as normal retirement age under the plan) or life expectancy. Such
products and portfolios change their asset allocation and associated
risk levels over time with the objective of becoming more conservative
(i.e., decreasing risk of losses) with increasing age. As noted above,
asset allocation decisions for eligible products and portfolios are not
required to take into account risk tolerances, investments or other
preferences of an individual participant. An example of such a fund or
portfolio may be a ``life-cycle'' or ``targeted-retirement-date'' fund
or account. See Sec. 2550.404c-5(e)(5)(i). The reference to ``an
investment fund product or model portfolio'' is intended to make clear
that this alternative might be a ``stand alone'' product or a ``fund of
funds'' comprised of various investment options otherwise available
under the plan for participant investments. In the context of a fund of
funds portfolio, it is likely that money market, stable value and
similarly performing capital preservation vehicles will play a role in
comprising the mix of equity and fixed-income exposures.
The second alternative is an investment fund product or model
portfolio that is designed to provide long-term appreciation and
capital preservation through a mix of equity and fixed income exposures
consistent with a target level of risk appropriate for participants of
the plan as a whole. For purposes of this alternative, asset allocation
decisions for such products and portfolios are not required to take
into account the age of an individual participant, but rather focus on
the demographics of the participant population as a whole. An example
of such a fund or portfolio may be a ``balanced'' fund. As with the
preceding alternative, the reference to ``an investment fund product or
model portfolio'' is intended to make clear that this alternative might
be a ``stand alone'' product or a ``fund of funds'' comprised of
various investment options otherwise available under the plan for
participant investments. In the context of a fund of funds portfolio,
it is likely that money market, stable value and similarly performing
capital preservation vehicles will play a role in comprising the mix of
equity and fixed-income exposures for this alternative.
Unlike the first alternative, which focuses on the age, target
retirement date (such as normal retirement age under the plan) or life
expectancy of an individual participant, the second alternative
requires a fiduciary to take into account the demographics of the
plan's participants, similar to the considerations a fiduciary would
take into account in managing an individual account plan that does not
provide for participant direction. For this reason, a
[[Page 56811]]
fiduciary may, in connection with the duty to monitor investment
alternatives available under the plan, conclude that a new or
additional investment fund product or model portfolio is required to
take into account significant changes in the demographics (e.g., age)
of the plan's participant population.
The third alternative is an investment management service with
respect to which an investment manager allocates the assets of a
participant's individual account to achieve varying degrees of long-
term appreciation and capital preservation through a mix of equity and
fixed income exposures, offered through investment alternatives
available under the plan, based on the participant's age, target
retirement date (such as normal retirement age under the plan) or life
expectancy. Such portfolios change their asset allocation and
associated risk levels over time with the objective of becoming more
conservative (i.e., decreasing risk of losses) with increasing age. As
with the first alternative, the proposed regulation makes clear that,
as with the other alternatives described in the regulation, asset
allocation decisions are not required to take into account risk
tolerances, other investments or other preferences of an individual
participant. An example of such a service may be a ``managed account.''
\12\
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\12\ With regard to this alternative, the Department notes that
in 2003, a working group of the Advisory Council on Employee Welfare
and Pension Benefit Plans submitted a report on optional
professional management in defined contribution plans. While the
Advisory Council report focused on the use of managed account
services in which participants played an active role in preparing an
investment profile, the report nonetheless provides support for
including such services within the definition of a qualified default
investment alternative. This report may be accessed at http://www.dol.gov/ebsa/publications/AC_1107b03_report.html
.
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Although investment management services are included within the
scope of relief, the Department notes that relief similar to that
provided by this proposed regulation is available to plan fiduciaries
under the statute. Specifically, section 402(c)(3) of ERISA provides
that ``a person who is a named fiduciary with respect to control or
management of the assets of a plan may appoint an investment manager or
managers to manage (including the power to acquire and dispose of) any
assets of a plan.'' Section 405(d) of ERISA provides that ``[i]f an
investment manager or managers have been appointed under section
402(c)(3), then * * * no trustee shall be liable for the acts or
omissions of such investment manager or managers, or be under an
obligation to invest or otherwise manage any asset of the plan which is
subject to the management of such investment manager.'' The Department
included investment management services within the scope of fiduciary
relief in order to avoid any ambiguity concerning the scope of relief
available to plan fiduciaries in the context of participant directed
individual account plans.
C. Miscellaneous Issues
Preemption
Section 902 of the Pension Protection Act added a new section
514(e)(1) to ERISA providing that notwithstanding any other provision
of section 514, title I of ERISA shall supersede any State law that
would directly or indirectly prohibit or restrict the inclusion in any
plan of an automatic contribution arrangement. Section 902 further
added section 514(e)(2) to ERISA defining the term ``automatic
contribution arrangement'' as an arrangement under which a participant:
may elect to have the plan sponsor make payments as contributions under
the plan on behalf of the participant, or to the participant directly
in cash; is treated as having elected to have the plan sponsor make
such contributions in an amount equal to a uniform percentage of
compensation provided under the plan until the participant specifically
elects not to have such contributions made (or specifically elects to
have such contributions made at a different percentage); and under
which such contributions are invested in accordance with regulations
prescribed by the Secretary of Labor under section 404(c)(5) of ERISA.
The Department specifically requests comments on whether and to what
extent regulations would be helpful in addressing the preemption
provisions of section 514(e) of ERISA.
Enforcement
Section 902 of the Pension Protection Act amended section 502(c)(4)
of ERISA to provide that the Secretary of Labor may assess a civil
penalty against any person of up to $1,100 a day for each violation by
any person of section 302(b)(7)(F)(vi) or section 514(e)(3) of ERISA.
Implementing regulations will be developed in a separate rulemaking.
D. Request for Comments
The Department invites comments from interested persons on all
aspects of the proposed regulation. Comments should be addressed to the
Office of Regulations and Interpretations, Employee Benefits Security
Administration, Room N-5669, U.S. Department of Labor, 200 Constitution
Avenue, NW., Washington, DC 20210, Attn: Default Investment Regulation.
Commenters are encouraged to submit comments electronically to
e-ORI@dol.gov or http://www.regulations.gov. All comments received will be
available to the public at http://www.dol.gov/ebsa and
http://www.regulations.gov. Comments also will be available for public
inspection at the Public Disclosure Room, N-1513, Employee Benefits
Security Administration, 200 Constitution Avenue, NW., Washington, DC
20210.
Comments on this proposal should be submitted to the Department on
or before November 13, 2006.
E. Effective Date
The Department proposes to make this regulation effective 60 days
after the date of publication of the final rule in the Federal
Register.
F. Regulatory Impact Analysis
Summary
This proposed regulation is expected to have two major, positive
economic consequences. First, default investments will be directed
toward higher-return portfolios boosting average account performance.
Second, automatic enrollment provisions will become more common
boosting participation in retirement savings plans. Both of these
effects will tend on average and on aggregate to increase retirement
savings, especially among younger workers with low earnings and
frequent job changes. A substantial number of individuals will enjoy
significant increases in retirement income.\13\ The magnitude of these
effects will be large in absolute terms and proportionately large for
many directly affected individuals, but will be modest relative to
overall aggregate retirement savings.
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\13\ In rare cases, retirement income may decrease slightly. A
few individuals may wind up contributing for some period of time at
a default rate that is lower than the rate they otherwise would have
elected (this risk will be minimized in plans that automatically
escalate default contribution rates). A few may realize lower
returns in a qualified default investment alternative than they
would otherwise have realized.
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The magnitude of the proposed regulation's effects will depend on
plan sponsor and participant choices. The effects will be cumulative
and will become fully realized only after workers beginning their
careers today reach retirement. For these reasons, any estimates of the
regulation's effects are subject to substantial uncertainty. The
Department has developed low- and high-impact estimates, to illustrate
a range of potential long-term effects.
[[Page 56812]]
In the very long run the proposed regulation is predicted to
increase aggregate 401(k) plan account balances by between 2 percent
and 5 percent, or approximately $45 billion and $90 billion if
represented at 2005 levels. The portion invested in equity will
increase by between 3 percent and 5 percent, or $27 billion and $48
billon.
For individuals born in 1985 and surviving to age 67, holding other
factors constant, low-impact estimates suggest that the proposed
regulation will increase pension income by an average of $2,010 per
year (in 2005 dollars) for 10 percent, but decrease it by $1,120 per
year on average for 5 percent. Pension income would be unchanged for
the remaining 85 percent. High-impact estimates suggest that average
annual pension income will increase by $2,740 for 14 percent, fall by
$1,460 for 6 percent, and be unchanged for 80 percent.
The costs and benefits of the proposed regulation are not simple,
direct functions of the foregoing gross dollar estimates. Increases in
retirement savings due to automatic enrollment will be offset by either
decreases in current consumption or reductions in other savings, so net
benefits will be smaller than the predicted increases in retirement
savings. The proposed regulation may also have macroeconomic
consequences, which are likely to be small but positive. An increase in
retirement saving is likely to promote investment and long-term
economic productivity and growth. The Department therefore concludes
that the benefits of this proposed regulation will exceed its costs by
a wide margin.
In accordance with OMB Circular A-4(available at http://www.whitehouse.gov/omb/circulars/a004/a-4.pdf
), Table 1 below depicts
an accounting statement showing the annualized benefits and transfers
associated with the provisions of this proposed rule.
BILLING CODE 4510-29-P
[[Page 56813]]
[GRAPHIC] [TIFF OMITTED] TP27SE06.094
BILLING CODE 4510-29-C
Executive Order 12866
Under Executive Order 12866, the Department must determine whether
a regulatory action is ``significant'' and therefore subject to the
requirements of the Executive Order and subject to review by the Office
of Management and Budget (OMB). Under section 3(f) of the Executive
Order, a ``significant regulatory action'' is an action that is likely
to result in a rule (1) having an annual effect on the economy of $100
million or more, or adversely and materially affecting a sector of the
[[Page 56814]]
economy, productivity, competition, jobs, the environment, public
health or safety, or State, local or tribal governments or communities
(also referred to as ``economically significant''); (2) creating
serious inconsistency or otherwise interfering with an action taken or
planned by another agency; (3) materially altering the budgetary
impacts of entitlement grants, user fees, or loan programs or the
rights and obligations of recipients thereof; or (4) raising novel
legal or policy issues arising out of legal mandates, the President's
priorities, or the principles set forth in the Executive Order. OMB has
determined that this action is significant under section 3(f)(1)
because it is likely to have an annual effect on the economy of $100
million or more. Accordingly, the Department has undertaken, as
described below, an analysis of the costs and benefits of the proposed
regulation. The Department believes that the proposed regulation's
benefits justify its costs.
Alternatives Considered by the Department
Prior to the enactment of the Pension Protection Act, the
Department considered providing relief under section 404(a) of ERISA,
rather than section 404(c), in response to concerns that conditioning
relief on compliance with the Department's regulations under section
404(c), 29 CFR 2550.404c-1, may deter adoption of automatic enrollment
provisions. Inasmuch as the relief provided by recently enacted section
404(c)(5) of ERISA does not condition relief on compliance with the
Department's regulations under section 404(c), the Department concluded
that adopting a regulation under section 404(c)(5) effectively provided
the same relief it considered providing under section 404(a).
In defining the three types of investment products, portfolios or
services that may be used as a qualified default investment
alternative, the Department applied certain criteria. These criteria
included consistency with market trends and mainstream financial
planning practices. The Department entertained including as an
additional type of investment product near risk-free fixed income
instruments. Such instruments might have been defined so as to include
money market mutual funds, certain bank deposits, and stable value
insurance products. Including such instruments might yield some
benefits. It is possible that at least some plan sponsors strongly
prefer to use as default investments such instruments rather than any
of the three types embraced by the proposed rule. It is further
possible that some such sponsors would adopt automatic enrollment
programs if and only if the fiduciary relief afforded by the proposed
regulation was extended to include such instruments. In that case,
including such instruments in the proposed regulation might boost
participation and net retirement income for some individuals. The
Department believes such cases would be rare, however. The proposed
rule, by providing relief from fiduciary liability, is both intended
and expected to tilt plan sponsors' default investment preferences away
from such instruments and toward the three types it embraces. Moreover,
many plan sponsors currently use such instruments as default
investments under automatic enrollment programs, and they and others
might continue to do so after adoption of the proposed rule. The
proposed rule leaves intact the current legal provisions applicable to
the use of such instruments as default investments.
On the other hand, including such instruments might erode benefits.
Consider plan sponsors that under the proposed rule will adopt
automatic enrollment programs and use as default investments one of the
three types defined in the proposed rule. If such near-risk-free
instruments were included as a fourth type, some of these plan sponsors
might instead use such instruments as default investments, thereby
reducing average investment performance and retirement income for some
individuals. The Department therefore believes that including such
instruments would be more likely to erode benefits than to increase
them. Accordingly, the Department omitted such instruments from the
types defined in the proposed rule.
The Department also considered whether to include or omit an
investment fund product or model portfolio that establishes a uniform
mix of equity and fixed income exposures for all affected participants,
ultimately deciding to include such a type as the second of the three
types defined in the proposed rule. Such a product or model portfolio
has some drawbacks relative to the other two types of investment
products, portfolios or services that may be used as a qualified
default investment alternative. Unlike the latter types, its target
level of risk must be appropriate for participants of the plan as a
whole but cannot be separately calibrated for each participant or for
particular classes of participants. Therefore, while its risk level may
be appropriate for all affected participants it is unlikely to be
optimal for all. However, such a product or model portfolio may also
have relative advantages. Compared with the other two types such a
product or portfolio may be simpler, less expensive and easier to
explain and understand. These advantages may outweigh the potential
advantage of more customized risk levels, especially for plans covering
relatively homogenous populations. And the inclusion of such products
or model portfolios along with the other two types of investment
products, portfolios or services might help heighten competition in the
market and thereby enhance product quality and affordability across all
three types.
Regulatory Flexibility Act
The Regulatory Flexibility Act (5 U.S.C. 601 et seq.) (RFA) imposes
certain requirements with respect to Federal rules that are subject to
the notice and comment requirements of section 553(b) of the
Administrative Procedure Act (5 U.S.C. 551 et seq.) and are likely to
have a significant economic impact on a substantial number of small
entities. Small entities include small businesses, organizations, and
governmental jurisdictions.
For purposes of analysis under the RFA, the Department proposes to
continue to consider a small entity to be an employee benefit plan with
fewer than 100 participants. The basis of this definition is found in
section 104(a)(2) of ERISA, which permits the Secretary to prescribe
simplified annual reports for pension plans that cover fewer than 100
participants. Under section 104(a)(3) of ERISA, the Secretary may also
provide for exemptions or simplified annual reporting and disclosure
for welfare benefit plans. Pursuant to the authority of section
104(a)(3) of ERISA, the Department has previously issued at 29 CFR
2520.104-20, 2520.104-21, 2520.104-41, 2520.104-46, and 2520.104b-10
certain simplified reporting provisions and limited exemptions from
reporting and disclosure requirements for small plans, including
unfunded or insured welfare plans that cover fewer than 100
participants and satisfy certain other requirements.
Further, while some large employers may have small plans, in
general small employers maintain most small plans. Thus, the Department
believes that assessing the impact of these proposed rules on small
plans is an appropriate substitute for evaluating the effect on small
entities. The definition of small entity considered appropriate for
this purpose differs, however, from a definition of small business that
is based on size standards promulgated by the Small Business
Administration
[[Page 56815]]
(SBA) (13 CFR 121.201) pursuant to the Small Business Act (15 U.S.C.
631 et seq.). The Department therefore requests comments on the
appropriateness of the size standard used in evaluating the impact of
these proposed rules on small entities.
The reasons the Department is proposing this regulation, and the
objectives of and legal basis for the proposed regulation, are
discussed earlier in this preamble.
The Department has concluded that the primary effects of this
proposed regulation will be to increase retirement savings and pension
incomes for participants and beneficiaries by directing default
investments to higher-performing portfolios and by promoting the
implementation of automatic enrollment programs in participant directed
individual account pension plans. Applying this assessment under the
standards of the RFA, the Department believes that the impact of this
proposed regulation will fall primarily on participants in participant
directed individual account pension plans, and not on the plans
themselves or on the employers that sponsor the plans. By promoting
automatic enrollment programs and thereby increasing aggregate
participant contributions, the proposed regulation may also increase
some employers' matching contributions, including matching
contributions made by small plans. For reasons explained below,
however, the Department has concluded that this effect is not a
sufficient basis for concluding that the proposed regulation will have
a significant impact on a substantial number of small entities.\14\
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\14\ The proposed regulation requires affected plans to disclose
to participants and beneficiaries certain information related to
default investment provisions and default investments. As discussed
below in connection with the Paperwork Reduction Act, the burden of
compliance with the information collection provisions, which will be
borne by plan sponsors and plans, will be minor, relative to the
anticipated benefits of the regulation.
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Many plan sponsors provide matching contributions. The Department
estimates that, if the proposed regulation is finalized, approximately
10 to 20 percent of all small participant directed defined contribution
plans, or as many as 28,000 to 56,000 small plans, may adopt automatic
enrollment programs and, consequently, may incur additional matching
contributions. Such an increase in automatic enrollment programs could
have the indirect effect of increasing aggregate matching contributions
in small plans by between $100 million and $300 million annually
(expressed at 2005 levels). The effect of increased matching
contributions is expected to be proportionately similar for small and
large entities. However, adverse consequences are not expected, for
either large or small plans, because the adoption of automatic
enrollment programs and the provision of matching contributions are,
generally, voluntary and at the discretion of the plan sponsor.
Reliance on the proposed regulation and, therefore, compliance with its
provisions are also voluntary on the part of the plan sponsor.
Accordingly, it is highly unlikely that the proposed regulation would
have a significant impact on a substantial number of small entities.
Therefore, the head of the Employee Benefits Security Administration
hereby certifies, as required under section 605(b) of the RFA, that
this proposed regulation will not, if promulgated, have a significant
economic impact on a substantial number of small entities.
The Department is unaware of any duplicative, overlapping or
conflicting federal rules.
Paperwork Reduction Act
As part of its continuing effort to reduce paperwork and respondent
burden, the Department of Labor conducts a preclearance consultation
program to provide the general public and Federal agencies with an
opportunity to comment on proposed and continuing collections of
information in accordance with the Paperwork Reduction Act of 1995 (PRA
95) (44 U.S.C. 3506(c)(2)(A)). This helps to ensure that the public
understands the Department's collection instructions; respondents can
provide the requested data in the desired format, the reporting burden
(time and financial resources) is minimized, and the Department can
properly assess the impact of collection requirements on respondents.
Currently, the Department is soliciting comments concerning the
information collection request (ICR) included in the Proposed
Regulation on Default Investment Alternatives under Participant
Directed Individual Account Plans. A copy of the ICR may be obtained by
contacting the person listed in the PRA Addressee section below.
The Department has submitted a copy of the proposed regulation to
OMB in accordance with 44 U.S.C. 3507(d) for review of its information
collections. The Department and OMB are particularly interested in
comments that:
Evaluate whether the proposed collection of information is
necessary for the proper performance of the functions of the agency,
including whether the information will have practical utility;
Evaluate the accuracy of the agency's estimate of the
burden of the collection of information, including the validity of the
methodology and assumptions used;
Enhance the quality, utility, and clarity of the
information to be collected; and
Minimize the burden of the collection of information on
those who are to respond, including through the use of appropriate
automated, electronic, mechanical, or other technological collection
techniques or other forms of information technology, e.g., by
permitting electronic submission of responses.
Comments should be sent to the Office of Information and Regulatory
Affairs, Office of Management and Budget, Room 10235, New Executive
Office Building, Washington, DC 20503; Attention: Desk Officer for the
Employee Benefits Security Administration. Although comments may be
submitted through November 13, 2006, OMB requests that comments be
received within 30 days of publication of the Notice of Proposed
Rulemaking to ensure their consideration.
PRA Addressee: Address requests for copies of the ICR to Susan G.
Lahne, Office of Policy and Research, U.S. Department of Labor,
Employee Benefits Security Administration, 200 Constitution Avenue,
NW., Room N-5718, Washington, DC 20210. Telephone: (202) 693-8410; Fax:
(202) 219-5333. These are not toll-free numbers.
The proposed Regulation on Default Investment Alternatives under
Participant Directed Individual Account Plans (29 CFR 2550.404c-5)
would provide certain relief for fiduciaries who make investment
decisions on behalf of participants and beneficiaries in individual
account pension plans that provide for participant direction of
investments when such participants and beneficiaries fail to direct the
investment of their account assets. The regulation describes conditions
under which a participant who fails to provide investment direction
will be treated as having exercised control over assets in his or her
account under an individual account plan as provided in section
404(c)(5)(A) of ERISA. The proposed regulation would require that the
assets of non-directing participants be invested in one of the
qualified default investment alternatives described in the proposed
regulation and that certain other specified conditions be met.
[[Page 56816]]
This ICR pertains to two separate disclosure requirements that are
conditions to the relief created by the proposed regulation, as
follows: (1) An annual notice containing specified information that
must be provided to any individual whose assets may in the future be
invested in a qualified default investment alternative at least 30 days
prior to the fiduciary's initial investment, and thereafter at least 30
days before the beginning of each plan year; and (2) pass-through to
participants and beneficiaries of any material (such as account
statements, prospectuses, and proxy voting material) provided to the
plan relating to the participant's or beneficiary's investment in a
qualified default investment alternative. The information collection
provisions of this proposed regulation are intended to ensure that
participants and beneficiaries who are provided the opportunity to
direct the investment of their account balances, but who do not do so,
are adequately informed about the plan's provisions for default
investment and about investments made on their behalf under the plan's
default provisions.
The estimates of respondents and responses are derived primarily
from the Form 5500 Series filings for the 2003 plan year, which is the
most recent reliable data available to the Department. The burden for
the preparation and distribution of the disclosures is treated as an
hour burden. Additional cost burden derives solely from materials and
postage. It is assumed that electronic means of communication will be
used in 38 percent of the responses pertaining to annual notices and
that such communications will make use of existing systems.
Accordingly, no cost has been attributed to the electronic distribution
of information.
Annual Notice--29 CFR 2550.404c-5(c)(3). The proposed regulation
requires that a notice be provided at least 30 days before any portion
of a participant's or beneficiary's account balance is initially
invested in a qualified default investment alternative and annually
thereafter. The notice must describe (1) the circumstances under which
assets in a participant's individual account may be invested in a
qualified default investment alternative; (2) the qualified default
investment alternative, including its investment objectives, risk and
return characteristics (if applicable), and fees and expenses; (3) the
participants' and beneficiaries' right to direct the investment of the
assets to any other investment alternative offered under the plan,
without financial penalty; and (4) where participants and beneficiaries
can obtain information about the other investment alternatives
available under the plan. The proposed regulation states that the
initial notice may be included in the plan's summary plan description
or a summary of material modifications, or it may be provided as a
separate notice.
The Department estimates that 418,000 \15\ participant directed
individual account pension plans will prepare and distribute annual
notices to 61,612,000 eligible workers, participants and beneficiaries
in the first year in which this proposed regulation (if finalized)
becomes applicable. Preparation of the annual notice in the first year
is estimated to require one-half hour of legal professional time for
each plan, for a total aggregate estimate of 209,000 burden hours. For
the 62 percent of participants and beneficiaries who will receive the
annual notice by mail (38,200,000 individuals), distribution of the
annual notice is estimated to require an additional 306,000 hours of
clerical time, based on an estimate of one-half minute of clerical time
per notice. No additional burden hours are attributed to the
distribution of the annual notice to the remaining 38 percent of
participants and beneficiaries who will receive this notice
electronically (23,413,000 individuals). The total annual burden hours
estimated for the annual notice in the first year, therefore, are
515,000. The equivalent cost for this burden hour estimate is
$22,548,000 (legal professional time is valued at $83 per hour, and
clerical time is valued at $17 per hour).\16\
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\15\ All numbers used in this paperwork burden estimate have
been rounded to the nearest thousand.
\16\ Hourly wage estimates are based on data from the Bureau of
Labor Statistics 2000 Occupational Employment Survey and data from
the 2001 Employment Cost Index, and overhead assumptions by EBSA.
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In addition to burden hours, the Department has estimated annual
costs attributable to the annual notice for the first year, based on
materials and postage, at $18,718,000. This comprises the material cost
for a two-page annual notice ($.10 per notice) to 38,200,000
participants and beneficiaries (62 percent of 61,612,000 participants
and beneficiaries), which equals $3,820,000, plus postage at $0.39 per
mailing, which equals $14,898,000. Total annual costs for the annual
notice in the first year are therefore estimated at $18,718,000.
In years subsequent to the first year of applicability, the
Department estimates that annual notices will be prepared only by newly
established participant directed individual account pension plans and
plans that changed their choice of qualified default investment
alternative. For purposes of burden analysis, the Department has
assumed that one-third (\1/3\) of all participant directed individual
account plans (139,000 plans) will prepare and distribute new or
updated initial notices to all participants and beneficiaries,
requiring 24 minutes of legal professional time per notice. The
preparation of the initial notice in each subsequent year is estimated
to require 56,000 hours. However, the number of participants receiving
initial notices stays the same. As in the calculation for the initial
year, distribution to the 62 percent of participants and beneficiaries
who will receive the initial notice by mail (38,200,000 individuals)
will require 306,000 hours and $18,718,000 additional materials and
postage cost. (As for the first year, the Department has assumed that
electronic distribution of the initial notice in subsequent years will
not add any significant additional paperwork burden.)
Based on those assumptions, the Department estimates that the total
burden hours for annual notices in each year after the first year of
applicability will fall to 361,000 hours. The equivalent cost of such
an hour burden (using the same assumptions as for the first year) is
$9,823,000. The total cost burden estimated for subsequent years for
the annual notice will stay at $18,718,000.
Pass-through Material--29 CFR 2550.404c-5(c)(4). Under the proposed
regulation, any material received by a plan (such as account
statements, prospectuses, and proxy voting material) that relates to a
default investment must be passed through to the participant or
beneficiary on whose behalf the default investment was made. The
proposed regulation imposes this requirement only with respect to
participants and beneficiaries who have an investment in a qualified
default investment alternative that was made by default. In conformity
with the assumptions underlying the other economic analyses in this
preamble, the Department has assumed that, at any given time, 5.3
percent of participants and beneficiaries in participant directed
individual account pension plans (2,351,000 individuals) will have
default investments. For purposes of this burden analysis, the
Department has also assumed that plans will receive materials that must
be passed through the participants and beneficiaries on a quarterly
basis. This assumption takes into account that many, although not all,
plans will receive quarterly account
[[Page 56817]]
statements and prospectuses, and that plans will also receive other
pass-through materials on occasion. These two factors result in an
estimate of 9,405,000 responses (distributions of pass-through
materials) per year. Duplication and packaging of the pass-through
material is estimated to require 1.5 minutes of clerical time per
distribution, for an annual hour burden estimate of 235,000 hours of
clerical time. The equivalent cost of this hour burden is estimated at
$3,997,000. Additional cost burden for the pass-through of material is
estimated to include paper cost (40 pages of material yearly per
participant or beneficiary) and postage ($.58 per mailing) at
$10,157,000 annually for 4 distributions per participant or beneficiary
with a default investment.
These paperwork burden estimates are summarized as follows:
Type of Review: New collection.
Agency: Employee Benefits Security Administration, Department of
Labor.
Title: Default Investment Alternatives under Participant Directed
Individual Account Plans.
OMB Number: 1210-NEW.
Affected Public: Business or other for-profit; not-for-profit
institutions.
Respondents: 417,000.
Responses: 71,017,000.
Frequency of Response: Annually; occasionally.
Estimated Total Annual Burden Hours: 750,000 (first year).
Estimated Total Annual Burden Cost: $28,875,000.
Congressional Review Act
This notice of proposed rulemaking is subject to the provisions of
the Congressional Review Act provisions of the Small Business
Regulatory Enforcement Fairness Act of 1996 (5 U.S.C. 801 et seq.) and,
if finalized, will be transmitted to the Congress and the Comptroller
General for review.
Unfunded Mandates Reform Act
Pursuant to provisions of the Unfunded Mandates Reform Act of 1995
(Pub. L. 104-4), this rule does not include any Federal mandate that
may result in expenditures by State, local, or tribal governments, or
the private sector, which may impose an annual burden of $100 million
or more.
Discussion of Economic Impacts
Default Investments
A majority \17\ of 401(k) plans with automatic enrollment offer as
default investment vehicles money market or stable value funds or
similarly-performing vehicles. The proposed regulation is expected to
reduce this proportion by encouraging plans to offer default investment
vehicles that include a mix of equity and fixed income instruments.
---------------------------------------------------------------------------
\17\ Various surveys estimate the proportion at 50 percent (48th
Annual Survey of Profit Sharing/401(k) Plans, supra note 2, at 37,
Table 64), 58 percent (2004 Annual 401(k) Benchmarking Survey, supra
note 2, at 7, Exhibit 20), and 81 percent (Utkus, supra note 4, at
3).
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As a result of this proposed regulation, it is estimated that in
the long run 401(k) plan equity holdings expressed at 2005 levels will
increase by between $27 billion and $48 billion. The portion of this
estimated increase that is attributable directly to the direction of a
larger share of default investments into equity is between $11 billion
and $14 billion.\18\ The rest is attributable to increased
contributions, which are discussed below under the heading
``Participation and Contribution Behavior.''
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\18\ It should be noted that these estimates pertain only to
default investments made on behalf of default participants under
automatic enrollment programs. The default investment proposed
regulation is not so limited. Therefore, these estimates are likely
to omit some of the direction of a larger share of default
investments into equity that will occur under the proposed
regulation. The Department lacks data on the amount of default
investment activity occurring outside the default participation
context, or any basis for predicting whether or how much such
activity might increase as a result of the proposed regulation. The
Department invites comments on these questions.
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Account Performance
Historically, over long time horizons, diversified portfolios that
include equities have tended to outperform those consisting only of
very low risk, short term debt instruments, often by large amounts.
From 1926 to 2004, large company stocks returned 10.4 percent annually
on average, long-term corporate bonds 5.9 percent, and U.S. Treasury
bills 3.7 percent.\19\ Stocks are also riskier, however: the standard
deviations in annual returns for these three securities classes over
this period were 20.3 percent, 8.6 percent and 3.1 percent.\20\ One-
year large company stock returns ranged from -43 percent to 54 percent,
long-term corporate bond returns from -8 percent to 43 percent, and
U.S. Treasury bill returns from 0 percent to 15 percent.\21\ But 20-
year returns on these classes of securities ranged respectively from 3
percent to 18 percent, 1 percent to 12 percent, and from 0.4 percent to
8 percent.\22\ Based on this history, it is widely believed to be
advantageous for long-term savers, such as workers saving for
retirement, to invest a substantial portion of their assets in
equity.\23\
---------------------------------------------------------------------------
\19\ Stocks, Bonds, Bills and Inflation 2005 Yearbook, Ibbotson
Assocs., at 117, Table 6-7 (2005).
\20\ Id.
\21\ Id. at 38-39, Table 2-5.
\22\ Id. at 50-51, Table 2-11.
\23\ See, e.g., Utkus, supra note 4.
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As noted above, this proposed regulation is expected to result in
the direction of default investments from very low-risk instruments
such as money market funds to diversified portfolios that include a
substantial proportion of equities. If historical patterns hold, this
in turn is expected to improve investment results for a large majority
of affected individuals. As a result of this proposed regulation, in
the long run aggregate 401(k) account balances are estimated to
increase by between $45 billion and $89 billion, expressed at 2005
levels. The portion of this estimated increase directly attributable to
direction of default investments from very low-risk instruments into
higher-performing portfolios is between $7 billion and $9 billion; the
remainder is attributable to expected increases in contributions,
discussed below under the heading ``Participation and Contribution
Behavior.''
Automatic Enrollment
Automatic enrollment programs are growing in popularity. These
programs covered only about 5 percent of workers eligible for 401(k)
plans in 2002,\24\ but the number may have increased to 18 percent
today \25\ and could reach 25 percent in the near future. The
Department expects and intends that this proposed regulation, by
alleviating some fiduciary concerns that might otherwise discourage
implementation of automatic enrollment programs, will promote wider
implementation of such programs. As a result of the proposed
regulation, in the near future such programs may cover 35 percent to 45
percent of eligible workers rather than 25 percent.\26\
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\24\ Bureau of Labor Statistics, National Compensation Survey:
Employee Benefits in Private Industry in the United States, 2002-
2003, Bulletin 2573, at 109 (2005).
\25\ EBSA estimate. The proportion of plans in various size
classes that provide automatic enrollment was taken from 48th Annual
Survey of Profit Sharing/401(k) Plans, supra note 2, at 36, Table
61. EBSA took a weighted average of these proportions, reflecting
the distribution of 401(k) participants across the plan size
classes, as estimated by EBSA based on annual reports filed by plans
with EBSA.
\26\ The incidence of automatic enrollment appears to be
growing, by one estimate from 8.4 percent of plans in 2003 to 10.5
percent in 2004 (Id. at 36), by another from 14 percent in 2003 to
19 percent in 2005 (Survey Findings: Trends and Experiences in
401(k) Plans, 2005, supra note 2, at 1, 13). Another survey found no
growth between 2003 and 2004. 2004 Annual 401(k) Benchmarking
Survey, supra note 2, at 6. Indicators of future growth are mixed.
Most point to a potential for large growth, but it is unclear how
much of this growth will be realized. The same survey that found no
growth between 2003 and 2004 also found that, in 2004, 14 percent of
plan sponsors had not yet implemented but were considering
implementing automatic enrollment. Id. at 6, Exhibit 17. By another
estimate, in 2005, 28 percent of plan sponsors indicated that they
were likely to implement automatic enrollment over the next year.
See Survey Findings: Hot Topics in Retirement 2005, (Hewitt
Associates LLC) 2005, at 11. But 53 percent indicated they were
unlikely to implement any automatic plan features, including 28
percent that cited concern about assuming additional fiduciary
responsibility. Id. at 12. To estimate the impact of this proposed
regulation on account balances and pension income, EBSA adopted the
following assumptions. If current trends and concerns continued, the
incidence of automatic enrollment would soon reach 25 percent of
eligible employees, and then remain at that level. The proposed
regulation, by relieving fiduciary concerns that discourage
implementation of automatic enrollment, would increase that
incidence to between 35 percent (low impact estimates) and 45
percent (high impact estimates). In addition, new provisions for a
nondiscrimination safe harbor under the Code for ``qualified
automatic contribution arrangements,'' added by section 902 of the
Pension Protection Act, are likely to affect the future incidence of
automatic enrollment. These assumptions are highly uncertain and
EBSA invites comments on their validity and suggestions as to how to
develop more reliable estimates of the future incidence of automatic
enrollment programs.
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[[Page 56818]]
Participation and Contribution Behavior
Analyses of automatic enrollment programs demonstrate that such
programs increase participation. The increase is most pronounced among
employees whose participation rates otherwise tend to be lowest, namely
lower-paid, younger and shorter-tenure employees. Automatic enrollment
programs increase many such employees' contribution rates from zero to
the default rate, often supplemented by some employer matching
contribution. These additional contributions tend to come early in the
employees' careers and therefore can add disproportionately to
retirement income as investment returns accumulate over a long
period.\27\
---------------------------------------------------------------------------
\27\ However, there is also evidence that automatic enrollment
programs can have the effect of lowering contribution rates for a
few employees below the level that they would have elected absent
automatic enrollment. At present, surveys indicate that the default
contribution rate is usually either 2 percent or 3 percent of
salary. Some employees who might otherwise have enrolled (either at
first eligibility or later) and elected a higher contribution rate
may instead permit themselves to be enrolled at the default rate.
Once contributing at the default rate they may continue at that rate
for some time. See, e.g., James J. Choi, David Laibson, Brigitte C.
Madrian & Andrew Metrick, Saving for Retirement on the Path of Least
Resistance, (July 19, 2004); see also Choi, Laibson & Madrian, supra
note 1. The potential for lowering of contribution rates will be
minimized in plans that provide for automatic escalation of default
contribution rates, such as will be required under new tax
nondiscrimination safe harbor provisions for ``qualified automatic
contribution arrangements,'' added by section 902 of the Pension
Protection Act.
---------------------------------------------------------------------------
Plans implementing automatic enrollment programs may increase their
participation rates on average from approximately 70 percent to perhaps
90 percent. Consequently, the Department estimates that this proposed
regulation will increase overall 401(k) participation rates from 72
percent to between 75 percent and 77 percent. Aggregate annual
contributions are expected to grow on net by between $1.9 billion and
$3.8 billion, expressed at 2005 levels. These and related estimates are
summarized Table 2 below.
[GRAPHIC] [TIFF OMITTED] TP27SE06.095
Retirement Income From 401(k) Plans
For all individuals born in 1985 and surviving to age 67, holding
other factors constant, low-impact estimates suggest that the proposed
regulation may increase pension income by an average of $2,010 per year
(in 2005 dollars) for 10 percent, but could decrease it by $1,120 per
year on average for 5 percent. Pension income would be unchanged for
the remaining 85 percent. High-impact estimates suggest that average
annual pension income may increase by $2,740 for 14 percent, fall by
$1,460 for 6 percent, and be unchanged for 80 percent. The number of
individuals experiencing increases in retirement income is estimated to
be approximately twice the number experiencing decreases, and the
average gains are estimated to be approximately twice the size of
average losses. These estimates are summarized Table 3 below. (The
incidence and size of gains are likely to be larger than estimated
here, and those of any losses are likely to be smaller, if plans
provide for escalating default contribution rates or higher default
contribution rates than assumed here.)
[[Page 56819]]
[GRAPHIC] [TIFF OMITTED] TP27SE06.096
Cost
Plan sponsors may incur some administrative cost in order to meet
the conditions of the proposed regulation. The Department generally
expects such cost to be low. The annual notice provision can be
satisfied by adding information to existing notices and disclosures,
such as the Summary Plan Description, the annual investment election
form, or by adapting information provided to the plan by the investment
manager of a qualified default investment alternative. The requirement
to pass through investment material to participants and beneficiaries
does not impose extensive costs. These revisions may be no more
extensive than those associated with other amendments that plans
implement from time to time. The boundaries of the proposed regulation
are sufficiently broad to encompass a wide range of readily available
and competitively priced investment products and services. It is likely
that a large majority of participant directed plans already offer one
or more investment options that would fall within the proposed
regulation. For these reasons, it is likely that the administrative
cost for a plan sponsor to take advantage of the relief afforded by the
proposed regulation will be low. The Department invites comments on the
administrative cost of this proposed regulation, and suggestions as to
how to minimize that cost.
The proposed regulation may indirectly prompt some plan sponsors to
shoulder additional costs in terms of increased retirement benefits
paid to employees. For example, it is expected that the proposed
regulation, by promoting the adoption of automatic enrollment programs,
will have the indirect affect of increasing aggregate employer matching
contributions by between $700 million and $1.3 billion annually
(expressed at 2005 levels). Adverse consequences are not expected
because the adoption of automatic enrollment programs and the provision
of matching contributions generally are at the discretion of the plan
sponsor. Use of the proposed regulation and, therefore, compliance with
its provisions are also voluntary on the part of the plan sponsor.
Additional Potential Consequences
The Department anticipates that this proposed regulation will have
two major economic consequences. Default investments will be directed
toward higher-return instruments boosting average account performance,
and automatic enrollment provisions will become more common boosting
participation. However, it is possible that the proposed regulation
will have additional, indirect consequences, which could affect future
retirement income levels. The Department invites public comment on the
likelihood and implications of any such consequences, including
comments addressing the following questions.
Will plan sponsors that direct default investments from
very low-risk instruments into higher-performing portfolios make other
changes to investment options or undertake new efforts to inform or
influence participants' investment decisions? Will those plan sponsors
that implement automatic enrollment programs change other provisions of
their plans as well? For example, might they change matching
contribution formulas, eligibility or vesting provisions, loan
programs, or distribution policies?
More than one-half of all participant directed individual
account plans recently reported compliance with ERISA section 404(c)(1)
and associated regulations. While the fiduciary protections afforded by
this proposed regulation for default investments are intended to be
similar to those afforded by the regulation under section 404(c)(1) of
ERISA for participants' active investment elections, it is possible
that some fiduciaries who are covered by the proposed regulation in
connection with
[[Page 56820]]
default investments will not be covered by the regulation under section
404(c)(1) in connection with participant directed investments out of
default investments. If so, how might the proposed regulation's
incentives interact with those associated with the existing ERISA
section 404(c) regulation, and to what effect?
Will employees who make additional contributions as a
result of new automatic enrollment programs reduce their current
consumption or other types of current saving, or some of each? Will
they be more or less likely than otherwise similar participants to
retain or roll over their accounts, preserving them into retirement?
Changes such as these could either augment or offset the effects of
this proposed regulation on retirement saving and pension income. For
example, by one estimate, among employees eligible for a 401(k) plan
with automatic enrollment and a life cycle fund investment default,
moving the default contribution up from 3 percent to 6 percent could
increase the median earnings replacement rate from 401(k) savings in
each of the four earnings quartiles by between 6 and 10 percentage
points.\28\
---------------------------------------------------------------------------
\28\ Holden & VanDerhei, supra note 1, at 15, Figure 10.
---------------------------------------------------------------------------
Cost-Benefit Assessment
The costs and benefits of the proposed regulation are not simple,
direct functions of the foregoing gross dollar estimates. For example,
increases in retirement savings due to automatic enrollment will be
offset by either decreases in current consumption or reductions in
other savings. Increases due to higher returns will entail additional
risk. Therefore, net benefits will be smaller than the predicted
increases in retirement savings. The Department did not attempt to
quantify these welfare effects, believing that there is insufficient
data on the time preference for consumption and level of risk aversion
in the affected population.\29\
---------------------------------------------------------------------------
\29\ As noted below, peer reviewers raised questions about
welfare effects in connection with peer review.
---------------------------------------------------------------------------
The proposed regulation will have distributional consequences, the
costs and benefits of which are open to different interpretations.
Average increases in pension income will be larger for individuals with
higher career earnings, but they will be proportionately larger for
those with lower career earnings (see Table 4 below). Moreover, while
average pension incomes will rise in each of the four career earnings
quarterlies, a small minority of individuals in each quartile could
lose some pension income (see Table 3).
The proposed regulation may also have macroeconomic consequences,
which are likely to be small but positive. An increase in retirement
saving is likely to promote investment and long-term economic
productivity and growth. The increase in retirement saving will be very
small relative to overall market capitalization, and may be offset in
part by reductions in other saving. Therefore macroeconomic benefits
are likely to be small.\30\
---------------------------------------------------------------------------
\30\ Insofar as the Department expects contributions to
increase, the Department expects taxes on income to be
correspondingly deferred. The magnitude of this effect would depend
on the timing of contributions and withdrawals and the tax rates
applicable at those times.
---------------------------------------------------------------------------
Based on the foregoing analysis and estimates, the Department is
confident that the proposed regulation will increase aggregate
retirement savings and pension income substantially. The Department
therefore concludes that the benefits of this proposed regulation will
exceed its costs by a wide margin, and invites comments on this
conclusion.
[GRAPHIC] [TIFF OMITTED] TP27SE06.097
Basis of Estimates
The Department estimated the effect of the proposed regulation on
401(k) plan participation, contributions, account balances, and
investment mix, and its effect on pension incomes at age 67, using a
microsimulation model of lifetime pension accumulations for a birth
cohort, known as PENSIM.\31\ To produce the low and high impact
estimates presented here, PENSIM was parameterized and applied as
follows.
---------------------------------------------------------------------------
\31\ PENSIM was developed for the Department by the Policy
Simulation Group as a tool for examining the macroeconomic and
distributional implications of private pension trends and policies.
Detailed information on PENSIM is available at http://www.polsim.com/PENSIM.html.
Examples of PENSIM applications include
comparisons of retirement income prospects for different generations
contained in U.S. Government Accountability Office, Report No. 03-
429, Retirement Income: Intergenerational Comparisons of Wealth and
Future Income (2003) and comparisons of pension income produced by
traditional defined benefit pension plans and cash balance pension
plans contained in U.S. Government Accountability Office, Report No.
06-42, Private Pensions: Information on Cash Balance Pension Plans
(2005). As noted below, the choice of PENSIM as the basis for these
estimates was questioned in the context of peer review.
---------------------------------------------------------------------------
First, automatic enrollment was assigned randomly to achieve
incidences of 25 percent (baseline), 35
[[Page 56821]]
percent (low impact) and 45 percent (high impact) of 401(k) plan
eligible employees. Next, participation and default participation rates
were adjusted to reflect available research findings on these rates at
various tenures in the presence and absence of automatic enrollment
programs.\32\ The default contribution rate was assumed to be 3
percent, which surveys indicate is the most common rate currently in
use.\33\ The investment of contributions made by default was directed
as follows:\34\ in the baseline estimates, to U.S. Treasury bonds;\35\
in the low- and high-impact estimates, to a mix resembling a life cycle
fund, with 100 percent minus the participant's age in equity and the
remainder in U.S. Treasury bonds. Returns to equity were determined
stochastically. The distribution was lognormal with a nominal mean of
9.48 percent \36\ and standard deviation of 16.54 percent.\37\
---------------------------------------------------------------------------
\32\ These findings were drawn from Choi, Laibson & Madrian,
supra note 1. The overall participation rate under automatic
enrollment was adjusted upward to 90 percent.
\33\ See, e.g., 2004 Annual 401(k) Benchmarking Survey; supra
note 2, at 6; see also Survey Findings: Trends and Experiences in
401(k) Plans, supra note 2, at 16;'' see also 48th Annual Survey of
Profit Sharing/401(k) Plans, supra note 2, at 36.
\34\ These estimates assume complete correspondence between
default participation in 401(k) plans and default investing.
Participants contributing by default are assumed to invest by
default, while those who actively elect to contribute or who are in
plans without elective contributions are assumed to actively invest.
In practice neither of these assumptions will hold all of the time.
Some participants contributing by default may actively direct their
investments. Perhaps more important, some active contributors or
participants in plans without elective contributions may invest by
default--and this proposed regulation may affect the incidence of
such default investing. The Department did not attempt to estimate
the extent or effect of default investing not associated with
default contributing. The Department was unable to locate data on
the extent of such default investing, but believes it is likely to
be small relative to that of default investing of default
contributions. The Department is likewise uncertain how much the
proposed regulation might affect the incidence of such default
investing, but believes that the economic effects of changes in that
incidence will be modest insofar as the asset allocation of the
active investments such default investments would replace are likely
on average and aggregate to not differ much from the asset
allocation of the defaults. The Department also notes that a large
majority of the estimated economic effects of the proposed
regulation derive from increased contributions rather than increased
equity investment, so the omission from the estimates of some
default investment effects may have only a modest effect on the
total. The Department invites comments on its assumptions and
estimates relating to the incidence of default investments.
\35\ On the risk return spectrum, Treasury bonds generally fall
between money market and stable value funds on one side and balanced
and life cycle funds on the other. They serve here as a proxy for
the current default investments connected with automatic enrollment
programs, which are mostly money market and stable value funds but
include a substantial proportion of balanced and life cycle funds.
\36\ This is the rate used by the Office of the Actuary, U.S.
Social Security Administration, to estimate returns to proposed
personal accounts in the Social Security program.
\37\ This is parallel to volatility assumed by Vanguard in
illustrating the effects of alternative default investments. See
Utkus, supra note 4, at 17.
---------------------------------------------------------------------------
To estimate the effects of the proposed regulation, the Department
compared the baseline estimates with the low- and high-impact
estimates. Because the proposed regulation's effects will be cumulative
and gradual, estimates were prepared for the 1985 birth cohort, whose
working lives would almost entirely follow implementation of the
proposed regulation. To estimate participation rates, contributions,
account balances and investment mixes, the cohort was sampled at random
ages from 21 to 65, and results for individuals participating in 401(k)
plans when sampled were aggregated, with all dollar amounts adjusted to
2005 levels. This roughly illustrates a point-in-time snapshot of plans
in the future.\38\ To estimate effects on pension incomes, account
balances available at retirement \39\ were converted into lifetime
annuities, and pension incomes of cohort members surviving to age 67
were measured and compared.
---------------------------------------------------------------------------
\38\ Because PENSIM is a birth cohort-based model (rather than a
panel-based model that simulates the experience of an entire
population from year to year) it does not directly provide point-in-
time aggregate estimates for the overall population. These PENSIM-
derived estimates serve as a proxy for such panel-derived point-in-
time estimates. The PENSIM-based estimates in effect blend the
experience of younger workers in the nearer future with that of
older workers in the more distant future, producing a sort of
longitudinal central tendency. The estimated participation and
contribution rates serve as proxies for the average across many
future years (reflecting near-immediate, ongoing effects). The
estimated account balances serve as proxies for some point in the
distant future (reflecting cumulative effects). Actual aggregate
participation rates and contribution amounts will vary over time
because of changes in certain population variables such as birth
rates, age-specific labor force participation rates, and
productivity and compensation levels. Any long-term forecasts of
such changes are highly uncertain, however. The Department therefore
did not attempt to adjust its estimates for such changes, believing
such adjustments would be of questionable analytic value. Because
the PENSIM-derived contribution estimates blend experience at
different points in time and do not represent changes in population
contributions over time or the timing of those changes, they do not
lend themselves to discounting, conversion to net present values or
level annuity equivalents. Rather, they can be interpreted as
proxies for level annuity equivalents, albeit proxies which neglect
the aforementioned changes in population variables.
\39\ Taking into account individuals' propensities to cash out
their accounts prior to retirement.
---------------------------------------------------------------------------
The estimates are highly uncertain. The long time horizon compounds
the uncertainty. One of the greatest uncertainties relates to the
default contribution rate, which is assumed to be fixed at 3
percent.\40\ Higher initial default contribution rates, or default
provisions that increase contribution rates as tenure and/or pay
increases, might enlarge the positive effects on pension income and
reduce the negative effects. But it is unclear whether plan sponsors
will adopt such approaches, or if they do, whether they might make
other changes to their plans or whether more eligible employees might
decline automatic participation. The Department therefore has no
reliable basis for estimating the effects of such changes in automatic
enrollment programs.\41\ The Department invites comments on this and
other areas of uncertainty in its estimates.
---------------------------------------------------------------------------
\40\ As noted below, other areas of uncertainty, including rates
of return, the rate of adoption of automatic enrollment,
participation rates under automatic enrollment, and other savings
decisions, were raised in connection with peer review.
\41\ Nonetheless, to illustrate the potential impact of higher
default contribution rates, the Department estimated the effect of
the proposed regulation where the default contribution rate in
automatic enrollment programs is 5 percent rather than 3 percent.
The estimate holds constant other plan characteristics and
participants' default rates and elective behaviors. In this
scenario, in the very long run the proposed regulation is predicted
to increase aggregate 401(k) plan account balances by between 3
percent and 6 percent, or approximately $60 billion and $114 billion
if represented at 2005 levels. For individuals born in 1985 and
surviving to age 67, holding other factors constant, low-impact
estimates suggest that the proposed regulation will increase pension
income by an average of $2,200 per year (in 2005 dollars) for 11
percent, and decrease it by $810 per year on average for 4 percent.
Pension income would be unchanged for the remaining 85 percent.
High-impact estimates suggest that average annual pension income
will increase by $2,880 for 15 percent, fall by $1,040 for 5
percent, and be unchanged for 80 percent.
---------------------------------------------------------------------------
Peer Review
The ``Final Information Quality Bulletin for Peer Review'' issued
by the Office of Management and Budget on December 16, 2004 (the
Bulletin) establishes that important scientific information shall be
peer reviewed by qualified specialists before it is disseminated by the
federal government. Collectively, the PENSIM model, the data and
methods underlying it, the surveys and literature used to parameterize
it, and the Department's interpretation of these and application of
them to produce the estimates presented in this regulatory impact
analysis (RIA) constitute a ``highly influential scientific
assessment'' under the Bulletin. Therefore, pursuant to the Bulletin,
the Department arranged for review of this assessment by three highly
qualified independent reviewers. The Department provided each reviewer
with instructions for review pursuant to the Bulletin, a draft of the
Notice of
[[Page 56822]]
Proposed Rulemaking (NPRM) including a draft RIA, technical
documentation of PENSIM and its application in support of the RIA, and
detailed tables of related PENSIM estimates. The instructions directed
the reviewers to focus on the technical and scientific issues in the
assessment rather than the policy proposed in the NPRM. Each reviewer
separately reviewed the assessment embodied in these materials and
submitted to the Department a peer review report. All of the
aforementioned materials are being published together with the
Department's written response to the peer reviews on the Department's
Web site, concurrent with the publication of this NPRM, at http://www.dol.gov/ebsa
.
The reviews offer both praise for and criticism of the assessment.
They question numerous specific modeling assumptions and identify
potential indirect effects that were not estimated. They note that
welfare effects (as distinguished from simple dollar impacts on
retirement saving), which the Department did not estimate, may be
negative if consumers are risk averse or prefer current to future
consumption. One review criticizes PENSIM's reduced form modeling
approach as lacking the structural, behavioral foundation necessary to
predict results and evaluate welfare effects, finds the PENSIM
estimates ``unconvincing,'' and concludes that the Department has
failed to provide a scientific rationale for the policy initiative
contained in the NPRM.
While many of the reviews' criticisms have merit, the Department
does not believe that they cast serious doubt on the RIA's primary
conclusions: that the proposed rule on net will increase retirement
savings and thereby benefit consumers. The Department's written
response to the reviews qualifies and tempers some of the RIA's
conclusions. It answers, to the extent possible, major questions raised
in the reviews, including questions about welfare effects. It defends
the Department's reliance on PENSIM as a basis for its estimates and
explains why the Department did not estimate net welfare effects but
believes such effects to be positive. It also offers a tentative,
prioritized plan for conducting sensitivity tests and otherwise
refining its assessment and RIA in connection with a possible final
rulemaking.
Federalism Statement. Executive Order 13132 (August 4, 1999)
outlines fundamental principles of federalism and requires federal
agencies to adhere to specific criteria in the process of their
formulation and implementation of policies that have substantial direct
effects on the States, the relationship between the national government
and the States, or on the distribution of power and responsibilities
among the various levels of government. The proposed rule does not have
federalism implications because it has no substantial direct effect on
the States, on the relationship between the national government and the
States, or on the distribution of power and responsibilities among the
various levels of government. Section 514 of ERISA provides, with
certain exceptions specifically enumerated, that the provisions of
Titles I and IV of ERISA supersede any and all laws of the States as
they relate to any employee benefit plan covered under ERISA. The
requirements implemented in the proposed rule do not alter the
fundamental provisions of the statute with respect to employee benefit
plans, and as such would have no implications for the States or the
relationship or distribution of power between the national government
and the States.
List of Subjects in 29 CFR Part 2550
Employee benefit plans, Exemptions, Fiduciaries, Investments,
Pensions, Prohibited transactions, Real estate, Securities, Surety
bonds, Trusts and trustees.
For the reasons set forth in the preamble, the Department proposes
to amend Chapter XXV, Subchapter F, Part 2550 of Title 29 of the Code
of Federal Regulations as follows:
Subchapter F--Fiduciary Responsibility Under the Employee
Retirement Income Security Act of 1974
PART 2550--RULES AND REGULATIONS FOR FIDUCIARY RESPONSIBILITY
1. The authority citation for part 2550 is revised to read as
follows:
Authority: 29 U.S.C. 1135; sec. 657, Pub. L. 107-16, 115 Stat.
38; and Secretary of Labor's Order No. 1-2003, 68 FR 5374 (Feb. 3,
2003). Sec. 2550.401b-1 also issued under sec. 102, Reorganization
Plan No. 4 of 1978, 43 FR 47713 (Oct. 17, 1978), 3 CFR, 1978 Comp.
332, effective Dec. 31, 1978, 44 FR 1065 (Jan. 3, 1978), 3 CFR, 1978
Comp. 332. Sec. 2550.401c-1 also issued under 29 U.S.C. 1101.
Sections 2550.404c-1 and 2550.404c-5 also issued under 29 U.S.C.
1104. Sec. 2550.407c-3 also issued under 29 U.S.C. 1107. Sec.
2550.408b-1 also issued under 29 U.S.C. 1108(b)(1) and sec. 102,
Reorganization Plan No. 4 of 1978, 3 CFR, 1978 Comp. p. 332,
effective Dec. 31, 1978, 44 FR 1065 (Jan. 3, 1978), and 3 CFR, 1978
Comp. 332. Sec. 2550.412-1 also issued under 29 U.S.C. 1112.
2. Add Sec. 2550.404c-5 to read as follows:
Sec. 2550.404c-5 Fiduciary relief for investments in qualified
default investment alternatives.
(a) In general. (1) This section implements the fiduciary relief
provided under section 404(c)(5) of the Employee Retirement Income
Security Act of 1974, as amended (ERISA or the Act), 29 U.S.C. 1001 et
seq., under which a participant or beneficiary in an individual account
plan will be treated as exercising control over the assets in his or
her account for purposes of ERISA section 404(c)(1) with respect to the
amount of contributions and earnings that, in the absence of an
investment election by the participant, are invested by the plan in
accordance with this regulation. If a participant or beneficiary is
treated as exercising control over the assets in his or her account in
accordance with ERISA section 404(c)(1) no person who is otherwise a
fiduciary shall be liable under part 4 of title I of ERISA for any loss
or by reason of any breach which results from such participant's or
beneficiary's exercise of control. Except as specifically provided in
paragraph (c)(6) of this section a plan need not meet the requirements
for an ERISA section 404(c) plan under 29 CFR 2550.404c-1 in order for
a plan fiduciary to obtain the relief under this section.
(2) The standards set forth in this section apply solely for
purposes of determining whether a fiduciary meets the requirements of
this proposed regulation. Such standards are not intended to be the
exclusive means by which a fiduciary might satisfy his or her
responsibilities under the Act with respect to the investment of assets
in the individual account of a participant or beneficiary.
(b) Fiduciary relief. (1) Except as provided in paragraphs (b)(2),
(3), and (4) of this section, a fiduciary of an individual account plan
that permits participants or beneficiaries to direct the investment of
assets in their accounts and that meets the conditions of paragraph (c)
of this section shall not be liable for any loss, or by reason of any
breach under part 4 of title I of ERISA, that is the direct and
necessary result of--
(i) Investing all or part of a participant's or beneficiary's
account in a qualified default investment alternative, or
(ii) Investment decisions made by the entity described in paragraph
(e)(3) of this section in connection with the management of a qualified
default investment alternative.
(2) Nothing in this section shall relieve a fiduciary from his or
her duties
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under part 4 of title I of ERISA to prudently select and monitor any
qualified default investment alternative under the plan or from any
liability that results from a failure to satisfy these duties,
including liability for any resulting losses.
(3) Nothing in this section shall relieve an investment manager
described in paragraph (e)(3)(i) from its fiduciary duties under part 4
of title I of ERISA or from any liability that results from a failure
to satisfy these duties, including liability for any resulting losses.
(4) Nothing in this section shall provide relief from the
prohibited transaction provisions of section 406 of ERISA, or from any
liability that results from a violation of those provisions, including
liability for any resulting losses.
(c) Conditions. With respect to the investment of assets in the
individual account of a participant or beneficiary, a fiduciary shall
qualify for the relief described in paragraph (b)(1) of this section
if:
(1) Assets are invested in a ``qualified default investment
alternative'' within the meaning of paragraph (e) of this section;
(2) The participant or beneficiary on whose behalf the investment
is made had the opportunity to direct the investment of the assets in
his or her account but did not direct the investment of the assets;
(3) The participant or beneficiary on whose behalf an investment in
a qualified default investment alternative may be made is furnished
within a reasonable period of time of at least 30 days in advance of
the first such investment and within a reasonable period of time of at
least 30 days in advance of each subsequent plan year, a summary plan
description, summary of material modification, or other notice that
meets the requirements of paragraph (d) of this section;
(4) Under the terms of the plan any material provided to the plan
relating to a participant's or beneficiary's investment in a qualified
default investment alternative (e.g., account statements, prospectuses,
proxy voting material) will be provided to the participant or
beneficiary;
(5) Any participant or beneficiary on whose behalf assets are
invested in a qualified default investment alternative may, consistent
with the terms of the plan (but in no event less frequently than once
within any three month period), transfer, in whole or in part, such
assets to any other investment alternative available under the plan
without financial penalty; and
(6) The plan offers a ``broad range of investment alternatives''
within the meaning of 29 CFR 2550.404c--1(b)(3).
(d) Notice. The notice required by paragraph (c)(3) of this section
shall be written in a manner calculated to be understood by the average
plan participant and contain the following:
(1) A description of the circumstances under which assets in the
individual account of a participant or beneficiary may be invested on
behalf of the participant and beneficiary in a qualified default
investment alternative;
(2) A description of the qualified default investment alternative,
including a description of the investment objectives, risk and return
characteristics (if applicable), and fees and expenses attendant to the
investment alternative;
(3) A description of the right of the participants and
beneficiaries on whose behalf assets are invested in a qualified
default investment alternative to direct the investment of those assets
to any other investment alternative under the plan, without financial
penalty; and
(4) An explanation of where the participants and beneficiaries can
obtain investment information concerning the other investment
alternatives available under the plan.
(e) Qualified default investment alternative. For purposes of this
section, a qualified default investment alternative means an investment
alternative that:
(1)(i) Does not hold or permit the acquisition of employer
securities, except as provided in paragraph (e)(1)(ii) of this section.
(ii) Paragraph (e)(1)(i) of this section shall not apply to:
(A) 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 and with respect to which investment in such
securities is made in accordance with the stated investment objectives
of the investment vehicle and independent of the plan sponsor or an
affiliate thereof; or
(B) With respect to a qualified default investment alternative
described in paragraph (e)(5)(iii) of this section, employer securities
acquired as a matching contribution from the employer/plan sponsor, or
employer securities acquired prior to management by the investment
management service;
(2) Except as otherwise provided in paragraph (c)(5) of this
section, does not impose financial penalties or otherwise restrict the
ability of a participant or beneficiary to transfer, in whole or in
part, his or her investment from the qualified default investment
alternative to any other investment alternative available under the
plan;
(3) Is:
(i) Managed by an investment manager, as defined in section 3(38)
of the Act, or
(ii) An investment company registered under the Investment Company
Act of 1940;
(4) Is diversified so as to minimize the risk of large losses; and
(5) Constitutes one of the following:
(i) An investment fund product or model portfolio that is designed
to provide varying degrees of long-term appreciation and capital
preservation through a mix of equity and fixed income exposures based
on the participant's age, target retirement date (such as normal
retirement age under the plan) or life expectancy. Such products and
portfolios change their asset allocations and associated risk levels
over time with the objective of becoming more conservative (i.e.,
decreasing risk of losses) with increasing age. For purposes of this
paragraph (e)(5)(i), asset allocation decisions for such products and
portfolios are not required to take into account risk tolerances,
investments or other preferences of an individual participant. An
example of such a fund or portfolio may be a ``life-cycle'' or
``targeted-retirement-date'' fund or account.
(ii) An investment fund product or model portfolio that is designed
to provide long-term appreciation and capital preservation through a
mix of equity and fixed income exposures consistent with a target level
of risk appropriate for participants of the plan as a whole. For
purposes of this paragraph (e)(5)(ii), asset allocation decisions for
such products and portfolios are not required to take into account the
age, risk tolerances, investments or other preferences of an individual
participant. An example of such a fund or portfolio may be a
``balanced'' fund.
(iii) An investment management service with respect to which an
investment manager allocates the assets of a participant's individual
account to achieve varying degrees of long-term appreciation and
capital preservation through a mix of equity and fixed income
exposures, offered through investment alternatives available under the
plan, based on the participant's age, target retirement date (such as
normal retirement age under the plan) or life expectancy. Such
portfolios change their asset allocations and associated
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risk levels for an individual account over time with the objective of
becoming more conservative (i.e., decreasing risk of losses) with
increasing age. For purposes of this paragraph (e)(5)(iii), asset
allocation decisions are not required to take into account risk
tolerances, investments or other preferences of an individual
participant. An example of such a service may be a ``managed account.''
Signed at Washington, DC, this 22nd day of September.
Ann L. Combs,
Assistant Secretary, Employee Benefits Security Administration,
Department of Labor.
[FR Doc. 06-8282 Filed 9-26-06; 8:45 am]
BILLING CODE 4510-29-P
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