Do You Need to Change Your Default Investment Fund?

March 20, 2007

Retirement plan sponsors or committees responsible for selecting investment options in 401(k) and other participant directed plans historically have designated the most “conservative” fund among the fund alternatives as the default investment fund.  This typically is a fund such as a money market, fixed income or stable value fund.  Contributions to the plan for participants who fail to make an investment direction are automatically invested in the default fund.  Some participants also may be influenced in making their investment direction decisions by the designated default fund.  Like all decisions relating to the selection and retention of plan investment options, the selection of the default fund is a fiduciary decision for which investment fiduciaries can be held liable if they fail to apply an appropriate level of prudence in their decision-making.  So when is the last time you evaluated your plan’s default fund?  Is that fund still an appropriate choice?

Many investment advisers in recent years have been counseling that money market or stable value funds may no longer be the best or even a prudent default fund choice for most plans.  Late last year the Department of Labor affirmed this view by issuing proposed regulations under the new Pension Protection Act encouraging investment fiduciaries to select a default investment fund providing a balance of income and growth potential.  These regulations provide relief from liability for fiduciaries who meet certain participant notification requirements and designate a ‘qualified default investment alternative’ (QDIA) for the investment of contributions in the absence of investment direction from the participant.  Three QDIA options qualify for this fiduciary safe-harbor:

• Life-Cycle or Targeted-Retirement-Date Fund, which provides a mix of equity and fixed income investments based upon the participant’s age, target retirement date or life expectancy.

• Balanced Fund, which provides a mix of equity and fixed income investments for long-term appreciation and capital preservation.

• Professionally Managed Account, under which an investment manager invests in a mix of equity and fixed income investments to achieve varying degrees of long-term appreciation and capital preservation.

The designation of a default investment fund, like all plan investment decisions, is extremely important and will have an impact on the retirement income and security of plan participants.  You should give consideration to other default investment fund options if you have not reviewed this decision recently or if your default fund is a money market, fixed income or other stable investment fund.

If you have any questions regarding this alert or other Employee Benefits Law related issues, please contact one of our Employee Benefits attorneys.

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