Re-Enrolling: Doing Well While Doing Good

We have recently decided to “re-enroll” our law firm’s 401(k) plan. The purpose is to improve the investing by the participants. A side benefit is fiduciary protection for the plan committee and the law corporation. In a sense, the change will do good for participants—they will be better invested, while it will do well for the fiduciaries—because of the legal protections.

What is re-enrollment ... and why does it work that way?

The DOL’s regulation for qualified default investment alternatives, or QDIAs, provides a fiduciary “safe harbor” where defaulted participants are placed in certain types of investments. (A default occurs where a participant is given the opportunity to direct his investments, but fails to do so.) There are only three kinds of long-term QDIAs. Those are: age-based funds and models; risk-based funds and models; and managed accounts. The most common use of those QDIAs are for defaults by new participants ... for either regularly enrolled plans or automatically enrolled plans. However, QDIAs are not limited to those uses.

We have carefully evaluated the QDIA rules and, based on our analysis (as well as comments made by DOL officials), we have determined that a plan can be re-enrolled and the QDIA protections can be obtained for participants who default on the re-enrollment.

By “re-enrollment,” we mean that the plan fiduciaries can, in effect, re-start the plan from an investment perspective. To do that, the plan would provide a notice to participants (of at least 30 days) that they will be required to direct their investments by a specified deadline. Participants would also be given the information required by the QDIA regulation, including information about the default investments and other plan investments. At the end of the period, the participants who had not re-directed their investments would be defaulted into a QDIA, for example, an age-appropriate target date fund. (Of course, the same protections would apply for risk-based funds and managed accounts.)

Why would a plan sponsor want to do that? In a nutshell, to improve the way that participants are investing ... and to obtain the fiduciary protections (the so-called “safe harbor”) that the QDIA rules offer.

To put this in perspective, many, if not most, 401(k) plans were adopted before target date funds, life-style funds and managed accounts were popular. As a result, many long-term participants did not have an opportunity to select those funds when they initially entered their plans. While one could argue that existing participants had that opportunity when the new funds or services were added to the plan, there is a considerable amount of evidence that, once participants have made their initial elections, they make few, if any, changes—the so-called inertia effect. As a result, a re-enrollment process will cause participants to re-visit their investment preferences and their objectives and to consider whether to accept the default into “portfolio investments,” that is, into QDIAs.

In addition to improving participant investing (and there is clear evidence that QDIA-type investments do improve participant investing), the fiduciaries also receive considerable protection if they follow the default process outlined in the DOL regulation. Of course, that begs the question of why do fiduciaries need protection. There are two answers to that question. First, for default investments, fiduciaries have always been on the hook. Secondly, for participant-directed investments, fiduciaries are only protected from imprudent participant investments if their plan complies with the 20 to 25 requirements of 404(c). It is our experience that, while most plans intend to comply with 404(c), few take the steps needed to obtain that protection.

So, re-enrollment is truly a case of doing well while doing good. It improves the overall quality of the plan while simultaneously offering a high level of protection to fiduciaries. It doesn’t get much better than that.

Disclaimer Required by IRS Rules of Practice:
Any discussion of tax matters contained herein is not intended or written to be used, and cannot be used, for the purpose of avoiding any penalties that may be imposed under Federal tax laws.