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Secretary of Labor Thomas E. Perez
     DOL Home > Federal Register > Final Rules > EBSA
EBSA Final Rules

Default Investment Alternatives Under Participant Directed Individual Account Plans   [10/24/2007]
[PDF]
FR Doc 07-5147

[Federal Register: October 24, 2007 (Volume 72, Number 205)]
[Rules and Regulations]               
[Page 60451-60480]
From the Federal Register Online via GPO Access [wais.access.gpo.gov]
[DOCID:fr24oc07-22]                         


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Part III





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; Final Rule


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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.

ACTION: Final rule.

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SUMMARY: This document contains a final regulation that implements 
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 in 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 final regulation will not be liable for any loss, or 
by reason of any breach, that occurs as a result of such investments. 
This regulation describes the types of investments that qualify as 
default investment alternatives under section 404(c)(5) of ERISA. Plan 
fiduciaries remain responsible for the prudent selection and monitoring 
of the qualified default investment alternative. The regulation 
conditions relief upon advance notice to participants and beneficiaries 
describing 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 qualified default 
investment alternative, and the right of participants and beneficiaries 
to direct investments out of the qualified default investment 
alternative. This regulation 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: This final rule is effective on December 24, 2007.

FOR FURTHER INFORMATION CONTACT: Lisa M. Alexander, Kristen L. Zarenko, 
or Katherine D. Lewis, Office of Regulations and Interpretations, 
Employee Benefits Security Administration, (202) 693-8500. This is not 
a toll-free number.

SUPPLEMENTARY INFORMATION:

A. Background

    With the enactment of the Pension Protection Act of 2006 (Pension 
Protection Act), section 404(c) of ERISA was amended to provide relief 
afforded 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 regulation under section 404(c)(5) of ERISA. The relief 
afforded by section 404(c)(5), therefore, is not contingent on a plan 
being an ``ERISA 404(c) plan'' or otherwise meeting the requirements of 
the Department's regulations at Sec.  2550.404c-1. The amendments made 
by section 624 of the Pension Protection Act apply to plan years 
beginning after December 31, 2006.
    On September 27, 2006, the Department, exercising its authority 
under section 505 of ERISA and consistent with section 624 of the 
Pension Protection Act, published a notice of proposed rulemaking in 
the Federal Register (71 FR 56806) that, upon adoption, would implement 
the provisions of ERISA section 404(c)(5). The notice included an 
invitation to interested persons to comment on the proposal. In 
response to this invitation, the Department received over 120 written 
comments from a variety of parties, including plan sponsors and 
fiduciaries, plan service providers, financial institutions, and 
employee benefit plan industry representatives. Submissions are 
available for review under Public Comments on the Laws & Regulations 
page of the Department's Employee Benefits Security Administration Web 
site at http://www.dol.gov/ebsa.

    Set forth below is an overview of the final regulation, along with 
a discussion of the public comments received on the proposal.

B. Overview of Final Rule

Scope of the Fiduciary Relief

    Paragraph (a)(1) of Sec.  2550.404c-5, like the proposal, generally 
describes the scope of the regulation and 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. Paragraph (a)(2) of Sec.  2550.404c-5, 
also like the proposal, makes clear that the standards set forth in the 
regulation apply solely for purposes of determining whether a fiduciary 
meets the requirements of the regulation. These standards are not 
intended to be the exclusive means by which a fiduciary might satisfy 
his or her responsibilities under ERISA with respect to the investment 
of assets on behalf of a participant or beneficiary in an individual 
account plan who fails to give investment directions. As recognized by 
the Department in the preamble to the proposal, investments in money 
market funds, stable value products and other capital preservation 
investment vehicles may be prudent for some participants or 
beneficiaries even though such investments themselves may not generally 
constitute qualified default investment alternatives for purposes of 
the regulation. The Department further notes that such investments, 
while not themselves qualified default investment alternatives for 
purposes of investments made following the effective date of this 
regulation, may nonetheless constitute part of the investment portfolio 
of a qualified default investment alternative.
    Paragraph (b) of Sec.  2550.404c-5 defines the scope of the 
fiduciary relief provided. Paragraph (b)(1) of the proposal provided 
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, or by reason of any breach under part 
4 of title I of ERISA, that is the direct and necessary result of 
investing all or part of a

[[Page 60453]]

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 Department has revised 
paragraph (b)(1) of the final regulation to clarify that 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 
any qualified default investment alternative within the meaning of 
paragraph (e), 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 phrase ``any qualified default 
investment alternative'' in the final regulation is intended to make 
clear that a fiduciary will be afforded relief without regard to which 
type of qualified default investment alternative the fiduciary selects, 
provided that the fiduciary prudently selects the particular product, 
portfolio or service, and meets the other conditions of the regulation.
    Some commenters asked whether the relief provided by the final 
regulation covers a plan fiduciary's decision regarding which of the 
qualified default investment alternatives will be available to a plan's 
participants and beneficiaries who fail to direct their investments. As 
long as a plan fiduciary selects any of the qualified default 
investment alternatives, and otherwise complies with the conditions of 
the rule, the plan fiduciary will obtain the fiduciary relief described 
in the rule. The Department believes that each of these qualified 
default investment alternatives is appropriate for participants and 
beneficiaries who fail to provide investment direction; accordingly, 
the rule does not require a plan fiduciary to undertake an evaluation 
as to which of the qualified default investment alternatives provided 
for in the regulation is the most prudent for a participant or the 
plan. However, the plan fiduciary must prudently select and monitor an 
investment fund, model portfolio, or investment management service 
within any category of qualified default investment alternatives in 
accordance with ERISA's general fiduciary rules. For example, a plan 
fiduciary that chooses an investment management service that is 
intended to comply with paragraph (e)(4)(iii) of the final regulation 
must undertake a careful evaluation to prudently select among different 
investment management services.

Application of General Fiduciary Standards

    The scope of fiduciary relief provided by this regulation 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 regulation. As with section 
404(c)(1) of the Act and the regulation issued thereunder (29 CFR 
2550.404c-1), the final regulation does not provide relief from the 
general fiduciary rules applicable to the selection and monitoring of a 
particular qualified 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.
    Several commenters asked the Department to provide additional 
guidance concerning the general fiduciary obligations of these plan 
fiduciaries in selecting a qualified default investment alternative. 
The selection of a particular qualified default investment alternative 
(i.e. a specific product, portfolio or service) is a fiduciary act and, 
therefore, ERISA obligates fiduciaries to act prudently and solely in 
the interest of the plan's participants and beneficiaries. A fiduciary 
must engage in an objective, thorough, and analytical process that 
involves consideration of the quality of competing providers and 
investment products, as appropriate. As with other investment 
alternatives made available under the plan, fiduciaries must carefully 
consider investment fees and expenses when choosing a qualified default 
investment alternative. See paragraph (b)(2) of Sec.  2550.404c-5.
    Paragraph (b)(3) of the final regulation has been modified to 
reflect changes to paragraph (e)(3)(i) regarding persons responsible 
for the management of a qualified default investment alternative's 
assets. Paragraph (b)(3) of Sec.  2550.404c-5 makes clear that nothing 
in the regulation relieves any such fiduciaries from their general 
fiduciary duties or from any liability that results from a failure to 
satisfy these duties, including liability for any resulting losses. As 
proposed, paragraph (b)(3) was limited to investment managers. The 
final regulation, at paragraph (e)(3)(i) of Sec.  2550.404c-5, broadens 
the category of persons who can manage the assets of a qualified 
default investment alternative, thereby requiring a conforming change 
to paragraph (b)(3). The changes to paragraph (e)(3)(i) are discussed 
in detail below.
    Finally, the regulation also 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. Therefore, plan fiduciaries must avoid self-
dealing, conflicts of interest, and other improper influences when 
selecting a qualified default investment alternative. See paragraph 
(b)(4) of Sec.  2550.404c-5.

Application of Final Rule to Circumstances Other Than Automatic 
Enrollment

    Several commenters requested clarification on the extent to which 
the fiduciary relief provided by the final regulation will be available 
to plan fiduciaries for assets that are invested in a qualified default 
investment alternative on behalf of participants and beneficiaries in 
circumstances other than automatic enrollment. Consistent with the 
views expressed concerning the scope of the relief provided by the 
proposed regulation, it is the view of the Department that nothing in 
the final regulation limits the application of the fiduciary relief to 
investments made only on behalf of participants who are automatically 
enrolled in their plan. Like the proposal, the final regulation applies 
to situations beyond automatic enrollment. Examples of such situations 
include: The failure of a participant or beneficiary to provide 
investment direction following the elimination of an investment 
alternative or a change in service provider, the failure of a 
participant or beneficiary to provide investment instruction following 
a rollover from another plan, and any other failure of a participant to 
provide investment instruction. Whenever a participant or beneficiary 
has the opportunity to direct the investment of assets in his or her 
account, but does not direct the investment of such assets, plan 
fiduciaries may avail themselves of the relief provided by this final 
regulation, so long as all of its conditions have been satisfied.

Conditions for the Fiduciary Relief

    Like the proposal, the final regulation contains six conditions for 
relief. These

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conditions are set forth in paragraph (c) of the regulation.
    The first condition of the final regulation, consistent with the 
Department's proposal, requires that assets invested on behalf of 
participants or beneficiaries under the final regulation be invested in 
a ``qualified default investment alternative.'' See Sec.  2550.404c-
5(c)(1). This condition is unchanged from the proposal.
    The second condition also is unchanged from the proposal. The 
participant or beneficiary on whose behalf assets are being invested in 
a qualified default investment alternative must have had the 
opportunity to direct the investment of assets in his or her account 
but did not direct the investment of 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 continues to require that participants or 
beneficiaries receive information concerning the investments that may 
be made on their behalf. As in the proposal, the final regulation 
requires both an initial notice and an annual notice. The proposed 
regulation required an initial notice within a reasonable period of 
time of at least 30 days in advance of the first investment. A number 
of commenters explained that requiring 30 days' advance notice would 
preclude plans with immediate eligibility and automatic enrollment from 
withholding of contributions as of the first pay period. Commenters 
argued that plan sponsors should not be discouraged from enrolling 
employees in their plan on the earliest possible date.
    The Department agrees that plan sponsors should not be discouraged 
from enrolling employees on the earliest possible date. To address this 
issue, the Department has modified the advance notice requirements that 
appeared in the proposed regulation. For purposes of the initial 
notification requirement, the final regulation, at paragraph (c)(3)(i), 
provides that the notice must be provided (A) at least 30 days in 
advance of the date of plan eligibility, or at least 30 days in advance 
of any first investment in a qualified default investment alternative 
on behalf of a participant or beneficiary described in paragraph 
(c)(2), or (B) on or before the date of plan eligibility, provided the 
participant has the opportunity to make a permissible withdrawal (as 
determined under section 414(w) of the Internal Revenue Code of 1986 
(Code)).
    With regard to the foregoing, the Department notes that, unlike the 
proposal, the final regulation measures the time period for the 30-day 
advance notice requirement from the date of plan eligibility to better 
coordinate the notice requirements with the Code provisions governing 
permissible withdrawals. The Department also notes that if a fiduciary 
fails to comply with the final regulation for a participant's first 
elective contribution because a notice is not provided at least 30 days 
in advance of plan eligibility, the fiduciary may obtain relief for 
later contributions with respect to which the 30-day advance notice 
requirement is satisfied.
    In addition, while retaining the general 30-day advance notice 
requirement, the final regulation also permits notice ``on or before'' 
the date of plan eligibility if the participant is permitted to make a 
permissible withdrawal in accordance with 414(w) of the Code. In this 
regard, the Department believes that if participants are not going to 
be afforded the option of withdrawing their contributions without 
additional tax, such participants should be given notice sufficiently 
in advance of the contribution to enable them to opt out of plan 
participation.
    The Department notes that the phrase in paragraph (c)(3)(i)--``or 
at least 30 days in advance of any first investment in a qualified 
default investment alternative''--is intended to accommodate 
circumstances other than elective contributions. For example, although 
fiduciary relief would not be available with respect to a fiduciary's 
investment of a participant or beneficiary's rollover amount from 
another plan into a qualified default investment alternative if the 30-
day advance notice requirement is not satisfied, relief may be 
available when a fiduciary invests the rollover amount into a qualified 
default investment alternative after satisfying the notice requirement 
in paragraph (c)(3)(i)(A) as well as the regulation's other conditions.
    Finally, the phrase--``in advance of the date of plan eligibility * 
* * or any first investment in a qualified default investment 
alternative''--is not intended to foreclose availability of relief to 
fiduciaries that, prior to the adoption of the 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 date of plan eligibility * * * or any 
first investment''--should be read to mean the first investment with 
respect to which relief under the final regulation is intended to apply 
after the effective date of the regulation.
    The timing of the annual notice requirement contained in the final 
regulation has not changed from the proposal. Notice must be provided 
within a reasonable period of time of at least 30 days in advance of 
each subsequent plan year. See Sec.  2550.404c-5(c)(3)(ii). One 
commenter requested that the Department eliminate the annual notice 
requirement. The Department retained the annual notice requirement 
because the Pension Protection Act specifically amended ERISA to 
require an annual notice. Further, the Department believes that it is 
important to provide regular and ongoing notice to participants and 
beneficiaries whose assets are invested in a qualified default 
investment alternative to ensure that they are in a position to make 
informed decisions concerning their participation in their employer's 
plan. Several commenters supported the furnishing of an annual reminder 
to participants and beneficiaries that their assets have been invested 
in a qualified default investment alternative and that participants and 
beneficiaries may direct their contributions into other investment 
alternatives available under the plan.
    Paragraph (c)(3), as proposed, provided that the required 
disclosures could be included in a summary plan description, summary of 
material modification or other notice meeting the requirements of 
paragraph (d), which described the content required in the notice. Some 
commenters expressed concern that permitting the notice requirement to 
be satisfied though a plan's summary plan description or summary of 
material modification may result in participants overlooking or 
ignoring information relating to their participation and the investment 
of contributions on their behalf. The Department is persuaded that, 
given the potential length and complexity of summary plan descriptions 
and summaries of material modifications, the furnishing of the required 
disclosures through a separate notice will reduce the likelihood of a 
participant or beneficiary missing or ignoring information about his or 
her plan participation and the investment of the assets in his or her 
account in a qualified default investment alternative. Accordingly, the 
final regulation, at paragraph (c)(3), has been modified to eliminate 
references to providing notice through a summary plan description or

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summary of material modifications. The Department notes that the notice 
requirements of ERISA section 404(c)(5)(B) and this regulation, and the 
notice requirements of sections 401(k)(13)(E) and 414(w)(4) of the 
Code, as amended by the Pension Protection Act, are similar. 
Accordingly, while the final regulation provides for disclosure through 
a separate notice, the Department anticipates that the notice 
requirements of this final regulation and the notice requirements of 
sections 401(k)(13)(E) and 414(w)(4) of the Code could be satisfied in 
a single disclosure document. Further, the Department notes that 
nothing in the regulation should be construed to preclude the 
distribution of the initial or annual notices with other materials 
being furnished to participants and beneficiaries. In this regard, the 
Department recognizes that there may be cost savings that result from 
distributing multiple disclosures simultaneously and, to the extent 
that distribution costs may be charged to the accounts of individual 
participants and beneficiaries, efforts to minimize such costs should 
be encouraged.
    The fourth condition of the proposed regulation required that, 
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) would be provided to the participant or beneficiary. 
See proposed regulation Sec.  2550.404c-5(c)(4). Several commenters 
asked the Department to clarify whether the phrase ``under the terms of 
the plan'' would require plan amendments to explicitly incorporate the 
proposed rule's disclosure provision. Commenters suggested that 
paragraph (c)(4) of the proposal could be read to require that the 
disclosure provisions be described in the formal plan document, and the 
commenters suggested that it is unclear what documents would suffice to 
meet this condition. The phrase ``under the terms of the plan'' was 
merely intended to ensure that plans provide for the required pass-
through of information. Taking into account both the fact that a pass-
through of information is a specific condition of the regulation and 
the comments on this provision, the Department has concluded that the 
phrase is confusing and not necessary. Accordingly, the phrase ``under 
the terms of the plan'' has been removed from paragraph (c)(4) of the 
final regulation. See Sec.  2550.404c-5(c)(4).
    Commenters also requested clarification as to the material intended 
to be included in the reference to ``material provided to the plan'' in 
paragraph (c)(4). Specifically, commenters inquired whether material 
provided to the plan includes information within the custody of a plan 
service provider or the fiduciary responsible for selecting a qualified 
default investment alternative, and whether ``material provided to the 
plan'' includes aggregate, plan-level information received by the plan. 
Commenters also asked for clarification regarding the manner in which 
information shall be ``provided to the participant or beneficiary'' in 
paragraph (c)(4) of the proposed regulation. A number of commenters 
suggested that the final regulation permit disclosure of information 
upon request; others recommended that the disclosure requirement should 
be satisfied by including a statement in the notice required by 
paragraph (c)(3) of the proposed regulation that provides direction to 
a participant or beneficiary regarding where he or she can find 
information about the qualified default investment alternatives. Other 
commenters asked whether plans could make materials available to a 
participant or beneficiary instead of affirmatively providing materials 
to them.
    Other commenters suggested that a participant or beneficiary on 
whose behalf assets are invested in a qualified default investment 
alternative should not be required to be furnished more material than 
is required to be furnished to those individuals who direct their 
investments. In this regard, commenters recommended that the Department 
apply the same standard set forth in the section 404(c) regulation for 
the pass-through of information to both participants who fail to direct 
their investments and participants who elect to direct their 
investments.
    The Department believes that participants who fail to direct their 
investments should be furnished no less information than is required to 
be passed through to participants who elect to direct their investments 
under the plan. The Department also believes there is little, if any, 
basis for requiring defaulted participants to be furnished more 
information than is required to be passed through to other 
participants. For this reason, the Department has adopted the 
recommendation of those commenters that the pass-through disclosure 
requirements applicable to section 404(c) plans be applied to the pass-
through of information under the final regulation. The Department, 
therefore, has modified paragraph (c)(4) to provide that a fiduciary 
shall qualify for the relief described in paragraph (b)(1) of the final 
regulation if a fiduciary provides material to participants and 
beneficiaries as set forth in paragraphs (b)(2)(i)(B)(1)(viii) and 
(ix), and paragraph (b)(2)(i)(B)(2) of the 404(c) regulation, relating 
to a participant's or beneficiary's investment in a qualified default 
investment alternative. The Department notes that, as part of a 
separate regulatory initiative, it is reviewing the disclosure 
requirements applicable to participants and beneficiaries in 
participant-directed individual account plans and that, to the extent 
that the pass-through disclosure requirements contained in Sec.  
2550.404c-1 are amended, the language of paragraph (c)(4), as modified, 
will ensure such amendments automatically extend to Sec.  2550.404c-5. 
The Department notes, in responding to one commenter's request for 
clarification, that the plan's obligation to pass through information 
to participants or beneficiaries would be considered satisfied if the 
required information is furnished directly to the participant or 
beneficiary by the provider of the investment alternative or other 
third-party.
    The fifth condition of the proposal required 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 proposed regulation Sec.  2550.404c-
5(c)(5). This provision was intended to ensure 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 was 
not intended to confer greater rights on participants or beneficiaries 
whose accounts the plan invests in qualified default investment 
alternatives than are otherwise available under the plan. 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

[[Page 60456]]

investments on a quarterly basis. Similarly, if a plan permits daily 
investment direction, participants and beneficiaries with investments 
in a qualified default investment alternative must be permitted to 
direct their investments on a daily basis.
    The Department received many comments requesting clarification on 
this requirement, most often concerning what the Department considers 
to be a financial penalty. Commenters asked whether investment-level 
fees and restrictions, as opposed to fees or other restrictions that 
are imposed by the plan or the plan sponsor, would be considered 
impermissible restrictions or ``financial penalties.'' Commenters 
explained that fees and limitations that are part of the investment 
product are beyond the control of the plan sponsor and should not be 
considered financial penalties for purposes of the final regulation. 
The comment letters provided many examples of investment-level fees or 
restrictions that commenters believed should not be considered 
punitive, including redemption fees, back-end sales loads, reinvestment 
timing restrictions, market value adjustments, equity ``wash'' 
restrictions, and surrender charges.
    In response to these and other comments, the Department has 
modified and restructured paragraph (c)(5) of the final regulation to 
provide more clarity with respect to limitations that may or may not be 
imposed on participants and beneficiaries who are defaulted into a 
qualified default investment alternative. As modified and restructured, 
paragraph (c)(5) of the final regulation includes three conditions 
applicable to a defaulted participant's or beneficiary's ability to 
move assets out of a qualified default investment alternative.
    The first condition, as in the proposal, is intended to ensure that 
defaulted participants and beneficiaries have the same rights as other 
participants and beneficiaries under the plan regarding the frequency 
with which they may direct an investment out of a qualified default 
investment alternative. In this regard, paragraph (c)(5)(i) provides 
that any participant or beneficiary on whose behalf assets are invested 
in a qualified default investment alternative must be able to transfer, 
in whole or in part, such assets to any other investment alternative 
available under the plan with a frequency consistent with that afforded 
participants and beneficiaries who elect to invest in the qualified 
default investment alternative, but not less frequently than once 
within any three month period. The Department received no substantive 
comments on this provision and it is being adopted unchanged from the 
proposal.
    The second and third conditions, at paragraphs (c)(5)(ii) and 
(iii), relate to limitations (i.e., restrictions, fees, etc.) other 
than those relating to the frequency with which participants may direct 
their investment out of a qualified default investment alternative, 
which are addressed in paragraph (c)(5)(i). Unlike the proposal, which 
limited the imposition of financial penalties for the period of a 
defaulted participant's or beneficiary's investment, the regulation, as 
modified, precludes the imposition of any restrictions, fees or 
expenses (other than investment management and similar types of fees 
and expenses) during the first 90 days of a defaulted participant's or 
beneficiary's investment in the qualified default investment 
alternative. At the end of the 90-day period, defaulted participants 
and beneficiaries may be subject to the restrictions, fees or expenses 
that are otherwise applicable to participants and beneficiaries under 
the plan who elected to invest in that qualified default investment 
alternative. While the condition on restrictions, fees and expenses is 
limited to 90 days, the condition, as explained below, is broad in its 
application, thereby providing defaulted participants and beneficiaries 
an opportunity to redirect or withdraw their contributions. Also, the 
Department believes that restrictions or fees on qualified default 
investment alternatives are more likely to be waived if this period is 
shortened to 90 days. The 90-day period is defined by reference to the 
participant's first elective contribution as determined under section 
414(w)(2)(B) of the Code, thereby enabling participants, if their plan 
permits, to make a permissible withdrawal without being subject to the 
10 percent additional tax under section 72(t) of the Code.
    Specifically, paragraph (c)(5)(ii) of the regulation provides that 
any transfer or permissible withdrawal described in paragraph (c)(5) 
resulting from a participant's or beneficiary's election to make such a 
transfer or withdrawal during the 90-day period beginning on the date 
of the participant's first elective contribution as determined under 
section 414(w)(2)(B) of the Code, or other first investment in a 
qualified default investment alternative on behalf of a participant or 
beneficiary described in paragraph (c)(2), shall not be subject to any 
restrictions, fees or expenses (except those fees and expenses that are 
charged on an ongoing basis for the investment itself, such as 
investment management and similar fees, and are not imposed, or do not 
vary, based on a participant's or beneficiary's decision to withdraw, 
sell or transfer assets out of the investment alternative). 
Accordingly, no restriction, fee, or expense may be imposed on any 
transfer or permissible withdrawal of assets, whether assessed by the 
plan, the plan sponsor, or as part of an underlying investment product 
or portfolio, and regardless of whether or not the restriction, fee, or 
expense is considered to be a ``penalty.'' This provision, therefore, 
would prevent the imposition of any surrender charge, liquidation or 
exchange fee, or redemption fee. It also would prohibit any market 
value adjustment or ``round-trip'' restriction on the ability of the 
participant or beneficiary to reinvest within a defined period of time. 
As long as the participant's or beneficiary's election is made within 
the applicable 90-day period, no such charges may be imposed even if, 
due to administrative or other delays, the actual transfer or 
withdrawal does not take place until after the 90-day period.
    Paragraph (c)(5)(ii)(B) makes clear that the limitations of 
paragraph (c)(5)(ii)(A) do not apply to fees and expenses that are 
charged on an ongoing basis for the operation of the investment itself, 
such as investment management fees, distribution and/or service fees 
(``12b-1'' fees), and administrative-type fees (legal, accounting, 
transfer agent expenses, etc.), and are not imposed, or do not vary, 
based on a participant's or beneficiary's decision to withdraw, sell or 
transfer assets out of the investment alternative. In response to a 
request for a clarification, the Department further notes that to the 
extent that a participant or beneficiary loses the right to elect an 
annuity as a result of a transfer out of a qualified default investment 
alternative with an annuity feature, such loss would not constitute an 
impermissible restriction for purposes of paragraph (c)(5)(ii) inasmuch 
as the annuity feature is a component of the investment alternative 
itself.
    Paragraph (c)(5)(iii) of the final regulation provides that, 
following the end of the 90-day period described in paragraph 
(c)(5)(ii)(A), any transfer or permissible withdrawal described in 
paragraph (c)(5) shall not be subject to any restrictions, fees or 
expenses not otherwise applicable to a participant or beneficiary who 
elected to invest in that qualified default investment alternative. 
This provision is intended to ensure that defaulted participants and 
beneficiaries are not subject to restrictions, fees or penalties that 
would serve to create a greater disincentive for defaulted participants 
and beneficiaries, than for other participants and

[[Page 60457]]

beneficiaries under the plan, to withdraw or transfer assets from a 
qualified default investment alternative.
    The Department notes that the final rule does not otherwise 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 of paragraph (c) of the regulation adopts, 
without modification from the proposal, the requirement that plans 
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).\1\ See Sec.  2550.404c-5(c)(6). 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. The Department received 
no substantive objections to this provision and, as indicated, is 
adopting the provision without change.
---------------------------------------------------------------------------

    \1\ 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; * * *''
---------------------------------------------------------------------------

Notices

    As discussed above, relief under the final 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.
    As proposed, paragraph (d) of Sec.  2550.404c-5 required 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, including a 
description of any applicable restrictions, fees, or expenses in 
connection with such transfer; and (4) an explanation of where the 
participants and beneficiaries can obtain investment information 
concerning the other investment alternatives available under the plan.
    A few commenters suggested expanding the content of the notice to 
include procedures for electing other investment options, a description 
of the right to request additional information, a description of any 
right to obtain investment advice (if available), a description of fees 
associated with the qualified default investment alternatives, 
information about other investment options under the plan, etc. While 
the Department did not adopt all of the changes suggested by the 
commenters, the Department has modified the notice content requirements 
to broaden the required disclosures. As modified, the Department 
intends that the furnishing of a notice in accordance with the timing 
and content requirements of this regulation will not only satisfy the 
notice requirements of section 404(c)(5)(B) of ERISA but also the 
notice requirements under the preemption provisions of ERISA section 
514 applicable to an ``automatic contribution arrangement,'' within the 
meaning of ERISA section 514(e)(2).
    ERISA section 404(c)(5)(B)(i)(I) provides for the furnishing of 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.'' ERISA section 514(e)(1) 
provides for the preemption of State laws that would directly or 
indirectly prohibit or restrict the inclusion in any plan of an 
automatic contribution arrangement. Section 514(e)(3) provides that a 
plan administrator of an automatic contribution arrangement shall 
provide a notice describing the rights and obligations of participants 
under the arrangement and such notice shall include ``an explanation of 
the participant's right under the arrangement not to have elective 
contributions made on the participant's behalf (or to elect to have 
such contributions made at a different percentage)'' and an explanation 
of ``how contributions made under the arrangement will be invested in 
the absence of any investment election by the participant.''
    In addition to broadening the required disclosures, the Department 
revised the disclosures relating to restrictions, fees and expenses to 
conform the notice requirements to the changes in paragraph (c)(5) 
relating to restrictions, fees or expenses. As modified, paragraph (d) 
of the final regulation provides that the notices required by paragraph 
(c)(3) shall include: (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 or beneficiary in a 
qualified default investment alternative; and, if applicable, an 
explanation of the circumstances under which elective contributions 
will be made on behalf of a participant, the percentage of such 
contribution, and the right of the participant to elect not to have 
such contributions made on his or her behalf (or to elect to have such 
contributions made at a different percentage); (2) an explanation of 
the right of participants and beneficiaries to direct the investment of 
assets in their individual accounts; (3) 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; (4) 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, including a description of any 
applicable restrictions, fees or expenses in connection with such 
transfer; and (5) an explanation of where the participants and 
beneficiaries can obtain investment information concerning the other 
investment alternatives available under the plan.
    Other commenters suggested that the Department provide a model 
notice.

[[Page 60458]]

Because applicable plan provisions and qualified default investment 
alternatives may vary considerably from plan to plan, the Department 
believes it would be difficult to provide model language that is 
general enough to accommodate different plans and different investment 
products and portfolios and that would allow sufficient flexibility to 
plan sponsors. Accordingly, the final regulation does not include model 
language for plan sponsors. However, the Department will explore this 
concept in the future in coordination with the Department of Treasury 
concerning the similar notice requirements contained in sections 
401(k)(13)(E) and 414(w) of the Code.
    Commenters also requested guidance concerning the extent to which 
the final regulation's notice requirements could be satisfied by 
electronic distribution. The Department currently is reviewing its 
rules relating to the use of electronic media for disclosures under 
title I of ERISA. In the absence of guidance to the contrary, it is the 
view of the Department that plans that wish to use electronic means by 
which to satisfy their notice requirements may rely on either guidance 
issued by the Department of Labor at 29 CFR 2520.104b-1(c) or the 
guidance issued by the Department of the Treasury and Internal Revenue 
Service at 26 CFR 1.401(a)-21 relating to the use of electronic media.

Qualified Default Investment Alternatives

    Under the final regulation, as in 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 four requirements for a 
``qualified default investment alternative.''
    The first requirement, at paragraph (e)(1), addresses investments 
in employer securities. As indicated in the preamble to the proposal, 
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 be 
unnecessarily limiting and complicated. Accordingly, the proposal, in 
addition to establishing a general prohibition against qualified 
default investment alternatives holding or permitting acquisition of 
employer securities, provided two exceptions to the rule. While, as 
discussed below, the Department did receive comments generally 
requesting different or expanded exceptions to the general prohibition, 
the Department has determined it appropriate to adopt paragraph (e)(1) 
without modification from the proposal.
    The two exceptions to the general prohibition are set forth in 
paragraph (e)(1)(ii). The first exception applies 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 (e.g., a common or collective trust 
fund or pooled investment fund) 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.
    Several commenters suggested that the exception to investments in 
employer securities should extend to circumstances when the plan 
sponsor delegates investment responsibilities to an ERISA section 3(38) 
investment manager and with respect to which the plan sponsor has no 
discretion regarding the acquisition or holding of employer securities. 
The Department did not adopt this suggestion because in such instances 
the investment manager may be following the investment policies 
established by the plan sponsor, and, while the plan sponsor may not be 
directly exercising discretion with respect to the acquisition or 
holding of employer securities, the plan sponsor might indirectly be 
influencing such decision through an investment policy that requires 
the investment manager to acquire or hold various amounts of employer 
securities. In the Department's view, limiting the exception to 
regulated financial institutions avoids this type of problem.
    Another commenter suggested that the Department limit qualified 
default investment alternatives to a 10% investment in employer 
securities. The Department did not adopt this suggestion because it 
believes that a percentage limit test would effectively require that a 
plan sponsor or other fiduciary monitor on a daily, if not more 
frequent, basis the specific holdings of the qualified default 
investment alternative and fluctuations in the value of the assets in 
the qualified default investment alternative to determine compliance 
with a percentage limit. Such a test would, in the Department's view, 
result in considerable uncertainty as to whether at any given time the 
intended designated qualified default investment alternative actually 
met the requirements of the regulation. The Department believes that 
the approach it has taken to limiting employer securities provides both 
flexibility and certainty.
    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)(4)(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; however, 
an investment management service will be considered to be serving as a 
qualified default investment alternative only with respect to assets of 
a participant's or beneficiary's account over which the investment 
management service has authority to exercise discretion.
    In the case of employer securities acquired as matching 
contributions that are subject to a restriction on transferability, 
relief would not be available with respect to such securities until the 
investment management service has an unrestricted right to transfer the 
securities. 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 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 qualified default 
investment alternative, the final regulation continues to permit an 
investment management service to hold and manage those employer 
securities in the absence of participant or beneficiary direction. 
Although the investment management service may not acquire additional 
employer securities using participant

[[Page 60459]]

contributions, the investment management service may reduce the amount 
of employer securities held by the account of the participant or 
beneficiary.
    One commenter suggested that the exception be extended to qualified 
default investment alternatives other than the investment management 
service described in paragraph (e)(4)(iii). An employer securities 
match can only constitute part of a qualified default investment 
alternative if the fiduciary selects an investment management service 
as the qualified default investment alternative, because only in the 
investment management service context is the responsible fiduciary 
undertaking the duty to evaluate the appropriate exposure to employer 
securities for a particular participant or beneficiary and undertaking 
the obligation to sell employer securities until the participant's or 
beneficiary's account reflects that appropriate exposure. Accordingly, 
the Department declines to adopt the commenter's suggestion to expand 
the second employer securities exception to other qualified default 
investment alternatives. The Department further notes that this 
regulation does not provide relief for the acquisition of employer 
securities by an investment service.
    The second requirement, at paragraph (e)(2), is intended to ensure 
that the qualified default investment alternative itself does not 
impose any restrictions, fees or expenses inconsistent with the 
requirements of paragraph (c)(5) of Sec.  2550.404c-5. While the 
provision has been redrafted for clarity, it is substantively the same 
as in the proposal and, therefore, is being adopted without substantive 
change.
    The third requirement, at paragraph (e)(3), addresses the 
management of a qualified default investment option. As proposed, the 
regulation required 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. Several commenters suggested that requiring a 
qualified default investment alternative to be managed by an investment 
manager, or to be an investment company, is too restrictive.
    A number of commenters noted that section 3(38) of ERISA excludes 
from the definition of the term ``investment manager'' named 
fiduciaries, as defined in section 402(a)(2) of ERISA \2\ and 
trustees.\3\ With regard to named fiduciaries, commenters pointed out 
that a number of employers serve as named fiduciaries and manage their 
plan investments in-house, resulting in reduced administrative and 
investment management costs. Commenters also noted that implementation 
of the requirement as proposed would eliminate the ability of plan 
sponsors who are named fiduciaries to directly manage a qualified 
default investment alternative, use asset allocation models, develop 
asset allocations themselves, or engage investment consultants (who may 
or may not be fiduciaries) to assist in the development of asset 
allocations. Other commenters, however, suggested that the final 
regulation retain the requirement that only investment managers within 
the meaning of section 3(38) of ERISA or registered investment 
companies be permitted to manage qualified default investment 
alternatives. Commenters suggested that investment management decisions 
should be made by investment professionals who are investment managers 
within the meaning of section 3(38) of ERISA; they asserted that 
requiring a 3(38) manager is safer and more prudent than other 
alternatives, and such requirement is administratively feasible.
---------------------------------------------------------------------------

    \2\ Section 402(a)(2) of ERISA provides that the term ``named 
fiduciary'' means a fiduciary who is named in the plan instrument, 
or who, pursuant to a procedure specified in the plan, is identified 
as a fiduciary by a person who is an employer or employee 
organization with respect to the plan, or by such an employer and 
such an employee organization acting jointly.
    \3\ Section 3(38) defines the term ``investment manager'' to 
mean any fiduciary (other than a trustee or named fiduciary, as 
defined in section 402(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 [15 U.S.C. 80b-3a(a)], 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; 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.
---------------------------------------------------------------------------

    With regard to permitting plan sponsors to manage a qualified 
default investment alternative, the Department is persuaded that a plan 
sponsor's willingness to serve as a named fiduciary responsible for the 
management of the plan's investment options in conjunction with the 
potential cost savings to plan participants that can result from such 
management, is a sufficient basis to expand the regulation to permit 
plan sponsors that are named fiduciaries to manage a qualified default 
investment alternative. This modification is reflected in paragraph 
(e)(3)(i)(C).
    A number of commenters also indicated that, under the proposal, 
investment consultants engaged by plan sponsors would have to assume 
fiduciary responsibility for asset allocations in order to obtain 
relief under the proposal. These commenters suggested that requiring an 
investment consultant to assume fiduciary responsibility for asset 
allocation would increase costs for the provision of such consulting 
services, and that these costs inevitably would be passed along to 
participants. Commenters also asserted that the use of asset allocation 
models is well-established and is often an effective way to lower costs 
and to provide a clean structure and process for the formation, 
selection and monitoring of all elements of a prudent default 
investment alternative. The commenters also noted that many plan 
sponsors develop generic asset allocations and select particular funds, 
tailored to a particular plan, with the input of an investment 
consultant who may be an investment adviser under the Investment 
Advisers Act of 1940. With regard to these comments, the Department 
continues to believe 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 fiduciaries and those fiduciaries must 
acknowledge their fiduciary responsibility and liability under the 
ERISA. The Department notes, however, that plan sponsors who serve as 
named fiduciaries of a qualified default investment alternative may, to 
the extent they consider it prudent, engage investment consultants, 
utilize asset allocation models (computer-based or otherwise), etc. to 
carry out their investment management/asset allocation 
responsibilities. Accordingly, the Department does not believe the 
regulation in this regard should to any significant degree alter the 
availability or cost of such services.
    With regard to the exclusion of trustees from the ``investment 
manager'' definition, commenters suggested that the final regulation 
make clear that bank trustees of collective investment funds are 
permitted to manage a qualified default investment alternative. In this 
regard, commenters noted that the definition of ``investment managers'' 
recognizes that banks and other

[[Page 60460]]

institutions can be investment managers, citing ERISA section 
3(38)(B)(ii) and (iii), and should not be foreclosed from managing a 
qualified default investment alternative solely on the basis that the 
institution might otherwise serve as a trustee. These commenters noted 
that, similar to investment managers, banks as trustees of collective 
funds have fiduciary responsibility and liability under ERISA with 
respect to the funds they maintain. The Department is persuaded that an 
entity that meets the requirements of section 3(38)(A), (B) and (C) 
should not be precluded from assuming fiduciary responsibility and 
liability for the underlying investment management/asset allocation 
decisions of a qualified default investment alternative solely because 
that entity serves in a trustee capacity for the plan.\4\ The 
Department has modified the final regulation accordingly. This 
modification is reflected in paragraph (e)(3)(i)(B).
---------------------------------------------------------------------------

    \4\ This position is consistent with the Department's long-held 
view that the parenthetical language of section 3(38) was merely 
intended to indicate that in order for a person to be an investment 
manager for a plan, that person must be more than a mere trustee or 
named fiduciary. See Advisory Opinion No. 77-69/70A
---------------------------------------------------------------------------

    In response to a request from one commenter, the Department 
confirms that the provisions of the regulation do not preclude a 
qualified default investment alternative from having more than one 
fiduciary (e.g., investment manager) responsible for the investment 
management/asset allocation decisions of the investment alternative, as 
would be the case in an arrangement utilizing a ``fund of funds'' 
approach to designing a qualified default investment alternative.
    As with the proposal, the regulation permits a qualified default 
investment alternative to be an investment company registered under the 
Investment Company Act of 1940. See paragraph (e)(3)(ii) of Sec.  
2550.404c-5.
    In addition to the foregoing, paragraph (e)(3) has been expanded to 
include certain capital preservation products and funds described in 
paragraph (e)(4)(iv) and (v) of Sec.  2550.404c-5. These products and 
funds are discussed below.
    The last requirement for a qualified default investment alternative 
conditions relief on the use of specified types of investment fund 
products, model portfolios or services. See Sec.  2550.404c-5(e)(4). In 
the proposal, the Department identified three categories of investment 
alternatives that it determined appropriate for achieving meaningful 
retirement savings over the long-term for those participants and 
beneficiaries who, for one reason or another, do not elect to direct 
the investment of their pension plan assets. After careful 
consideration of all the comments concerning the nature and type of the 
investment alternatives that should be included as qualified default 
investment alternatives under the regulation, the Department, as 
discussed below, has decided to retain the three proposed categories of 
investment alternatives, essentially unchanged from the proposal, as 
the type of alternatives appropriate for default investments under the 
regulation. However, in recognition of the fact that some plan sponsors 
may find it desirable to reduce investment risks for all or part of 
their workforce following employees' initial enrollment in the plan, 
the Department has added a limited capital preservation option that 
would constitute a qualified default investment alternative under the 
regulation for purposes of contributions made on behalf of a 
participant for a 120-day period following the date of the 
participant's first elective contribution. See paragraph (e)(4)(iv). In 
addition, the Department has modified the regulation to include a 
``grandfather''-like provision pursuant to which stable value products 
and funds will constitute a qualified default investment alternative 
under the regulation for purposes of investments made prior to the 
effective date of the regulation. See paragraph (e)(4)(v).
    As noted above, the three categories of investment alternatives set 
forth in the proposal are being adopted essentially unchanged from the 
proposal. One organizational change appearing in the final regulation 
involves the inclusion of diversification language in each of three 
categories, rather than as a separate requirement of general 
applicability as in the proposal (see paragraph (e)(4) of proposed 
regulation Sec.  2550.404c-5). This change accommodates the addition of 
the capital preservation investment alternatives mentioned above that 
may not, given the nature of the investment, satisfy a diversification 
standard.
    Some commenters expressed concern that the Department's approach to 
defining qualified default investment alternatives takes into account 
only products currently available in the marketplace and that the 
defining of qualified default investment alternatives should be based 
on more general criteria. These commenters emphasized that the 
regulation should not stifle creativity in the development of the next 
generation of retirement products. While the Department does provide 
examples of products, portfolios and services that would fall within 
the framework of the various definitions of products, portfolios and 
services set forth in the regulation, these examples are provided 
solely for the purpose of providing the benefits community with 
guidance as to what might be included within the defined categories and 
are not intended in any way to limit the application of the definitions 
to such vehicles. The Department believes that, on the basis of the 
information it has at this time and the comments on the proposal 
generally, the approach it is taking to defining qualified default 
investment alternatives for purposes of the regulation is sufficiently 
flexible to accommodate future innovations and developments in 
retirement products.
    A number of commenters requested clarification concerning 
application of the regulation to possible qualified default investment 
alternatives that are offered through variable annuity contracts. 
Commenters explained that variable annuity contracts typically permit 
participants to invest in a variety of investments through one or more 
separate accounts (or sub-accounts within the separate account) that 
would qualify as qualified default investment alternatives under the 
regulation. Commenters also requested confirmation that the 
availability of annuity purchase rights, death benefit guarantees, 
investment guarantees or other features common to variable annuity 
contracts would not themselves affect the status of a variable annuity 
contract that otherwise met the requirements for a qualified default 
investment alternative. Consistent with providing flexibility and 
encouraging innovation in the development and offering of retirement 
products, model portfolios or services, the Department intends that the 
definition of ``qualified default investment alternative'' be construed 
to include products and portfolios offered through variable annuity and 
similar contracts, as well as through common and collective trust funds 
or other pooled investment funds, where the qualified default 
investment alternative satisfies all of the conditions of the 
regulation. For purposes of identifying the entity responsible for the 
management of the qualified default investment alternative in such 
arrangements pursuant to paragraph (e)(3) of Sec.  2550.404c-5, it is 
the view of the Department that such a determination is made by 
reference to the entity (e.g., separate account, sub-account, or 
similar entity) that is responsible for carrying out the day-to-day 
investment management/asset allocation responsibilities. Finally, with 
regard to such products and portfolios,

[[Page 60461]]

it is the view of the Department that the availability of annuity 
purchase rights, death benefit guarantees, investment guarantees or 
other features common to variable annuity contracts will not themselves 
affect the status of a fund, product or portfolio as a qualified 
default investment alternative when the conditions of the regulation 
are satisfied. A new paragraph (e)(4)(vi) was added to the regulation 
to clarify these principles.
    A number of commenters submitted questions or comments concerning 
the specific investment alternatives described in the regulation.
    The first investment alternative set forth in the regulation, at 
paragraph (e)(4)(i), is an investment fund, product or model portfolio 
that applies generally accepted investment theories, is diversified so 
as to minimize the risk of large losses, and 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. Consistent with the proposal, 
the description provides that 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. Also like the proposal, the description 
makes clear that 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.
    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. 
As noted in the proposal, the Department believes that, 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.
    Several commenters asked the Department to clarify whether a plan 
fiduciary must, or may, consider demographic or other factors in 
addition to a participant's age or target retirement date when 
selecting an investment product intended to satisfy the first category 
of qualified default investment alternatives. For example, commenters 
suggested that a plan fiduciary may wish to take into account an 
employer-provided defined benefit plan or an employer stock 
contribution when selecting the plan's default investment product. 
Although the final regulation does not preclude consideration of 
factors other than a participant's age or target retirement date in 
these circumstances, the regulation is clear that such considerations 
are neither required nor necessary as a condition to a fiduciary 
obtaining relief under the regulation. The Department intended to 
provide plan fiduciaries with certainty that they have complied with 
the requirements of the regulation; accordingly, as long as a plan 
fiduciary satisfies its general obligations under ERISA when selecting 
any qualified default investment alternative, the fiduciary will not 
lose the relief provided by the regulation if he or she selects a 
product, portfolio or service described in the regulation.
    One commenter requested clarification concerning the status of 
``lifestyle'' funds. ``Lifestyle'' funds were defined as being similar 
to ``lifecycle'' funds, except that the allocation in a given lifestyle 
fund does not change over time to become more conservative. That is, 
the investment manager of a lifestyle fund invests the fund's assets to 
achieve a predetermined level of risk, such as ``conservative,'' 
``moderate,'' or ``aggressive.'' While it does not appear that a 
lifestyle fund, as defined by the commenter, would by itself satisfy 
the requirements for a product or portfolio within the meaning of 
paragraph (e)(4)(i), such a fund could, in the Department's view, 
constitute part of a qualified default investment alternative within 
the meaning of paragraph (e)(4)(i). Similarly, nothing in the final 
regulation precludes an investment manager from allocating a portion of 
a participant's assets to such a fund as part of a qualified default 
investment alternative within the meaning of paragraph (e)(4)(iii). It 
is also possible that a lifestyle fund, as defined by the commenter, 
might be able to constitute an investment within the meaning of 
paragraph (e)(4)(ii), an example of which is a ``balanced'' fund.
    With respect to the language requiring that the investment fund, 
product or model portfolio provide varying degrees of long-term 
appreciation and capital preservation through ``a mix of equity and 
fixed income exposures,'' one commenter inquired whether the Department 
intended to exclude funds that had no fixed income exposure, which, 
according to the commenter, might be appropriate for young individuals 
many years away from retirement. While the Department believes that 
such an investment option may be appropriate for individuals actively 
electing to direct their own investments, the Department believes that 
when an investment is a default investment, the investment should 
provide for some level of capital preservation through fixed income 
investments. Accordingly, the final regulation, like the proposal, 
continues to require that the qualified default investment 
alternatives, defined in paragraph (e)(4)(i), (ii) and (iii), be 
designed to provide degrees of long-term appreciation and capital 
preservation through a mix of equity and fixed income exposures.
    The second investment alternative set forth in the regulation, at 
paragraph (e)(4)(ii), is an investment fund product or model portfolio 
that applies generally accepted investment theories, is diversified so 
as to minimize the risk of large losses, and 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 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.
    Although commenters generally supported inclusion of a balanced 
investment option as a qualified default investment alternative, a 
number of commenters had questions or expressed concern regarding the 
requirement that the investment alternative define its investment 
objectives by reference to ``a target level of risk appropriate for 
participants of the plan as a whole.'' Commenters indicated that having 
to take into account the ``participants of the plan as a whole'' would 
result in uncertainty as to whether the plan sponsor properly matched 
the chosen fund to its participant population. In

[[Page 60462]]

addition, commenters asserted that the on-going monitoring necessary 
for the plan fiduciary to ensure the continued appropriateness of the 
match would likely result in unnecessary burdens and costs. One 
commenter explained that balanced funds as a group hold approximately 
60-65% percent of their portfolios in equity investments,\5\ and that 
the typical balanced fund would be somewhat more conservatively 
invested than most targeted-retirement-date funds; hence, the commenter 
argued that balanced funds are an appropriate default for all workers. 
The commenter further noted that periodic monitoring, while adding 
unnecessary costs, will likely never produce an impetus for changing to 
a different balanced fund option. After careful consideration of the 
comments, the Department has decided to retain the requirement that, 
for purposes of paragraph (e)(4)(ii), the selected qualified default 
investment alternative reflect ``a target level of risk appropriate for 
participants of the plan as a whole.'' The Department recognizes that, 
to the extent that a particular investment fund product or model 
portfolio does not itself consider or adjust its balance of fixed 
income and equity exposures to take into account a target level of risk 
appropriate for the participants of the plan as a whole, plan 
fiduciaries will retain that responsibility. The Department believes 
that, as a practical matter, this responsibility would be discharged by 
the fiduciary in connection with the prudent selection and monitoring 
of the investment fund product.\6\ Specifically, fiduciaries would take 
into account the diversification of the portfolio, the liquidity and 
current return of the portfolio relative to the anticipated cash flow 
requirements of the plan, the projected return of the portfolio 
relative to funding objectives of the plan, and the fees and expenses 
attendant to the investment.\7\
---------------------------------------------------------------------------

    \5\ Investment Company Institute, Quarterly Supplementary Data 
for Quarter Ending June 30, 2006.
    \6\ See paragraph (b)(2) of 29 CFR 2550.404c-5.
    \7\ See 29 CFR 2550.404a-(b).
---------------------------------------------------------------------------

    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, and would be similar to the considerations a 
fiduciary would take into account in managing an individual account 
plan that does not provide for participant direction. A number of 
commenters asked the Department to clarify the demographic factors that 
should be considered by the fiduciary. The Department understands that 
the only information a plan fiduciary may know about its participant 
population is age. Thus, when determining a target level of risk 
appropriate for participants of a plan as a whole, a plan fiduciary is 
required to consider the age of the participant population. However, a 
plan fiduciary is not foreclosed from considering other factors 
relevant to the participant population, if the fiduciary so chooses.
    The third alternative set forth in the regulation, at paragraph 
(e)(4)(iii), 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.\8\ 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. Similar to the first 
two alternatives, these portfolios must be structured in accordance 
with generally accepted investment theories and diversified so as to 
minimize the risk of large losses. The final regulation also clarifies 
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.''
---------------------------------------------------------------------------

    \8\ Although investment management services are included within 
the scope of relief, the Department notes that relief similar to 
that provided by this 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 the 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)(1) 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.
---------------------------------------------------------------------------

    One commenter requested clarification that, with regard to a 
participant's account holding employer securities with restrictions on 
transferability, the investment management service could serve as 
qualified default investment alternative for purposes of all other 
assets in the participant's account with respect to which the managed 
account has investment discretion. As discussed earlier, the mere fact 
that 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, will not preclude an investment management service from 
serving as a qualified default investment alternative. However, an 
investment management service will be considered to be serving as a 
qualified default investment alternative only with respect to the 
assets of a participant's or beneficiary's account over which the 
investment management service has authority to exercise discretion. If 
the investment management service does not have the authority to 
exercise discretion over investments in employer securities, the 
investment management service will not be a qualified default 
investment alternative with respect to those securities. See discussion 
of paragraph (e)(1)(ii) of Sec.  2550.404c-5, above.
    Another commenter expressed concern that requiring the manager of a 
managed account qualified default investment alternative to be an 
investment manager may prevent plan sponsors from using existing 
managed account programs, such as that addressed in Advisory Opinion 
2001-09A (the ``SunAmerica Opinion''). The Department believes these 
concerns are addressed by the modifications to paragraph (e)(3)(i)(C), 
pursuant to which plan sponsors who are named fiduciaries may manage 
qualified default investment alternatives.
    Many commenters expressed concern that the Department did not 
include capital preservation, in particular stable value, products as 
qualified default investment alternatives on a stand alone basis. These 
commenters pointed out that stable value funds are utilized by a large 
number of plans as default investment funds. These funds are often 
chosen by plan sponsors because they provide: Safety of principal; 
bond-like returns without the volatility associated with bonds; 
stability and steady growth of principal and earned income; and 
benefit-responsive liquidity, so that plan participants may transact at 
``book value.'' Commenters supporting stable value funds argued that 
stable value funds are superior to money market

[[Page 60463]]

funds and other cash-equivalent products because stable value 
investments earn higher rates of return than money market funds and 
other cash-equivalent products. A number of these commenters also 
suggested that stable value funds are appropriate for plans with 
different demographics, including, for example, plans that cover 
younger, higher turnover employees who are likely to elect lump sum 
payments, or plans that cover older, near-retirement employees.
    Commenters in support of the inclusion of stable value products 
also indicated that stable value funds have relatively low costs 
compared to life-cycle, targeted-retirement-date and balanced funds, 
particularly those that use a ``fund of funds'' structure. These 
commenters expressed the view that, because stable value returns are 
comparable to intermediate corporate bond returns, the premium, if any, 
of equity investments over stable value investments has been 
overstated. Many of the commenters argued that the exclusion of stable 
value funds would unduly discourage plan sponsors from using stable 
value funds as a default option, to the detriment of plan participants. 
These commenters argued that limiting default investment alternative 
choices discourages plans from implementing automatic enrollment. In 
addition, some commenters suggest that if participants whose account 
balances are invested in qualified default investment alternatives 
react negatively to volatile equity performance by opting out of plan 
participation when losses occur, the regulation may ultimately decrease 
retirement savings, and the potential gains expected from funds with 
higher historical long-term performance records will not materialize. 
Some of the comments supporting the inclusion of capital preservation 
products also argued that the Congress, in referencing ``a mix of asset 
classes consistent with capital preservation or long-term capital 
appreciation, or a blend of both'' in section 624 of the Pension 
Protection Act, intended the Department to include capital preservation 
products as a separate stand alone qualified default investment 
alternative.
    The Department also received comments in support of its 
determination that capital preservation products, such as money market 
funds, stable value funds and similarly performing investment vehicles, 
should not themselves constitute qualified default investment 
alternatives under the regulation.
    After careful consideration of the comments addressing this issue 
and assessment of related economic impacts, the Department has 
determined, except as otherwise discussed below, not to include capital 
preservation products, such as money market or stable value funds, as a 
separate long-term investment option under the regulation. As a short-
term investment, money market or stable value funds may not, in the 
Department's view, significantly affect retirement savings. The 
Department recognizes, however, that such investments can, and in many 
instances will, play an important role as a component of a diversified 
portfolio that constitutes a qualified default investment alternative. 
It is the view of the Department that investments made on behalf of 
defaulted participants ought to and often will be long-term investments 
and that investment of defaulted participants' contributions and 
earnings in money market and stable value funds will not over the long-
term produce rates of return as favorable as those generated by 
products, portfolios and services included as qualified default 
investment alternatives, thereby decreasing the likelihood that 
participants invested in capital preservation products will have 
adequate retirement savings.
    The Department also is concerned that including capital 
preservation and stable value products as a qualified default 
investment alternative for future contributions on behalf of defaulted 
participants may impede, or even reverse, the current trend away from 
the use of such products as default investments. The Department 
understands that, because account balances invested in capital 
preservation products are unlikely to show a nominal loss, a number of 
employers, if given a choice between capital preservation products and 
more diversified investment options, may be more likely to opt for 
capital preservation products because they are perceived as presenting 
less litigation risk for employers. If so, inclusion of a capital 
preservation option without limitation may increase utilization of 
capital preservation products as default investments and, thereby, 
increase the number of participants likely to have inadequate 
retirement savings, as compared with savings that would be generated 
through investments in the established qualified default investment 
alternatives.
    Lastly, the Department is concerned that inclusion of a capital 
preservation product as a qualified default investment alternative, 
without limitation, may be perceived by participants and beneficiaries 
as an endorsement by the government, by virtue of its inclusion in the 
regulation, or as an endorsement by the employer, by virtue of its 
selection as the qualified default investment alternative, as an 
appropriate investment for long-term retirement savings. Although the 
Department recognizes that such perceptions on the part of some 
participants and beneficiaries might be addressed with investment 
education and investment advice, the Department nonetheless is 
concerned that, overall, the potentially adverse effect on long-term 
retirement savings may be significant.
    In light of these concerns, the Department, as indicated above, has 
not included a capital preservation investment alternative as a long-
term stand alone investment option for future contributions under the 
final regulation. The Department, however, has added two exceptions to 
the regulation that accommodate limited investments in capital 
preservation products as qualified default investment alternatives. The 
first exception is at paragraph (e)(4)(iv). In general, this exception 
treats investments in capital preservation products or funds as an 
investment in a qualified default investment alternative for a 120-day 
period following a participant's first elective contribution (as 
determined under section 414(w)(2)(B) of the Code).
    Specifically, paragraph (e)(4)(iv)(A) recognizes, subject to the 
limitations of paragraph (e)(4)(iv)(B), as a qualified default 
investment alternative an investment product that is designed to 
preserve principal and provide a reasonable rate of return, whether or 
not guaranteed, consistent with liquidity. The product description and 
applicable standards are similar to the standards adopted for purposes 
of automatic rollovers of mandatory distributions at 29 CFR 2550.404a-
2. The Department believes it is appropriate to include capital 
preservation products as a limited-duration qualified default 
investment alternative to afford plan sponsors the flexibility of 
utilizing a near risk-free investment alternative for the investment of 
contributions during the period of time when employees are most likely 
to opt out of plan participation. The use of capital preservation 
products in these circumstances will enable plan sponsors to return 
contributed amounts to participants who opt out without concern about 
loss of principal. In this regard, the limitation set forth in 
paragraph (e)(4)(iv)(B) provides that capital preservation products 
described in paragraph (e)(4)(iv)(A) shall, with respect to any given 
participant, be treated as a qualified default investment

[[Page 60464]]

alternative for a 120-day period following the participant's first 
elective contribution (as determined under section 414(w)(2)(B) of the 
Code). At the end of the 120-day period, capital preservation products 
would cease to be a qualified default investment alternative with 
respect to any assets of the participant that continue to be invested 
in such products. In order to avail itself of the relief afforded by 
the regulation, the plan fiduciary must redirect the participant's 
investment in the capital preservation product to another qualified 
default investment alternative prior to the end of the 120-day period. 
As previously stated, such alternative may include an appropriate 
capital preservation component in the context of a diversified 
portfolio.
    The 120-day time frame is intended to provide plans that allow an 
employee to elect to make a permissible withdrawal, consistent with 
section 414(w) of the Code, a reasonable amount of time following the 
end of the 90-day period provided in section 414(w)(2)(B) (i.e., the 
period during which employees may elect to make a permissible 
withdrawal) to effectuate a transfer of a participant's assets to 
another qualified default investment alternative.
    The second exception relating to capital preservation products and 
funds is at paragraph (e)(4)(v). This exception, unlike the first, is 
intended to be limited to stable value products and funds with respect 
to which plan sponsors are typically limited by the terms of the 
investment contracts from unilaterally reinvesting assets on behalf of 
participants who fail to give investment direction without triggering a 
surrender charge or other fees that could directly and adversely affect 
participant account balances. Under the exception, stable value 
products and funds will be treated as a qualified default investment 
alternative solely for purposes of investments in such products or 
funds made prior to the effective date of this regulation. The 
Department believes that this ``grandfather''-type provision 
accommodates the concerns of commenters regarding the utilization of 
stable value products and funds by plan sponsors as their default 
investment option in the absence of guidance concerning fiduciary 
responsibilities attendant to default investments generally, guidance 
like that provided by this regulation. At the same time, by limiting 
the exception to pre-effective date contributions, plan sponsors are 
encouraged to assess whether and under what circumstances they wish to 
avail themselves of the relief provided under the regulation by 
utilizing a qualified default investment alternative that extends to 
participant contributions made after the effective date of this 
regulation. It is important to note, however, that, as indicated in the 
regulation itself, the standards applicable to qualified default 
investment alternatives set forth in the regulation 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. Accordingly, 
fiduciaries may, without regard to this regulation, conclude that a 
stable value product or fund is an appropriate default investment for 
their employees and use such product or fund for contributions on 
behalf of defaulted employees after the effective date of this 
regulation.
    It also is important to note with regard to both of the exceptions 
discussed above that the relief afforded by the regulation for 
investments in the covered products or funds on behalf of defaulted 
participants is contingent on compliance with all the requirements of 
the regulation.
    Finally, the Department disagrees with commenters' assertion that 
the Department's decision not to include capital preservation products 
as a qualified default investment alternative is inconsistent with 
Congressional intent. The Department believes that Congress, in 
enacting section 624 of the Pension Protection Act, provided the 
Department broad discretion in framing a regulation that would permit 
the Department to include or exclude capital preservation products as a 
separate qualified default investment alternative. The Department also 
notes that, pursuant to section 505 of ERISA, the Secretary may 
prescribe such regulations as are necessary or appropriate to carry out 
the provisions title I of ERISA.

C. Miscellaneous Issues

Transition Issues

    A number of commenters raised issues concerning the status of 
existing default investments and transfers to default investments that 
would meet the requirements of the regulation. Specifically, commenters 
requested guidance on what steps should be taken to ensure that a 
plan's current default investments, which also meet the requirements of 
the regulation, will be treated as qualified default investment 
alternatives after the effective date of the regulation. Other 
commenters requested guidance on what steps should be taken when a plan 
is moving from default investments that do not meet the requirements of 
the regulation to qualified default investment alternatives. In both 
scenarios, commenters noted that plans often will not have the records 
necessary to distinguish participants who were defaulted into a default 
investment from those who affirmatively elected to invest in that 
investment. Some commenters requested retroactive relief for 
investments that would not otherwise constitute qualified default 
investment alternatives because a plan's determination to transfer 
assets out of such investments could trigger a market value adjustment 
or similar withdrawal penalty.
    To ensure that an existing or a new default investment constitutes 
a qualified default investment alternative with respect to both 
existing assets and new contributions of participants or beneficiaries, 
plan fiduciaries must comply with the notice requirements of the 
regulation. It is the view of the Department that any participant or 
beneficiary, following receipt of a notice in accordance with the 
requirements of this regulation, may be treated as failing to give 
investment direction for purposes of paragraph (c)(2) of Sec.  
2550.404c-5, without regard to whether the participant or beneficiary 
was defaulted into or elected to invest in the original default 
investment vehicle of the plan. Under such circumstances, and assuming 
all other conditions of the regulation are satisfied, fiduciaries would 
obtain relief with respect to investments on behalf of those 
participants and beneficiaries in existing or new default investments 
that constitute qualified default investment alternatives.
    Several commenters requested guidance on the effective date of the 
regulation. While section 404(c)(5) of ERISA is effective for plan 
years beginning after December 31, 2006, relief under section 404(c)(5) 
is conditioned on, among other things, the investment of a 
participant's contributions and earnings ``in accordance with 
regulations issued by the Secretary.'' See section 404(c)(5)(A). 
Accordingly, relief under section 404(c)(5) is conditioned on 
compliance with the provisions of this final regulation, which provide 
relief only for investments on behalf of participants and beneficiaries 
who were furnished a notice in accordance with paragraphs (c)(3) and 
(d) of Sec.  2550.404c-5 and who did not give investment directions to 
the plan after the effective date of the regulation. Although the 
regulation only provides relief for investments in qualified default 
investment alternatives when participants and beneficiaries do

[[Page 60465]]

not give investment directions after the effective date of the 
regulation, compliance with the notice requirements may be achieved by 
providing notice in accordance with the regulation before its effective 
date.
    With regard to the possible assessment of market value adjustments 
or similar withdrawal penalties that may result from a fiduciary's 
decision to move assets to a qualified default investment alternative, 
the Department reminds fiduciaries that such decisions must be made in 
compliance with ERISA's prudence and exclusive purpose requirements. 
These decisions cannot be based solely on a fiduciary's desire to take 
advantage of the limited liability afforded by this regulation, without 
regard to the financial consequences to the plan's participants and 
beneficiaries. In this regard, the Department notes that the final 
regulation does not change the status of an otherwise prudent default 
investment into an imprudent default investment. The Department has 
attempted to make clear in both the preamble and the operative language 
of the final regulation that the standards set forth therein are not 
intended to be the exclusive means by which fiduciaries might satisfy 
their responsibilities under the Act with respect to the investment of 
assets on behalf of participants and beneficiaries who do not give 
investment directions.
    Further, as discussed above under Qualified Default Investment 
Alternatives, the Department modified the regulation to provide relief 
for investments made in stable value products or funds prior to the 
effective date of the regulation. This modification is intended to 
assist plan fiduciaries who may be limited by the terms of investment 
contracts for such products or funds from unilaterally reinvesting 
assets on behalf of participants who fail to direct their investments.
    One commenter requested that the Department make clear that once a 
participant or beneficiary directs any portion of his or her account 
balance, the participant or beneficiary is considered to have directed 
the investment of the entire account. The Department agrees that 
investment direction by a participant or beneficiary with respect to a 
portion of his or her account balance may be treated as a decision to 
retain the remainder of the account balance as currently invested, thus 
permitting the responsible fiduciary to consider the entire account 
balance as directed by the participant or beneficiary.
    A number of commenters requested that the Department clarify the 
interrelationship between ERISA section 404(c)(4)(A)--the ``mapping'' 
provisions--and section 404(c)(5) and this regulation. The most obvious 
difference between the two sections is the circumstances under which 
relief is available. The relief provided by section 404(c)(4) is 
limited to circumstances when a plan undertakes a ``qualified change in 
investment options'' within the meaning of section 404(c)(4)(B). In 
contrast, section 404(c)(5) and this regulation can apply to changes in 
investment options and to the selection of initial plan investments 
when participants or beneficiaries do not give investment directions. 
Section 404(c)(4) applies only when the investment option from which 
assets are being transferred was chosen by the participant or 
beneficiary (see section 404(c)(4)(C)(iii)). Section 404(c)(5), unlike 
404(c)(4), can apply to the selection of an investment alternative by 
the plan fiduciary in the absence of any affirmative direction by the 
participant or beneficiary. While the fiduciary relief afforded by 
section 404(c)(4) and section 404(c)(5) is similar, relief under 
section 404(c)(4) requires that new investments be reasonably similar 
to the investments of the participant or beneficiary immediately before 
the change, whereas relief under section 404(c)(5) requires investment 
to be made in qualified default investment alternatives. In the context 
of changing investment options under the plan, ERISA sections 404(c)(4) 
and 404(c)(5) provide fiduciaries flexibility in implementing such 
changes.

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. 
In the preamble to the proposed regulation, the Department specifically 
invited comment on whether, and to what extent, regulations would be 
helpful in addressing the preemption provision of section 514(e).
    In response to the Department's invitation, commenters indicated 
that, while the application of the preemption provisions should be 
clarified, they did not believe it was necessary at this time for the 
Department to prescribe regulations establishing minimum standards for 
automatic contribution arrangements. Commenters also argued that ERISA 
preemption should extend to all prudent investments under an automatic 
contribution arrangement, not just those determined to be qualified 
default investment alternatives under the Department's regulation. In 
addition, commenters argued that preemption should not depend on 
compliance with all the requirements of the regulation under section 
404(c)(5), noting that section 514(e) has an independent notice 
requirement. See section 514(e)(3).
    In an effort to clarify the application of the preemption 
provisions of section 514(e), the final regulation includes a new 
paragraph (f). As set forth in the regulation, section 514(e) broadly 
preempts any State law that would restrict the use of an automatic 
contribution arrangement. After reviewing the text and purpose of 
section 514(e), the Department concluded that Congress intended to 
supersede the application of such laws to any pension plan that 
provides for an automatic contribution arrangement, regardless of 
whether such plan includes an automatic contribution arrangement as 
defined in the regulation. This conclusion is reflected in paragraph 
(f)(2) of the final regulation.
    With the enactment of section 514(e), Congress intended to occupy 
the field with respect to automatic contribution arrangements.\9\ Thus, 
section 514(e) of ERISA does not merely supersede State laws 
``insofar'' as any particular plan complies with this final regulation, 
but rather generally supersedes any law ``which would directly or 
indirectly

[[Page 60466]]

prohibit or restrict the inclusion in any plan of an automatic 
contribution arrangement.'' This language stands in marked contrast to 
the familiar language of section 514(a) of ERISA, which supersedes 
State laws only ``insofar'' as they satisfy the ``relates to'' standard 
set forth in that section.\10\
---------------------------------------------------------------------------

    \9\ This interpretation of section 514(e) is consistent with the 
Technical Explanation of H.R. 4, the ``Pension Protection Act of 
2006,'' as Passed by the House on July 28, 2006, and as Considered 
by the Senate on August 3, 2006, a document prepared by the staff of 
the Joint Committee on Taxation. That document states, on page 230: 
``The State preemption rules under the bill are not limited to 
arrangements that meet the requirements of a qualified enrollment 
feature.''
    \10\ Section 514(a) of ERISA provides, in pertinent part, that 
``the provisions of this title and title IV shall supersede any and 
all State laws insofar as they may now or hereafter relate to any 
employee benefit plan * * *.'' Emphasis added.
---------------------------------------------------------------------------

    Additionally, Congress gave the Department discretion in section 
514(e)(1) to determine whether and to what extent preemption should be 
conditioned on plan compliance with minimum standards, stating that 
``[t]he Secretary may prescribe regulations which would establish 
minimum standards that such an arrangement would be required to satisfy 
in order for this subsection [on preemption] to apply in the case of 
such arrangement.'' Pursuant to this grant of discretionary authority, 
the Department has concluded, at this time, that it should not tie 
preemption to minimum standards for default investments. The 
Department, therefore, specifically provides in paragraph (f)(4) that 
nothing in the final regulation precludes a pension plan from including 
an automatic contribution arrangement that does not meet the conditions 
of paragraph (a) through (e) of the regulation. While relief under 
ERISA section 404(c)(5) is available only to plans that comply with the 
regulation, the Department has determined that it would be 
inappropriate to discourage plan fiduciaries from selecting default 
investments that are not identified in the regulation. State laws that 
hinder the use of any other default investments would be inconsistent 
with this determination, and with the discretionary authority Congress 
vested in the Department over the scope of ERISA preemption.
    Finally, in an effort to eliminate the need for multiple notices by 
plan administrators of automatic contribution arrangements, paragraph 
(f)(3) of the final regulation specifically provides that the 
administrator of an automatic contribution arrangement within the 
meaning of paragraph (f)(1) shall be considered to have satisfied the 
notice requirements of section 514(e)(3) if notices are furnished in 
accordance with paragraphs (c)(3) and (d) of the regulation. 
Accordingly, satisfaction of the notice requirements under section 
404(c)(5) and this regulation also will serve to satisfy the separate 
notice requirements set forth in section 514(e)(3) for automatic 
contribution arrangements.

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 for each violation of section 514(e)(3) of 
ERISA. Implementing regulations will be developed in a separate 
rulemaking.

D. Effective Date

    This final regulation will be effective 60 days after the date of 
its publication in the Federal Register.

E. Regulatory Impact Analysis

Summary

    This regulation is expected to have two major economic 
consequences. Default investments will be directed more toward higher-
return portfolios, boosting average investment returns, and automatic 
enrollment provisions will become more common, boosting participation. 
Both of these effects will increase average retirement savings, 
especially among workers who are younger, have lower earnings and/or 
more frequent job changes. A substantial number of individuals will 
enjoy significant increases in retirement income, while a few may 
experience decreases if the introduction of automatic enrollment slows 
their saving or if their default investment returns are particularly 
poor. The magnitude of these effects will be large in absolute terms 
and proportionately large for many directly affected individuals.
    The regulation's effects will be cumulative and gradual, and their 
magnitude will depend on plan sponsor and participant choices. The 
Department has developed low- and high-impact estimates to illustrate a 
range of potential long-term effects.
    By 2034 the regulation (together with the automatic enrollment 
provisions of the Pension Protection Act) is predicted to increase 
aggregate annual 401(k) plan contributions by between 2.6 percent and 
5.1 percent, or by $5.7 billion to $11.3 billion (expressed in 2006 
dollars). It is predicted to increase aggregate account balances by 
between 2.8 percent and 5.4 percent, or by $70 billion to $134 billion. 
Between 83 percent and 77 percent of net new 401(k) accumulations will 
be preserved for retirement rather than cashed out early.
    Low-impact estimates indicate that the regulation will increase 
pension income by $1.3 billion per year on aggregate for 1.6 million 
individuals age 65 and older in 2034, but decrease it by $0.3 billion 
per year for 0.6 million. High-impact estimates suggest that pension 
income will increase by $2.5 billion for 2.5 million and fall by $0.6 
billion for 0.9 million. Impacts on retirement income will be larger 
farther in the future, reflecting the fact that automatic enrollment 
and default investing disproportionately affect young workers.
    A substantial portion of the increase in retirement savings will be 
attributable directly to the movement of default investments away from 
stand-alone, fixed income capital preservation vehicles and toward 
qualified default investment alternatives that provide for capital 
appreciation as well as capital preservation. The majority of the 
increase, however, will be attributable to the proliferation of 
automatic enrollment.
    The Department believes that the net increase in retirement savings 
will translate into a net improvement in welfare. There is substantial 
risk that savings will fall short relative to many workers' retirement 
income expectations, especially in light of increasing health costs and 
stresses on defined benefit pension plans and the Social Security 
program. The regulation will help reduce that risk. An increase in 
retirement savings additionally is likely to promote investment and 
long-term economic productivity and growth. The Department therefore 
concludes that the benefits of this regulation will justify its costs.

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). Section 3(f) of the Executive Order 
defines a ``significant regulatory action'' as 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 
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

[[Page 60467]]

mandates, the President's priorities, or the principles set forth in 
the Executive Order. 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 
regulation. The Department believes that the regulation's benefits 
justify its costs.

Regulatory Flexibility Act

    The Department certified that the proposed regulation, if adopted, 
would not have a significant economic impact on a substantial number of 
small entities. 71 FR 56806, 56815 (Sept. 27, 2006). In explaining the 
basis for this certification, the Department noted that 10 to 20 
percent of small participant directed defined contribution plans 
(28,000 to 56,000 plans) might adopt automatic enrollment programs as a 
result of the regulation. Consequently, some of the employers 
sponsoring such plans may have to make additional matching 
contributions (up to $100 million to $300 million annually). The 
Department expects that the amount of such additional contributions to 
small plans would be proportionately similar to those to large plans. 
The Department did not expect the proposed regulation to have any 
adverse consequences for small plans or their sponsors because all the 
factors at issue, including the payment of matching contributions, the 
adoption of automatic enrollment programs, and compliance with the 
regulation are voluntary on the part of the plan sponsor.
    The Department received one comment regarding the proposed 
regulation's potential effect on small entities. The commenter believes 
that certain types of mutual funds that would be qualified default 
investment alternatives under paragraph (e)(4)(i) (e.g., life-cycle or 
target-retirement date funds) sometimes invest in other types of mutual 
funds. According to the commenter, the investment advisers for the 
life-cycle or target-retirement-date funds may have an incentive to 
skew the fund's allocation toward sub funds that generate higher fees 
than to funds that would be most appropriate for the age or expected 
retirement date of the affected participants. The commenter stated that 
fiduciaries of small plans wishing to use the safe harbor would need to 
expend disproportionately more resources than large plan fiduciaries in 
making sure that the asset allocations (and thus, the corresponding fee 
structures) are not tainted by conflicts of interest. Specifically, the 
commenter was concerned that unlike larger plans which could conduct 
analyses of the neutrality of asset allocations in-house, small plans 
would have to expend resources on using outside consultants to conduct 
such analyses or face potential liability for a failure to do so. The 
commenter mentioned that some funds are willing to indemnify 
fiduciaries of large plans from any liability associated with choosing 
such funds. The commenter suggested that the Department add measures to 
mitigate the likelihood of conflicts, such as requiring that such funds 
allocate assets pursuant to independent algorithms and require equal 
treatment for small plan fiduciaries with regard to indemnification.
    Plan fiduciaries must take into account potential conflicts of 
interest and the reasonableness of fees in choosing and monitoring any 
investment option for a plan, whether covered under the safe harbor or 
not. This obligation flows from the fiduciary duties of prudence and 
loyalty to the participants set out in ERISA section 404(a)(1). The 
regulation imposes no new requirements for selecting qualified default 
investment alternatives. For large or small plans, the duty to evaluate 
a plan investment option exists regardless of whether the plan includes 
an automatic enrollment feature or whether the fiduciary is seeking to 
comply with this regulation. Thus, the Department continues to believe 
that this regulation would not have a significant effect on a 
substantial number of small entities.
    The Department considered the commenter's suggestions. Adopting 
them, however, could limit plans' choices or increase the cost of 
qualified default investment alternatives. The regulation does not 
prevent plan fiduciaries from taking features such as independent 
algorithms into account in choosing qualified default investment 
alternatives. If it determines that a widespread need for such 
assistance exists, the Department may consider providing guidance for 
small plans regarding prudent selection of qualified default investment 
alternatives.
    The Department has also considered the changes made in this 
document from the proposed regulation. These changes, including the 
modified notice requirement, allowing trustees and certain plan 
sponsors to manage qualified default investment alternatives, and the 
addition of a temporary qualified default investment alternative are 
discussed more fully earlier in this document. They do not affect the 
Department's determination regarding the regulation's impact on small 
entities. Therefore, the Department recertifies its earlier conclusion 
that this regulation will not have a significant economic impact on a 
substantial number of small entities.

Paperwork Reduction Act

    In accordance with the requirements of the Paperwork Reduction Act 
of 1995 (PRA) (44 U.S.C. 3506(c)(2)), the proposed regulation solicited 
comments on the information collections included in the proposed 
regulation. The Department also submitted an information collection 
request (ICR) to OMB in accordance with 44 U.S.C. 3507(d), 
contemporaneously with the publication of the proposed regulation, for 
OMB's review.\11\ Although no public comments were received that 
specifically addressed the paperwork burden analysis of the information 
collections, the comments that were submitted, and which are described 
earlier in this preamble, contained information relevant to the costs 
and administrative burdens attendant to the proposals. The Department 
took into account such public comments in connection with making 
changes to the proposal, analyzing the economic impact of the 
proposals, and developing the revised paperwork burden analysis 
summarized below.
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    \11\ On Nov. 20, 2006, OMB issued a notice (ICR Reference No. 
200608-1210-003) that it would not approve the Department's request 
for approval of the information collection provisions until after 
consideration of public comment on the proposed regulation and 
promulgation of a final rule, describing any changes.
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    In connection with publication of this final rule, the Department 
has submitted an ICR to OMB for its request of a new collection. The 
public is advised that an agency may not conduct or sponsor, and a 
person is not required to respond to, a collection of information 
unless it displays a currently valid OMB control number. The Department 
intends to publish a notice announcing OMB's decision upon review of 
the Department's ICR.
    A copy of the ICR may be obtained by contacting the PRA addressee 
shown below or at http://www.RegInfo.gov. PRA ADDRESSEE: Gerald B. 

Lindrew, 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) 219-4745. These are not toll-free numbers.
    The regulation provides certain specified relief from fiduciary 
liability for fiduciaries who make investment decisions on behalf of 
participants and beneficiaries in individual account

[[Page 60468]]

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 or beneficiary 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 regulation requires that the assets 
of non-directing participants or beneficiaries be invested in one of 
the qualified default investment alternatives described in the 
regulation and that certain other specified conditions be met.
    The regulation imposes two separate disclosure requirements to 
participants and beneficiaries that are conditions to the relief 
created by the final regulation, as follows: (1) The plan must provide 
an initial notice containing specified information to any individual 
whose assets may be invested in a qualified default investment 
alternative generally at least 30 days prior to the date of plan 
eligibility (or on or before the date of plan eligibility if the 
participant is permitted to make a withdrawal under Code section 
414(w)) and thereafter annually at least 30 days before the beginning 
of each plan year; and (2) the plan must provide certain materials that 
it receives relating to participants' and beneficiaries' investments in 
a qualified default investment alternative. The ``pass-through'' 
materials that must be provided are those specified in the Department's 
regulation under ERISA section 404(c) at 29 CFR 2550.404c-
1(b)(2)(i)(B)(1)(viii) and (ix) and 29 CFR 404c-1(b)(2)(i)(B)(2). The 
information collection provisions of this 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 on which the 
Department's burden analysis is based are derived primarily from the 
Form 5500 Series filings for the 2004 plan year, which are the most 
recent reliable data available to the Department.\12\ 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 the initial and 
annual notices and that such communications will make use of existing 
systems. Accordingly, no cost has been attributed to the electronic 
distribution of information.
---------------------------------------------------------------------------

    \12\ The Department does not anticipate an increase in the 
number of Form 5500 filings merely due to the changes to the Form 
5500 for 2007 to 2009.
---------------------------------------------------------------------------

    Annual Notice--29 CFR 2550.404c-5(c)(3). The regulation requires 
that notice be provided initially, before any portion of a 
participant's or beneficiary's account balance is invested in a 
qualified default investment alternative, and annually thereafter. The 
notice generally must describe: (1) The circumstances under which 
assets in the individual account of a participant or beneficiary may be 
invested on behalf of the participant or beneficiary in a qualified 
default investment alternative; and, if applicable, an explanation of 
the circumstances under which elective contributions will be made on 
behalf of a participant, the percentage of such contributions, and the 
right of the participant to elect not to have such contributions made 
on the participant's behalf (or to elect to have such contributions 
made at a different percentage); (2) the right of participants and 
beneficiaries to direct the investment of assets in their accounts; (3) 
the qualified default investment alternative, including its investment 
objectives, risk and return characteristics (if applicable), and fees 
and expenses; (4) the participants' and beneficiaries' right to direct 
the investment of the assets to any other investment alternative 
offered under the plan, including a description of any applicable 
restrictions, fees or expenses in connection with such a transfer; and 
(5) where participants and beneficiaries can obtain information about 
the other investment alternatives available under the plan.
    The Department estimates that 424,000\13\ participant directed 
individual account pension plans will prepare and distribute notices to 
62,544,000 eligible workers, participants and beneficiaries in the 
first year in which this regulation becomes applicable. Preparation of 
the 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 212,000 burden hours. For the 62 percent of participants and 
beneficiaries who will receive the notice by mail (38,777,000 
individuals), distribution of the notice is estimated to require an 
additional 310,000 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 notice to the remaining 38 
percent of participants and beneficiaries who will receive this notice 
electronically (23,767,000 individuals). The total annual burden hours 
estimated for the notice in the first year, therefore, are 522,000. The 
equivalent cost for this burden hour estimate is $30,232,000 (legal 
professional time is valued at $106 per hour, and clerical time is 
valued at $25 per hour).\14\
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    \13\ All numbers used in this paperwork burden estimate have 
been rounded to the nearest thousand.
    \14\ EBSA estimates based on the Bureau of Labor Statistics, 
National Occupational Employment Survey (May 2005) and the Bureau of 
Labor Statistics, Employment Cost Index (Sept. 2006).
---------------------------------------------------------------------------

    In addition to burden hours, the Department has estimated annual 
costs attributable to the notice for the first year, based on materials 
and postage, at $19,776,000. This comprises the material cost for a 
two-page notice ($.10 per notice) to 38,777,000 participants and 
beneficiaries (62 percent of 62,544000 participants and beneficiaries), 
which equals $3,878,000, plus postage at $0.41 per mailing, which 
equals $15,899,000. Total annual costs for the notice in the first year 
are therefore estimated at $19,776,000.
    In years subsequent to the first year of applicability, the 
Department estimates that notices will be prepared only by newly 
established participant directed individual account pension plans and 
plans that change 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 (141,000 plans) will prepare and distribute new or 
updated notices to all participants and beneficiaries, requiring 24 
minutes of legal professional time per notice. The preparation of these 
notices in each subsequent year is estimated to require 57,000 hours. 
However, the number of participants receiving 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 notice 
by mail (38,777,000 individuals) will require 310,000 hours and 
$19,776,000 additional materials and postage cost. (As for the first 
year, the Department has assumed that electronic distribution of the 
notice in subsequent years will not add any significant additional 
paperwork burden.)
    Based on those assumptions, the Department estimates that the total

[[Page 60469]]

burden hours for notices under this regulation in each year after the 
first year of applicability will fall to 367,000 hours. The equivalent 
cost of such an hour burden (using the same assumptions as for the 
first year) is $13,749,000. The total cost burden estimated for 
subsequent years for the notice will remain at $19,776,000.
    Pass-through Material--29 CFR 2550.404c-5(c)(4). Under the 
regulation, the fiduciary shall qualify for the relief described in 
paragraph (b)(1) of the final regulation if a fiduciary provides 
material to participants and beneficiaries as set forth in paragraphs 
(b)(2)(i)(B)(1)(viii) and (ix), and paragraph (b)(2)(i)(B)(2) of the 
404(c) regulation. In addition, plans must be prepared to provide 
certain information on request and must therefore maintain such 
information in updated form in order to comply. The paperwork burden 
for the pass-through disclosure requirements calculated here does not 
include pass-through disclosure burden for section 404(c) plans, as 
these disclosures for section 404(c) plans were considered in the 
renewal to OMB Control No. 1210-0090.\15\
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    \15\ See 71 FR 64564 (Nov. 2, 2006). The paperwork burden as 
calculated for section 404(c) plans assumes that plans send pass-
through disclosures to all participants and beneficiaries in section 
404(c) plans, not only to the ones that are actively directing their 
investments.
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    The 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 (3,794,000 individuals) will have 
default investments. Of these, 1,072,000 individuals are invested in 
participant directed individual account pension plans that are not 
section 404(c) plans. 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 financial statements and prospectuses, and 
that plans will also receive other pass-through materials on occasion. 
These two factors result in an estimate of 4,286,000 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 107,000 hours of clerical time. The equivalent cost of this 
hour burden is estimated at $2,679,000. Additional cost burden for the 
pass-through of material is estimated to include paper cost (40 pages 
of material yearly per participant or beneficiary) and postage ($.58 
per mailing) at $4,629,000 annually for 4 distributions per participant 
or beneficiary with a default investment.
    Plans also need to maintain information in order to provide certain 
information on request. This preparation is estimated to require one 
hour of clerical time for each of the 162,000 newly affected plans, for 
a total of 162,000 burden hours. The Department assumes that, on 
average, plans will make one disclosure upon request every year and 
that it takes one-half minute of clerical time per disclosure to send 
out the materials, requiring about 4,000 hours of clerical time. In 
total, the preparation and sending of information upon request requires 
166,000 burden hours with equivalent costs of $4,145,000. Additional 
cost burden for the material is estimated to include paper cost (20 
pages of material yearly per information request) and postage ($0.89 
per mailing) at $306,000.\16\
---------------------------------------------------------------------------

    \16\ The burden arising from these disclosure requirements will 
be the same in subsequent years.
---------------------------------------------------------------------------

    In total, the Department estimates that providing pass-through 
disclosures to non-directing participants and beneficiaries under this 
regulation will require annual burden hours of approximately 273,000 
hours (with equivalent costs of $6,824,000) and total costs of 
$4,935,000.
    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-AB10.
    Affected Public: Business or other for-profit; not-for-profit 
institutions.
    Respondents: 424,000.
    Responses: 66,991,000.
    Frequency of Response: Annually; occasionally.
    Estimated Total Annual Burden Hours: 795,000 (first year).
    Estimated Total Annual Burden Cost: $24,711,000 (first year).

Congressional Review Act

    This notice of final rulemaking is subject to the Congressional 
Review Act provisions of the Small Business Regulatory Enforcement 
Fairness Act of 1996 (5 U.S.C. 801 et seq.) and therefore has been 
transmitted to the Congress and the Comptroller General for review.

Unfunded Mandates Reform Act

    Pursuant to the 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, that may impose an annual burden of $100 million 
or more, adjusted for inflation.

Economic Impacts

    By 2034 the regulation (together with the automatic enrollment 
provisions of the Pension Protection Act) is predicted to increase 
aggregate account balances by between 2.8 percent and 5.4 percent, or 
by $70 billion to $134 billion.
Investment Mix
    A large but declining proportion \17\ of 401(k) plans currently 
direct default investments exclusively to fixed income capital 
preservation vehicles such as money market or stable value funds. By 
reducing risks attendant to fiduciary responsibility and liability, 
this regulation is expected to encourage more plans to direct default 
investments to vehicles that include a mix of equity and fixed income 
instruments and thereby provide the potential for capital appreciation 
as well as capital preservation.
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    \17\ Various surveys estimate the proportion at 40 percent 
(Profit Sharing/401(k) Council of America, 49th Annual Survey of 
Profit Sharing and 401(k) Plans (2006) at 39), 41 percent (Deloitte 
Consulting, Annual 401(k) Benchmarking Survey, 2005/2006 Edition 
(2006) at 7), and 21 percent (Vanguard, How America Saves 2006 
(Sept. 2006) at 26 ). Surveys also reveal a trend away from capital 
preservation defaults toward investment vehicles like those included 
as qualified default investment alternatives for future 
contributions under this regulation.
---------------------------------------------------------------------------

    As a result of this regulation, it is estimated that in 2034, 
401(k) plan investments in qualified default investment alternative-
type vehicles (expressed in 2006 dollars) will increase by between $65 
billion and $116 billion. The portion of this estimated increase that 
is attributable directly to the redirection of default investments is 
between $18 billion and $24 billion. The rest is attributable to 
increased contributions, which are discussed below.\18\
---------------------------------------------------------------------------

    \18\ These estimates pertain only to default investments made on 
behalf of defaulted participants under automatic enrollment 
programs. The default investment regulation is not so limited. 
Therefore, these estimates are likely to omit some of the 
redirection of default investments that will occur under the 
regulation.

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[[Page 60470]]

Investment Performance
    Historically, over long time horizons, diversified portfolios that 
include equities have tended to deliver higher returns than those 
consisting only of lower risk debt instruments.\19\ It therefore is 
widely believed to be advantageous to invest retirement savings in 
diversified portfolios that include equity.\20\
---------------------------------------------------------------------------

    \19\ See, e.g., Ibbotson Associates, Stocks, Bonds, Bills and 
Inflation, 2006 Yearbook (2006).
    \20\ See, e.g., U.S. Securities and Exchange Commission, 
Beginners' Guide to Asset Allocation, Diversification, and 
Rebalancing (May 2007), at http://www.sec.gov/investor/pubs/assetallocation.htm
; and Stephen P. Utkus, Selecting a Default Fund 

for a Defined Contribution Plan, Vanguard Center for Retirement 
Research, Volume 14 (June 2005) at 6.
---------------------------------------------------------------------------

    As noted above, this regulation is expected to encourage the 
redirection of default investments from stand-alone, low-risk capital 
preservation instruments to diversified portfolios that include 
equities. This in turn is expected to improve investment results for a 
large majority of affected individuals, increasing aggregate account 
balances by an estimated $5 billion to $7 billion in 2034.
    In deriving these estimates, in response to public and peer 
reviewer comments, the Department refined its assumptions regarding 
investment performance relative to those relied on in its estimates of 
the proposed regulation's effects. This is explained further below 
under headings ``Basis of Estimates'' and ``Peer Review.''
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,\21\ but the number may now be as high as 24 percent \22\ 
and could reach 35 percent in the near future, absent this final 
rule.\23\
---------------------------------------------------------------------------

    \21\ U.S. Bureau of Labor Statistics, National Compensation 
Survey: Employee Benefits in Private Industry in the United States, 
2002-2003, Bulletin 2573 (Jan. 2005).
    \22\ EBSA estimate. The proportion of plans in various size 
classes that provide automatic enrollment was taken from Profit 
Sharing/401(k) Council of America, 49th Annual Survey of Profit 
Sharing and 401(k) Plans (2006) at 38. 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.
    \23\ The incidence of automatic enrollment appears to be 
growing. According to one series of surveys automatic enrollment 
spread from 8.4 percent of plans in 2003 to 16.9 percent in 2005 
(Profit Sharing/401(k) Council of America, 49th Annual Survey of 
Profit Sharing and 401(k) Plans (2006) at 38). Another found that 
automatic enrollment spread from 15 percent of plans in 2003 to 23 
percent in 2005 with an additional 29 percent considering it for the 
future (Deloitte Consulting, 2003 Annual 401(k) Benchmarking Survey 
(2004) at 25 and Deloitte Consulting, Annual 401(k) Benchmarking 
Survey 2005/2006 Edition (2006) at 7). According to yet another, it 
grew from 14 percent in 2003 to 24 percent in 2006, with 23 percent 
of the remainder ``very likely'' and 25 percent ``somewhat likely'' 
to begin automatic enrollment within the year (Hewitt Associates 
LLC, Survey Findings: Trends and Experiences in 401(k) Plans, 2005 
(2005) at 13, and Hewitt Associates LLC, Survey Findings: Hot Topics 
in Retirement, 2006 (2006) at 3).
---------------------------------------------------------------------------

    The Department expects and intends that this regulation, together 
with the automatic enrollment provisions of the Pension Protection Act, 
will promote wider implementation of automatic enrollment programs. The 
regulation will help alleviate fiduciary concerns that might otherwise 
discourage implementation of automatic enrollment programs. It will 
also make it possible for plan sponsors to take advantage of Pension 
Protection Act provisions that waive certain Internal Revenue Code bars 
against discrimination in favor of highly compensated employees and 
that preempt state laws unfriendly to automatic enrollment programs. As 
a result of the regulation, in the near future automatic enrollment 
programs may cover 50 percent to 65 percent of 401(k)-eligible workers 
rather than 35 percent.\24\
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    \24\ The Department believes these figures reasonably illustrate 
a range of possible outcomes. The Department is confident that the 
regulation will increase the incidence of automatic enrollment. 
According to one survey, among plans that currently are somewhat or 
very unlikely to offer automatic enrollment in the future, 36 
percent cite the need for the Department to identify appropriate 
default investments, 33 percent cite the need for preemption of 
unfriendly state laws, and 30 percent cite the need for relief from 
nondiscrimination requirements (Hewitt Associates LLC, Survey 
Findings: Hot Topics in Retirement, 2006 (2006) at 5).
---------------------------------------------------------------------------

Participation
    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.\25\ Automatic 
enrollment programs increase many such employees' contribution rates 
from zero to the default rate, often supplemented by some employer 
matching contributions. 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. However, there is also evidence that 
automatic enrollment programs can have the effect of lowering 
contribution rates for some employees below the level that they would 
have elected absent automatic enrollment. Current surveys indicate that 
the default contribution rates are typically set at 3 percent of 
salary.\26\ Some employees who might otherwise have actively enrolled 
in a plan (either at first eligibility or later) and elected a higher 
contribution rate may instead permit themselves to be enrolled at the 
default rate. \27\
    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 regulation 
will increase overall 401(k) participation rates from 73 percent to 
between 77 percent and 80 percent.\28\ Aggregate annual contributions 
in 2034 are expected to grow on net by between $5.7 billion and $11.3 
billion (expressed in 2006 dollars). These and related estimates are 
summarized in Table 1 below.
---------------------------------------------------------------------------

    \25\ According to the Department's low- and high-impact 
estimates (respectively), under the regulation, active (non-
defaulted) participants will number between 32 million and 33 
million in 2034. Their ages will average between 44.2 and 44.1 
years, and their pay will average between 160 percent and 158 
percent of average earnings calculated by the Social Security 
Administration. Defaulted participants will number between 4.2 
million and 5.4 million. In contrast to active participants, their 
ages will average between 34.0 and 34.1 years, and their pay will 
average between 109 percent and 108 percent of average pay in Social 
Security covered employment.
    \26\ It is possible that in the future more plans will provide 
for higher or escalating default contribution rates. The Pension 
Protection Act waives certain bars against discrimination in favor 
of highly compensated employees for 401(k) plans with automatic 
enrollment that satisfy certain conditions. One such condition 
generally provides that a participant's default contribution rate 
must escalate to at least 6 percent not later than his fourth year 
of participation.
    \27\ See, e.g., James J. Choi, David Laibson, Brigette C. 
Madrian and Andrew Metrick, Saving for Retirement on the Path of 
Least Resistance (updated draft analysis, July 19, 2004) at 56-57, 
Figures 2A-2D; and James J. Choi, David Laibson and Brigitte C. 
Madrian, Plan Design and 401(k) Savings Outcomes (written for the 
National Tax Journal Forum on Pensions, June 2004) at 11.
    \28\ These numbers are rounded to the nearest percentage point.

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[[Page 60471]]

[GRAPHIC] [TIFF OMITTED] TR24OC07.005

Preservation
    New employee contributions attributable to automatic enrollment 
will be attributable disproportionately to younger, lower-paid, 
shorter-tenure workers.
    Some such workers, who absent automatic enrollment would have 
delayed participation, will begin contributing earlier and thereby 
accumulate larger balances. The investment of these contributions in 
qualified default investment alternatives, rather than in capital 
preservation vehicles, will further enlarge account balances on 
average. Larger balances are more likely to be preserved for 
retirement. Therefore it is possible that the regulation will increase 
the proportion of 401(k) accounts that are preserved.\29\
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    \29\ There will be other, smaller effects. Because larger 
accounts are more likely to be preserved, any effect of the 
regulation on account balances may also affect the preservation 
rate. As noted below, while automatic enrollment increases 
contributions for many workers, it may decrease them for a few. 
Likewise, while movement from capital preservation investments to 
qualified default investment alternatives will boost investment 
returns for many, it may reduce returns for a few. All of these 
effects in turn affect account balances and preservation rates. The 
Department's estimates account for all of these effects.
---------------------------------------------------------------------------

    On the other hand, other such workers may accumulate only small 
accounts before leaving their jobs. Historically, younger, lower-paid 
workers with small accounts have tended disproportionately to cash out 
their accounts upon job change rather than preserve them in tax-
deferred retirement accounts. It is therefore also possible that, by 
encouraging automatic enrollment, the proportion (but not the total 
amount) of 401(k) accounts preserved for retirement could decrease.
    The Department estimates that these effects will nearly offset one 
another. Workers will leave an estimated 4.3 million 401(k)-eligible 
jobs in 2033. As a result of this regulation (together with the 
automatic enrollment provisions of the Pension Protection Act), the 
number leaving with positive account balances will grow from 2.30 
million to between 2.45 million and 2.61 million. The proportion of 
those leaving with positive accounts that preserve their accounts for 
retirement will fall slightly from 61.0 percent to between 60.4 percent 
and 59.7 percent, and the proportion of the account balances preserved 
will fall from 85.9 percent to between 85.8 percent and 85.4 percent. 
The regulation's marginal effect on the preservation of account 
balances can be illustrated by comparing estimated net increases in 
account-holding job leavers and their account balances with estimated 
net increases in preserved accounts. The proportion of net new job 
leavers with account balances that preserve their accounts is estimated 
to be approximately 50 percent, while the proportion of net new job-
leaver accounts that is preserved is estimated to be 83 percent to 77 
percent.
Retirement Income
    Low-impact estimates suggest that the regulation will increase 
pension income by $1.3 billion per year on aggregate for 1.6 million 
individuals age 65 and older in 2034 (expressed in 2006 dollars), but 
decrease it by $0.3 billion per year for 0.6 million. High-impact 
estimates suggest that average annual pension income will increase by 
$2.5 billion for 2.5 million and fall by $0.6 million for 0.9 million. 
These estimates are summarized in Table 2 below. Impacts on retirement 
income will be larger farther in the future, reflecting the fact that 
automatic enrollment and default investing disproportionately affect 
young workers.

[[Page 60472]]

[GRAPHIC] [TIFF OMITTED] TR24OC07.006

    The regulation is estimated to have distributional consequences, 
narrowing somewhat the distribution of pension income across earnings 
groups. Among all individuals age 65 or older in 2034, for example, 
those in the lowest lifetime earnings quartile would receive just 5 
percent of pension income absent the regulation, but they will receive 
9 percent of net gains from the regulation. The amount they gain will 
exceed the amount lost by a factor of five or six (see Table 3 below).
[GRAPHIC] [TIFF OMITTED] TR24OC07.007

Administrative Cost
    Plan sponsors may incur some administrative costs in order to meet 
the conditions of the regulation. The Department generally expects such 
costs to be low. Any changes to plan provisions or procedures necessary 
to satisfy the regulation's conditions are likely to be no more 
extensive than those associated with changes that plans implement from 
time to time in the normal course of business. The boundaries of the 
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 safe 
harbor. Costs attendant to the regulation's notice provisions can be 
mitigated by furnishing the notices together with other plan 
disclosures and/or through the use of electronic media. The requirement 
to pass through certain investment materials to participants and 
beneficiaries is the same as that already applicable to participant 
directed individual account plans operating in accordance with ERISA 
section 404(c). The Department's estimates of these costs are presented 
above under the heading Paperwork Reduction Act.
    The regulation may indirectly prompt some plan sponsors to shoulder 
additional benefit costs. For example, it is expected that the 
regulation, by promoting the adoption of automatic enrollment programs, 
will have the indirect effect of increasing aggregate employer matching 
contributions in 2034 by between $1.7 billion and $3.4

[[Page 60473]]

billion (expressed in 2006 dollars). 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. Reliance on the regulation and, therefore, compliance 
with its provisions are also voluntary on the part of the plan sponsor.
Cost-Benefit Assessment
    The Department believes that, by increasing average retirement 
income, the regulation will improve overall social welfare. There is 
mounting concern that many Americans have been preparing inadequately 
for retirement. Most workers are on track to have more retirement 
wealth than most current retirees, and recent declines in reported 
savings rates may not be cause for alarm in light of offsetting capital 
gains. Nonetheless, savings may fall short relative to workers' 
retirement income expectations, especially in light of increasing 
health costs and stresses on defined benefit pension plans and the 
Social Security program.\30\ Because of these real risks, the 
Department believes that policies that increase retirement savings can 
increase welfare by helping workers secure retirement living standards 
that meet their expectations.
---------------------------------------------------------------------------

    \30\ See generally U.S. Council of Economic Advisors, Economic 
Report of the President, February 2006 (2006).
---------------------------------------------------------------------------

    The regulation may also have macroeconomic consequences, which are 
likely to be small but positive. An increase in retirement savings is 
likely to promote investment and long-term economic productivity and 
growth. The increase in retirement savings will be very small relative 
to overall market capitalization. Therefore macroeconomic benefits are 
likely to be small. Based on the foregoing analysis and estimates, the 
Department believes that the benefits of this regulation will justify 
its costs.

Basis of Estimates

    The Department estimated the effect of the regulation on 401(k) 
plan participation, contributions, account balances, investment mix, 
and early cash outs, and its effect on pension incomes in retirement, 
using a microsimulation model of lifetime pension accumulations known 
as PENSIM.\31\ To produce the low and high impact estimates presented 
here, PENSIM was parameterized and applied as follows.
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    \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, Retirement 
Income: Intergenerational Comparisons of Wealth and Future Income, 
GAO-03-429 (Apr. 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, 
Pension Plans: Information on Cash Balance Pension Plans, GAO-06-42 
(Oct. 2006).
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    First, automatic enrollment was assigned randomly to 401(k) plan 
eligible employees to achieve incidences of 35 percent (baseline), 50 
percent (low impact) and 65 percent. 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\
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    \32\ These findings were drawn from James J. Choi, David Laibson 
and Brigitte C. Madrian, Plan Design and 401(k) Savings Outcomes 
(written for the National Tax Journal Forum on Pensions, June 2004). 
The overall participation rate under automatic enrollment was 
adjusted upward to 90 percent.
    \33\ See e.g., Vanguard, How America Saves 2006 (Sept. 2006 ) at 
26, Deloitte Consulting, Annual 401(k) Benchmarking Survey, 2005/
2006 Edition (2006) at 7; Hewitt Associates LLC, Survey Findings: 
Trends and Experiences in 401(k) Plans, 2005 (2005) at 16; and 
Profit Sharing/401(k) Council of America, 49th Annual Survey of 
Profit Sharing and 401(k) Plans (2006) at 38.
---------------------------------------------------------------------------

    Defaulted participants were assumed to invest their contributions 
as follows:\34\ in the baseline estimates, either in a money market 
fund \35\ (50 percent) or a qualified default investment alternative 
(50 percent); in the low- and high-impact estimates of the regulation's 
effects, all entirely to a qualified default investment 
alternative.\36\ Active contributors were assumed to invest their 
contributions either in a qualified default investment alternative (75 
percent), a U.S. Treasury bond fund (15 percent), or an even mix of the 
two (10 percent). Some employer contributions were assumed to be 
invested in company stock. Price inflation and real returns were 
estimated stochastically. Mean price inflation was assumed to be 2.8 
percent, and mean real returns to money market funds, Treasury bond 
funds, and equity funds, respectively, were assumed to be 1.3 percent, 
2.9 percent, and 4.9 percent. Deducted respectively from

[[Page 60474]]

these returns were assumed fees of 45, 45 and 75 basis points.
---------------------------------------------------------------------------

    \34\ These estimates assume complete correspondence between 
automatic enrollment in 401(k) plans and default investing. 
Participants contributing by automatic enrollment are assumed to 
invest in the plan's default investment, 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 who 
are automatically enrolled may nonetheless actively direct their 
investments. Some active contributors or participants in plans 
without elective contributions may choose to invest in the plan's 
default investment `` and this 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 automatic enrollment.
    \35\ Some comments on the proposed regulation suggested that 
money market funds may not accurately represent the range of capital 
preservation instruments that might serve as default investments. In 
particular, according to some comments, stable value funds, relative 
to money market funds, offer higher returns with similarly low risk. 
The Department's estimates of the effects of the proposed regulation 
did not reflect this possibility. The Department agrees that stable 
value funds, if they perform as projected by their proponents, would 
outperform money market funds and thereby narrow (but not eliminate) 
the gains in average account balances and retirement income 
estimated to result from the shift toward qualified default 
investment alternatives. However, the Department believes that this 
possibility should be assessed with caution. Economic theory 
suggests that if financial markets are efficient, financial 
instruments with similar risk characteristics will provide similar 
returns. It therefore seems likely that there are important 
differences between money market and stable value funds beyond any 
difference in average returns. The Department understands that 
stable value products may come with a variety of features that may 
sometimes erode actual returns in response, for example, to certain 
plan sponsor actions that have the effect of shifting participant 
account allocations away from such products. Such stable value 
product features may sometimes dissuade plans or participants from 
making investment changes that they otherwise would, thereby 
imposing opportunity costs. The Department also understands that 
stable value products may expose investors to the credit risk of the 
fund vendor in ways that money market funds do not. This credit risk 
may be sensitive to changes in interest rates. In light of these 
considerations the Department continues to believe that, for 
purposes of assessing the impact of this regulation, money market 
funds reasonably represent available near risk-free investment 
instruments.
    Nonetheless, in an effort to fully consider the potential 
implications of representations made in the comments, the Department 
tested the sensitivity of its low-impact estimates to 
representations regarding the investment performance of stable value 
products and assuming stable value products would be a substantial 
part of qualified default investments in the future. The sensitivity 
test puts aside the above considerations, and replaces money market 
fund performance with stylized stable value performance that is 200 
basis points higher and equally variable. Under this test scenario, 
the regulation would increase aggregate account balances in 2034 by 
$68 billion (for comparison the Department's primary estimate is $70 
billion), of which $3 billion (compared with $5 billon) is 
attributable to the shift of default investments from near risk-free 
instruments to qualified default investment alternatives. Among 
individuals age 65 and older in 2034, the number gaining retirement 
income would exceed the number losing by a ratio of 2.2 to 1 
(compared with 2.7 to 1) and the aggregate amount gained would 
exceed that lost by a ratio of 3.8 to 1 (compared with 4.1 to 1).
    \36\ The qualified default investment alternative is represented 
by a portfolio resembling a life cycle fund, with 100 percent minus 
the participant's age in equity and the remainder in U.S. Treasury 
bonds.
---------------------------------------------------------------------------

    To estimate the effects of the regulation, the Department compared 
the baseline estimates to the low- and high-impact estimates.
    For a more detailed explanation of the basis of these estimates, 
see Martin R. Holmer, ``PENSIM Analysis of Impact of Final Regulation 
on Defined--Contribution Default Investments'' (Policy Simulation 
Group, February 12, 2007). For additional estimation results, see 
Holmer, ``EBSA Automatic Enrollment RIA: Final Estimates'' (Policy 
Simulation Group, February 7, 2007). Both are available as part of the 
public docket associated with this regulation. Additional information 
on the Department's use of PENSIM in connection with this regulation is 
provided below, under the heading ``Peer Review.''

Sensitivity Tests

    As noted above, the Department anticipates that this regulation 
(together with the automatic enrollment provisions of the Pension 
Protection Act) will have two major, beneficial 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. In reaching 
its conclusion that the regulation will increase retirement income and 
improve social welfare, the Department took into account the potential 
sensitivity of its estimates to important economic and behavioral 
variables.
    One variable involves the future incidence of automatic enrollment 
programs. As noted above the Department assessed this variable by 
comparing both low- and high-impact estimates with a common baseline. 
This variable affects the magnitude but not the net positive direction 
of the regulation's estimated effects.
    The specific characteristics of future automatic enrollment 
programs constitute additional variables. For example, will new 
automatic enrollment programs cover only new employees, or existing 
non-participating employees as well? \37\ The Department's estimates 
reflect automatic enrollment of new employees only. If plan sponsors 
automatically enroll existing employees the regulation's effects will 
be larger than estimated, especially in the near term. What default 
contribution rates will prevail? \38\ The Department's primary 
estimates assume a uniform 3 percent default contribution rate. Higher 
contribution rates would increase the size of default participants' 
contributions, but might also discourage some from participating. To 
illustrate these potential effects the Department produced two 
alternative low-impact estimates substituting a 4.5-percent default 
contribution rate. One estimate assumed that the impact of automatic 
enrollment on participation was undiminished by the higher default 
contribution rate, the other that it was diminished by half. These were 
compared with the primary baseline estimate. Where the Department's 
primary low-impact estimate placed the increase in aggregate account 
balances in 2034 at $70 billion, the first alternative placed it at 
$123 billion, the second at $40 billion.
---------------------------------------------------------------------------

    \37\ According to one survey, 24 percent of employers with 
automatic enrollment programs extended initial automatic enrollment 
beyond new hires to include the entire eligible population (Deloitte 
Consulting, Annual 401(k) Benchmarking Survey, 2005/2006 Edition 
(2006) at 8).
    \38\ According to one survey, 14 percent of plans with automatic 
enrollment provided for escalating default contributions in 2005, up 
from 7 percent in 2004 (Profit Sharing/401(k) Council of America, 
49th Annual Survey of Profit Sharing and 401(k) Plans (2006) at 39). 
According to another, among the 24 percent of surveyed employers 
offering automatic enrollment in 2006, 17 percent planned to 
introduce escalating default contributions and 6 percent intended to 
increase the default contribution rate; none planned to lower it 
(Hewitt Associates LLC, Survey Findings: Hot Topics in Retirement, 
2006 (2006) at 4).
---------------------------------------------------------------------------

    Additional variables concern what other changes plan sponsors might 
make to their plans. Plan sponsors implementing qualified default 
investment alternatives may make other changes to investment options or 
undertake new efforts to inform or influence participants' investment 
decisions. Plan sponsors that maintain or begin automatic enrollment 
programs may change other provisions of their plans, such as matching 
contribution formulas, eligibility or vesting provisions, loan 
programs, or distribution policies. Changes such as these could either 
augment or offset the effects of this regulation.
    The investment advice and automatic enrollment provisions of the 
Pension Protection Act will promote activities and plan designs that 
are likely to augment the regulation's positive effects on retirement 
savings. Those provisions will help make investment advice available to 
more participants and will promote automatic enrollment programs with 
escalating default contribution rates, generous employer matching 
contributions and short vesting periods.
    Default participants may make other changes in their savings 
behavior. Default participation might foster financial literacy or a 
taste for saving, which could augment the regulation's effect. 
Alternatively, default participants might offset their default savings 
by reducing other savings or taking on debt. In particular, they may be 
less likely than active participants to preserve their accounts for 
retirement when leaving a job.\39\ To assess the implications of this 
possibility the Department produced alternative baseline and low-impact 
estimates, which assume that participants who leave their jobs while in 
default status never preserve their accounts. (Default participants who 
become active participants before leaving their jobs are assumed to 
preserve their accounts at the same rate as other active participants.) 
The alternative estimates represent a worst case outer bound. As noted 
above, comparing its primary baseline and low-impact estimates, the 
Department found that in 2033, 50 percent of net new job leavers with 
account balances preserve 83 percent of all net new job-leaver account 
balances. Comparing the respective alternative estimates, the 
Department found that the corresponding figures are 25 percent and 72 
percent. Based on the Department's primary baseline and low-impact 
estimates, the regulation is expected to reduce the proportion of 
account holding job leavers that preserve their accounts from 61.0 
percent to 60.4 percent and the proportion of their accounts that is 
preserved from 85.9 percent to 85.8 percent. Based on the alternative 
estimates, the corresponding reductions are from 56.9 percent to 54.7 
percent and from 85.3 percent to 84.9 percent. Both the primary and 
alternative estimates strongly suggest that most new retirement saving 
resulting from this regulation (together with the automatic enrollment 
provisions of the Pension

[[Page 60475]]

Protection Act) will be preserved for retirement. While one effect of 
the regulation will be to create many very small and short-lived 
accounts that participants never actively manage and may be unlikely to 
preserve, the Department expects that the larger effect will be to spur 
new, early default contributions by participants who later actively 
manage their accounts and are likely to preserve them.
---------------------------------------------------------------------------

    \39\ A number of factors may diminish this possibility. First, 
participants who contribute and invest by default may also tend to 
handle account distribution opportunities by default. Laws governing 
plans' default distribution provisions provide for the preservation 
of all but the smallest accounts. Absent participant direction to 
the contrary, accounts of $5,000 or more must remain in the plan, 
and smaller accounts of $1,000 or more must either remain in the 
plan or be rolled directly into an IRA. Second, some 401(k) plan 
sponsors reserve eligibility and automatic enrollment for employees 
who complete a specified period of service, such as one year. It is 
possible that sponsors with higher-turnover work forces and/or those 
offering automatic enrollment are or will be more likely to provide 
for such waiting periods for eligibility, perhaps in order to avoid 
the expense of churning very small accounts. Third, it is possible 
that the small fraction of employees who decline automatic 
enrollment (perhaps 10 percent) may be largely the same ones who 
would decline to preserve their accounts. In that case, participants 
added by automatic enrollment might be more likely to preserve them.
---------------------------------------------------------------------------

    The regulation may encourage active (in addition to default) 
investments in qualified default investment alternatives--a phenomenon 
sometimes referred to as an endorsement effect. If so, the impact of 
the regulation on asset allocation, and the attendant net positive 
effect on account balances and retirement income, will be 
amplified.\40\
---------------------------------------------------------------------------

    \40\ There is some evidence to suggest that qualified default 
investment alternatives, once established as plan defaults, may 
claim a disproportionate share of active investments as well. There 
is some evidence that participants may gravitate toward investment 
options that appear to be endorsed by their employers, such as by 
responding to employers' directing of matching contributions into 
company stock by investing more participant-directed funds in 
company stock as well (see, e.g., Jeffrey R. Brown, Nellie Liang and 
Scott Weisbenner, Individual Account Investment Options and 
Portfolio Choice: Behavioral Lessons from 401(k) Plans, (Sept. 2006) 
at 18). This paper summarizes some prior evidence and provides some 
new evidence of this effect, but also raises the possibility that 
this effect may be attributable instead to other factors. 
Participants have been found to exhibit inertia in their investment 
choices, being slow to rebalance or to respond to changes in the 
investment options offered to them (see, e.g., Olivia S. Mitchell, 
Gary R. Mottola, Stephen P. Utkus, and Takeshi Yamaguchi, The 
Inattentive Participant: Portfolio Trading Behavior in 401(k) Plans, 
Pension Research Council Working Paper 2006-5 (2006) at 16, which 
finds a lack of rebalancing; see also Jeffrey R. Brown and Scott 
Weisbenner, Individual Account Investment Options and Portfolio 
Choice: Behavioral Lessons from 401(k) Plans (Dec. 2004) at 23, 37, 
Tables 8a, 8b, which finds inertia in participant response to the 
addition of new funds). Most on point, some early experience with 
automatic enrollment programs suggests that a previously available 
investment alternative, once established as a default in an 
automatic enrollment program, may attract an increased proportion of 
actively directed participant accounts (see, e.g, John Beshears, 
James J. Choi, David Laibson and Brigitte C. Madrian, The Importance 
of Default Options for Retirement Savings Outcomes: Evidence from 
the United States, National Bureau of Economic Research Working 
Paper 12009 (Jan. 2006), which provides some evidence of such an 
endorsement effect; see also Fidelity Investments, Building Futures 
Volume VII: How Workplace Savings are Shaping the Future of 
Retirement, (2006) at 124-138, for data on the concentration of 
participant accounts in default investment alternatives). To assess 
the potential implications of an endorsement effect for the impact 
of this regulation, the Department carried out a sensitivity test of 
its low-impact estimates of the regulation's effects. Where the 
Department's primary estimates take into account the default 
investment of defaulted participants' accounts only (no endorsement 
effect), the sensitivity test additionally assumes that 20 percent 
of actively directed accounts in plans with automatic enrollment 
will be directed to default investment alternatives (20 percent 
endorsement effect). Compared with the primary estimates, the 
sensitivity test indicates that regulation will increase aggregate 
account balances in 2034, expressed in 2006 dollars, by $87 billion 
(rather than $70 billion), of which $26 billion (rather than $5 
billion) will be directly attributable to the allocation of more 
assets to qualified default investment alternatives (the rest will 
be attributable to growth in automatic enrollment).
---------------------------------------------------------------------------

    Because the regulation's effects will be cumulative and gradual, 
they will be fully realized only in the very long run, generally when 
workers beginning careers today have long since retired. This long time 
horizon introduces additional, longer-term variables, but most of these 
implicate less the regulation's effects than the baseline. For example, 
future investment results may vary.\41\ Other variables, which the 
Department did not attempt to quantify, include future career patterns 
and compensation levels and mixes.
---------------------------------------------------------------------------

    \41\ The Department's estimates illustrate some of this as 
variation in results across individuals.
---------------------------------------------------------------------------

Peer Review

    OMB's ``Final Information Quality Bulletin for Peer Review'' (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 estimate the effects of this regulation and the proposed 
regulation constitute a ``highly influential scientific assessment'' 
under the Bulletin. Pursuant to the Bulletin, the Department therefore 
subjected this assessment to peer review. All materials associated with 
that review, including the Department's full response to the peer 
review, are available to the public as part of the docket associated 
with this regulation.\42\
---------------------------------------------------------------------------

    \42\ Please see http://www.dol.gov/ebsa/regs/peerreview.html.

---------------------------------------------------------------------------

    The analysis presented here has been refined in several ways in 
response to the peer review.
    The review questioned whether default participants would cash out 
their accounts rather than preserve them for retirement. The 
Department's primary estimates assume that default accounts will be 
cashed out or preserved at the same rates as other similarly-sized 
accounts.\43\ The results, as reported above, suggest that balances 
attributable to new default contributions will be nearly as likely as 
other balances to be preserved. It is possible, however, that default 
participants will be less likely to preserve their accounts than active 
participants with similar-sized accounts. The Department therefore 
prepared alternative estimates that account for this possibility. The 
results appear under the heading ``Sensitivity Testing'' above.
---------------------------------------------------------------------------

    \43\ The Department's estimate of the effect of the proposed 
regulation assigned uniform cash out probabilities (derived from an 
industry survey) to accounts within certain arbitrary size 
categories. For example, all accounts smaller than approximately 
$11,000 (expressed at 2005 levels) were assigned the same cash out 
probability. This may have understated the propensity to cash out 
very small accounts. The Department has since refined its estimation 
of cash out probabilities. These probabilities are now estimated as 
a continuous function of account size, based on household survey 
data.
---------------------------------------------------------------------------

    The review questioned whether lower-paid workers might be more risk 
averse and might therefore be susceptible to welfare losses if their 
default investments are redirected from capital preservation vehicles 
to qualified default investment alternatives. In response the 
Department more closely examined the regulation's impact on lower-paid 
workers, finding disproportionate gains in pension income, as described 
above. These gains may help offset any welfare losses due to sub-
optimal risk exposure. In addition, the Department believes the 
required notice to participants regarding default investments will 
facilitate the ability of workers to easily choose to actively change 
their risk exposure if the qualified default investment alternatives do 
not meet their risk preferences.
    The reviews questioned the Department's assumptions regarding 
investment returns, saying they exaggerated the equity premium, 
neglected fees, and neglected variation in inflation and returns to 
debt instruments. In response the Department has moderated its 
assumption regarding the equity premium,\44\ accounted for fees, and 
incorporated stochastic variation in inflation and debt returns.
---------------------------------------------------------------------------

    \44\ In its estimates of the effects of the proposed regulation 
the Department had assumed a real average equity return of 6.5 
percent, which was consistent with long-term historical performance. 
The estimates presented here assume a real average return of 4.9 
percent, which is more in line with recent performance and 
commenters' expectations of the future.
---------------------------------------------------------------------------

Alternatives Considered

Capital Preservation Products
    In defining the types of investment products, portfolios or 
services that may be used as a long-term qualified default investment 
alternative, the Department, after careful consideration of the many 
comments supporting capital preservation products, and assessment of 
related economic impacts, determined not to include capital

[[Page 60476]]

preservation products, such as money market or stable value funds, as a 
stand-alone long-term investment option for contributions made after 
the effective date of this regulation. However, the Department believes 
that such investments can play an important role as a component of a 
qualified default investment alternative. Further, it is important to 
note that the exclusion of such funds as a qualified default investment 
alternative does not preclude their use as a default investment 
option--fiduciaries are free to adopt default investments they deem to 
be prudent without availing themselves of the fiduciary relief afforded 
by this regulation.
    Including such instruments for future contributions might have 
yielded some benefits if, for example, their inclusion would encourage 
more plan sponsors to implement automatic enrollment programs or fewer 
workers to opt out of them. The Department believes such cases would be 
rare, however. First, a decreasing proportion of plans already are 
designating such instruments as default investments.\45\ Second, 
workers concerned that a default investment provides more risk than 
they prefer need not refuse or terminate \46\ participation in 
response, but instead need only direct their contributions into a 
different investment option otherwise available in the plan.
---------------------------------------------------------------------------

    \45\ According to one survey, in 2006, 17 percent of sponsors 
with automatic enrollment programs were likely to change their 
default from such instruments to qualified default investment 
alternative-type instruments, while just 4 percent were likely to do 
the opposite (Hewitt Associates LLC, Survey Findings: Hot Topics in 
Retirement 2006 (2006) at 4). According to another, between 1999 and 
2005 the proportion designating such instruments as defaults 
decreased from 69 percent to 56 percent, while the proportion 
designating qualified default investment alternative-type 
instruments as defaults increased from 28 percent to 39 percent 
(Hewitt Associates LLC, Survey Findings: Trends and Experiences in 
401(k) Plans 2005, (2005) at 15).
    \46\ Might a risk-averse participant, enrolled and invested by 
default, terminate participation in response to news that their 
account had suffered principal losses? Perhaps not. The same inertia 
that leads some participants to enroll and invest by default might 
also prevent them from terminating participation. The Department 
also observes that an early principal loss usually will not 
translate into a decline in the account balance reported in a 
quarterly statement, since quarterly contributions are likely to 
more than offset such losses during at least the first few years of 
participation.
---------------------------------------------------------------------------

    Including such instruments might benefit some affected short-tenure 
participants who cash out and spend their accounts during downturns in 
equity prices. Historically, though, equity returns are positive more 
often then they are negative, so this potential benefit is likely to be 
outweighed by the opportunity cost to affected short-tenure 
participants who cash out during upturns.\47\ Moreover, the Department 
believes that this regulation should be calibrated to foster 
preservation of retirement accounts rather than to accommodate 
cashouts, consistent with other provisions of law, such as the 
mandatory withholding and additional tax provisions applicable to 
premature distributions.
---------------------------------------------------------------------------

    \47\ Such potential benefits would additionally be offset by 
reduced average returns to default investors who do not cash out 
early. As noted above, the Department estimates that most default 
contributions will be preserved for retirement. As discussed above, 
even the subset of short term workers who cash out their accounts 
will experience an overall aggregate increase in wealth from this 
regulation. Thus, the concern for fostering preservation of 
retirement accounts is not being weighed against aggregate losses to 
this subset of workers, but is instead being weighed against the 
added volatility their accounts might experience. In weighing these 
interests, the Department kept in mind that short term employees 
concerned about this volatility are always free to choose a 
different investment option.
---------------------------------------------------------------------------

    Some comments on the proposed regulation expressed concern that 
qualified default investment alternatives would expose risk averse 
participants to excessive investment risk, and on that basis urged the 
Department to include stand-alone capital preservation instruments as 
qualified default investment alternatives. The Department is not 
persuaded by this argument, however, for three reasons. First, the 
regulation's primary goal is to promote default investments that 
enhance retirement saving, not to align default investments with 
individuals' levels of risk tolerance.\48\ Second, the Department 
nonetheless believes that the qualified default investment alternatives 
included in the regulation can satisfy most affected individuals' risk 
preferences.\49\ Finally, participants who find default investments too 
risky can opt out of them without opting out of plan participation 
entirely.
---------------------------------------------------------------------------

    \48\ In theory individuals can optimize their investment mix 
over time to match their personal taste for risk and return. The 
regulation's provisions that establish participants' right to direct 
their investments out of qualified default alternatives give 
participants the opportunity to so do. But in practice investors 
sometimes do not optimize their investment alternatives. Some may 
lack clear, fixed and rational preferences for risk and return. Some 
investors' tastes for risky assets may be distorted by imperfect 
information, or by irrational and ineffectual behavioral phenomena 
such as naive diversification (a tendency to divide assets equally 
across available options), sub-optimal excessive concentration in 
company stock, market timing, mental accounting and framing, and 
reliance on peer examples (see, e.g., Richard H. Thaler and Shlomo 
Benartzi, The Behavioral Economics of Retirement Savings Behavior, 
AARP Public Policy Institute white paper 2007-02 (Jan. 
2007) at 6-16), or inertia. This regulation promotes default 
investments that can enhance such investors' retirement savings 
prospects.
    \49\ One commenter on the proposed regulation called the 
Department's attention to a study of optimal investment mixes for 
investors with different levels of risk aversion. The study employed 
techniques known as stochastic dominance analysis of asset class 
performance and multi-period investor utility optimization, 
explaining that these techniques are in some ways superior to 
alternatives such as mean-variance analysis of asset class 
performance and single-period utility optimization. The commenter 
criticized the Department's use of the latter, potentially inferior 
techniques to assess the question of what mix of asset classes best 
matches investors' tastes. But in fact the Department did not assess 
this question, focusing instead on how different asset class mixes 
affect retirement savings accumulations. Interestingly the study, 
which utilized stable value product performance data supplied by the 
industry, concluded that for most investors most of the time, the 
optimal portfolio will include a mix of equity and stable value 
products rather than stable value products alone. This suggests to 
the Department that the qualified default investment alternatives 
included in this regulation encompass most investors' levels of risk 
tolerance. The Department also notes that most 401(k) plan 
participants who actively direct their investments include equity in 
their portfolios (see, e.g., Sarah Holden and Jack VanDerhei, 401(k) 
Plan Asset Allocation, Account Balances, and Loan Activity in 2005, 
EBRI Issue Brief No. 296 (Aug. 2006) at 9, Figure 8; see also 
Fidelity Investments, Building Futures Volume VII: How Workplace 
Savings are Shaping the Future of Retirement (2006) at 128, Figure 
130).
---------------------------------------------------------------------------

    Some comments cautioned that the exclusion of stand-alone capital 
preservation products from the definition of qualified default 
investment alternatives would prompt a large, rapid movement of money 
across asset classes, with negative consequences for financial markets. 
In particular according to these comments, movement out of stable value 
products might repress those products' future interest crediting rates 
and thereby harm investors who continue to hold them. The Department 
believes, however, that movement away from stable value products and 
therefore any negative impact on forward crediting rates will be 
modest, as only a relatively small portion of current assets in stable 
value products appears to be attributable to defaulted 
participants.\50\ Additionally,

[[Page 60477]]

according to these comments, movement out of stable value products 
might alter short-term conditions in the markets for debt securities 
that underlie such products. Decreased demand for stable value products 
might then repress the price of underlying debt instruments and 
increased demand for qualified default investment alternatives might 
drive up equity prices. The Department believes any such effects would 
be gradual and negligible.\51\
---------------------------------------------------------------------------

    \50\ There are several reasons to believe that asset allocation 
will not shift very abruptly, and that stable value products will 
continue to claim a large share of 401(k) plan assets. First, while 
this regulation generally does not extend fiduciary relief to 
default investments that consist solely of stable value products, it 
does not foreclose qualified default investment alternatives from 
including such products, and leaves intact general fiduciary 
provisions that may otherwise permit default investments that 
consist solely of such products. A significant number of plans 
currently utilize stable value products as their default investment 
option, reflecting determinations by a significant number of plan 
fiduciaries that stand-alone stable value products are a prudent 
investment for defaulted participants. Nothing in this regulation is 
intended to suggest or require that a plan fiduciary change an 
otherwise prudent selection of a stable value product for a plan's 
default investment option. The Department therefore anticipates that 
some plans will continue to direct all or a portion of default 
investments to stable value products. Second, the Department expects 
that stable value products will continue to be offered as an 
investment option by many participant-directed plans and selected by 
many participants. It is expected that participants will invest only 
a small fraction of assets by default, and will actively direct a 
large majority of assets. The Department's low- and high-impact 
estimates respectively suggest that between 1.2 percent and 1.5 
percent of 401(k) plan assets will be invested by default in 2034. 
Viewed another way, absent this regulation, the Department estimates 
that just $10 billion would be invested by default in capital 
preservation vehicles in 2034 (expressed in 2006 dollars). This 
compares with approximately $400 billion of 401(k) assets invested 
in stable value products today. Third, there will be some offsetting 
effect, deriving from the increase in actively invested account 
balances expected to result from this regulation. The Department 
estimates that the regulation, by promoting automatic enrollment and 
higher average investment performance, will increase aggregate 
actively invested account balances in 2034 by between $59 billion 
and $114 billion (expressed in 2006 dollars), or between 2.4 percent 
and 4.6 percent, while aggregate default invested account balances 
will grow by just $11 billion to $20 billion. Stable value products 
will capture some share of the increase in actively invested account 
balances. Fourth, the extent to which some plans do move money out 
of stable value products may be additionally moderated by stable 
value product features that have the effect of discouraging large 
movements and by associated fiduciary considerations. Plan 
fiduciaries, in determining whether, how and under what 
circumstances a change should be made in the plan's default 
investment option, must assess, among other things, the potential 
economic consequences of such a change to participants' investments 
in such options. Finally, because this regulation includes a 
``grandfather''-like provision applicable to certain stable value 
products, it provides no direct incentive for plan fiduciaries to 
reallocate account balances heretofore invested by default in such 
products.
    \51\ As noted above, the Department expects that asset 
allocation will not shift very abruptly, and that stable value 
products will continue to claim a large share of 401(k) assets. In 
addition, while stable value products comprise a substantial 
fraction of all 401(k) assets (perhaps as much as 20 percent), their 
underlying portfolios hold only a small fraction (generally between 
0.5 percent and 2 percent) of all debt and of major debt categories 
such as mortgages, corporate bonds and treasury and agency issues. 
These estimates are based on stable value product data provided by 
the Stable Value Industry Association and the U.S. Federal Reserve 
Board of Governors' Flow of Funds Accounts.
---------------------------------------------------------------------------

    If included as a qualified default investment alternative and 
thereby promoted as a default investment, stand-alone capital 
preservation products' generally inferior long-term investment returns 
would almost certainly erode the regulation's beneficial effect on 
retirement income. The Department estimates that including capital 
preservation instruments as a stand-alone qualified default investment 
alternative would reduce aggregate account balances in 2034 by between 
$5 billion and $7 billion (expressed in 2006 dollars).\52\ This 
negative effect will be larger if there is an endorsement effect ($26 
billion under the low-impact estimate)--that is, if the instruments 
status as a qualified default investment alternative encourages active 
(in addition to default) investments in them.\53\
---------------------------------------------------------------------------

    \52\ This assumes that, as under the baseline, 50 percent of 
default contributions will be directed to capital preservation 
products and 50 percent to (other) qualified default investment 
alternatives.
    \53\ For this calculation, the Department assumes a 20 percent 
endorsement effect.
---------------------------------------------------------------------------

    Finally, the Department believes it is desirable for a default 
investment vehicle to be diversified across asset classes, rather than 
to include only a single asset class. Such diversification can improve 
a portfolio's risk and return efficiency.
    In summary, in weighing the merits of potential qualified default 
investment alternatives, the Department sought primarily to promote 
default investments that enhance retirement savings. The Department 
considered market trends, generally accepted investment theories, 
mainstream financial planning practices, and actual investor behavior, 
as well as the estimated effect of qualified default investment 
alternatives on retirement savings. All of these criteria suggest that 
it is desirable to invest retirement savings in vehicles that provide 
for the possibility of capital appreciation in addition to capital 
preservation.
    Accordingly, the Department did not include stand-alone capital 
preservation instruments among the qualified default investment 
alternatives under the regulation. However, the Department has modified 
the regulation to include a ``grandfather''-like provision pursuant to 
which stable value products and funds will constitute a qualified 
default investment alternative under the regulation for purposes of 
investments made prior to the effective date of the regulation.
Balanced Defaults
    The Department also considered whether to include as a qualified 
default investment alternative an investment fund product or model 
portfolio that establishes a uniform mix of equity and fixed income 
exposures for all affected participants. Such a product or model 
portfolio 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 potential qualified 
default investment alternatives such a product or portfolio may be 
simpler, less expensive and easier to explain and understand. These 
advantages sometimes may outweigh the potential advantage of more 
customized risk levels. And the inclusion of such products or model 
portfolios might help heighten competition in the market and thereby 
enhance product quality and affordability across all qualified default 
investment alternatives. Accordingly, the Department has included such 
instruments as qualified default investment alternatives under this 
regulation.

Federalism Statement

    Executive Order 13132 (August 4, 1998) outlines fundamental 
principles of federalism and requires Federal agencies to adhere to 
specific criteria in the formulation and implementation of policies 
that have a substantial direct effect on the States, the relationship 
between the national government and the States, or on the distributive 
power and responsibilities among the various levels of government. As 
noted above, section 902(f) of the Pension Protection Act adds a new 
provision to ERISA (section 514(e)) providing that notwithstanding any 
other provision of section 514, Title I of ERISA supersedes State laws 
that would directly or indirectly prohibit or restrict the inclusion of 
an automatic contribution arrangement in any plan. In the preamble to 
the notice of proposed rulemaking published on September 27, 2006, the 
Department specifically discussed the preemption provision enacted in 
the Pension Protection Act and requested comments on whether, and to 
what extent, addressing this provision in the regulations would be 
helpful. Although no States provided comments on the proposed 
regulation, other commenters requested that the Department use the 
regulation to clarify the application of the statutory preemption 
provision. As noted elsewhere in this preamble, paragraph (f) of the 
final regulation addresses those comments. In accordance with section 4 
of the E.O. 13132, the Department of Labor has construed the preemptive 
effect of ERISA section 514(e) at the minimum level necessary to 
achieve the objectives of the statute.

[[Page 60478]]

    In any event, the Department does not view the final rule, as 
distinct from the statute, as having a substantial direct effect on the 
States, on the relationship between the national government and the 
States, or on the distribution of power among the various levels of 
government. The statute preempts State laws and the regulation merely 
clarifies application of the statutory provision in a way that is 
consistent with the plain language and the legislative history. State 
wage withholding restrictions will not be affected except as they apply 
to automatic contribution arrangements of ERISA-covered plans. 
Moreover, the regulation imposes no compliance costs on State or local 
governments. As a result, the Department concludes that the final 
regulation does not have federalism implications.

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.

0
For the reasons set forth in the preamble, the Department amends 
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

0
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.

0
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 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 any qualified default investment alternative 
within the meaning of paragraph (e) of this section, 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 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 any fiduciary described 
in paragraph (e)(3)(i) of this section 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 a 
notice that meets the requirements of paragraph (d) of this section:
    (i) (A) At least 30 days in advance of the date of plan 
eligibility, or at least 30 days in advance of the date of any first 
investment in a qualified default investment alternative on behalf of a 
participant or beneficiary described in paragraph (c)(2) of this 
section; or
    (B) On or before the date of plan eligibility provided the 
participant has the opportunity to make a permissible withdrawal (as 
determined under section 414(w) of the Internal Revenue Code of 1986, 
as amended (Code)); and
    (ii) Within a reasonable period of time of at least 30 days in 
advance of each subsequent plan year;
    (4) A fiduciary provides to a participant or beneficiary the 
material set forth in 29 CFR 2550.404c-1(b)(2)(i)(B)(1)(viii) and (ix) 
and 29 CFR 404c-1(b)(2)(i)(B)(2) relating to a participant's or 
beneficiary's investment in a qualified default investment alternative;
    (5)(i) Any participant or beneficiary on whose behalf assets are 
invested in

[[Page 60479]]

a qualified default investment alternative may transfer, in whole or in 
part, such assets to any other investment alternative available under 
the plan with a frequency consistent with that afforded to a 
participant or beneficiary who elected to invest in the qualified 
default investment alternative, but not less frequently than once 
within any three month period;
    (ii)(A) Except as provided in paragraph (c)(5)(ii)(B) of this 
section, any transfer described in paragraph (c)(5)(i), or any 
permissible withdrawal as determined under section 414(w)(2) of the 
Code, by a participant or beneficiary of assets invested in a qualified 
default investment alternative, in whole or in part, resulting from the 
participant's or beneficiary's election to make such a transfer or 
withdrawal during the 90-day period beginning on the date of the 
participant's first elective contribution as determined under section 
414(w)(2)(B) of the Code, or other first investment in a qualified 
default investment alternative on behalf of a participant or 
beneficiary described in paragraph (c)(2) of this section, shall not be 
subject to any restrictions, fees or expenses (including surrender 
charges, liquidation or exchange fees, redemption fees and similar 
expenses charged in connection with the liquidation of, or transfer 
from, the investment);
    (B) Paragraph (c)(5)(ii)(A) of this section shall not apply to fees 
and expenses that are charged on an ongoing basis for the operation of 
the investment itself (such as investment management fees, distribution 
and/or service fees, ``12b-1'' fees, or legal, accounting, transfer 
agent and similar administrative expenses), and are not imposed, or do 
not vary, based on a participant's or beneficiary's decision to 
withdraw, sell or transfer assets out of the qualified default 
investment alternative; and
    (iii) Following the end of the 90-day period described in paragraph 
(c)(5)(ii)(A) of this section, any transfer or permissible withdrawal 
described in this paragraph (c)(5) of this section shall not be subject 
to any restrictions, fees or expenses not otherwise applicable to a 
participant or beneficiary who elected to invest in that qualified 
default investment alternative; 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 shall 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 or beneficiary in a qualified default 
investment alternative; and, if applicable, an explanation of the 
circumstances under which elective contributions will be made on behalf 
of a participant, the percentage of such contributions, and the right 
of the participant to elect not to have such contributions made on the 
participant's behalf (or to elect to have such contributions made at a 
different percentage);
    (2) An explanation of the right of participants and beneficiaries 
to direct the investment of assets in their individual accounts;
    (3) 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;
    (4) 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, including a 
description of any applicable restrictions, fees or expenses in 
connection with such transfer; and
    (5) 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 available to participants and beneficiaries that:
    (1)(i) Does not hold or permit the acquisition of employer 
securities, except as provided in paragraph (ii).
    (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)(4)(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 to the extent the 
investment management service has discretionary authority over the 
disposition of such employer securities;
    (2) Satisfies the requirements of paragraph (c)(5) of this section 
regarding 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: (A) an investment manager, within the meaning of 
section 3(38) of the Act; (B) a trustee of the plan that meets the 
requirements of section 3(38)(A), (B) and (C) of the Act; or (C) the 
plan sponsor who is a named fiduciary, within the meaning of section 
402(a)(2) of the Act;
    (ii) An investment company registered under the Investment Company 
Act of 1940; or
    (iii) An investment product or fund described in paragraph 
(e)(4)(iv) or (v) of this section; and
    (4) Constitutes one of the following:
    (i) An investment fund product or model portfolio that applies 
generally accepted investment theories, is diversified so as to 
minimize the risk of large losses and 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)(4)(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 applies 
generally accepted investment theories, is diversified so as to 
minimize the risk of large losses and 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)(4)(ii), asset allocation

[[Page 60480]]

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 a 
fiduciary, within the meaning of paragraph (e)(3)(i) of this section, 
applying generally accepted investment theories, 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 are diversified so as to minimize the risk 
of large losses and change their asset allocations and associated 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)(4)(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.''
    (iv)(A) Subject to paragraph (e)(4)(iv)(B) of this section, an 
investment product or fund designed to preserve principal and provide a 
reasonable rate of return, whether or not such return is guaranteed, 
consistent with liquidity. Such investment product shall for purposes 
of this paragraph (e)(4)(iv):
    (1) Seek to maintain, over the term of the investment, the dollar 
value that is equal to the amount invested in the product; and
    (2) Be offered by a State or federally regulated financial 
institution.
    (B) An investment product described in this paragraph (e)(4)(iv) 
shall constitute a qualified default investment alternative for 
purposes of paragraph (e) of this section for not more than 120 days 
after the date of the participant's first elective contribution (as 
determined under section 414(w)(2)(B) of the Code).
    (v)(A) Subject to paragraph (e)(4)(v)(B) of this section, an 
investment product or fund designed to guarantee principal and a rate 
of return generally consistent with that earned on intermediate 
investment grade bonds, while providing liquidity for withdrawals by 
participants and beneficiaries, including transfers to other investment 
alternatives. Such investment product or fund shall, for purposes of 
this paragraph (e)(4)(v), meet the following requirements:
    (1) There are no fees or surrender charges imposed in connection 
with withdrawals initiated by a participant or beneficiary; and
    (2) Principal and rates of return are guaranteed by a State or 
federally regulated financial institution.
    (B) An investment product or fund described in this paragraph 
(e)(4)(v) shall constitute a qualified default investment alternative 
for purposes of paragraph (e) of this section solely for purposes of 
assets invested in such product or fund before December 24, 2007.
    (vi) An investment fund product or model portfolio that otherwise 
meets the requirements of this section shall not fail to constitute a 
product or portfolio for purposes of paragraph (e)(4)(i) or (ii) of 
this section solely because the product or portfolio is offered through 
variable annuity or similar contracts or through common or collective 
trust funds or pooled investment funds and without regard to whether 
such contracts or funds provide annuity purchase rights, investment 
guarantees, death benefit guarantees or other features ancillary to the 
investment fund product or model portfolio.
    (f) Preemption of State laws. (1) Section 514(e)(1) of the Act 
provides that title I of the Act supersedes any State law that would 
directly or indirectly prohibit or restrict the inclusion in any plan 
of an automatic contribution arrangement. For purposes of section 
514(e) of the Act and this paragraph (f), an automatic contribution 
arrangement is an arrangement (or the provisions of a plan) under 
which:
    (i) A participant may elect to have the plan sponsor make payments 
as contributions under the plan on his or her behalf or receive such 
payments directly in cash;
    (ii) A participant 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
    (iii) Contributions are invested in accordance with paragraphs (a) 
through (e) of this section.
    (2) A State law that would directly or indirectly prohibit or 
restrict the inclusion in any pension plan of an automatic contribution 
arrangement is superseded as to any pension plan, regardless of whether 
such plan includes an automatic contribution arrangement as defined in 
paragraph (f)(1) of this section.
    (3) The administrator of an automatic contribution arrangement 
within the meaning of paragraph (f)(1) of this section shall be 
considered to have satisfied the notice requirements of section 
514(e)(3) of the Act if notices are furnished in accordance with 
paragraphs (c)(3) and (d) of this section. (4) Nothing in this 
paragraph (f) precludes a pension plan from including an automatic 
contribution arrangement that does not meet the conditions of 
paragraphs (a) through (e) of this section.

    Signed at Washington, DC, this 15th day of October, 2007.
Bradford P. Campbell,
Assistant Secretary, Employee Benefits Security Administration, 
Department of Labor.
[FR Doc. 07-5147 Filed 10-23-07; 8:45 am]

BILLING CODE 4510-29-P