Understanding ERISA 404(c): Importance, Compliance, and the Role of QDIAs

ERISA 404(c) protects employers from liability for investment losses resulting from 401(k) participants making their own investment decisions. ERISA 404(c) does not absolve employers of their fiduciary responsibility to prudently select and monitor their 401(k) plan’s investment menu, but it does offer valuable protection when funds prudently selected for participants underperform.

To comply with ERISA 404(c), a 401(k) plan must provide a variety of investment options and sufficient information for participants to make informed choices. Although the requirements may seem daunting, structuring a 401(k) plan to meet ERISA 404(c) is actually straightforward and simple to implement. Here’s what you need to know to ensure your plan is compliant.

Why ERISA 404(c) is Important

ERISA 404(c) is beneficial for both employers and employees. It limits an employer’s liability for investment losses resulting from 401(k) participant decision-making while ensuring employees are offered a variety of 401(k) investment options and the information necessary to make informed choices.

ERISA 404(c) Compliance Requirements

For an employer to take advantage of the protections offered by ERISA 404(c), their 401(k) plan must meet the following requirements:

1. 1. Offer a Broad Range of Investment Options: The plan must provide at least three diversified investment alternatives, each with different risk and return characteristics. This diversity requirement ensures that participants can diversify their portfolios according to their individual risk tolerances and retirement goals.
   2. Provide Sufficient Investment Information: Participants must receive adequate information to make informed decisions about their investments. Required information includes detailed descriptions of the investment options, their associated risks and returns, and any fees that may apply.
   3. Ensure Participant Control Over Investments: Participants should be able to change their investment selections with a frequency appropriate to the volatility of the investment options. This flexibility allows them to adjust their portfolios in response to market changes or personal circumstances.
   4. Notify Participants About ERISA 404(c): Plan sponsors must inform participants that the plan is intended to comply with ERISA 404(c) and that fiduciaries may be relieved of liability for losses resulting from participants' investment decisions.

How to Meet the ERISA 404(c) Requirements

Here are practical steps to ensure your plan meets the ERISA 404(c) requirements:

1. 1. Offer a Broad Range of Investment Options: A simple three-fund lineup, including equity (stock), fixed income (bond), and capital preservation (money market or stable value) funds, can suffice if the equity and fixed income funds are diversified. This means their investment objective should be either tracking or outperforming a broad market benchmark – tracking in the case of an index fund, outperforming in the case of an active fund.
   2. Provide Sufficient Investment Information: All participant-directed plans must distribute a fee notice to participants annually to meet ERISA 404(a)-5 fee disclosure rules. The investment information requirement of the notice also meet the investment information requirement of ERISA 404(c).
   3. Ensure Participant Control Over Investments: An ERISA 404(c) plan plan must permit participants to transfer into core investment options at least as frequently as they are permitted to transfer out of the most volatile investment option available, but no less frequently than quarterly.
   4. Notify Participants About ERISA 404(c): Most 401(k) plans notify participants about their ERISA 404(c) status in a Summary Plan Description (SPD).

A QDIA Extends 404(c) Protection to Default Investments

When a 401(k) participant does not make investment choices, their contributions are invested in the plan’s default fund. When the default fund meets Qualified Default Investment Alternative (QDIA) requirements, ERISA 404(c) protection is extended, ensuring an employer is not held liable for investment losses incurred in the fund. The main types of QDIAs include:

1. 1. Lifecycle or Target-Date Funds: These funds automatically adjust their asset allocation mix based on the participant's age or expected retirement date.
   2. Balanced Funds: These funds maintain a diversified portfolio of equities and fixed income investments.
   3. Managed Accounts: These accounts provide a personalized investment strategy based on the participant's risk tolerance and retirement goals.

To qualify as a QDIA, the investment option must also be diversified to minimize the risk of large losses, must not invest participant contributions in employer securities, and must be prudently selected and monitored by the plan fiduciaries. A participant notice requirement also applies.

ERISA 404(c) is a Win-Win that’s Easy to Achieve!

ERISA 404(c) offers a valuable framework for employers to limit their 401(k) liability while empowering employees to make informed 401(k) investing decisions. Achieving this win-win is easy. The requirements of ERISA 404(c) are straightforward and simple to implement generally.

Have further questions? Ask your 401(k) provider. They should be able to help.