Mutual funds that charge redemption fees will not qualify as default investments under the Department of Labor's recently announced final rules.
"The final rule provides that no redemption fee may be imposed during the first 90 days of a de-faulted participant's investment" in a qualified default investment alternative, Gloria Della, a Labor De-partment spokeswoman, wrote in an e-mail.
QDIAs are investments that can be used by employers who automatically enroll their employees in 401(k) plans.
Under the Pension Protection Act of 2006, employers can automatically enroll employees in 401(k)s unless employees elect not to participate in the defined contribution retirement savings plans. The money must be invested in QDIAs in order to protect employers from liability.
The Labor Department approved three types of long-term investments for QDIAs: life cycle or target date funds that invest assets based on an investor's age or projected retirement date; managed accounts; and balanced funds. No-interest capital preservation investments can be used for the first 120 days only, after which the money must be moved to one of the other types of accounts.
Many funds adopted redemption fees after the mutual fund market-timing scandal that erupted in 2003. The fees are imposed for redemptions that are made within a short time of the fund's purchase to discourage people from moving in and out of funds quickly.
"Most redemption fees are charged within the first 90 days," said Larry Goldbrum, general counsel of The SPARK Institute Inc. of Simsbury, Conn., which represents the retirement plan services industry.
The institute had asked for clarification on whether funds charging redemption fees could qualify for "safe harbor" treatment — meaning that employers who follow the Department of Labor's regulations would be protected from liability.
"What the department is saying is, mutual funds that have redemption fees will not qualify for safe-harbor protection as a default fund," Mr. Goldbrum said.
The final rule, which takes effect Dec. 24, stipulates that 401(k) participants whose money has been invested in a default plan must be able to move the money to other types of investments without penalty for the first 90 days.
"The department made it very clear that they considered redemption fees to be a penalty for the purposes of this rule," Mr. Goldbrum said.
Funds that impose redemption fees could still qualify for the safe harbor, he said, if they give exceptions to 401(k) participants who elect to move their money out of the fund within the first 90 days.
Many funds that impose redemption fees are not the types of funds that are likely to be used as default options, said Chris Wloszczyna, a spokesman for the Investment Company Institute in Washington.
Market timing was typically done with international funds or funds with limited market capitalization. "Chances are, [default investments are] not going to be an international micro-cap fund" or other relatively illiquid types of investments, Mr. Wloszczyna said.
Balanced funds and life cycle funds that will be used as default investments "are not the kind of funds that typically would have a redemption fee," he added.
The automatic-enrollment system is expected to result in major growth of 401(k) plans. About a third of workers who are eligible for 401(k)-type plans do not participate, according to the Labor Department.
Automatic-enrollment plans could reduce that rate to less than 10%, it said.
Under the new rules for automatic-enrollment default investment options, between $70 billion and $134 billion in additional retirement savings is expected to be accumulated by 2034, the Labor Department said.
Even with the new restrictions on redemption fees, "in the grand scheme of things, [the mutual fund industry has] gotten a much bigger victory," Mr. Goldbrum said.
The ICI strongly opposed allowing capital preservation investments, such as stable-value funds, to be included as default investment options, arguing that capital preservation investments would not generate great enough returns for employees to retire with adequate assets.
Led by the American Council of Life Insurers in Washington, the life insurance industry — which manages much of the $300-plus billion in stable-value investments — had fought to try to include stable-value funds among QDIAs (
InvestmentNews, July 23).
"The rule is encouraging diversified portfolios," said Matt Smith, managing director of Russell Retirement Services, a division of Russell Investment Group of Tacoma, Wash., that provides investments and consulting advice to DC plan sponsors.
Sara Hansard can be reached at [email protected].
