The DOL’s proposed regulation on selecting investments, including alternative assets, 2026-06178.pdf, identifies six factors that should be considered in the process of selecting any investments for participant-directed plans, such as 401(k) plans and private sector 403(b) plans. The six factors are: Performance, Fees, Liquidity, Valuation, Performance Benchmark, and Complexity. The proposal describes each of those factors and provides 20 examples of their application.
In my post Alternative Assets (9) I discussed the second factor, Fees. My last two articles, Alternative Assets (10) and Alternative Assets (11), examined the first two Fees examples in the proposal. This article looks at the third example of the application of the Fees factor.
The third example is:
(3) Example. Fees; Lifetime income—
(i) Facts. A plan sponsor makes a plan design decision to add a lifetime income benefit to its existing participant-directed individual account plan. The named fiduciary of the plan selects an asset allocation fund offered through a variable annuity contract to implement the plan sponsor’s decision. The new designated investment alternative is similar in all material respects—risk, return, liquidity, and allocation profile—to another designated investment alternative already on the plan investment menu except that the designated investment alternative already on the plan investment menu does not offer lifetime income through a variable annuity contract. The two designated investment alternatives have the same expense ratio, but the designated investment alternative offered through the variable annuity contract has an additional fee associated with the ability of participants to select the lifetime income feature. The additional fee typically secures more favorable annuity conversion rates throughout the life of the contract than would be available outside of the contract. The named fiduciary consults with an investment advice fiduciary within the meaning of section 3(21)(A)(ii) of ERISA. The investment advice fiduciary analyzes the annuity market generally, as well as the break-even ages and additional fee of the designated investment alternative, which analysis the named fiduciary critically evaluates and adopts in determining, within its discretion, that the designated investment alternative with the lifetime income benefit provides commensurate value for the fees charged.
(The bolding in this article is mine…just to emphasize the points that I consider the most important.)
Comment: This probably refers to a target date suite where the plan fiduciaries can select one version of the TDFs without the lifetime guarantee and another version that is identical (in the sense that it is the same set of TDFs), but it has an insured guarantee attached…with an added cost for the annuity guarantee.
The example includes the fact that the plan sponsor made the decision to add a lifetime income benefit. That is, in my view, intended to point out that the decision to add lifetime income to the plan was a settlor decision and not a fiduciary decision. But, of course, the implementation of the decision is a fiduciary act.
(ii) Analysis. The named fiduciary must act prudently when implementing the plan sponsor’s decision to add a lifetime income benefit to the plan. Although the named fiduciary must appropriately consider a reasonable number of similar alternatives, the designated investment alternative already on the plan investment menu satisfies this standard because it is both sufficiently different from the designated investment alternative being added to the plan investment menu due to its lifetime income benefit feature and sufficiently comparable because it is identical in each other material respect. The lifetime income feature has added value to the plan and therefore justifies higher total fees than the designated investment alternative without this feature.
Comment: I think that the DOL’s point is that the fiduciaries have already vetted the basic investment (that is, the TDF suite) and therefore do not need to do that again. Instead, the DOL is saying, in my interpretation, that the fiduciary concern under these facts is to determine if the quality and cost of the insured guarantee is justified by the anticipated benefit to the participants.
(iii) Conclusion. The named fiduciary in this example did not act imprudently by adding the new designated investment alternative to the plan investment menu solely because it has higher fees than the similar designated investment alternative without the lifetime income benefit feature that is already on the plan investment menu. To satisfy the consideration and determination requirements under paragraph (h) of this section, and section 404(a)(1)(B) of ERISA, the named fiduciary considered and determined that the additional fee under the variable annuity contract is appropriate in relation to the value it brings to furthering the purposes of the plan.
Comment: The factual description of the process used by the fiduciary in this case appears to be prudent and appropriate. If I were to quibble about anything, it would be that fiduciaries should investigate other competitive guaranteed products to determine if this type of guarantee is the appropriate one for the covered participants, whether the insurance company was experienced and capable in administering guaranteed products, and whether the contract/annuity provisions were prudent for the participants. But I like the fact that the cost versus value analysis was done and the fact that an investment advice fiduciary (presumably competent on insurance issues) was engaged.
The discussion of the example in the preamble is:
Paragraph (h)(3) of the proposed regulation provides an example reflecting the value proposition that a lifetime income benefit option can bring to furthering the purposes of the plan in question. In this example, the plan fiduciary implements the plan settlor’s decision to add a lifetime income benefit option to the plan. To do so, the plan fiduciary selects a new designated investment alternative: an asset allocation fund offered through a variable annuity contract. This designated investment alternative is similar in all material respects—such as risk, return, liquidity, and allocation profile—to another designated investment alternative already on the plan investment menu, except that the existing designated investment alternative does not offer a lifetime income through a variable annuity contract. The two designated investment alternatives have the same expense ratio, but the new designated investment alternative offered through the variable annuity contract has an additional fee associated with the ability of participants to select the lifetime income feature. In this example, the plan fiduciary consults with an investment advice fiduciary, as defined in section 3(21)(A)(ii) of ERISA, who analyzes the annuity market generally, as well as the break-even ages and additional fee of the new designated investment alternative. The example concludes that the fiduciary satisfied the consideration and determination requirement of paragraph (h) and section 404(a)(1)(B) of ERISA in deciding that the additional fee under the variable annuity contract is appropriate in relation to the commensurate value it brings in furthering the purposes of the plan.
Comment: This explanation makes the point that the plan fiduciary sought the advice of a fiduciary advisor. Going forward, the proposal, if finalized anywhere close to where it is now, will encourage plan fiduciaries to engage advisors. In my view, it could lead to many plan sponsors using 3(38) discretionary investment advisors…and particularly advisors who have home office support on selection of insured products and private funds.
I particularly like the statement in the conclusion that “The plan fiduciary then critically evaluates this analysis and adopts it in determining that the new alternative provides commensurate value for the fees charged.” A number of courts have said that fiduciaries cannot “blindly” accept the recommendations of their advisors. Instead fiduciaries must examine the recommendation, ask questions of the advisor, understand the basis for the recommendation, and then adopt the recommendation as their own decision.
I also like that the example goes into some detail in describing a robust process. I hope, and believe, that the final regulation will be viewed as a process-driven rule and the retirement plan community will emphasize the fiduciary process where that is not already the case.
Concluding Thoughts
As I see it, the first part of a prudent process has three steps: (1) determine what information is needed to make a prudent decision about a particular factor (e.g., fees and costs) for a particular investment (e.g., an insured product); (2) gather that information; and, in the words of the DOL (3) “analytically, thoroughly, and objectively” evaluate the information. It will be incumbent on investment advisors to educate committee members and other plan sponsor fiduciaries about that process and then to lead them through it.
