My earlier posts discussed four of the six Factors in the DOL’s proposed regulation that apply to most investments in participant-directed private sector plans. This article discusses the second example of the application of the Liquidity Factor, which is one of the two Factors (along with the Valuation Factor) that specifically target illiquid, hard-to-value investments, such as private funds.

As background, 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 earlier posts, I covered four of the factors—Performance, Fees, Performance Benchmarks and Complexity, and their examples.

In my last two articles, Alternative Assets (22) and Alternative Assets (23), I looked at the Liquidity factor and the first example of that factor.  This article looks at the second example:

(2) Example. Participant level liquidity; lifetime income—

(i) Facts. The investment policy statement of a participant-directed individual account plan calls for lifetime income options on the plan investment menu. The named fiduciary selects several designated investment alternatives with such features, including a deferred annuity contract. Allocations to this contract, which are made on a monthly basis, grow at a rate specified under the contract, and monthly payments for life begin when the participant reaches age 65. Allocations to this contract become fully committed after 90 days and any immediate withdrawals by a participant before age 65 result in a penalty and a market value adjustment to the value of the annuity that begins at age 65. The restrictions on liquidity throughout the growth period enable greater monthly payments at age 65.

(The bolding in this article is mine…just to emphasize the points that I consider the most important.)

Comment: This example illustrates a liquidity issue at the participant level.  While the example is of a deferred annuity contract, the concept and the prudence standard would apply to an limitation on liquidity, such as a penalty, a market value adjustment, a contingent deferred sales charge, a put requirement (e.g., a 12-month put to get out of an investment without a reduction in value), or a timing restriction, such as a requirement to queue up for a limited number of quarterly redemptions.  The broad legal concept is that restrictions and limitations are permissible and could be prudent if the restriction is justified by the enhanced value for the investment (e.g., greater returns or less volatility).  Of course, that requires that fiduciaries fully appreciate the restriction and the enhanced value, and the relationship between the two.

(ii) Analysis. Paragraph (i) of this section clarifies that plan fiduciaries must appropriately consider the potential participant-level events that may trigger a plan’s need for immediate liquidity, and must determine that the designated investment alternative, at the time of selection, will have sufficient liquidity to meet the anticipated liquidity needs of the plan. When assessing the liquidity needs of the plan, the plan fiduciary in this example must balance the restrictions on liquidity under the annuity contract with the value of the guaranteed monthly payments under the annuity contract, recognizing that such guarantees help plan participants manage investment and longevity risk. The fact that a designated investment alternative is fully allocated to an illiquid product, like an annuity, does not foreclose its selection, including, for example, where the fiduciary determines within its discretion that the lack of liquidity is justified by a commensurate expected increase in return on investment, certainty with respect to future payments, or both.

Comment: The DOL’s analysis makes sense and is, in my view, consistent with long-standing interpretations of ERISA.  I assume the purpose for including this example is to provide comfort to fiduciaries for selecting products that guarantee lifelong income, such as annuities. Coupled with the fiduciary safe harbor for selecting insurance companies (in the 2019 SECURE Act), this should provide some comfort for choosing annuity products that are illiquid or have liquidity restrictions.  However, there is still a fiduciary duty to prudently select the particular annuity contract and liquidity is part of that equation.

(iii) Conclusion. In this example, the named fiduciary would satisfy the consideration and determination requirements of paragraph (i) of this section, and section 404(a)(1)(B) of ERISA, with respect to the designated investment alternative in question if the named fiduciary concluded that the increase in the value of the monthly payments and the certainty of the insurer’s guarantee under the annuity contract justified the restrictions on liquidity.

Comment: No surprises here. While that conclusion and process looks good on paper, fiduciaries must still go through the process of considering the burden of the restrictions versus the benefit of the particular annuity (or, more generally, the benefit of any investment with liquidity restrictions).  That is easy to write, but hard to do.  For example, how do you weigh the value versus the restriction?  That isn’t answered by the DOL; it is left to the plan fiduciaries to consider.  Realistically, as long as the restrictions are reasonable, and the investment (or annuity) has significant enhanced value, it would be difficult to successfully challenge a fiduciary decision. The real risk lies where the appropriate information wasn’t gathered and evaluated in a knowledgeable manner….it is, in the final analysis, the process.

The preamble discusses this example as follows:

Paragraph (i)(2) of the proposed regulation contains a positive example of how a plan fiduciary may be deemed to have appropriately considered the participant-level liquidity needs of the plan when selecting as a designated investment alternative a guaranteed deferred annuity contract that contains substantial restrictions on liquidity at the participant level. The example illustrates that the mechanics of the annuity in the contract at issue are such that monthly participant contributions purchase increments of deferred income with payments for life beginning when the participant reaches age 65. These monthly contributions are fully committed (i.e., not liquid) after 90 days, and any immediate withdrawals by the participant before age 65 would result in a penalty and a market value adjustment to the value of the annuity that begins at age 65.

This example concludes that the plan fiduciary in question would satisfy the consideration and determination requirements of paragraph (i) of the proposed regulation (i.e., the liquidity factor) if the fiduciary, after an objective, thorough, and analytical investigation, concludes that the increase in the value of the guaranteed monthly payments for the lives of the participants and beneficiaries that select to invest in this designated investment alternative and the certainty of the insurer’s guarantee under the contract justify the restrictions on liquidity. Put differently, the example demonstrates that the plan fiduciary in this example must balance the restrictions on liquidity under the annuity contract with the value of the guaranteed monthly payments under the annuity contract, recognizing that such guarantees help plan participants manage investment and longevity risk for the rest of their lives, and determine that the lack of liquidity is justified by a commensurate expected increase in the return on investment or certainty with respect to future payments.

Comment: In the preamble, the DOL makes my point in the Comment on the Conclusion. It is the process, which the DOL describes as “…if the fiduciary, after an objective, thorough, and analytical investigation, concludes that the increase in the value of the guaranteed monthly payments for the lives of the participants and beneficiaries that select to invest in this designated investment alternative and the certainty of the insurer’s guarantee under the contract justify the restrictions on liquidity.”

I believe that “an objective, thorough, and analytical investigation” can be described conversationally as having five parts:

• Determine the information that a person who is knowledgeable about the particular investment/product would want to review to make an investment decision.
• Gather that information.
• Review the information.
• Make a reasonable decision based on the information.
• If a fiduciary can’t do any of the first four steps, hire an advisor who can.

Keep in mind that, if a plan fiduciary engages in a process that complies with the Liquidity factor, the proposed regulation (once finalized) will provide a presumption of prudence.

Concluding Thoughts

Unlike some of the other 19 examples, this one doesn’t cover any new territory or impose any new burdens on fiduciaries.  Instead, it provides comfort to fiduciaries by acknowledging that liquidity restrictions—for example, on annuity products—are permissible (and can be prudent) if the restrictions on liquidity are offset by enhanced value of the investments.

Fiduciaries must balance those considerations.