Target-date funds that feature annuities may be used asqualified default investment alternatives in 401(k) plans, according to a Labor Department information letter.

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The letter, which was a response to an inquiry from TIAAregarding one of the firm’s custom TDF products, attempts toclarify existing agency guidance on how TDFs with annuities can comply with QDIAprotocol.

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One of the existing requirements for an investment to qualify asa QDIA is that participants must be able totransfer their investment from one product to another qualifiedoption after three months.

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TIAA’s Income for Life Custom Portfolios invest a portion of aparticipant’s savings into an annuity sleeve. The allocationincreases according to the fund’s glide path. The funds cap aparticipant’s allocation to the annuity sleeve at 50 percent.

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With TIAA’s custom TDFs, participants can transfer the assetsinvested in the annuity sleeve to another in-plan QDIA for thefirst 12 months after the initial investment.

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After the first year, participants can only transfer funds fromthe annuity sleeve on a restricted basis. During the next sevenyears, participants can move money out of the annuity sleeve, butonly in limited installments. Such liquidity restrictions are ofcourse protocol for most annuity investments.

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In its letter to TIAA, the DOL says the annuity sleeve in theILCP target-date fund does not qualify as a QDIA under a strictinterpretation of the existing regulatory language.

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But the letter then goes on to explain that plan sponsors canuse TDFs with annuity features and still satisfy their fiduciaryobligations.

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In order for an investment to qualify as a QDIA, the regulatorylanguage says participants must be able to transfer assets from onequalified investment to another “with a frequency consistent withthat afforded participants and beneficiaries who elect to invest inthe QDIA, but not less frequently than once within any three monthperiod,” according to the information letter.

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But in the information letter, the DOL suggests plan sponsorshave more latitude to use TDFs with annuities than is implied inthe existing regulatory language.

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“The Department’s overarching focus when developing the QDIAregulation, including the types of investment alternatives thatcould be QDIAs, was on the long-term accumulation of retirementsavings as a way to ensure adequate retirement income,” accordingto the letter.

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Since establishing the QDIA requirements, annuities’ potentialvalue to retirement savers has emerged as a central issue amonginvestment experts, industry stakeholders, and policy makers onCapitol Hill.

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“The Department (of Labor), along with the Treasury Departmentand other stakeholders, identified the need for lifetime income asan important public policy issue and has supported initiatives thatcould lead to broader use of lifetime income options in definedcontribution plans as a supplement to and enhancement ofaccumulation of retirement savings,” the letter says.

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In the spirit of that effort, the letter says that nothing inthe existing QDIA rules stands in the way of a plan fiduciarymaking a determination that it would be prudent to defaultparticipants into a TDF featuring an annuity.

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The letter notes that prudence requires plan fiduciaries toengage in an “objective, thorough and analytical process” whenselecting a TDF with an annuity as a default investment in a 401(k)plan.

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The cost of the annuity, the specifics of the liquiditylimitations of a given annuity, and the demographics ofparticipants in the plan must be considered by prudent fiduciaries,the letter says.

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Moreover, sponsors must consider the extra communication effortsnecessary to adequately educate participants on the liquiditylimitations of annuities.

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Ultimately, whether a TDF with an annuity feature qualifies as aQDIA depends “on the facts and circumstances” of a specific plan,the letter says.

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Nick Thornton

Nick Thornton is a financial writer covering retirement and health care issues for BenefitsPRO and ALM Media. He greatly enjoys learning from the vast minds in the legal, academic, advisory and money management communities when covering the retirement space. He's also written on international marketing trends, financial institution risk management, defense and energy issues, the restaurant industry in New York City, surfing, cigars, rum, travel, and fishing. When not writing, he's pushing into some land or water.