Are Qualified Default Investment Alternatives (QDIAs) Good, Bad or Lazy “Choices” for Participants?
“Choices” has quotation marks around it in the title above because many participants’ investments are in QDIAs due to participants never making an explicit choice regarding their 401(k) investments. While it may appear lazy to not make investment elections for one’s retirement plan, it’s possible that some participants review the QDIA and make a conscious choice that the QDIA is an appropriate investment for them. However, it’s likely that most of the participants whose investments are in QDIAs are there either because the participants are overwhelmed by the process of researching each investment option, or they lack the level of understanding/experience to even do the research, or they are procrastinators and this task never gets to the “urgent” level of their priorities.
Are QDIAs good, bad, or lazy choices?
Of course, the correct answer is, it depends on the QDIAs being offered by each plan and the investment profile for each participant. Since there isn’t a one-size-fits-all answer to this question, let’s back up a little bit and gain some understanding about QDIAs – how they are determined, who is responsible for them, and why have they become so prevalent in 401(k) plans. Maybe then we will have a better idea as to whether they are good, bad or lazy choices.
What are QDIAs?
Default investments are not new, but they became much more common after the Pension Protection Act (PPA) of 2006. PPA made automatic enrollment features attractive for 401(k) plans. By amending the Employee Retirement Income Security Act (ERISA), PPA created a safe harbor that reduced fiduciaries’ liability if a QDIA is the default investment for participants who make no affirmative election.
While plans with automatic enrollment features need QDIAs to protect plan fiduciaries from potential liability for losses when participants fail to actively direct investments, other situations occur in 401(k) plans that may result in the need for QDIAs, too. These include:
- Incomplete enrollment forms
- Removal of investment options with no clear mapping
- Employer contributions on behalf of an employee who isn’t contributing
- Death benefits for which the beneficiary has not made investment elections
- Qualified Domestic Relations Orders (QDROs) without any investment selections
- Rollovers with no investment selections
- Missing participants
The Department of Labor (DOL) rules provide for four types of QDIAs:
- A product with a mix of investments that takes into account the individual’s age or retirement date (e.g., target date funds).
- An investment service that allocates contributions among existing plan options to provide an asset mix that takes into account the individual’s age or retirement date (e.g., a managed account).
- A product with a mix of investments that takes into account the characteristics of the group of employees as a whole, rather than each individual (e.g., a balanced fund); and
- A capital preservation product (e.g., money market fund) for only the first 120 days of participation (an option for plan sponsors wishing to simplify administration if workers opt-out of participation before incurring an additional tax).
Also, a QDIA must be managed by an investment manager, plan trustee, plan sponsor, or a committee comprised primarily of employees of the plan sponsor that is a named fiduciary, or it must be an investment company registered under the Investment Company Act of 1940.
Plan sponsors are responsible for the prudent selection of appropriate QDIAs for their plans, as well as for monitoring QDIAs to ensure that they remain a prudent default investment. The selection process includes considering:
- The age of individual participants or the average age of the group of participants; and
- The costs and fees of the QDIAs.
When one considers all the governance surrounding QDIAs, they are probably good choices for most participants, not just those who don’t actively make a choice. These investments take into account many of the considerations that are needed for a managed portfolio, so and they offer some protection for people who have limited investment experience and knowledge. A QDIA protects employees from missing out on potential long-term growth and simplifies the decision-making process by selecting the asset allocation of the 401(k) investments for them. It is likely that the QDIA may be the best choice, and not just the lazy choice, for a lot of a plan’s participants.
Mike Bourne is the managing partner for Atéssa Benefits, a TPA firm specializing in defined benefit (DB) plan administration and ERISA Compliance. He is also a partner in MB Actuarial Services, which provides outsourced services to over 700 DB plans for other TPA firms. Both firms are located in San Diego, CA. He is also a CPA and an MBA from the University of Chicago
