Investing February 23, 2022

QDIA Basics

What plan sponsors need to know about qualified default investment alternative rules and how to select the appropriate one for their employees.
Reported by
Art by Carol Rollo

Qualified default investment alternatives provide plan sponsors with a safe harbor for investing retirement plan participants’ contributions in the absence of participant direction. Along with allocating participants’ retirement deferrals, such investment options also ease the employer’s fiduciary liability, according to industry experts.

QDIAs were authorized by the Pension Protection Act of 2006, and final regulations were issued by the Department of Labor in 2007. By easing plan sponsors’ fiduciary liability for defaulting participants’ savings into certain investments, experts say QDIAs removed an impediment to more widespread use of automatic enrollment in defined contribution plans.

Get more!  Sign up for PLANSPONSOR newsletters.

“These options really helped address plan fiduciary concerns about the liability of undirected investment decisions,” explains Joni Tibbetts, vice president for management, retirement and income solutions at Principal Financial Group, in Des Moines, Iowa. “They’re really addressing plan fiduciaries’ concerns about the liability of investment losses, while providing participants [with] investments that may lead to future growth. That’s really the genesis of why they were introduced.”

QDIAs help to maximize participants’ accumulated retirement savings over a career, says David Morehead, vice president at retirement pan adviser OneDigital, in San Diego, California.   

“For employees, it takes what can sometimes feel like guesswork or maybe uninformed decision making out of the equation and allows the professional money manager to allocate their assets on their behalf with a lot of thought and research behind the decisions being made there,” Morehead explains.

He says QDIAs benefit plan sponsors as well. “The fiduciary liability protection that comes with QDIA compliance makes employers tremendously more comfortable putting employees in an investment option that entails a little bit of risk but is likely the best investment option for them long term,” he says.

Rules of the Road

The DOL’s Employee Benefits Security Administration is in charge of executing Congress’ PPA legislation for QDIAs, effecting the rules and regulations, and providing ongoing oversight. 

Plan sponsors can select from a menu of approved QDIAs, according to EBSA. That includes:

  • A product with a mix of investments that takes into account the individual’s age or retirement date (an example of such a product could be a lifecycle [risk-based] or targeted-retirement-date fund);
  • 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 (an example of such a service could be a professionally 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 (an example of such a product could be a balanced fund); and
  • A capital preservation product 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).

Plan sponsors must also conform to several conditions under the rules to obtain safe harbor relief from fiduciary liability for investment outcomes:

  • Assets must be invested in a “qualified default investment alternative” as defined in the regulation;
  • Participants and beneficiaries must have been given an opportunity to provide investment direction but have not done so;
  • A notice generally must be furnished to participants and beneficiaries in advance of the first investment in the QDIA and annually thereafter. The rule describes the information that must be included in the notice;
  • Material, such as investment prospectuses, provided to the plan for the QDIA must be furnished to participants and beneficiaries;
  • Participants and beneficiaries must have the opportunity to direct investments out of a QDIA as frequently as from other plan investments, but at least quarterly;
  • The rule limits the fees that can be imposed on a participant who opts out of participation in the plan or who decides to direct their investments; and
  • The plan must offer a “broad range of investment alternatives” as defined in the DOL’s regulation under Section 404(c) of the Employee Retirement Income Security Act.

Morehead reaffirms that disclosure requirements are key for plan sponsors. “Otherwise, [the QDIA selected] loses basically all of the benefits for the plan sponsor,” he says.

Some funds won’t qualify as a QDIA, Morehead adds, including funds without fixed-income exposures, for example. “That knocks the fund out from being a QDIA right there,” he says.

“The main requirement for a QDIA is generally that it not be exclusively in one particular kind of investment,” explains Andrew Oringer, a partner in Dechert’s ERISA and executive compensation group in New York City.

QDIA Trends

Since the introduction of QDIAs, target-date funds, which assign an asset allocation to participants based on their age, have become the most popular choice. According to the 2021 PLANSPONSOR Defined Contribution Survey, 75.6% of respondents overall use a TDF as their default investment for automatic enrollment.

By comparison, only 1% of DC plan sponsors indicated that they use a stable value fund or guaranteed investment contract as the default for automatic enrollment; 2.3% said they use a risk-based asset allocation fund; 3.4% reported they use a professionally managed account; and 5.1% use a balanced fund.

The vast majority, nearly 99% of OneDigital’s plan sponsor clients, use an age-based QDIA, Morehead says.

“More recently, they’ve also been looking at managed accounts, but I’d say an age-based option is generally the starting point,” he adds.

While “a broad array of possible QDIAs,” are available to plan sponsors, “what we have seen in the market is fairly clear, trending to the use of target-date funds,” Oringer says.

A Cerulli and Associates study with the SPARK [Society of Professional Asset Managers and Recordkeepers] Institute shows that 71% of plan sponsors use a TDF, 9% use a managed account and 5% use a dynamic QDIA.

Dynamic QDIAs are investment options that start a participant off in one investment product or solution, such as a target-date fund, and automatically transition the participant—upon reaching a certain threshold including account balance or age—into another retirement-focused product.

QDIA Selection

The right QDIA for a plan sponsor depends on the demographics of the employer’s workforce, its plan design and its investment philosophy, sources explain. Another important consideration is the level of investment sophistication of the workforce, Tibbets says.

“An employer can consider factors such as participant ages, compensation levels, plan contribution rates, automatic enrollment percentages, turnover and distribution activity,” she says.

For example, some plan sponsors may use managed accounts to maximize participants’ retirement readiness because these funds can offer greater personalization of investment options and tailored advice, Tibbetts explains.

“Most of the QDIA options are designed for the plan generally at the plan level, but managed account options are really customized at that individual participant’s needs,” she says. “The employer, of course, needs to evaluate the cost of the performance of each option, but it’s really key for the plan fiduciary to understand the differences in these options, the asset classes and how this really might change over time, because it’s really important that a fiduciary selects the best option upfront.”

Morehead performs demographic analysis with the plan sponsor, with several questions, to select a few fund managers that offer target-date or managed account funds to find the best fit, he says. Morehead says he will talk with the plan sponsor about its investment philosophy and fund composition, and he will educate the investment committee on nuances between selections.

The firm’s analysis also includes U.S. Census data, the average age at the company and median age. Additionally, it will consider whether the plan sponsor prefers active or passive asset management, and tactical or strategic investment management, Morehead adds.  

“Income is another big demographic factor that we look at, as well as number of participants with an outstanding loan. We also look at the percentage of terminated participants that take a distribution versus leave their money in the plan,” he says. “A couple of other really prominent ones that I also like to look at are presence of a self-directed brokerage account [and] other retirement plans that the plan sponsor may be offering.”

Morehead explains that, typically, higher average income translates into higher participation and savings rates. “When we have high, consistent investments from participants, this affords us more ability to assume a higher level of market risk in our TDF recommendation based on this positive behavior,” he says. “If we have lower income, participation and savings rates, this will typically lend toward a more conservative strategy being more important.”

The number of participants with an outstanding loan and the percentage of terminated participants that take a distribution versus leave money in the plan help establish a time horizon when making investment recommendations to plan sponsors, Morehead adds. 

“The presence of an SDBA will help guide our recommendations when it comes to the number of asset classes and the overall investment strategy—for example, active versus passive, or tactical versus strategic,” he says.

In addition, Morehead says, if participants have access to a defined benefit pension plan, it allows them to take more risk in DC plan investments. “That’s a really good foundation which would then allow them to have a little bit riskier investment allocation for potentially higher returns, better growth,” he says.

Investing February 22, 2022

Considerations for Tweaking the Investment Menu for Older Participants

Participants approaching retirement and those who decide to remain in the plan need additional choices and can benefit from assets that aren’t correlated to equities.
Reported by

Plan sponsors can maximize their defined contribution retirement plans by adding investment menu options for retired participants and workers who are nearing retirement, according to sources.

Plan design evolutions and attendant changes in participant use since the Pension Protection Act of 2006 “should transform how plan sponsors are thinking about the [investment] menu,” offered to participants, says Jeremy Stempien, principal, portfolio manager and strategist at PGIM DC Solutions.       

Get more!  Sign up for PLANSPONSOR newsletters.

Participants who are invested in a target-date fund and nearing retirement, for example, can have their asset allocations automatically de-risked to become more conservative as they age, from riskier equities into less risky fixed-income investments. 

“The traditional asset classes still are key components—U.S. equities, non-U.S. equities, core bonds, short duration, fixed income or cash—those are on menus and they still apply to what’s really an important aspect for those older individuals or retirees,” Stempien says. “But beyond that, where we see a substantial gap in plan menus today in order to serve those same constituents,” is options to address retirement risks.

He doesn’t advise that plan sponsors ditch equities for participants who are near retirement, but instead that employers address what needs to be tweaked or added, to ensure that older workers can build retirement-centric portfolios and achieve better outcomes for lifetime income through retirement to account for longevity risk. 

For example, plan sponsors should consider adding liquid and illiquid asset classes to investment menus to help the cohort, Stempien explains. Investment menus for the retired and near-retired can be bolstered with Treasury inflation-protected securities, also known as TIPs; commodities; real assets; and longer-duration bonds, he says.

Illiquid options could fit within a professionally managed portfolio or managed account option outside of the core TDF menu, he adds.

“[Asset classes] like real estate, private debt and private equity can be considered,” Stempien says. “In a managed portfolio design for retirees, [those] can play more of a role.”

Adding investment options that are noncorrelated to equities, such as real asset funds, are a sound offering for retirees and near-retires. The assets don’t correlate to the stock or bond market, says Chuck Williams, CEO at Finspire, a Chicago-based corporate retirement planning consultant.

“That’s going to be important to have that diversification in retirement,” he adds.

Plan sponsors have been wary of adding so many options as to be confusing to participants, Stempien says, and studies have shown that the growth of plan assets in TDFs may be reducing the importance of investment options on the core menu.

“Most of the accepted DC research out there doesn’t really account for DC investor profiles today,” he says. “The research that’s out there tends to say that larger menus with more options lead to inappropriate participant allocations because participants don’t know how to use them, but what’s missing there is that with the rise of target-date funds and really of the QDIA [qualified default investment alternative], that’s not as much of a concern today, as the number of people self-allocating has decreased substantially.”

Previous research has also shown that plan sponsors are encouraging retiring participants to keep their assets in the plan. But despite that push to remain in-plan, many investment menus have limited options for the retired and near-retired cohort, Josh Cohen, PGIM head of DC client solutions, previously said. 

“When we look at what’s typically on a menu versus what’s needed for retirement income, most menus are short on options such as additional fixed-income options, longer duration, more inflation-sensitive asset classes and income-producing asset classes such as commodities, real assets and real estate,” he explained.  

Another problem for older workers is that many plan investment menus are tailored toward equity growth options, with an average of three equity funds to each bond option, Stempien says. He says plan sponsors should therefore examine the plan investment menu for inefficiencies. A plan with several U.S. equity options could be culled down, for instance.

“Plans should be very intentional in terms of the coverage [of asset classes] that they provide,” he says. “[It’s] condensing a variety of international equity funds down to one or two, and then giving some more attention to the asset classes that are lacking. It doesn’t necessarily mean menus have to get bigger, just that plan sponsors from a plan design perspective should be thinking about how to make them smarter and more efficient.”

Participant Base

Plan sponsors must give a close examination to their retired and near-retired participants to determine how to structure the investment menu or what needs to be added, says Stempien. He says it’s important to know how many retired participants remain in the plan, and if the plan has encouraged near-retirees to keep retirement assets in-plan.

“The older the participants and the more the plan sponsors are trying to encourage participants to stay in a plan as they age—which would mean into and then even during the retirement years—the more important a robust plan menu becomes,” he says.

Williams suggests plan sponsors can also use managed retirement income strategies for this cohort. To help older workers and retirees, plan sponsors can also include TDFs that have guaranteed minimum withdrawal benefits and other retirement income products such as annuities, he adds.

«