Just How Does a QDIA Wind Up on a Menu?

The letters come so trippingly off the tongue: QDIA. Established by the Department of Labor (DOL) in the 2006 Pension Protection Act, the investment has a few important points. One is protection for employers from any liability, in case plan participants suffer investment losses.

“What a QDIA does is offer a plan sponsor a safe harbor under the law,” Leslie Beale, general counsel and chief compliance officer at BPV Capital Management, tells PLANSPONSOR.

Beale says the DOL was concerned that people were not saving enough for retirement. The act allowed employers to automatically enroll participants in a workplace savings plan, and the QDIA was constructed as a way to choose an investment for those plan participants who did not choose how to allocate their contributions within the investment menu.

The DOL wanted plan sponsors to be able to default participants into investments that would allow people to achieve a rate of return adequate to meet their needs in retirement, Beale explains. “The idea is that cash or money markets don’t keep pace with inflation, and so are inadequate to ensure a reasonable retirement.”

Before the Pension Protection Act, participants who did not make an election were typically defaulted into options such as cash and money markets. The problem: these did not provide an adequate return to meet retirees’ needs, Beale says. To address this, the DOL constructed a series of regulations that would support the use of more aggressive qualified investment alternatives.

Beale calls this area of investments “a narrow world, where an employee doesn’t elect into the defined contribution plan, and you’re going to default them. What are you going to do with those default contributions?” The investment regulations for this group are also more narrowly defined, Beale says. “More narrow than the general definition of what would be a good offering in a retirement plan.”

An investment vehicle must meet one of several requirements to be used as a QDIA. An investment can be age-based, such as a target-date investment. Balanced or risk-based investments, such as BPV’s Core Diversification Fund (BPVDX), can be used as QDIAs. Another possibility is the very individualized age-based managed account.

“It’s up to the plan sponsor to select a fund that meets the requirements, which they need to do in a prudent way,” Beale says. “This gives them a safe harbor-ready defense in case someone comes along 20 years later and says, ‘You defaulted me into a fund that was inappropriate for me.’”

Beale says her firm's core diversification fund seemed to fit the qualifications very well for a QDIA. It would be categorized as a balanced fund. “We asked for an opinion letter,” she explains. “We took the fund and its prospectus and portfolio manager and talked to a lawyer to see if they met the criteria to meet QDIA status.” The fund follows generally accepted investment theory and is diversified to a minimum risk of large loss. It is designed for long-term wealth preservation and capital appreciation through a mix of equities and fixed income. Beale says the opinion letter about the fund says it meets all the requirements, and fits the definition of a balanced or risk-based fund.

Beale explains that the word “approval” is a bit of a misnomer. “There is no formal approval process to designate a fund family as a QDIA,” Beale says. “On our end, as sponsor of a fund, there’s no approval, but we have an opinion letter from an attorney saying the fund meets the qualifications for a QDIA.”

The process is more akin to a partnership between a fund company that says, “Here’s our fund—we’ve done the analysis and think it meets the first three criteria. We’d like you to consider it for your work force.” Then if it seems like a good fit, the plan fiduciary says, “We think it would be suitable for our work force.”

It is not as simple as just sending an investment to the DOL to look over, Beale says. A fund that doesn’t meet the criteria that a plan sponsor needs could still work as an offering in a retirement plan, even if it is not suitable as a QDIA.

Beale says she would probably describe the process as straightforward, and the people she works with who are not lawyers probably would see it differently. “It’s a very legal process,” Beale says. “It does require the use of specialized counsel who have knowledge of both the investment world and the Employee Retirement Income Security Act (ERISA). Once you find counsel, it is fairly straightforward, you look at the prospectus and the investment strategy of the fund and the regulations, and see if fits into the regulatory definitions.”

Plan sponsors that are considering a fund need to consider several factors, Beale says, such as the relative or aggregate age of their work force as a whole; the planned retirement age of their workforce and the general risk tolerance of the workforce are also important.

“That’s a very difficult thing for a plan fiduciary to determine,” Beale notes. “It’s going to be pretty narrow.” It generally doesn’t make sense to have a highly aggressive offering in a QDIA. “You’re really looking at a subset of risk,” she says.

From a risk-return profile, plan sponsors look for an investment that consistently provides more return than the current rate of inflation and does not suffer large losses, Beale says. “Downside protection is often more important than actual upside returns,” she notes. “If you think about the purpose of a retirement investment, consistency is truly key in the retirement space.”