Reasons for implementing a Qualified Default Investment Alternative

Participants don’t know what they don’t know.

After sifting through the June 2017 issue of PlanSponsor magazine, I found yet another staggering statistic that reaffirms not only the importance of retirement plan education, but also the positive impact that plan design can have on participant outcomes. In a recent study by The American College of Financial Services, they found that “three in four retirement-aged adults failed a quiz on ways to make their nest eggs last through retirement”. An even more alarming result was that Americans between the ages of 60 and 75 have difficulty understanding important financial topics focused on investment considerations and retirement income sustainability. Let`s not chalk this up to poor quiz taking skills, either. According to the study, “61% of respondents reported having high levels of retirement income knowledge, however, only 33% of those passed the quiz”. It`s simple, this study highlights the importance of providing proper and ongoing education to retirement plan participants. It should also prompt employers to learn more about effective plan design techniques, different types of investment vehicles and available safe harbors.

Yes, plan sponsors can help enhance participant outcomes.

Employers (aka plan sponsors) have the opportunity to utilize default options within their retirement plan to help prevent participants from making detrimental investment decisions. Yes, there are many financially savvy participants that feel comfortable making their own investment decisions and they can still direct their investments, as they see fit. That said, plan sponsors could take advantage of a Qualified Default Investment Alternative (QDIA) to help ensure accounts are properly diversified while helping those not comfortable making investment decisions on their own. Basically, the QDIA serves as a default for those participants that do not make an election, by mistake or consciously. And for those financially savvy participants that are defaulted into the QDIA during an initial enrollment or re-enrollment process, they can still opt-out and continue with their own choices.

Yes, there is a Safe Harbor for Plan Sponsors.

Plan sponsors can benefit from an available safe harbor for their QDIA selection. This safe harbor was enacted with the Pension Protection Act of 2006 (PPA) and provides relief for 401k plan fiduciaries under Section 404(c) of the Employee Retirement Income Security Act of 1974 (ERISA). Under Section 404(c), a plan fiduciary will not be responsible for investment losses borne from a participant’s investment election, as long as certain procedural requirements are adhered to and a properly recognized investment is selected as the default. 

What Investments are recognized as a QDIA?

The QDIA can be structured to use a Balanced Fund, a Managed Account, or a Target-Date Fund. A capital preservation fund (i.e., stable value) can also be used but only for an initial 120-day timeframe. Please note, the type of QDIA selected is an important decision and should factor in plan demographics.

A Snapshot of the Industry

There are many plan providers and consultants that positively shape and impact retirement outcomes for participants on a daily basis. In my opinion, the industry has done an outstanding job of helping plan sponsors realize the importance of offering investment options that are designed to equip participants with a better chance to achieve retirement goals. We can see the results of these efforts when viewing recent statistics on Target Date Funds (TDFs), one of the options that qualify as a QDIA.  For note, assets in TDFs have grown from $132.7 billion (March, 2008) to $940.9 billion, as of the end of the first quarter of 2017, according to Strategic Insight[1]. These types of investment portfolios can have a positive impact on participant’s retirement account balances because they are diversified, they manage investment risk over time, and they are designed to be a participants total portfolio allocation. TDFs also operate with a built in asset allocation strategy that reduces equity exposure over time and is often based on the number of years left until retirement. Please note, that there are many types of TDF constructs and strategies. For example, some investment managers will reduce equities over a participant’s lifetime, while others manage to a shorter timeframe (to retirement). This trajectory is commonly referred to as the “glide path” and is an important consideration when analyzing, selecting and benchmarking the different types of TDFs on performance and risk.

Bottom-line

Employers have the capability to improve their employees’ retirement success without having to contribute more dollars. There are plan design techniques and investment vehicles available that when combined (i.e., QDIA), can serve as an effective method for enhancing participant outcomes. Just as important, plan sponsors can take advantage of a safe harbor for their QDIA selection, deeming this a real “no-brainer”.

 

[1] Cirillo, M. 2017. TDF Analysis: Strategic Insight`s quarterly target-date fund analysis. Plansponsor.com June 2017. p.6