This blog is part of a series focusing on how plan sponsors can improve participant outcomes and simplify participant choices through plan design considerations. So far, we have written on automatic enrollment and automatic increase, re-enrollment, and Roth contribution features. In this post, I will discuss the selection process of the plan’s Qualified Default Investment Alternative, otherwise known as QDIA.
One of the main goals of the Pension Protection Act of 2006 (PPA) was to increase participation in company-sponsored retirement plans. While we can’t solely attribute increased participation to automatic enrollment, Vanguard’s client base has seen average participation increase by seven percentage points since 2006 on a plan weighted basis. PPA sought to address this issue through automatic enrollment. A key feature of automatic enrollment is that a default investment election is needed given that participants have not made an affirmative decision to enroll. PPA extended the liability relief for investment outcomes to plan fiduciaries as long as the plan used a QDIA.
Four types of QDIA’s are allowed under PPA[2][3]:
- A product that accounts for a participant’s time horizon to retirement (e.g., target date fund)
- A product that allocates investments based on a desired risk level (e.g., target risk fund or balanced fund)
- A service that invests a participant portfolio based on their circumstances (e.g., managed account)
- A capital preservation product for the first 120 days of participation and then moved into one of the other three options described above (e.g., stable value, money market, etc.)
In order to receive the liability relief, fiduciaries must ensure that participants receive annual notice explaining default; the participant has a reasonable period of time after the notice to make a designation; and the investment option is one of the four options listed above and meets the other QDIA requirements (e.g., no trading fees, diversified, no employer securities, etc.)2.
As with any fiduciary decision, a plan committee should make the QDIA selection using a prudent process. Below is an example selection and monitoring process for a plan’s QDIA option.
Gather relevant information:
- Plan design features (e.g. employer contributions, distribution options, etc.)
- Participant demographic data (salary, contribution rates, tenure, distribution practices, etc.)
- Committee preferences (active v. passive, asset class diversification, riskiness, etc.)
Analyze information:
- Asset allocation
- Expenses and fees
- Historical performance and risk statistics
Meet and make a decision:
- How do the options align with selection objectives defined in step 1
- Discuss relative merits of each option
- Determine if more information is needed
Document the process:
- Include relevant materials in the fiduciary file
- Establish criteria and timing for ongoing monitoring
My career in this industry includes pre- and post-PPA periods – yes, I am feeling old. Early in my career, I observed very few plan committees that were willing to default participants to a ‘risky’ option (one that provided exposure to equities), even though intellectually they understood the opportunity cost of low-risk cash investments over a career and the typical participant’s inertia when it comes to investment decisions. In the 10+ years since PPA, the industry has come to a clear consensus – 77.5% of plan sponsors use target date funds as their QDIA according to survey data[4]. The figures rise to the low to mid 80% for plans with 1,000+ participants. While target date funds are far from perfect, I believe participants have a far better chance of achieving a secure retirement since the institution of this plan design ‘nudge.’
Notes:
[1] Vanguard Investments, How America Saves 2019
[2] https://www.dol.gov/agencies/ebsa/about-ebsa/our-activities/resource-center/fact-sheets/default-investment-alternatives-under-participant-directed-individual-account-plans
[3] https://www.dol.gov/sites/dolgov/files/EBSA/about-ebsa/our-activities/resource-center/fact-sheets/final-rule-qdia-in-participant-directed-account-plans.pdf
[4] 60th Annual Survey of Profit Sharing and 401(k) Plans, Plan Sponsor Council of America, 2018
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