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Qualified Default Investment Alternatives In 2006, the Pension Protection Act (PPA) was signed into law with the objective of encouraging ERISA-defined contribution plans to adopt automatic enrollment features that would force plan participants to "opt-out", rather than "opt-in", to their company’s retirement plan. One component of PPA required the Department of Labor (DOL) to draft regulation that would assist employers in selecting default investment options for participants that do not make an active investment election in their plan. On October 24, 2007 the Employee Benefits Security Administration (EBSA) of the DOL issued final regulations governing default investment options. The final regulations provided safe harbor relief from fiduciary liability for participant outcomes, if the plan sponsor selected a qualified default investment alternative (QDIA) and met all of the other requirements for disclosure and participant flexibility. It is important to note that the final regulations did not require plans to comply with the rules, but instead created a safe harbor protection for those plans that elected to comply. Up until the creation of the QDIA rules, most plan sponsors had selected their plan’s stable value, general account product, or money market fund as the default investment option if participants failed to make an investment election for their assets in the plan. These types of investments were generally considered the "safest" option within the plan, because they were designed to minimize market volatility and loss of principal. While these types of investment might have provided short term safety, they offered minimal opportunity for long-term gains sufficient to provide a participant with a comfortable nest egg at retirement. By selecting these types of investments as the default option, many plan sponsors were overweighting market risk (the loss of principal) versus the other risk types facing retirement investors (i.e. inflation risk and longevity risk). The final regulations released by the EBSA outlined which options qualified as QDIAs. According to the EBSA, the objective of the final regulations was "…to ensure that an investment qualifying as a QDIA is appropriate as a single investment capable of meeting a worker’s long-term retirement savings needs." The final regulations did not specify individual products that qualified, instead it outlined four categories of products that would meet the objectives and qualify as QDIAs. The EBSA provided the following description for the four types of QDIAs¹:
Of the four types of investment products that qualified, three are viable options for most plan sponsors. The fourth option, a capital preservation product that could be used for a limited time only, is not feasible for most plan sponsors because it would require them to track the 120 day deadline and re-default a participant into another option if they failed to make an election in the 120 day window. The 3 workable options created a noted break from the past, in that they are options that would consist of a blended mix of stocks and bonds, rather than the more conservative, cash-like options that were so popular up until that point. Many plan sponsors see managed accounts as an inadequate default option because they are most effective when a participant is actively engaged with the solution and is willing to provide detailed information on their specific situation so that the solution can be tailored to the individual’s specific needs. Most default participants become default because they are unwilling to make even simple decisions, let alone provide the financial background necessary for a managed account solution. And finding a single balanced fund (or model portfolio) that is suitable for all, or at least the vast majority, of the sponsor’s participant population is difficult because of varying circumstances. Plan sponsors risk being too conservative or too aggressive for some portion of their employee population depending on what they ultimately select as the balanced fund. Of the three options, target date funds are, by a large margin, the most heavily adopted type of QDIA investment option. They offer a large advantage over the other two options in that they are easy to use and easy to communicate. Compared to a professionally-managed account solution, they are less expensive and require less front-end input of information from the plan participant. Target date funds are also more attractive than the balanced fund solution, because they allow for some difference in asset allocation and risk profile based on an individual’s age. Please refer to our white paper, Evaluating Target Date Fund Structure, for more information regarding considerations in selecting a target date product. Multnomah Group, Inc. Copyright 2010. Multnomah Group, Inc. All Rights Reserved. ¹ Employee Benefits Security Administration “Regulation Relating to Qualified Investment Alternatives in Participant-Directed Individual Account Plans”, April 2008.
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