What is a Qualified Default Investment Alternative (QDIA)?
You’ve probably heard of a Qualified Default Investment Alternative (QDIA). But what is it really—and does your 401(k) plan need one? Read on for the answers to the most commonly asked questions about QDIAs.
What is a QDIA?
Used when 401(k) plan participants haven’t made an active investment election, a QDIA is the plan’s default investment.
Here’s how it works: When money is contributed to the plan, it’s automatically invested in the QDIA that was selected by the plan fiduciary (typically, the business owner or the plan sponsor). The employee can leave the money in the QDIA or transfer it to another plan investment.
When (and why) was the QDIA introduced?
The concept of a QDIA was first introduced when the Pension Protection Act of 2006 (PPA) was signed into law. Designed to boost employee retirement savings, the PPA removed barriers that prevented employers from adopting automatic enrollment. At the time, fears about legal liability for market fluctuations and the applicability of state wage withholding laws had prevented many employers from adopting automatic enrollment—or had led them to select low-risk, low-return options as default investments.
The PPA eliminated those fears by amending the Employee Retirement Income Security Act (ERISA) to provide a safe harbor for plan fiduciaries who invest participant assets in certain types of default investment alternatives when participants do not give investment direction. To assist employers in selecting QDIAs that met employees’ long-term retirement needs, the Department of Labor (DOL) issued a final regulation detailing the characteristics of these investments (see What kinds of investments qualify as QDIAs? below).
Why does having a QDIA matter?
When a 401(k) plan has a QDIA that meets the DOL’s rules, then the plan fiduciary is not liable for the QDIA’s investment performance. Without a QDIA, the plan fiduciary is potentially liable for investment losses when participants don’t actively direct their plan investments.
Plus, having a QDIA in place means that employee accounts are well positioned—even if an active investment decision is never taken. If you select an appropriate default investment for your plan, you can feel confident knowing that your employees’ retirement dollars are invested in a vehicle that offers the potential for growth.
Does my retirement plan need a QDIA?
Yes, it’s a smart idea for all plans to have a QDIA. That’s because, at some point, money may be contributed to the plan, and participants may not have an investment election on file. This could happen in a number of situations, including when money is contributed to an account but no active investment elections have been established, such as when an employer makes a contribution but an employee isn’t contributing to the plan; or when an employee rolls money into the 401(k) plan prior to making investment elections.
It makes sense then, that plans with automatic enrollment must have a QDIA.
Are there any other important QDIA regulations that I need to know about?
Yes, the DOL details several conditions plan sponsors must follow in order to obtain safe harbor relief from fiduciary liability for investment outcomes, including:
- A notice generally must be provided to participants and beneficiaries in advance of their first QDIA investment, and then on an annual basis after that
- Information about the QDIA must be provided to participants and beneficiaries which must include the following:
- An explanation of the employee’s rights under the plan to designate how the contributions will be invested;
- An explanation of how assets will be invested if no action taken regarding investment election;
- Description of the actual QDIA, which includes the investment objectives, characteristics of risk and return, and any fees and expenses involved
- Participants and beneficiaries must have the opportunity to direct investments out of a QDIA as frequently as other plan investments, but at least quarterly
For more information, consult the DOL fact sheet.
What kinds of investments qualify as QDIAs?
The DOL regulations don’t identify specific investment products. Instead, they describe mechanisms for investing participant contributions in a way that meets long-term retirement saving needs. Specifically, there are four types of QDIAs:
- 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 (for example, a professionally managed account like the one offered by Betterment)
- A product with a mix of investments that takes into account the individual’s age or retirement date (for example, a life-cycle or target-date fund)
- 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 (for example, a balanced fund)
The fourth type of QDIA is a capital preservation product, such as a stable value fund, that can only be used for the first 120 days of participation. This may be an option for Eligible Automatic Contribution Arrangement (EACA) plans that allow withdrawals of unintended deferrals within the first 90 days without penalty. We’re excluding further discussion of this option here since plans must still have one of the other QDIAs in cases where the participant takes no action within the first 120 days.
What are the pros and cons of each type of QDIA?
Let’s breakdown each of the first three QDIAs:
1. 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
Such an investment service, or managed account, is often preferred as a QDIA over the other options because they can be much more personalized. This is the QDIA provided as part of Betterment 401(k)s.
And Betterment factors in more than just age (or years to retirement) when assigning participants to one of our 101 core portfolios. We utilize specific data including salary, balance, state of residence, plan rules, and more.
And while managed accounts can be pricey, they don’t have to be. Betterment’s solution, which is just a fraction of the cost of most providers, offers personalized advice and an easy-to-use platform that can also take external and spousal/partner accounts into consideration.
2. A product with a mix of investments that takes into account the individual’s age or retirement date
When QDIAs were introduced in 2006, target date funds were the preferred default investment. The concept is simple: pick the target date fund with the year that most closely matches the year the investor plans to retire. For example, in 2020 if the investor is 45 and retirement is 20 years away, the 2040 Target Date Fund would be selected. As the investor moves closer to their retirement date, the fund adjusts its asset mix to become more conservative.
One common criticism of target date funds today is that the personalization ends there. Target date funds are too simple and their one-size-fits-all portfolio allocations do not serve any individual investor very well. Plus, target date funds are often far more expensive compared to other alternatives. Finally, most target date funds are composed of investments from the same company—and very few fund companies excel at investing across every sector and asset class.
Many experts view target date funds as outdated QDIAs and less desirable than managed accounts. Morningstar, a global investment research company, discusses the pros and cons of managed accounts versus target date funds, and predicts that they may become obsolete over time.
3. A product with a mix of investments that takes into account the characteristics of the group of employees as a whole
This kind of product—for example, a balanced fund—offers a mix of equity and fixed-income investments. However, it’s based on group demographics and not on the retirement needs of individual participants. Therefore, using a balanced fund as a QDIA is a blunt instrument that by definition will have an investment mix that is either too heavily weighted to one asset class or another for most participants in your plan.
Better QDIAs—and better 401(k) plans
Betterment provides tailored allocation advice based on what each individual investor needs. That means greater personalization—and potentially greater investment results—for your employees.
At Betterment, we monitor plan participants’ investing progress to make sure they’re on track to reach their goals. When they’re not on target, we provide actionable advice to get them back on the road to investment success. As a 3(38) investment manager, we assume full responsibility for selecting and monitoring plan investments—including your QDIA. That means fiduciary relief for you and better results for your employees. All of this for a fraction of the cost of most providers.
The exchange-traded fund (ETF) difference
Another key component that sets Betterment apart from the competition is our exclusive use of ETFs. Cost-effective, highly flexible, and technologically sophisticated, ETFs are rapidly gaining in popularity among retirement investors. Here’s why:
- Low cost—ETFs generally cost far less than mutual funds, which means more money stays invested
- Diversified—All of the ETFs used by Betterment are well-diversified so that investors are not overly exposed to individual stocks, bonds, sectors, or countries—which may mean better returns in the long run
- Sophisticated—ETFs take advantage of decades of technological advances in buying, selling, and pricing securities. Learn more about these five attributes now.
Helping your employees live better
Our mission is simple: to empower people to do what’s best for their money so they can live better. Every aspect of our solution from our QDIAs to our user-friendly investment platform is designed to give your employees a more personalized, holistic experience. We invite you to learn more about what we can do for you.
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