Inertia is a strong force. It is why many retirement plan participants never make changes to their savings rates and investments within their plans. Unfortunately, this can lead to some bad outcomes. It isn’t unusual to hear stories of people who have contributed to their plans for years, but who never made an affirmative decision on the money would be invested. Consequently, it has sat in cash, rather than enjoying the much larger gains of the stock and bond markets.
The QDIA can prevent such occurrences. It is set as the default fund, or investment option, if an employee fails to make an investment election on their own. If the QDIA meets the ERISA criteria of an approved default investment fund, you as the plan sponsor are not liable for the investment outcome of the fund, even if it loses money over some period.
Historically, the QDIA was generally a money market fund, which often resulted in significant opportunity costs, as described in the example above. However, since 2007 it has been easier to offer participants QDIAs that invest in more diversified funds of stocks and bonds, without subjecting the plan sponsor to risk that may arise if the participant experiences investment losses.
Target date funds are an increasingly common QDIA. These funds target dates in the future, which may approximate the retirement date of participants. The funds start out aggressive, investing mostly in stocks, when the participant is young. But the funds gradually get more conservative, investing more heavily in bonds, as retirement approaches. Thus, they offer a sort of “one-stop shop” for those not wanting to select and monitor their own investments over time.
Selecting appropriate funds, such as target date funds, is just one component of setting up a QDIA that benefits participants and protects the plan sponsor. Some of other components, as stipulated by ERISA include:
- Sending annual notices that describe under what circumstances participants’ assets may be invested in the QDIA.
- Participants having the opportunity to direct their own investments using a wide variety of funds.
- Plans may not charge extra fees, or set restrictions, on the transfer of funds out of QDIA within the first 90 days.
- The plan must provide a prospectus for the QDIA, like all the other funds in your lineup.
Although setting a QDIA does not eliminate all of your fiduciary liability associated with selecting a fund line-up, it does provide a solution for when an employee fails to provide direction for contributions. If you have, or are considering setting up, auto-enrollment, setting the QDIA properly is an even more important step. As always, your plan’s investment advisor and TPA can help guide you through the selection and implementation process.