Author: Paul A. Carl, CHSA, CPFA™Vice President, Retirement Plan Consulting, Registered Representative
Let’s face facts, not all retirement plan participants are engaged in their retirement investments. Some, even though they can and should, simply do not make positive elections from a plan’s menu of investment options.
Until the Department of Labor issued its Qualified Default Investment Alternative (QDIA) regulation in 2007, most retirement plans used the cash equivalent investment option as the plan default. The only exception I personally can recall was a case in which a Chief Financial Officer directed the use of a global equity fund as the plan default.
Let me simplify the QDIA regulation.
It created three categories of default options:
- The traditional balanced fund
- The asset allocation fund
- Managed models
Prior to the proliferation of asset allocation funds, the balanced fund was the go-to investment option available to meet the needs of investors seeking stock and bond exposure in one fund. Most balanced funds own a mix of individual stocks and bonds. Much of the balanced fund performance relies on the selection of those individual stocks and bonds.
Asset allocation funds, on the other hand, offer two flavors—risk-based and age-based.
Both types tend to create further diversification by using “a fund of funds” concept. There can be anywhere from three to six or more risk-based funds available under a fund family. The plan fiduciary who elects the risk-based fund as the QDIA must determine which risk-based fund will be the QDIA. This entails a whole process of evaluating participant demographics including ages, education level and quantifying overall risk tolerance. Frankly, it’s no different than setting the investment objective for all participants in a pooled account format.
The age-based asset allocation fund, better known as the target date fund, has become the most popular QDIA. In March 2022, CNBC cited a Vanguard study reflecting 98% of 401(k) plans use target date funds and Morningstar reported $1.8 trillion were invested in target date mutual funds. Because these funds use a glidepath to manage the proportion of equity to fixed income, as the years tick-away, these funds automatically switch from higher-risk investments into lower-risk investments.
The third category, managed models, come in various types and varieties. They can present the same challenges for plan fiduciaries, including determining which allocation is the most appropriate for the participant demographics. They are also frequently the most expensive choice for the participant. I will explore managed models in more detail in a future Retirement Mediation.
Which QDIA is right for your plan participants?
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