The 401k is the most popular retirement account available to Americans.
A 401K QDIA is a component of a 401k that is often misunderstood by 401k plan participants.
In this article, we explain what a 401k QDIA is and how you can use this information to manage the investments inside of your 401k.
What is a QDIA?
A 401(k) Qualified Default Investment Alternative (QDIA) is a default investment used when money is contributed to an employee’s 401(k) account. Any contributions are automatically invested in the QDIA that is selected by the plan fiduciary (business owner or plan sponsor) even when the employee has not made any active investment election.
Before 2006, employers could face legal liability for market fluctuations from adopting automatic enrollment. This also led to employers selecting low-risk, low-return investment options. The Pension Protection Act of 2006 removed these barriers to boost employee retirement savings and provided a safe harbor for plan sponsors or employers to invest employee contributions into default investment alternatives.
When should a 401(k) have a QDIA?
Having a QDIA means employee accounts are well positioned offering the much needed confidence that their retirement savings are invested with a potential for significant growth.
Although QDIA is not mandatory, it is a smart option to have QDIA as many employee contributions might not have an investment election. Plans with automatic enrollment features obviously have default investment needs, but several instances occur in the life of 401(k) resulting in the need for a QDIA such as:
- 401(k) rollovers
- Employer contributions or profit sharing even when the employee is not contributing
- Beneficiary/alternative payee balances
- Missing persons
- Updated or discontinued investment options
- Qualified Domestic Relations Order (QDRO)
- Incomplete enrollment forms
What are the Advantages of QDIA?
QDIA has advantages for both employers as well as employees.
For plan sponsors:
- Relieve plan sponsors from fiduciary responsibility with respect to selecting default investments for automatic enrollment plans
- Enhance the ability of the 401(k) to provide a secure retirement for employees
- Reduce concerns about an employee’s lack of understanding in making investment decisions
- Great way for a novice to stay invested and plan for retirement using an automated approach
- Ensure employee contributions are invested for long-term retirement savings
- Prevents employees from the stress associated with an active investment process
What is an approved QDIA?
The U.S. Department of Labor (DOL) has approved four types of QDIAs:
- A product with a mix of investments that takes into account the individuals age or retirement date – for example, a lifecycle or target date fund.
- 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 managed account.
- A product with a mix of investments that takes into account the characteristics of the group of employees, rather than each individual – for example, a balanced fund.
- A short-term, low-risk, low-return product (a capital preservation product) for only the first 120 days of participation – for example, a stable value fund.
Let us elaborate on the type of funds under QDIAs:
Lifecycle or Target-Retirement-Date Fund:
- Investment model created based on participants age, retirement age and life expectancy
- Target funds are not professionally managed for individual investors
- Criticized for their one-size-fits-all approach
- Far more expensive compared to other options
- Most funds are composed of investments from the same company
- Fund is actively managed by investment managers
- An appropriate asset mix of equities and fixed income for each individual
- Considers the primary decision factors of age, retirement age and life expectancy
- A more personalized investment approach
- Mix of equity and fixed income investments
- Based on group demographics of the plan
- Does not consider individual risk tolerances
- Serves as a capital preservation product for the first 120 days of participation
- Participant can withdraw unintended deferrals during the first 90 days without penalty or redirect assets into another investment option within 120 days after enrollment
- If participant does neither, assets are transferred to one of the three approved QDIAs described above
With the exception of the stable value fund, QDIAs include the potential for asset class diversification, thus serving as a great risk management tool to help manage investment risks, diversification and inflation.
Note: Without an approved QDIA, plan fiduciaries remain potentially liable for losses when a participant fails to actively direct investments.
Safe Harbor Relief from QDIAs
The Department of Labor details several guidelines for plan sponsors to obtain safe harbor relief from fiduciary liability for investment outcomes when default investments are one of the four approved QDIA types:
- Participants and beneficiaries must have been given an opportunity to provide investment decisions but failed to do so
- Before their first QDIA investment, a notice generally must be provided 30 days in advance to participants and beneficiaries and 30 days prior to every year thereafter
- All information pertaining to the QDIA must be provided to participants and beneficiaries and must include the following:
- Description of the actual QDIA, which includes the investment objectives, characteristics of risk and return, and any fees and expenses involved;
- A description of deferral percentage and the participants right to change that percentage;
- An explanation of how assets will be invested if no action taken regarding investment election;
- An explanation of the employee’s rights under the plan to designate how the contributions will be invested;
- Referral to sources of additional information about QDIAs offered under the plan
- The plan may not impose financial penalties or otherwise restrict the ability of a participant or beneficiary to transfer the investment from the QDIA to any alternative investment
- Participants and beneficiaries must have the opportunity to direct investments out of a QDIA as frequently as from other plan investments, but at least quarterly
- The plan must offer a broad range of investment alternatives as defined by the DOLs regulation under section 404(c) of ERISA
Note: QDIAs are not permitted to invest in or hold employer stock, except when it is held or acquired by a registered investment company that is independent of the plan sponsor or when it is acquired as a matching contribution.
If you still have concerns regarding QDIA, please consult a financial advisor to determine if QDIA is appropriate for your plan or if your current plan complies with QDIA regulations.