A 401(k) QDIA is a default investment option that plan sponsors can offer for plan participants who don’t make their own investment selections.
What is a QDIA?
QDIA stands for Qualified Default Investment Alternative. QDIAs arose out of the Pension Protection Act (PPA) of 2006. The PPA allowed plan sponsors of defined contribution plans like a 401(k) to direct the contributions of participants who do not specify an investment section to certain default options while still meeting their fiduciary responsibilities.
The PPA specifies that plan sponsors can designate a target date fund, a managed account, a life cycle fund or a balanced fund as the QDIA. In the case of a target date fund, a life cycle fund or a managed account the QDIA for a given participant would be the fund choice appropriate to their age.
The QDIA offers the plan sponsor a safe harbor from fiduciary liability in the event the investment loses money as long they follow certain procedures as set forth by the Department of Labor (DOL). These include:
- The plan sponsor must provide a notice to the participants and beneficiaries prior to their first QDIA contribution to the plan.
- The notice should provide information about the QDIA option including:
- An explanation of the employee’s rights under the plan to designate how their contributions are directed.
- An explanation of how and where their contributions will be invested if they do not designate a choice to the plan sponsor.
- A description of the QDIA including its investment objectives, risk and return characteristics and all fees and expenses associated with this investment option.
- The participants and beneficiaries must have the opportunity to move their money out of the QDIA and into other plan investments as often as with any other investment offered by the plan. At a minimum this must be available at least quarterly.
Why is a QDIA important?
Having a QDIA in place benefits both the plan participants and the plan sponsor.
In the case of the participants, those who do not feel comfortable making their own investment choices have an option that has been selected by the plan sponsor in adherence with the rules governing QDIAs. While the QDIA may or may not be the optimal choice for them, it is better that just putting their money into a cash option within the plan or not contributing at all.
For plan sponsors the QDIA process relieves them from fiduciary liability if the QDIA meets the criteria set forth by the DOL. A QDIA can be used in conjunction with an auto enrollment program to ensure that employees are saving something for their retirement. The QDIA is a logical place to direct these contributions if the participant doesn’t make an affirmative election. This also helps to ensure the participants are invested in a fashion that can help build their retirement savings and improve their overall financial wellness.
Types of QDIAs
The PPA allows for several types of investments to qualify as a QDIA.
- Target date funds are mutual funds that offer a diversified portfolio that is allocated based on a target date. Over time the fund manager reduces the fund’s allocation to stocks as the target date gets closer. Generally at some point the TDF will go into its glide path, where the allocation to equities levels off, at some point near or just after the target date. Typically the QDIA will be the target date fund nearest to the participant’s “normal” retirement date.
- Balanced funds are funds that typically have a static allocation between stocks and bonds, This might be 60/40 stocks to bonds, 40/60 or some other allocation. While balanced funds are not geared towards any particular age range, they do represent an all-in-one investment option for participants.
- Life-cycle funds are similar to target date funds in that the funds geared towards younger investors generally take more investment risk than the versions geared towards older investors. They represent a diversified option for participants who don’t make an affirmative choice on their own.
- Managed accounts. In some plans a managed account option that is tailored specifically to the participant may be offered as the QDIA option.
Advantages of having a QDIA
Financial wellness has become a priority for many employers. Financial stress can be both a drain on employee productivity and on employee health. Encouraging employees to save for retirement in the company’s 401(k) plan is one way many employers try to promote financial wellness.
One strategy that many plan sponsors use to ensure that employees are contributing at least something to the plan is auto enrollment. Coupling auto enrollment with the use of a QDIA allows the sponsor to direct those contributions for employees who are auto enrolled into the plan to the QDIA. This offers a fiduciary safe harbor for the plan sponsor.
Employees who are auto enrolled into the plan can take comfort from the fact that the QDIA option must meet certain criteria in order for the plan sponsor to take advantage of the fiduciary safe harbor. While the QDIA option might not be optimal for each participant over the long-term, it does provide a good starting point for them as they begin investing in the plan.
When does the annual notice need to be given and to whom?
Plan sponsors are required to provide the annual QDIA notice at least 30 days prior to the new plan year. The notice must be provided to current employees, beneficiaries and former employees who were defaulted into the QDIA option and who have not opted out of that election.
In the opinion of some experts, plan sponsors may consider giving the notice to all employees and participants to simplify the notification process and to be sure they are in full compliance with the rules.
How to get QDIA money?
Money that is defaulted into a QDIA option is accessible to the participant in the same fashion as any other contribution made to the plan. The participant is free to direct this money to other investment options in the plan at any point.
When should a 401(k) have a QDIA?
A QDIA can be used by any plan that wants to provide a viable investment default option for participants who do not make an affirmative election decision for their contributions into the plan.
QDIAs are especially important in plans that use automatic enrollment to encourage all employees to contribute to the plan. A QDIA must be reviewed and monitored by the plan sponsor in order for them to receive the fiduciary safe harbor protection a QDIA can offer. This represents a win-win situation for both the plan participants who don’t make an election for their plan contributions as well as for the plan sponsor.
Are QDIAs required?
QDIAs are not a requirement, even for plans that use auto enrollment. A plan sponsor may decide to leave the option of where to invest all contributions to the plan participants. Or they may choose a default option, like a money market fund, that does not qualify as an acceptable QDIA option.