How to Select The Proper QDIA For a Retirement Plan

Selecting the right Qualified Default Investment Alternative (QDIA) for a 401(k) plan is crucial for fiduciaries who want to ensure that the default investments align with participants' retirement goals, risk tolerance, and time horizons. QDIAs offer fiduciary protection to plan sponsors if participants do not actively choose an investment, provided that the sponsor selects a QDIA that meets specific guidelines. 

Here’s a guide on how to evaluate and choose the appropriate QDIA for a 401(k) plan: 

Understanding Retirement Plan QDIA Basics 

A QDIA is an investment option that plan sponsors can select to automatically invest contributions for participants who have not made their own investment choices. The main types of QDIAs are:

• Target Date Funds (TDFs): These funds automatically adjust asset allocation based on a participant’s expected retirement date, making them a popular QDIA choice.

• Balanced Funds: These funds maintain a fixed mix of equity and fixed-income investments and are suited for participants with moderate risk tolerance.

• Managed Accounts: These accounts offer a customized investment approach based on a participant’s individual risk profile, age, and other factors.

Each of these QDIAs has distinct characteristics that may fit different types of employees and risk tolerances. A deep understanding of these options is key to making a sound choice. 

Aligning the QDIA with Retirement Plan Participant Demographics and Needs 

When selecting a QDIA, it’s important to consider the unique characteristics of your plan’s participants:

• Age Range and Time to Retirement: If your workforce is primarily younger, TDFs may be a suitable choice, as they offer a glide path that reduces risk as retirement nears. On the other hand, a plan with many participants nearing retirement may benefit from balanced funds or managed accounts with more stable allocations.

• Risk Tolerance: Assess the general risk tolerance of your participant base. Balanced funds or managed accounts might be preferable if you believe your employees are risk-averse.

• Financial Knowledge: If the workforce has a low level of financial literacy, simpler QDIAs like TDFs can provide a hands-off approach. Managed accounts are more suited to participants who prefer some level of customization.

Analyzing the demographic profile and retirement readiness of your employees will help you choose a QDIA that better aligns with their retirement needs and long-term goals. 

Evaluating QDIA Performance and Fees 

The performance of a QDIA is essential to helping participants grow their retirement savings effectively. Here are steps to take when evaluating performance and fees:

• Historical Performance: Review the historical returns of each QDIA type, focusing on long-term performance rather than short-term fluctuations. A strong track record over five or ten years is preferable for building retirement wealth.
• Risk-Adjusted Returns: Compare the returns of potential QDIAs relative to the risk taken. Metrics like the Sharpe ratio can help you evaluate whether the returns justify the level of risk.
• Fee Structure: Pay close attention to the expense ratios of each QDIA option. Lower fees can have a significant impact on long-term returns, especially in TDFs and managed accounts, which may come with a range of fees based on the level of management involved.

Cost-effective QDIAs with solid long-term performance should be prioritized, as lower costs benefit participants’ growth potential and help you meet your fiduciary obligations. 

Considering the Glide Path in Target Date Funds for the QDIA 

If you are considering TDFs as your QDIA, examine their glide paths. The glide path represents the asset allocation over time, usually shifting from stocks to bonds as participants approach retirement. When evaluating glide paths:

• "To" vs. "Through" Glide Paths: TDFs with a “to” glide path reduce equity exposure significantly by the retirement date, while “through” glide paths continue to lower risk throughout retirement. If you anticipate that employees will keep funds invested post-retirement, a “through” strategy may be more appropriate. 
• Equity Exposure: Review the initial and ending equity exposure in the glide path to ensure it aligns with your participants' risk tolerance. High-equity exposure offers potential growth but may be volatile for participants nearing retirement.
• Manager Philosophy: Look into each fund manager’s investment philosophy. Some may take a conservative approach, while others might be aggressive in seeking returns.

The right TDF should align with participants' expected time in retirement and their comfort with risk during those years. 

Assessing Managed Accounts as a part of QDIAs 

Managed accounts as QDIAs offer more personalized portfolios based on individual factors like age, salary, and retirement goals. Consider the following when evaluating managed accounts:

• Customization Level: Ensure that the managed account service considers a range of factors, such as participants’ financial situations and preferences.
• Additional Fees: Managed accounts tend to have higher fees due to the personalized investment strategy. Evaluate whether the added costs are justified by the level of service and potential benefits.
• Participant Communication: Managed accounts work best when participants understand the benefits and features available. Choose a provider that communicates clearly with participants and allows them to update their profiles easily.

Managed accounts can be an excellent option if you have participants with varying financial profiles and a desire for customized investments. 

Regulatory Compliance and Fiduciary Duties related to QDIA selection & monitoring 

Fiduciaries must prioritize compliance with Department of Labor (DOL) regulations when selecting a QDIA. Here are the key regulatory considerations:

• Meeting QDIA Requirements: Make sure the chosen investment option qualifies as a QDIA according to DOL guidelines. This involves understanding allowable types, appropriate default procedures, and regular monitoring.

• Documenting the Selection Process: Maintain documentation that demonstrates a prudent process in selecting and monitoring the QDIA. This includes analysis of fees, performance, and suitability to participants.
• Annual Review: Fiduciaries are required to regularly review the QDIA to ensure it continues to meet the needs of plan participants. Monitoring and benchmarking against similar funds should be done annually.

Meeting regulatory requirements is essential to receive fiduciary protection and provide the best outcome for participants.

Final Thoughts

Selecting the right QDIA for a 401(k) plan involves careful consideration of participant demographics, investment performance, fees, and regulatory requirements. Fiduciaries must weigh the benefits and limitations of TDFs, balanced funds, and managed accounts, ensuring the chosen QDIA supports participants’ retirement goals effectively and cost-efficiently.

After selecting a QDIA, ongoing monitoring is critical to ensure it continues to meet the evolving needs of the participants. Ongoing reviews ensure that the QDIA remains suitable, competitive, and beneficial for participants as their retirement journey evolves. 

Informational Resources:

401kSpecialist Magazine: “The Right Way to Choose a QDIA” (May 1, 2024); Franklin Templeton: “Fiduciary Considerations: The Qualified Default Investment Alternative” (August, 2023); PlanSponsor Magazine: “QDIA Basics” (February 23, 2022).