1. What is a Qualified Default Investment Alternative (QDIA)?
The Pension Protection Act of 2006 (PPA) encouraged employers to adopt automatic enrollment features for their participant‐directed plans by providing a new type of fiduciary liability relief for “default investments,” or Qualified Default Investment Alternatives (QDIAs). A QDIA is used when a participant fails to make his or her own election. An investment must have specific qualifications to be considered a QDIA. Importantly, a QDIA’s asset allocation strategy need only take into account participant age, and does not need to consider an individual participant’s risk tolerance or other investment assets. One of four types of allowable QDIA’s, Target Date Funds (TDFs) were the QDIA in 95% of retirement plans in 2015 (Source: Vanguard, 2016).2. What due diligence should plan fiduciaries perform when choosing a TDF?
Target Date Funds were among the four types of investments given QDIA status in 2006 by the PPA. Plan fiduciaries were insulated from some liability for defaulting employee monies into TDF’s and other approved QDIA’s. This implied endorsement of TDFs could have given fiduciaries the impression that the government had done some of their due diligence on TDFs. Our experience in working with clients reveals a high level of interest in following a prudent process for selecting TDF’s. The Department of Labor’s 2013 Guidelines for Fiduciaries on TDF’s clarified the specific due diligence required on TDF’s. The importance for fiduciaries in following this guidance is underscored by the fact that TDF’s are generally the Plan’s QDIA. The selection and monitoring of the Plan’s QDIA requires due care on the part of fiduciaries to limit liability and to enhance employees’ investment outcomes.TDF’s are a unique investment, requiring more attention than traditional, single asset class mutual funds. The specific process for TDF due diligence should be covered in the plan sponsor’s Investment Policy Statement. Fiduciaries should evaluate the TDF offerings of several investment firms with attention to performance, risk, asset classes included, fees, asset allocation and the glide path. The glide path describes the change in asset allocation and risk over long holding periods. The glide path should be appropriate for the employee population in the Plan.
3. What is the importance of a TDFs glide path in meeting retirement objectives?
Target date funds automatically adjust their asset mixes to become more conservative as investors approach retirement age. This shift in the asset allocation over time is called the TDF’s glide path. Some TDFs’ glide paths are managed “to” retirement, while others are managed “through” retirement. Investment firms consider the following in designing a glide path.- The risk of outliving retirement assets should be the key driver of managing retirement portfolios so some firms maintain a significant equity allocation based on proprietary asset allocation, modeling and research.
- Time horizon should drive asset allocation throughout investor’s life and allocations should continue to shift to more conservative investments for several years after the target date to address the needs of retirees who wish to stay invested in a TDF.
- Active management, coupled with modest tactical asset allocation shifts, can help to enhance long-term performance; which gives the opportunity for outperformance over time.
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If you have any questions, or would like to begin talking to a retirement plan adviser about best fiduciary practices on target date funds in your retirement plan, please get in touch by email or by calling (855) 882-9177.
