To the consternation of many plan sponsors, nearly one-third of eligible employees forego participation in their 401k or 403b plans. The percentage is slightly higher, around 38 percent, for smaller plans which are already struggling to achieve cost efficiencies. Although low participation can be attributed to several factors, many in our industry are now pointing to automatic enrollment as a catch-all solution that has achieved positive results wherever it is used. And, while automatic enrollment is garnering more attention among plan sponsors, many are finding that they can increase their liability for investment losses. However, when properly combined with a Qualified Default Investment Alternative (QDIA), automatic enrollment can substantially reduce a plan sponsor’s fiduciary liability.
What exactly is a QDIA?
A QDIA is a type of investment account that meets the criteria of ERISA sec 404(c) which provides plan sponsors with a safe harbor from fiduciary liability for investment decisions made by participants in their 401k accounts. A QDIA is essentially an investment fund or option that is designated as a default fund in which participant contributions are invested should they fail to make an investment election on their own. If the QDIA meets the criteria of an approved default investment fund, the plan sponsor is not liable for the investment outcome of the fund.
QDIAs are an essential component of 401k plans seeking to increase participation through automatic enrollment and that allow participants to self-direct their investment options. Without an approved default fund, plan participants who are not actively engaged or knowledgeable in selecting an investment mix, could wind up choosing their own “default” fund, which may not be suitable for their circumstances; and if they sustain any losses, the plan sponsor may be liable for its failure to provide appropriate investment options.
An approved QDIA can consist of one of the following types of investments offered through a professional investment manager or an investment company registered under the Investment Company Act of 1940:
- Target Date Retirement Fund
- Balanced Fund
- Professionally Managed Account
Making a QDIA Work
As always, selecting a suitable investment option is one of the more important fiduciary duties of a plan sponsor. Along with its other fiduciary responsibilities, plan sponsors must meet additional requirements to ensure their QDIA component meets ERISA’s criteria for providing protective relief:
- Special communications must be provided to plan participants 30 days in advance of a potential investment in a QDIA; 30 days prior to an initial investment made to a QDIA on behalf of a participant; and just prior to the date a participant becomes eligible for the plan. In addition, participants must be given ample opportunity to make allowable withdrawals.
- Participants must receive annual notices that describe the circumstances under which their assets may be invested in a QDIA as well the circumstances under which elective investments will be made on their behalf. The notice must include the option of not electing to have contributions made to the QDIA.
- Participants must have the opportunity to direct their own investment, regardless of whether they actually do so.
- Participants must be provided with a full description of the QDIA including fees, expenses, investment objectives and its risk and return profile,
- Plan sponsors may not impose extra fees or restrictions on the transfer of funds out of a QDIA within the first 90 days.
- Participants must be given the same opportunity to move assets out of a QDIA as they do with other plan options.
- As with other types of investment options, participants must be provided with all relevant materials such as prospectuses and other notices pertaining to the QDIA.
It’s important to note that the mere presence of a QDIA in the plan does not eliminate the fiduciary liability associated with investment stewardship. However, it does alleviate the liability in the circumstance when a plan participant is automatically enrolled in a plan and then fails to provide direction for elective contributions. The QDIA, if properly selected and implemented, provides the plan sponsor with protective relief regardless of the investment outcome of the fund.
A QDIA could very well be the silver bullet plan sponsors need to increase plan participation through automatic enrollment, while keeping themselves better protected. By adding a few additional policies and procedures to participant communications (properly drafted and timed), plan sponsors can significantly improve their plan’s effectiveness and cost efficiency.