QDIAs: What 401(k) Sponsors Need to Know About the Default Investment

Every 401(k) plan has participants who never pick their investments. Some were automatically enrolled and never logged in. Some rolled money in from a prior plan and set it aside. Others meant to get to it and never did. The plan still has to invest that money somewhere.

That "somewhere" is the plan's default investment. When it is set up correctly, it is called a qualified default investment alternative, or QDIA, and it gives plan fiduciaries valuable legal protection. When it is not, the employer may be responsible for investment decisions the participant never made.

What a QDIA is

The Pension Protection Act of 2006 directed the Department of Labor to create a safe harbor for default investments, and the DOL issued its QDIA regulation in 2007. If a plan's default investment meets the regulation's requirements and participants receive the required notices, a participant who does not give investment instructions is treated as having directed the investment. In practical terms, plan fiduciaries are generally not liable for losses that result from investing that participant's account in the QDIA.

That relief matters. Without it, the fiduciary who chose the default would own the outcome of investing money for people who never weighed in.

The four types of QDIA

The regulation allows four kinds of investments to serve as a QDIA:

1. A target date or lifecycle fund, which uses a mix of stocks and bonds based on a participant's age or expected retirement date and becomes more conservative over time.
2. A balanced fund, which holds a mix of stocks and bonds appropriate for the participant group as a whole rather than for each individual.
3. A managed account service, in which an investment manager allocates each participant's account among the plan's funds based on the participant's age or retirement date.
4. A capital preservation option, such as a stable value or money market fund, but only for the first 120 days after a participant's first elective contribution. After that, the money must move to one of the other three types.

In most plans, the QDIA is a target date series. That is common, not required. The regulation does not favor one type over another, and the right choice depends on the plan and its participants.

A QDIA also has to be managed by an appropriate party, such as a registered investment company, a qualified investment manager, or the plan sponsor acting as a named fiduciary. It generally cannot invest participant contributions directly in employer securities.

The conditions you have to meet

Choosing a qualifying investment is only part of the requirement. To keep the protection, the plan must also:

• Give an initial notice generally at least 30 days before the participant first becomes eligible or before the first investment in the QDIA. Plans with certain automatic enrollment designs can give the notice on or before the eligibility date.
• Give an annual notice at least 30 days before the start of each plan year.
• Explain the default clearly, including when money will be invested in the QDIA, the participant's right to choose other investments, the QDIA's objectives, risk and return characteristics, and fees, and where to find more information.
• Pass along materials, such as fund documents, that the plan receives about the QDIA.
• Allow transfers out at least as often as participants can move money among other plan investments, and at least quarterly. During the first 90 days, a participant who moves out of the QDIA cannot be charged transfer fees or redemption charges beyond the fund's ordinary operating expenses.

Notice failures are one of the more common ways plans lose QDIA relief. Ask your recordkeeper whether notices are part of their service, how they are delivered, and whether you have proof they went out on time.

What the protection does not cover

QDIA relief covers losses from the default itself. It does not cover the decision of which QDIA to use. Selecting and monitoring the QDIA remains a fiduciary responsibility, and it is judged by the same prudent process as every other investment on the menu.

For a target date series, that means looking at the glide path, the underlying investments, fees, and how the series fits your workforce. A plan whose employees tend to roll their money out at retirement may have different needs than one where retirees keep their savings in the plan for years. Whatever you decide, document why you chose it and when you last reviewed it.

Why the QDIA matters more than it used to

SECURE 2.0 requires most new 401(k) and 403(b) plans established after December 29, 2022 to automatically enroll employees, beginning with plan years starting after December 31, 2024. Small and new businesses and certain other employers are exempt, but the direction is clear: more participants are being defaulted, and more money is landing in the QDIA.

The QDIA also collects money in other situations. Employer contributions for employees who never enrolled, balances mapped over during a recordkeeper change, and accounts re-enrolled into a new lineup often end up there. In many plans, the QDIA becomes the largest single holding. A decision that large deserves regular attention.

Questions to ask about your plan's QDIA

• Which QDIA type does the plan use, and why was it chosen?
• When was it last compared with alternatives, and is that review documented?
• Who sends the initial and annual notices, and can you confirm they were delivered on time?
• Does the QDIA's risk level fit the age and retirement patterns of your workforce?
• Are participants told clearly how to make their own choices if they prefer?

If your plan works with a 3(38) investment manager, selecting and monitoring the QDIA is generally part of that manager's role. When Northshire Consulting LLC | Registered Investment Advisory Firm serves as 3(38) investment manager, the QDIA is reviewed alongside the rest of the lineup.

Not sure your QDIA is set up to protect you? Brian Williams, CPFA®, of Northshire Consulting LLC | Registered Investment Advisory Firm meets with business owners to review plan investments and default provisions. Call 203-401-6062, email bwilliams@northshireconsulting.com, or visit northshireconsulting.com to schedule a plan review.

Frequently asked questions

Does our QDIA have to be a target date fund?

No. Target date funds are the most common choice, but a balanced fund or managed account can also qualify, and a capital preservation option can serve for the first 120 days. The choice should reflect a documented review of your plan and participants.

Does using a QDIA mean employees cannot lose money?

No. A QDIA can lose value, like any investment that holds stocks and bonds. The QDIA rules protect fiduciaries from liability for losses caused by the default itself. They do not protect participants from market losses.

Do we need a QDIA if our plan does not use automatic enrollment?

Usually, yes. Plans without automatic enrollment still receive money for participants who have not chosen investments, such as employer contributions, rollovers, and balances mapped during a lineup change. A QDIA gives that money a prudent home and gives fiduciaries relief.

This material is for educational purposes only and is not individualized investment, tax, or legal advice. Advisory services are offered through Northshire Consulting LLC | Registered Investment Advisory Firm.