A qualified default investment alternative (QDIA) is the default investment for defined contribution employer-sponsored retirement plans. If an employee contributes to a defined contribution retirement plan, like a 401(k), and does not specify how they want their money invested, it is automatically invested in the plan’s QDIA. A financial advisor could help you create or adjust a retirement plan for your needs and goals. Let’s break down how a QDIA works.
How Does a QDIA Work?
In 2006, Congress passed the Pension Protection Act (PPA) in order to assist employees with saving for retirement. One of the key provisions of the PPA was to establish the development of QDIAs for defined contribution retirement plans. The existence of a QDIA with a defined contribution retirement plan protects both the employee and the employer.
Over the years, defined contribution retirement plans have gradually replaced defined benefit pension plans in many companies. Defined benefit plans guarantee the employee a pension benefit for life. Defined contribution plans make no such guarantee. A company may set up a plan like a 401(k) so employees can save for retirement in a tax-advantaged account. The company may even match, at some level, employee contributions to their retirement account. But, there is no guarantee of a fixed amount of income in retirement. If the employee separates from the company, that 401(k) can often go with them or they can roll it over into an individual retirement account (IRA).
Employees often say that they are not savvy enough about investing to make logical and wealth-maximizing choices concerning the different investment options offered by the 401(k). If they decide to contribute to the 401(k) anyway or if contributing is mandatory by the company, they sometimes opt to contribute without choosing an investment option. When this happens, their money goes into the plan’s QDIA.
The existence of this default investment option, the QDIA, is helpful to employees who don’t feel competent to invest in one of the investment options. It is also beneficial to the employer because the QDIA provides a well-diversified default investment option for employees. If an employer has an automatic investment plan for the employees, the QDIA is helpful for employees who don’t sign up so the employer contributions will be invested in a well-diversified investment option. If the employer does not set up a QDIA as part of the retirement plan, then they may be held liable if the plan does not produce adequate results for the participants.
Under the Employee Retirement Income Security Act of 1974 (ERISA), a QDIA must be managed by an investment company, registered under the Investment Act of 1940, or a plan trustee, acting as a fiduciary. QDIAs must be one of these three options:
- Target-date funds (also called lifestyle funds)
- Balanced fund – based on the restrictions of the plan
- Professional management
There are other situations that may arise that show the wisdom of the QDIA. A few of them are:
- Contributions for an employee who is not contributing
- Problematic plan paperwork such as incomplete enrollment forms
- Beneficiary information is lacking.
- Qualified Domestic Relations Order is in place.
This is not an exhaustive list.
What Are the Types of QDIAs?
The investment vehicles or products are not mandated. Instead, the Department of Labor has suggested ways of investing contributions that lead to retirement savings. There are four types of QDIAs with the last one being a temporary solution:
- Target-Date or Lifestyle Fund: A product with a mix of financial assets that take into account the participant’s retirement age and forecasted retirement date. Target-date funds used to be the preferred option for QDIAs but it became apparent that this approach did not fit investors very well. They also tend to have a high expense ratio. Some predict that this type of QDIA will gradually be phased out.
- Balanced Fund: A product that takes into account the needs of the group rather than the needs of individual investors. A balanced fund has both equity and debt investments. Not all investors have the same need for a particular debt/equity mix. Investors in a balanced fund QDIA may not be getting individually maximized results but rather results for the group as a whole.
- Professionally managed product: A product managed by the investment company that chooses assets for the investor across product lines catering to the needs of the individual investors. A professionally managed fund may give the investor the best of both worlds by taking the employee retirement date into account along with the best asset mix for the investor.
- Capital Preservation Fund: A product aimed at preserving contributions for the first 120 days of participation. An example would be a money market fund. Plans must also have one of the other types of QDIA for cases when investors don’t take action during the first 120 days.
Bottom Line
A QDIA is also a necessity when a company sets up a defined contribution retirement plan for employees. It is a safeguard for the employer because it protects them from accusations of poor plan performance. It also gives employees who don’t know what to invest in a legitimate diversified and wealth-maximizing investment option.
Tips on Retirement
- When you are planning for retirement, don’t forget your Social Security income. You can use the SmartAsset social security income calculator.
- You can also use the SmartAsset retirement calculator to determine your current progress toward your retirement goals.
- Even though you have a retirement plan through your employer, do you have outside investments? You may need a financial advisor to navigate the retirement maze. SmartAsset’s free tool matches you with up to three financial advisors in your area, and you can interview your advisor matches at no cost to decide which one is right for you. If you’re ready to find an advisor who can help you achieve your financial goals, get started now.
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