<p>The Pension Protection Act (PPA) seems to have opened the market of investment options available for the qualified default investment alternatives (QDIA) and, in my opinion, encouraged the implementation of QDIA as a means of protecting plan participants who do not actively pay attention to their plans. I am not suggesting that either target date fund or target risk funds are a superior option for a QDIA, but if a plan administrator is not familiar with these terms, it would be wise to investigate further.</p>
<p>A "target date" fund is designed to reallocate investments automatically as a participant comes closer to retirement age (end target date of retirement). The idea behind these funds is that the investment will be managed with eye toward maximizing investment return with a changing risk level based on proximity to anticipated cash-out date. They would be more conservative on risk the closer you get to the fund end date. "Target risk" funds, however, are designed to expose the participant to a static risk level over the life of the investment and do not have a changing exposure to risk, but may change investments. These funds typically have conservative, aggressive and moderate risk levels.</p>
<p>Unlike target date funds, which assume that the participant's level of risk should decrease as they get older, target risk funds assume that the participant themselves (or the plan administrator in the case of a QDIA) will diversify into other risk level funds as needed over the life of their investments. For example, the assumption is that as a participant gets closer to retirement, they will shift their defined contribution allocation from "aggressive" to "moderate" or "conservative" of their own accord. But which is better for QDIA purposes? Should you choose a QDIA option that is risk specific or retirement age specific? </p>
<p>Remember that a QDIA, to provide protection for fiduciaries, the final regulations provide four QDIA investment alternative mechanisms, rather than specific products. An example of a product for each category is provided.</p>
<ol>
<li>A product with a mix of investments that takes into account the individual’s age, retirement date, or life expectancy (for example, a life-cycle or targeted-retirement-date fund);</li>
<li>A product with a mix of investments that takes into account the characteristics of the group of employees as a whole, rather than each individual (for example, a balanced fund);</li>
<li>An investment service that allocates contributions among existing plan options to provide an asset mix that takes into account the individual’s age or retirement date (for example, a professionally-managed account); and</li>
<li>A capital preservation product for only the first 120 days of participation. This eases administration, for example, in the case of workers that opt-out of participation within 90 days. After 120 days, the plan fiduciary must redirect the participant’s investment into the above three QDIA categories (unless the participant opted-out of the plan or redirected investments during the 90 days).</li>
</ol>
<p>The QDIA does not have to constitute a single investment option (such as a target date fund), but could consist of several options (such as part aggressive, part conservative, part moderate target risk fund). I think it is important for plan sponsors, in selecting appropriate fund options for QDIAs, to take into account the plan population and be aware of potential impact of each QDIA investment option. The plan fiduciary must also prudently select and monitor an investment fund, model portfolio, or investment management service within any category of QDIAs. For example, a plan fiduciary that chooses an investment management service must undertake a careful evaluation to prudently select among different investment services.</p>
<p>So it is possible that target date funds are best for your plan. It is also possible that target risk funds are the better option. But in any event, both should be considered as part of an informed fiduciary decision regarding QDIA options. One may not be better than the other. But plan sponsors should definitely make themselves aware of the positives and negatives of both if they are to be included (or excluded) from the QDIA.</p><img src="http://feeds.feedburner.com/~r/EmployeeBenefitsLegalBlog/~4/hKfnAxvuEqg" height="1" width="1"/>
