Default Disruption: Nuts and Bolts of QDIAs

Article by Ben Lewis, TIAA

When is the last time you took a close look at your 403(b) retirement plan’s default investment options? For independent school business officers, an often-overlooked HR risk management responsibility is to go beyond ensuring that staff and faculty are participating in the school’s plan to also helping them get the most out of their investments, particularly if they are in the plan’s default fund option. How do you optimize those investments so that participants enjoy potentially better outcomes over the long term?

Step Back for the Full Picture

According to the Department of Labor, 69 percent of independent K – 12 employees have access to a retirement plan at work. Moreover, 25 percent of private K – 12 institutions have implemented automatic enrollment, reports Spectrem Group. It can be constructive for business officers to step back to review these options. What is your 403(b) plan’s default option, and what factors were considered when it was originally chosen? Does the plan offer professional asset allocation and diversification? How are your employees contributing to their accounts? Are they satisfied with how their retirement funds are being managed?

Asking questions like these can help you evaluate your schools’ plan offerings and determine if there might be better ways to meet the needs of faculty and staff.

The QDIA Alternative

Historically, money market funds have been widely used default investments, as they are considered quite safe and face a low risk of losing investment value. Money market funds primarily invest exclusively in cash or cash-equivalent securities and are commonly used as short-term liquid investments. Over time, however, this “safe” approach can produce lower returns than many other investment options and may provide inadequate growth potential for long-term retirement accounts in particular. DOL does not consider money market funds a best practice default option for retirement plans.

An alternative default fund strategy, and one endorsed by DOL, is known as qualified default investment alternatives (QDIAs). DOL groups QDIAs into three categories, any one of which may be a good fit for independent school 403(b) plan participants based on the individual’s projected year of retirement, appetite for risk or other factors.

• Balanced fund: a relatively steady mix of stocks, bonds and occasionally money market components within a single portfolio. These hybrid-style portfolios do not materially change their asset mix, preventing them from accounting for changes in market volatility or an investor’s age or appetite for risk. Because balanced funds are allocated across stocks and bonds, they may be likely to weather volatile market conditions. Under DOL's QDIA regulation, a balanced fund can be a QDIA only if the plan sponsor determines that it is appropriate given the demographics of its workforce.
• Target-date fund (TDF)/lifecycle fund: a mix of investments that account for the individual’s age or retirement date; becomes more conservative over time and as the targeted retirement date approaches. TDFs differ from balanced funds in that they take into account the participant’s age when determining asset mix. For example, younger workers are invested in higher-risk investments at the beginning of their careers, but as they get closer to retirement their savings gradually are reallocated into more conservative investments. Nearly 74 percent of 403(b) plan sponsors use a target-date fund as their default investment, according to the Plan Sponsor Council of America. As with all mutual funds, the principal value of a target date fund isn’t guaranteed. The target date represents an approximate date when investors may plan to begin withdrawing from the fund.
• Managed account: owned by an individual investor but managed by a professional investment service; allocates contributions among plan options to provide an asset mix that accounts for each participant’s age or retirement date. A managed account can take into account each individual’s unique qualities like time, age, risk tolerance and retirement readiness goals, but it can also mean higher investment fees for individual investors.

Case Study: Stuart Country Day School

In Princeton, New Jersey, Stuart Country Day School of the Sacred Heart recently moved from individual to group contracts for its 403(b) plan, also engaging an independent fiduciary to provide 3(38) investment management services. The school then elected to implement lifecycle funds as its QDIA. Rose Neubert, director of finance and operations, says this default investment selection was among other changes the school made to its overall retirement plan offering.

“I had input from our investment committee, and we managed the nuts and bolts of implementing a lifecycle fund as our QDIA,” Neubert says. The process was “straightforward,” she adds, since the groundwork had been laid in the form of developing a calendar for how and when the administration would engage faculty and staff and implement plan changes.

Participant communication included straightforward information on employees’ investment options and associated fees, along with the opportunity to meet with advisors. Neubert says that participants were impressed with the scrutiny their investments received under the school’s 3(38) fiduciary arrangement, and the outreach and engagement paid off: Participants voluntarily increased their contributions by 40 percent.

“While going through significant changes over the past year, we’ve earned the trust of the faculty and staff because they know and expect we are continually paying attention to their investments,” Neubert says. Moreover, Stuart staff and faculty appreciate that target-date funds require them to make only one decision while still allowing for a diversified age-appropriate solution.

Ben Lewis is a senior managing director of the Select Plan Market at TIAA and a member of the NBOA Board of Directors. Prior to joining TIAA in 2012, he had a variety of roles at Putnam Investments and Fidelity Investments.

This information is provided for general educational purposes only. It should not be relied upon, or in place of, professional advice. Readers are advised to consider their investment objectives, risks, charges and expenses carefully before investing. Call 877-518-9161 or visit www.tiaa.org for product and fund prospectuses.