First of two parts
The 2006 Pension Protection Act and subsequent Department of Labor guidance provide for two new fiduciary safe-harborlike procedures for plan sponsors seeking relief from investment decisions associated with participant-directed retirement plans.
As with any fiduciary safe harbor, the procedures are voluntary, and the plan sponsor will be required to demonstrate conformance to have a defense from related liability.
The first new safe harbor is associated with providing participants with specific investment advice from a “fiduciary adviser” operating under an “eligible investment advice arrangement” — the subject of an earlier Fiduciary Corner column (InvestmentNews, Oct. 23).
The second new safe harbor, and the subject of this two-part column, is the “qualified-default-investment alternative.” These new provisions will help to insulate plan sponsors from liability associated with the allocation of a participant’s account to a more diversified investment option when the participant fails to provide any investment directions.
Both safe-harbor provisions include a number of record-keeping and administrative procedures that I am not going to cover here. Instead, I will focus on the fiduciary practices that are most likely to include the involvement of an investment adviser: the evaluation, selection and monitoring of QDIAs.
Plan sponsors often turn to investment advisers for assistance in managing their fiduciary roles and responsibilities. Considering the added complexities associated with QDIAs, I believe that the investment adviser will play an even more critical role in their application.
The Labor Department has defined a QDIA as an age-based, life cycle or targeted-retirement-date fund or account, a risk-based balanced fund and/or an investment management service.
The first question the investment adviser can help the plan sponsor to answer is: Which of the QDIAs is most appropriate (never use the word “best”), given participant demographics? As with most investment fiduciary decisions, there rarely is only one correct answer. Generally, there’s a range of appropriate responses. QDIAs are no exception.
The accompanying illustration is intended to graph the two inputs that are likely to have the greatest bearing on the evaluation of an appropriate QDIA:
Vertical axis: the level of investment sophistication of the participants.
Horizontal axis: the level of participant involvement in monitoring their investment portfolio.
Regardless of how knowledgeable the participants are, do they monitor their investment portfolio on a frequent basis? (I would have to plead guilty to neglect, having not taken a close look at my 401(k) investment options in almost three years.)
The QDIAs, along with a traditional lineup of investment options, are arrayed along a continuum. Several important points for clarity:
• The illustration is intended to be used as an aid in deciding which QDIAs may be appropriate for the participant base. There is nothing preventing the plan sponsor from using more than one QDIA.
• The QDIA is in addition to any other investment options the plan sponsor has already selected. It is not intended to replace a traditional menu of investment options but simply to augment it.
• The QDIA is defined specifically for those participants who do not provide any investment directions, but does not preclude a participant who is actively engaged in managing their portfolio from selecting a QDIA as an investment option.
• A participant can opt out of a QDIA at any time.
The illustration shows that the target maturity fund may be the most appropriate QDIA for participants who do not have a lot of investment experience and have not shown any interest in managing their investment decisions. (Their lack of involvement is the very reason the plan sponsor is directing the investment to a QDIA.) The primary variable of the target maturity QDIA is the participant’s investment time horizon.
Moving up the continuum, next are risk-based QDIAs, which are better suited for participants who are capable of understanding more complex investment concepts — specifically, investment risk — and who have shown some level of involvement in monitoring their investment portfolio.
Shown next is an investment management service, which can be thought of as a QDIA custom built by an investment manager (the Employee Retirement Income Security Act of 1974 uses the term “qualified-plan asset manager”) to the plan sponsor’s specifications. Anchoring the continuum in the upper right corner is a traditional lineup of investment options in which the participant puts together their own investment strategy. The traditional lineup is not a QDIA and is shown simply to illustrate its position relative to the QDIAs.
This chart also shows the suggested threshold of when it would make the most sense for the plan sponsor to engage the services of a fiduciary adviser.
While it’s always prudent for a plan sponsor to consider the services of a fiduciary adviser (it’s a voluntary safe harbor), if the plan sponsor has selected more-complex investment options, the fiduciary adviser safe harbor may become essential.
In evaluating a QDIA, the investment adviser also should consider:
• Is there any indication that the provider of the QDIA is involved in self-dealing, prohibitive transactions and/or conflicts of interest?
• Does each QDIA clearly define the investment time horizon associated with the investment strategy?
•Does each QDIA clearly define the level of risk associated with the investment strategy?
•Does each QDIA clearly define an expected, modeled return associated with the investment strategy?
•Are the asset classes used to construct each QDIA consistent with the identified risk, return and time horizon?
• Are the asset classes used to construct each QDIA consistent with the plan sponsor’s implementation and monitoring constraints?
• Is the plan sponsor’s investment policy statement sufficiently detailed to define, implement and manage each QDIA?
Next: the challenges associated with selecting and monitoring a QDIA.
Donald B. Trone is president of the Center for Fiduciary Studies and chief executive of Fiduciary360 LP, both in Sewickley, Pa.