Three is not enough when it comes to the Labor Department’s specified qualified default investment alternatives (QDIAs) for 401k plans, according to Jason Shapiro of Willis Towers Watson, who advises plan sponsors on DC plan investment strategies.
In a new paper, “QDIA evolutions—Moving defined contribution plans into the future,” Shapiro, a leader in Willis Towers Watson’s DC Strategy and thought leadership, says it’s high time to consider alternatives to target date funds, managed accounts and balanced funds. One of those alternatives that merit consideration, he says, are hybrid models that can balance cost and customization in a QDIA solution.
Shapiro notes the marketplace is seeing a great deal of evolution around QDIAs and believes that through combining current options in thoughtful ways and utilizing available features and systems innovatively, sponsors can create new solutions that not only meet the definition of a QDIA, but also help improve participant outcomes.
“From an investment perspective, we believe the [QDIA] is the most direct way to impact retirement readiness given the increase in auto-features such as automatic enrollment,” Shapiro says in the paper. “This can produce a strong, stable pool of assets that may be used to potentially create better participant outcomes through increased diversification, improved portfolio construction and other valuable features.”
Shapiro outlines three approaches he says sponsors should consider:
- Hybrid solutions: a low-cost generic asset allocation vehicle that transitions to a customized managed account later in a participant’s career.
- Unwrapped target date funds: a combination of traditional model portfolios and custom target date funds.
- In-retirement, income-focused solutions: converts participants’ plan balances into retirement spending through features that may include Social Security deferrals, deferred annuity purchases, non-guaranteed spending, and others.
Looking at the current state of the market, Shapiro says you could argue there is effectively only one truly utilized QDIA, citing the Willis Towers Watson 2017 U.S. Defined Contribution Plan Sponsor Survey which found an overwhelming 93% of plans currently use target date funds.
The DOL, of course, specifies three potential QDIAs for sponsors to choose from, but the more comprehensive answer is “more than three,” Shapiro argues.
“We believe through combining the three allowable QDIAs in thoughtful ways, and utilizing available features and systems innovatively, sponsors have the potential to create new solutions that meet the definition of a QDIA and help improve outcomes for participants,” the paper says, qualifying that statement by acknowledging that many QDIA evolutions are still in their infancy and need to progress further before waves of plan sponsors adopt these approaches.
“That said, we believe evolution is necessary as target date funds include implied, and often unintended, consequences such as bundled decision making and loss of scale in core lineups, while managed accounts are arguably not an ideal fit for default participants. Our view is that there are alternate implementations sponsors should consider.”
The paper goes on to discuss the three such QDIA evolutions (hybrid solutions, unwrapped TDFs and in-retirement, income-focused solutions) in detail, and concludes by saying all three ideas have merit and should be reviewed by plan sponsors.
Shapiro said that while Willis Towers Watson remains an advocate of target date funds in DC plans, today target date funds are asked to do more than they ever have in the past—to be a retirement readiness vehicle for a heterogeneous population of plan participants.
“We need to critically ask ourselves as an industry whether target date funds are up to the task,” Shapiro said. “If not, we should consider what the next step for QDIAs should be.”
He said now is the time to start thinking about building a leading, best-in-class QDIA, before we start to see the waves of retirees relying primarily on DC reaching retirement age. “If we wait until those participants are ready to leave the workforce, it may be too late.”