In Practice January 23, 2024

Nuts & Bolts: QDIAs

What new advisers need to know about qualified default investment alternatives in retirement plans.

Reported by

1) What is a QDIA?

“A QDIA is one of those wonderful government acronyms that means nothing to 99% of the population. It stands for qualified default investment alternative,” says David John, senior strategic policy advisor at the AARP Public Policy Institute. “It is the investment that is allowed for automatic enrolled retirement plans.”

Never miss a story — sign up for PLANADVISER newsletters to keep up on the latest retirement plan adviser news.

In its fact sheet on default investment alternatives from 2006, the Department of Labor makes one thing clear: The qualified default investment alternative is a plan fiduciary’s friend.

The DOL’s fact sheet furthers John’s point that the QDIA is a tool to enable and increase automatic enrollment in retirement plans, emphasizing right off the bat that auto-enrollment is such a crucial part of retirement saving.

“Approximately one-third of eligible workers do not participate in their employer-sponsored defined contribution plans (such as 401(k) plans),” the DOL wrote at the time. “Studies suggest that almost all of these workers would choose to remain participants if they were automatically enrolled. The increased savings would significantly improve their retirement security.”

From there, the DOL went on to explain that, to make auto-enrollment work, employers (which also means plan fiduciaries such as designated advisers) are “potentially liable for investment losses that may occur in such plans.” At that time, nearly 20 years ago, such liability was “a major impediment” to wider adoption of auto-enrollment.

In the same year, Congress passed the Pension Protection Act, which amended the Employee Retirement Income Security Act to provide a safe harbor for plan fiduciaries who default participants into certain types of investments when participants were not making the decisions themselves.

Plan sponsors and designated advisers have thereby been given relief from liability for investment outcomes, assuming they follow the rules laid out for QDIAs and are acting in accordance with ERISA fiduciary standards.

The DOL’s key rules regarding QDIAs include:

  • Participants and beneficiaries must have been given an opportunity to provide investment direction, but failed to do so;
  • A notice must be furnished to participants and beneficiaries 30 days in advance of the first investment and at least 30 days in advance of each subsequent plan year. The notice must include a description of the circumstances under which assets will be invested in a QDIA; a description of the investment objectives of the QDIA; and an explanation of the right of participants and beneficiaries to direct investment of the assets out of the QDIA;
  • Any material, such as investment prospectuses and other notices, provided to the plan through the QDIA must be furnished to participants and beneficiaries; and
  • The plan must offer a “broad range of investment alternatives,” as defined in under section 404(c) of ERISA.

2) What do I need to know about the QDIA as a retirement plan adviser?

If that is the basic background definition of a QDIA, what does one actually look like? How many options are possible to put into a plan?

“There are actually several different QDIAs, and the adviser also needs to be able to differentiate among those,” John notes. “A key factor is that all QDIAs are not the same. For instance, just [considering] target-date funds: Target-date funds have different guidelines, they have different investment groups: active, passive, etc.”

According to Betterment, a company focused on financial guidance, DOL regulations do not identify specific investment products. Instead, they describe mechanisms for investing participant contributions in a way that meets long-term retirement saving needs. Specifically, the DOL lays out four types of QDIAs:

  1. A product featuring a blend of investments, such as a life-cycle or target-date fund, designed to align with the individual’s age or retirement date;
  2. An investment service, like a professionally managed account, that distributes contributions among existing retirement plan options based on the individual’s age or retirement date;
  3. A product with a diversified investment mix tailored to the overall characteristics of a group of employees, as seen in a balanced fund; and
  4. A capital preservation product, like a stable value fund, limited to the initial 120 days of participation.

According to PLANSPONSOR’s 2024 DC Benchmarking report, TDFs make up 57% of deferrals from automatic enrollment across plan sponsors, though it is notable that among plan sponsors with $50 million to $200 million in assets, that figure jumps to 81.6%. Meanwhile, professionally managed accounts came in at 16.2% overall, most popular among plans with less than $25 million of assets. The breakdown was rounded out by balanced funds (5.7%), money market funds (2%), stable value funds (.7%) and risk-based lifestyle funds (.7%). Meanwhile, 11.2% of plan sponsors who took the survey were unsure, and 8.8% just chose “other” for options not listed. PLANSPONSOR, like PLANADVISER, is owned by ISS STOXX.

While TDFs are the runaway leader in popularity, John notes that it is not as simple as just choosing a few TDFs and walking away, particularly with a very active plaintiffs’ bar often suing plan fiduciaries for not properly managing or monitoring QDIAs. Some important things to keep in mind are laid out by the DOL in its fact sheet:

  • A QDIA may not impose financial penalties or otherwise restrict the ability of a participant or beneficiary to transfer the investment from the QDIA to any other investment alternative available under the plan;
  • A QDIA must be either managed by an investment manager or an investment company registered under the Investment Company Act of 1940;
  • A QDIA must be diversified so as to minimize the risk of large losses;
  • A QDIA may not invest participant contributions directly in employer securities; and
  • Plan fiduciaries are not relieved of liability for the prudent selection and monitoring of a QDIA.

According to the 2023 PLANADVISER Adviser Value Survey, investment menu review is more likely when a sponsor is working with a retirement plan adviser. Those plan sponsors with an adviser reported reviewing investments quarterly at a rate of 54.9%, annually at 24.2% and twice per year at 16.5%. Sponsors without an adviser reported reviewing investments quarterly at a rate of 26.7%, annually at 35.2% and twice per year at 10.5%.

3) How does the QDIA relate to my clients and business?

The QDIA’s impact is set to increase in coming years due to federal retirement legislation that mandates new retirement plans include auto-enrollment.

“Most clients are either using an automatic enrolled plan or looking at an automatic enrolled plan,” John says. “[The] SECURE 2.0 [Act of 2022] requires new plans now to include automatic enrollment, so auto-enrollment and other auto features are inevitably going to be part of the conversation. The adviser needs to be able to explain to their clients what is available and what is appropriate for their workforce.”

This is where the skill of the adviser comes into play, he says. They have to be knowledgeable on the composition of the workforce; history with saving (if there is any); the number of workers who leave the employer at any one time; and if they have seasonal employees.

“Essentially, they’re going to need to know a great deal about the client’s workforce in order to better advise them and to choose an investment pattern that is best suited for their client,” he says.

4) What are common misperceptions of or mistakes made when dealing with QDIAs?

One of the biggest mistakes advisers make with a QDIA is to assume that a TDF is the best alternative for all clients, according to John. He says in most cases a TDF is ideal, but there are managed funds and other alternatives that may be just as important or better, depending on the participant pool.

It’s also wrong to assume that all TDFs are the same, he notes.

“We have seen that target-date funds have different glide paths as to where they reduce the risk level of the investments,” he says. “They have different fee structures, etc.”

Many of the recent lawsuits against plan sponsors have alleged that the chosen TDF either produced poor performance or poor performance after fees, he notes. Advisers should be conscious of considering the TDFs being chosen and alternatives to help the plan sponsor choose the appropriate investment.

As John notes below, there are not only existing alternatives to TDFs, but new products coming to market regularly with ambitions of becoming a QDIA option.

5) What does the future look like for QDIAs?

John says an important consideration going forward will be to recognize that the use of a retirement plan differs depending on demographic of the workforce. He urges advisers to stay up to date on the latest research, as it will be an important part of their business in the future.

“At the moment, we typically look at an overall picture,” he says. “But we are about to discover that different genders and racial groups used the features of retirement plans differently. Advisers are going to need to focus on that.”

This is backed by a white paper from Wilshire stating that the future of defined contribution investing is poised for a major shift toward personalized solutions, ranging from more customized TDFs to managed accounts to model portfolios for retirement savers.

Additionally, in recent research from Sway Research, 17% of retirement plan advisers said they were offering a managed account option as a qualified default investment alternative for at least one client, though respondents also reported reservations in offering them as a QDIA, due in part to litigation concerns.

Furthermore, several investment product providers have begun to offer “dynamic QDIAs,” which put participants into a TDF early in their career, then converts them into a more personalized managed account as they near retirement.

John believes QDIAs will keep evolving along those lines, not just for personalization, but into other areas such as guaranteed income to supplement Social Security.

Looking at recent legislation, employers are going to have the option to include some form of lifetime income in the QDIA. In June 2023, representatives Donald Norcross, D-New Jersey, and Tim Walberg, R-Michigan, re-introduced the Lifetime Income for Employees Act, which would make it easier for annuities to be used as the default investment in 401(k) plans.

“The most popular version of that right now is something that would start to convert a proportion of the assets into an annuity starting at age, say, 45 or 55, or somewhere in that line,” John says. “There are a lot of new features that are likely to be added into QDIAs going forward. A good adviser will keep up to date and be ahead of the curve in knowing what they are and how they will benefit their clients.”

Deals & People January 23, 2024

Franklin Retirement Heads Aim to Double AUM

Yaqub Ahmed and Steven McKay, once competitors in the marketplace, will now seek to meet the AUM goal for Franklin's retirement, insurance and 529 business over at least the next five years. 

Reported by

Once colleagues early in their careers, Yaqub Ahmed and Steven McKay have since spent nearly three decades working in different sectors of institutional investing, often at competitors. Now they’re co-leading Franklin Templeton’s retirement and insurance business that, after closing its purchase of Putnam Investments in January, has more than $100 billion in defined contribution assets under management.

As of this year, Ahmed, head of Franklin’s retirement, insurance, sub-advisory and 529 college savings program, will co-lead the division with McKay. Putnam’s former head of global DCIO and institutional management was officially named to the role in January, though the leadership structure has been in the works for months, according to an interview with the two executives.

Want the latest retirement plan adviser news and insights? Sign up for PLANADVISER newsletters.

Yaqub Ahmed

Ahmed will be responsible for large and mega-sized DC institutional plans, along with initiatives such as personalization via managed accounts, retirement income and alternative asset exposure in DC plans. McKay will lead the distribution and national accounts teams, or what he calls, “the daily blocking and tackling of getting the strategy right.”

Ahmed notes that he met McKay about 28 years ago, when they were both at MFS Investment Management, and they have remained in touch through the years as they circled each other at various asset managers and recordkeepers.

“We’re going on three decades of partnership, friendship, and now we get to come full circle and work together again,” he says.

McKay, like many from the Putnam side of the deal’s DC asset management division, officially joined Franklin this January after a $925 million acquisition from Great West Lifeco Inc., which also owns Empower and which got a 6.2% stake in Franklin through the deal. Unlike most colleagues, McKay was on the deal team, working with Franklin’s Ahmed to structure the post-transaction future.

Steven McKay

“I had watched the success of Franklin from afar, and Qub and I kept close on things we were doing at Putnam as well, so it made it a little bit easier when we came together,” McKay says. “But there was also a lot of work and a lot of time spent with just Qub and I in a conference room figuring out what the best structure was—our focus, alignment, strategy and execution—but most importantly, how do we best serve our clients?”

Ahmed and McKay say there was no attrition, at least in their division, in the deal, because the retirement and insurance part of the transaction was “done for growth.” Franklin Templeton’s statements and 2023 annual report back the notion, calling out both the firm’s strategic growth areas of retirement and insurance-backed investment products, as well as noting the hundreds of billions of dollars American workers put into their retirement plans every year.

A scan of LinkedIn shows numerous senior leaders from Putnam’s DC business now carrying the Franklin Templeton name—moves a spokesperson confirmed—including positions such as director of retirement sales execution; director of strategic relationships; director of wealth planning; and institutional DC strategist.

Deal Rationale

Overall, Ahmed says the team has grown by more than 30% through the transaction. But the pair’s growth plans are even greater.

“We want to double our business over the next four to five years,” he says, referring to AUM. “We have an aggressive growth plan.”

Both Ahmed and McKay noted “gaps” in their prior business models that they believe the acquisition will help fill.

Ahmed noted Franklin’s strength in long-term, traditional investment assets, with gaps in target-date and stable value funds. These, he noted, are crucial and “sticky” offerings for DC investing; adding them through the Putnam acquisition “really rounded out our toolkit.”

McKay, for his part, noted an increased distribution network, including the ability to better reach strategic partners, such as advisers, in both the DC and retail space.

“We’ve optimized the distribution model to add business development directors in the field to really get to what I consider that movable middle—those thousands of advisers out there that need our help, that want our help and that are going to work with us in the DC space,” he says. “That was important to me, because we’ve had a lot of success at Putnam in certain areas over the years, but I always had a desire to add resources and capabilities to optimize the distribution model.”

Challenges

The team will face a consolidating (with this deal as a case in point) but increasingly competitive space of defined contribution investment only managers and retirement income providers. Franklin’s $100 billion in DC AUM looks like a relatively small figure when looking at DCIO giants BlackRock Inc. and the Vanguard Group, which both clocked roughly $1.16 trillion in DCIO assets at the end of 2022, according to PLANADVISER’s most recent DCIO Survey.

McKay notes that the combined team is fully aware that new scale alone will not guarantee Franklin reaches its goals.

“We have to get our focus right, we have to align the strategy to that focus, and we have to execute,” he says.

Ahmed points to the strategic relationships key to winning business among the “number of funds and strategies that are out there.” With decades in the sector, Ahmed says he and McKay are aware of the “the many hoops” needed to jump through in a highly regulated space with numerous intermediaries before getting to the ultimate end client: the retirement saver.

“We’re more focused on [the participant] now than ever before,” he says. “We’re focused on things like target-date and advice and managed accounts and retirement income, and you have to understand the retirement investor and their household to get those pieces correct.”

Ahmed notes an “advice gap” in the U.S. that he sees best solved through the workplace, particularly for the masses of people who aren’t affluent enough for individual wealth advisement. This is why, he says, it is so crucial for Franklin to focus on innovating in areas such as managed accounts, retirement income and access to alternative assets.

“We view the workplace as the financial epicenter for most U.S. workers,” Ahmed says. “That’s who they are looking to, and that’s the one place you can scale out these types of resources.”

«