Some plan sponsors may be reluctant to change the default investment, regardless of monitoring results, according to a new report by the Government Accountability Office (GAO).
The GAO report, initiated at the request of Sen. Elizabeth Warren (D-Mass.), noted that questions have arisen regarding whether the qualified default investment alternative (QDIA) types that sponsors select are serving the best interests of all participants or improving the prospects of a secure retirement for participants whose contributions and earnings remain in the QDIA for a lengthy period of time. The GAO looked into which options plan sponsors selected as QDIAs and why, as well as how plan sponsors monitor their plans’ QDIAs and what challenges, if any, plan sponsors report facing with regard to the selection and use of QDIAs.
Regulations Unclear
Plan sponsors responding to GAO's questionnaire and stakeholders GAO interviewed generally said that the regulations were unclear as to:
- how sponsors could fulfill the regulatory requirement to factor the ages of participants into their default investment selection;
- whether each default investment provided the same level of protection; or
- whether they were allowed to incorporate other retirement features, such as products offering guaranteed retirement income, into a plan's default investment.
Moreover, GAO noted that that uncertainty could lead some plan sponsors to make suboptimal choices when selecting a plan’s default investment that could have long-lasting negative effects on participants’ retirement savings. One plan sponsor stated that fear of potential litigation led the plan’s investment committee to decide against changing a QDIA, even though the committee believed that initial selection decisions had been prudent and participants would be better served by the change.
QDIA Considerations
The GAO noted that from 2009 through 2013, most employers that sponsored 401(k) plans reported using a target-date fund as their default. Based on questionnaires from 227 plan sponsors, GAO found that those plan sponsors generally looked for the following in their QDIA selection:
- asset diversification (156 chose this as a rationale);
- ease of participant understanding (141 chose this);
- limited fiduciary liability (132 chose this); and
- a fit with participant characteristics (86 chose this).
Other stakeholders that GAO interviewed highlighted other factors that could influence a plan sponsor’s default investment selection, such as plan sponsor preferences, plan circumstances or changes in the plan’s environment, such as a plan merger or court decision. Moreover, despite the number that selected limited fiduciary liability as a criteria, more than half of the 227 plan sponsors responding to GAO’s questionnaire indicated that the three QDIA types did not offer the same fiduciary protection, or they said that they did not know or had no basis to judge.
“Stakeholders” that GAO interviewed generally said that the type of default investment and a plan's circumstances — such as the availability of resources and expertise devoted to investment monitoring — can affect the extent of a plan sponsor's monitoring efforts and the response to monitoring results (GAO uses the term “stakeholders” in this report to refer to “a wide range of individuals knowledgeable of different aspects of 401(k) plans, participants, and investments”).
Reluctant to Change
However, plan sponsors responding to GAO's questionnaire and stakeholders GAO interviewed said that after an extensive default selection process, some plan sponsors may be reluctant to change the default investment regardless of monitoring results, going on to cite as an example a situation where a plan sponsor and service provider may have negotiated a reduction in overall plan investment management fees in exchange for using a provider's investment as a plan's default, a circumstance GAO said would make it more difficult to change.
Plan sponsors cited regulatory uncertainty, liability protection, and the adoption of innovative products as significant challenges when adopting one of the three default investment categories outlined in the QDIA regulations, which outline several specific conditions that plan sponsors must adhere to in order to receive relief from liability for any investment losses to participants that occur as a result of the investment.
The GAO report concludes that while the Pension Protection Act of 2006 (PPA) encouraged the adoption of QDIAs through the creation of safe harbor plan designs, some plan sponsors find the final DOL regulations to be unclear, especially with regard to the consideration of participant ages when selecting a QDIA, the extent of fiduciary protection, and the flexibility to allow innovations in QDIA products. “This lack of clarity could lead some plan sponsors to make suboptimal choices when selecting a plan’s default investment and could have long-lasting negative effects on participants’ retirement savings,” according to the GAO.
In its report, the GAO recommends that the Secretary of Labor direct the Assistant Secretary for the Employee Benefits Security Administration to assess the challenges that plan sponsors and stakeholders reported, including the extent to which these challenges can be addressed, and implement corrective actions through clarifying guidance or regulations, as appropriate.
“Without a better understanding of the requirements, plan sponsors — including those that have already adopted a QDIA — face difficulties trying to balance participant safeguards with solutions that can help them establish and sustain financially secure retirement plans for their employees.”
