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4 Things You Need to Know About Default Funds

A growing number of retirement plan participants — and retirement plan assets — are being invested in the default option selected for the plan.

The existence of default funds isn’t exactly a new phenomenon. Arguably it’s as old as that first participant enrollment form returned without the investment election section completed. 

Today it’s more likely to be a consequence of the adoption of automatic enrollment provisions following the passage of the Pension Protection Act of 2006, which removed several impediments to automatic enrollment plans, including amending the Employee Retirement Income Security Act (ERISA) to provide a safe harbor for plan fiduciaries investing participant assets in certain types of default investment alternatives (“qualified default investment alternatives,” or QDIAs) in the absence of participant investment direction.

Whatever the origins of your plan’s default option, here are four things you should know:

1. A default option doesn’t have to be a QDIA.

There are good and valid reasons to want your default fund to be a QDIA, primarily that the participant will be deemed to have exercised control over assets in his or her account if, in the absence of investment direction from the participant, the plan fiduciary invests the assets in a QDIA. That’s basically the equivalent of 404(c) protection from a participant lawsuit for the plan sponsor. That said, a default investment fund doesn’t have to be a QDIA, even if you have automatic enrollment.

2. A QDIA doesn’t have to be a target-date fund.

These days target-date funds are the low-hanging fruit of QDIA options, but balanced funds, target risk and professionally managed accounts are also explicitly acknowledged in the regulations. However, for a default fund to gain the safe harbor protections of a QDIA, it be structured in such a way as to take into account the age of the participant and/or the workforce.

Remember, however, that in order to be a QDIA, there are certain other obligations, including the requirement to notify those defaulting workers that they are being defaulted, and that they have a right to opt out — both upon enrollment and annually thereafter. Failure to provide the proper notices at the proper times has long been an impediment to fulfilling 404(c)’s conditions — and could be enough to thwart QDIA’s shield as well.

3. The fiduciary requirements to prudently monitor and select a QDIA are no less than for any other plan investment option — and they are fiduciary requirements. 

Plan fiduciaries can reap significant benefits from the adoption of a QDIA, and participants even more so — if the option is prudently selected and monitored. But, at a minimum, in the QDIA regulations, the Labor Department made it abundantly clear that “selection of a particular qualified default investment alternative … is a fiduciary act and, therefore, ERISA obligates fiduciaries to act prudently and solely in the interest of the plan’s participants and beneficiaries.” 

4. Just because a default fund isn’t a QDIA doesn’t mean it isn’t a prudent default choice.

While target-date vehicles are certainly convenient for plan sponsors and well-received by participants — and explicitly acknowledged as QDIA-eligible — they aren’t the exclusive prudent choice for a default option. Of course, choosing something else — a target-risk fund with no age orientation, a balanced offering, or even a stable value fund — won’t afford you the same protections that a QDIA will. 

On the other hand, a well-chosen, thoughtfully monitored investment default might not require them.