Pooled Employer Plans (PEPs) are becoming increasingly popular in today’s defined contribution plan landscape. PEPs are multiple employer plans that allow otherwise unrelated businesses to band together to offer a retirement plan to their employees, sharing the expenses and offloading the administrative and investment burden. However, not all PEPs are created equal, and understanding the importance of Qualified Default Investment Alternatives (QDIAs) is essential in differentiating among PEP plans. In this article, we will explore the two main types of QDIAs offered by PEPs: Target Date Funds (TDFs) and managed accounts.
A TDF is a type of investment vehicle that automatically adjusts the asset allocation mix over time to become more conservative as the target date (i.e., the participant’s retirement date) approaches. This is known as the glide path and is the predetermined asset allocation mix that is set by the fund’s management team.
TDFs can utilize underlying investment strategies that are either passive or active. Passive TDFs, also known as index TDFs, utilize only passively managed underlying investments. Passive TDFs have lower fees than active TDFs because they do not require active management by the underlying portfolio managers and aim to replicate a benchmark.
Active TDFs, on the other hand, utilize actively managed underlying portfolio managers who make decisions based on market conditions and the fund’s investment objectives. Active TDFs have higher fees than passive TDFs because of the added cost of active management that aims to outperform a benchmark.
In both active and passive TDFs the management team may adjust the glide path periodically to take into account changing market conditions, interest rate movements, or changes in investor behavior. So, even passive TDFs still have some characteristics of active management at the glidepath level. They may also make adjustments to the mix of assets within the fund to achieve better diversification, to manage risk, or in the case of active TDFs to replace one investment manager with a better one. Some PEP plans also offer managed accounts as a QDIA option. Managed accounts are personalized investment portfolios that are managed by a professional portfolio manager. While TDFs typically only consider a participant’s retirement age, a managed account solution will aim to reach out to the participant to gather additional information such as outside assets, as well as goals and risk tolerance. Managed accounts have higher fees than TDFs because of the added cost of gathering this additional data and managing to it. Because managed accounts generally are significantly more expensive than TDFs, it is important to carefully review the fees to ensure that they are reasonable, in line with industry standards, and especially that they provide value for the added cost.
Why the QDIA decision is important
Research shows most plan participants do not make active investment decisions in their retirement plan and remain invested in the default investment option chosen by the plan sponsor. As a result, the QDIA tends to be where the bulk of plan assets are invested. Therefore, it is a very important decision point for an employer to research when picking a PEP. The QDIA offered in a PEP also plays a significant role in determining the overall investment fees of the plan since again, many participants remain invested in the default option. If a PEP uses a passive TDF as its QDIA, the plan’s overall investment fees are likely to be lower compared to a plan that uses an active TDF or a managed account as its QDIA. This is because passive TDFs generally have lower fees, while managed accounts tend to have the highest fees due to the active management and personalized investment advice they offer.
What type of QDIA is available depends on the PEP. Many PEP providers offer only one QDIA option while others allow the participating employer to choose from a few options. Within the managed account space, some PEPs even allow the plan sponsor to choose who will be responsible for the investment management of the managed account. Other PEPs offer only a predetermined choice. Therefore, choosing a PEP and choosing the QDIA option will be closely tied together.
Employers should keep in mind the following when assessing their PEP and QDIA choices:
- Choosing the most suitable PEP and therefore QDIA is not always straightforward. Employers should evaluate and compare not only the costs but also additional services, investment processes, management teams, and potential returns. An employer may decide that the additional cost from an actively managed TDF or a managed account is prudent given the additional value it brings or if it is a better fit for employees. Employers will want to ensure that they’ve carefully thought through and analyzed all costs and benefits.
- Employers should ensure that they are making an apples-to-apples comparison when comparing PEP fees to their current 401(k)/403(b) plan fees. For example, a significant difference in fees may arise if an employer is currently using an active TDF and comparing its costs to a PEP that uses a passive TDF. Accurate comparisons are key to fully understanding the advantages of various PEPs.
When it comes to selecting a suitable PEP and QDIA option, it is crucial to consider various factors such as the demographics of the plan participants, as well as a thorough evaluation of the investment process, returns, and associated fees. To ensure that the selected PEP and QDIA options are in line with the participants’ needs and objectives, a comprehensive analysis of these crucial elements is imperative. Ultimately, the right PEP and QDIA options can make a significant impact on the retirement outcomes of plan participants, highlighting the importance of careful consideration and diligent selection for a participating employer.