Wednesday, May 25, 2011

IMHO -- Congress Got it Wrong With QDIAs ... Very Wrong

The Pension Protection Act of 2006 (PPA) was, in my opinion, a horrible piece of legislation. Frankly, it didn't protect many pensions and didn't do much else that, in retrospect, was very useful. One of the most well-regarded, at least initially, parts of PPA was the concept and requirement of Qualified Default Investment Alternatives, or QDIAs. In a nutshell, participants have their investments defaulted into a particular investment that is eligible to be a QDIA and unless they make an affirmative election to invest otherwise, there shall there assets reside.

The most popular QDIA has been Target Date Funds, or TDFs as they are usually referred to in the press. Most of the fund houses that offer them have one developed for each five-year age range. So, if you were born in 1970, for example, you will turn 65 in 2035, so you would get defaulted into the 2035 TDF. Some recordkeepers have gone so far as to say that if a plan's participants are not defaulted into their proprietary TDFs, then the sponsor needs to find a different recordkeeper.

This smells bad to me. And, it is.

I will probably explore this in more depth at some point, but let's consider some of what I view to be major flaws. First, as background, our 2035 Fund that we discussed is composed of assets in a broad, diversified group of asset classes. They are chosen to be appropriate for a person who is now 40 (or 41) years old who will retire in about 25 years at roughly age 65. Generally, its composition assumes that this pool of assets is their retirement income, perhaps in addition to Social Security. What is left out?

  • For a random participant, is their current level of savings more or less than the norm for 2035 participants?
  • Do they have outside savings? How are they invested?
  • Do they have a defined benefit either with this company or with a previous employer? An annuity from a defined benefit plan can be thought of as a fixed income investment lessening the need for other fixed income investments?
  • Does our participant have a working spouse? Does their spouse have a retirement plan? How is it invested?
There are many more, but bottom line, this Qualified DEFAULT Investment Alternative may be the correct default for only a small percentage of participants. Yet, all who don't make an affirmative election otherwise are defaulted into it. And, we haven't even talked about the fees and the specific funds that go into creating these funds of funds. The recordkeepers and fund houses will tell you that their TDFs are the greatest thing since sliced bread. I think otherwise.

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