GAO Identifies Reasons Most Plan Sponsors Use TDFs as QDIA

The fit with participant characteristics especially led to the decision to use TDFs as QDIAs.

In 2013, up to 72% of defined contribution (DC) plan sponsors used a target-date fund (TDF) as their qualified default investment alternative (QDIA), according to an analysis of three industry surveys by the Government Accountability Office (GAO).

In its report, “401(k)Plans: Clearer Regulations Could Help Plan Sponsors Choose Investments for Participants,” the GAO identified several factors that led the majority of plan sponsors to select TDFs over other QDIAs. Several stakeholders the GAO interviewed generally said that plan sponsors looked for design simplicity, fiduciary protection, and a fit with participant characteristics when selecting a default investment.

The fit with participant characteristics especially led to the decision to use TDFs as QDIAs. Plan sponsors interviewed by the GAO said they chose their QDIA type because it best fit the age distribution of their participant population. In one case, the sponsor stated that the age demographics of the plan’s participants ranged from 21 to 71, so it believed TDFs best fit the wide spectrum of participant ages.

Stakeholders interviewed and plan sponsors that responded to the GAO’s questionnaire highlighted specific reasons that could make a TDF an appropriate choice for a plan’s QDIA.

For example, several stakeholders stated that plan sponsors generally selected off-the-shelf TDFs because they are a conceptually simple, low-cost product that provides diversification and dynamic asset allocation throughout a participant’s career. Plan sponsors who selected off-the-shelf TDFs as their QDIA said these products have a simple design, provide age-based asset allocations at a low cost, and create appropriate retirement outcomes for participants who have little interest in investing and tended not to change their investment selections over time.

Stakeholders stated that plan sponsors generally selected custom TDFs because these products provide a more hands-on approach to investment management. Unlike off-the-shelf TDFs, custom TDFs allow sponsors to select best-in-class asset management to build a TDF series that meets the needs of the plan.

One plan sponsor told the GAO that her plan set out to develop a custom target-date glide path using plan specific demographic information and the current plan investment fund managers. As part of this process, a service provider selected a glide path that provided the best return for risk, based on participant demographics, income needs, and behavioral investment patterns.