How a 401(k) QDIA can help limit your fiduciary liability

LAST REVIEWED Feb 10 2022 8 MIN READ

By Wendy Baker, J.D.

Key Takeaways

  • A QDIA is a special type of default investment sometimes used in a 401(k) plan.

  • While not legally required in 401(k) plans, a QDIA can help reduce the liability of the plan’s investment fiduciaries.

  • QDIAs can help encourage adding automatic enrollment to a 401(k) plan, which can help increase participation.

As its name suggests, a Qualified Default Investment Alternative (QDIA) is a special type of default investment sometimes used in a 401(k) plan. 

This may sound simple enough, but it’s important to know the impact a QDIA has on your 401(k) plan. Under ERISA, the plan sponsor, the trustee, or another investment advisor (“investment fiduciaries”) have a fiduciary duty to diversify the plan's investments to minimize the risk of large losses.

While QDIAs are not legally required in 401(k) plans, they can help reduce the liability of the plan’s investment fiduciaries. If a 401(k) plan has a QDIA that meets Department of Labor (DOL) rules, the plan’s investment fiduciaries are not liable for the QDIA's investment performance. In this context, plan sponsors can rest easy knowing employees’ retirement dollars are being invested in a vehicle that offers growth potential. Without a QDIA, however, plan fiduciaries may be liable for investment losses if participants don’t choose to direct plan investments.

To help explain, we’ll outline what else you need to know about a 401(k) QDIA.

What is a QDIA?

A QDIA is a default investment vehicle selected by a plan’s investment fiduciaries to limit their fiduciary liability for investment losses when a participant fails to make an investment selection in a plan that allows participants to self-direct their investments.

The general rule under ERISA is that a plan’s investment fiduciaries are liable for all aspects of the selection and monitoring of plan investments. This means these fiduciaries risk a claim of fiduciary breach if the investments they select don’t perform well. For individual account type plans such as 401(k) plans, the investment fiduciaries may choose to reduce their fiduciary risk by taking advantage of a safe harbor outlined in ERISA Section 404(c). Under this safe harbor, if certain investment diversification requirements are met—along with certain timing and notice requirements—participants will self-direct their own investments and be solely responsible for poor investment decisions. 

But what if a participant fails to direct their own investments? Again, the plan’s investment fiduciaries are responsible for making investment decisions for that participant (and all of the associated risk). ERISA Section 404(c) provides a solution to this dilemma: Set a QDIA for the plan that applies to participants who don’t make investment selections on their own. The QDIA will then dictate how the participant's investments are selected and preserve the plan investment fiduciaries' protections under the 404(c) safe harbor.

What must a QDIA include?

The Pension Protection Act (PPA) directed the DOL to issue regulations to help employers select default investments that best serve the retirement needs of their employees. To meet the QDIA definition, investment must meet specific DOL requirements:

  • QDIA investment type. The selected savings vehicle must take one of four forms:

    • A life-cycle or target date fund, or any product with a mix of investments that takes into account an individual’s age or retirement date

    • An investment service that allocates contributions among existing plan options

    • A product with a mix of investments that takes into account the characteristics of the group, such as a balanced fund

    • A capital preservation product for only the first 120 days of participation, which helps employers avoid tax accrual should the participants opt out. (This option is rarely used because of the 120 day limitation.)

  • QDIA management. The investment must be managed by an investment manager, plan trustee, plan sponsor, or an employee committee.

  • QDIA notice. In addition to being given the opportunity to choose investments from a wide range of options, participants must be notified before their first QDIA investment is made, and annually after that.

  • QDIA notice requirements. Notices must include an explanation of the participant’s rights to decide how the funds in question are invested, an explanation of how the funds will be invested if the participant does not make investment elections, and a QDIA prospectus, including objectives, expected risk and return, and fees.

  • Withdrawal frequency. Participants must be able to reinvest QDIA funds in other investments as frequently as with other investments offered, and at least quarterly.

Does a 401(k) plan have to have a QDIA?

No, technically, 401(k) plans are not required to include a QDIA. However, selecting one is in your best interest for both your business’ and your employees’ best interests (more on this below). 

What is the risk not having a QDIA?

The plan’s investment fiduciaries will lose some of the protection of ERISA Section 404(c), assuming the plan is taking advantage of that safe harbor. Without a QDIA, the investment fiduciaries will remain responsible for determining how to invest assets for participants who do not make their own selection. 

How can I tell if a plan has a QDIA?

Review your plan documents and the notices provided to participants. The plan document should indicate if the plan will comply with ERISA Section 404(c). If so, it’s ready to take advantage of a QDIA. If the plan currently has a QDIA, an annual QDIA notice will be produced (typically by your service provider), which will state the plan’s QDIA.

How can a QDIA help 401(k) plan design?

QDIAs encourage employers to add automatic enrollment to their retirement plan, which can help bolster participation (Vanguard data shows that participation rates triple to 91% with automatic enrollment, compared to 28% with voluntary enrollment). According to the DOL, businesses had historically shied away from auto-enrollment features because they feared liability for participants’ investment performance. The PPA of 2006 amended ERISA to add legal protections for plan fiduciaries who invest unassigned contributions in a qualifying default investment. 

While automatic enrollment helps boost retirement savings, employees opted in by their employer might not be as motivated to select investments as voluntary participants, who may also delay choosing investment options. QDIAs serve in the best interest of participants and beneficiaries by incentivizing businesses to conservatively invest their money rather than letting contributions simply accumulate.

What if I don’t have a QDIA?

If after doing your due diligence, your plan doesn’t have a QDIA, you have a couple of options. You can determine whether an investment option within your plan meets QDIA requirements—or you can talk to a retirement plan provider about establishing one.

Human Interest makes it easy to save for the future. We combine automatically managed portfolios based on individual risk profiles to help small businesses and their employees achieve their retirement goals. Refer to our Investment Philosophy to learn more about our low-cost funds and built-in investment education—or talk with a retirement specialist to learn more.

Wendy Baker is Senior Legal Counsel at Human Interest, bringing over 25 years of experience exclusively in the ERISA space, spanning defined contribution plan recordkeeping and administration. She has a J.D. from Case Western Reserve University, is a member of the North Carolina and Ohio Bars, the American Bar Association, and industry groups.