A New Way to Manage Retirement Funds

Uncle Sam wants laggard 401(k) account holders to beef up their savings by channeling contributions into diversified default investments

If you're a relatively sophisticated investor—and keep an eye on your 401(k), rebalance the investments periodically, and are generally happy with the results—you probably don't need to know exactly what the new federal acronym, QDIA, might mean for your account.

But if your 401(k) contributions are currently going into a money market fund that doesn't even keep up with inflation, if you're opening a new 401(k), if you're too lazy or too busy to read your statements, or if you're confused about which of 15 or 20 funds to invest in, you should probably learn more about the new Qualified Default Investment Alternative (QDIA) authorized by the Pension Protection Act of 2006.

The QDIA is a topical issue because regulations for implementing the provision just went into effect at the end of 2007. Philip J. Suess, a principal and investment consultant for Mercer consulting in Chicago, says employers are moving quickly to offer the QDIA. Most people with these plans have already received a notice about the new rules or will get one soon.

Your Choice by Default

The notice to employees says that unless they sign up for other types of investments—say, a large-cap stock fund or a bond fund—new 401(k) account holders and current ones whose money is invested in a stable value or money market fund will find their employer automatically funneling future contributions into a default investment option chosen by the company's plan administrator. If you have actively chosen a range of other stocks, bonds, etc., for your account, you may also opt to put future contributions into the default investment. Click here to read the entire regulation, which specifies the information employers must provide about the default investments.

Employers may choose one of several QDIAs to offer. The primary ones are a target-date retirement fund, a "balanced fund," or a managed account. Federal rules require that the default investment should "combine both growth and income objectives, by investing in both stocks (for growth) and bonds (for income)."

A target-date fund contains investments deemed appropriate for people based on their age and the year they expect to retire. For example, Fidelity's "Freedom Funds" consist primarily of stock and bond funds aimed at people who expect to retire at any one of five-year intervals, from 2010 to 2050. Vanguard says that of their 528 plan sponsors who have adopted a QDIA, 83% have decided to offer this type of default option to their 401(k) account holders.

The second alternative, a balanced fund, contains diversified investments considered appropriate for investors of any age. If your employer chooses the third option, a managed account, you would essentially turn over investment decisions to a financial adviser, for which you'd pay a fee—such as 0.25% or 0.50%, based on the size of your account.

Right for You?

What type of investor should opt for a QDIA, and what type should not?

Cathy Pareto, a financial planner in Coral Gables, Fla., says "the default option is really designed for participants who are less well-informed and less inclined to oversee their investments and who might otherwise be tempted to sit in cash." She says the ideal candidate for a default option is a person who, with regard to a portfolio, likes to "set it and forget it"—or else a hyperactive investor who "constantly makes changes to his portfolio" and is prone to trying to time the market or pursue "hot" stocks of dubious potential.

In contrast, if you're satisfied with your current 401(k) portfolio, you probably shouldn't shift to the QDIA. Holly Thomas, a financial planner in Tampa, points out that if you have other investments outside your 401(k), choosing the default would risk "overlap and concentration issues with other investments." For example, you might not realize that equity funds both in and out of your 401(k) have substantial investments in the same stocks. She says that people who "are just slightly inclined to spend even a few hours a year monitoring their portfolio are better off coordinating the 401(k) with their other investments."

The 401(k) may appear to be a simple tool for financing your retirement, but anyone who has ever had an account knows otherwise. With luck, getting notice of this new regulation will spur many employees to take the time to assess their own 401(k) choices realistically and make the right decision for their future. A consoling feature of the new rule is that, if you choose the QDIA now and decide later that you'd rather manage your investments more actively, the rules require that your employer let you change your decision.

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