The Vanguard report, “Improving plan diversification through reenrollment in a QDIA,” notes that even though most defined contribution (DC) plans offer a broad range of prudent investment offerings, plan sponsors find that some participants make portfolio construction errors, concentrating their investments in employer stock, in specific asset classes or styles, or holding overly conservative or aggressive portfolios. Reenrollment through which the plan sponsor defaults participants’ assets and future contributions into the plan’s designated qualified default investment alternative (QDIA) can fix these errors.
Vanguard researched the effect of reenrollment on a large DC plan in 2008 and found that reenrollment immediately improved the portfolio diversification in the plan. Immediately following the initial reenrollment effort, 92% of the participants maintained either a full (74%) or partial (18%) position in the age-based target-date fund. This result was particularly striking in that the communications program strongly encouraged participants to take proactive action on their own. One year later, 87% of participants still maintained either a partial or full position in the target-date approach. It was their sole investment (61%) or part of their portfolio (26%).
The day after reenrollment, the stable value exposure fell from 26% to 3% and the average company stock exposure fell from 20% to 2%. Reducing these exposures was one of the goals of the reenrollment. Assets in these options flowed (through the default target-date funds) to domestic equities, bonds and international equities.
Plan sponsors need to weigh a variety of issues before proceeding with a reenrollment strategy. They should consider the effect of reenrollment on diversification and return potential, and also on risk levels. For some participants, improving portfolio diversification can mean improving long-term expected returns and increasing risk levels; for others, it can mean a reduction in both.
A plan sponsor’s decision to reenroll participants into the QDIA may relate to a specific investment option, a subgroup of participants, or the entire plan. In these instances, the sponsor implements such a change to enhance participant portfolio diversification and improve expected long-term retirement outcomes for participants.
A sponsor changing service providers may also make substantial changes in its investment menu. In lieu of attempting to map participant holdings from one set of investment options to another reasonably similar set of options, the sponsor can choose to default participants into the QDIA during the conversion process. Under certain circumstances, a sponsor may decide to make substantial changes to the plan’s investment lineup or eliminate a number of options. Rather than attempting to map those participants in the options being eliminated to similar new options, the sponsor may instead default the participants into a QDIA.
Under reenrollment, as long as participants are given proper advance notice and are provided an opportunity to make an alternative election, sponsors enjoy fiduciary protection in connection with participant investments—either because participants are transferred into the QDIA, or because they exercise control by opting out of the reenrollment. In addition to this fiduciary protection, the plan sponsor has taken affirmative steps to ensure proper diversification of participant accounts.
The research paper is available here.
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