Over the past several years, employers have been enhancing their retirement plans and increasing access to various types of professional investment guidance in an attempt to bolster employees' retirement readiness.1 One change has been the introduction of target-date funds (TDFs).
Target-Date Funds Defined
Target-date funds are investment vehicles that automatically reset their asset allocations over time to maintain a risk profile that is appropriate for a particular investor's "target date" for retirement. Generally, the name of each TDF in a series includes a specific year, such as "2020" or "2030." Plan participants choose a fund named for the year closest to their desired retirement year. From that point on, professional money managers handle the investment decisions, such as selecting individual securities for the portfolios and rebalancing the fund's asset allocations so that they become increasingly conservative the closer a participant gets to retirement.
Rapid Adoption Rates
Over the past several years, target-date funds have enjoyed a rapid ascent in the defined contribution plan space, surging from less than $100 million in total assets in 2005, to more than $500 million in 2013.1 It is estimated that by 2018, TDFs will garner more than 63% of total defined contribution plan participant contributions and account for 35% of total 401(k) plan assets.2, 3
Simplicity for Participants, Heightened Oversight for Sponsors
Plan participants gravitate to target-date funds for their simplicity. For instance, 84% of participants surveyed recently cited the risk management and asset allocation features of the funds as being "very important," while 42% were attracted to TDFs' built-in, "set-it-and-forget-it" diversification qualities.2
Yet for plan sponsors, the introduction of target-date funds meant heightened responsibility for appropriately seeking their intended goal of enhancing employees' retirement readiness. This responsibility takes on even greater significance when TDFs are used by plan sponsors as Qualified Default Investment Alternatives (QDIAs) -- an ERISA designation established in 2007 that states participants' plan contributions will automatically be "defaulted" into an appropriate investment option unless they actively decide to direct their investment dollars to other options offered by a plan.4
Key Selection Considerations
When evaluating the best target-date fund series to use as the default investment option for their retirement plan, sponsors may consider a number of factors, such as:
Participant demographics. Understanding the makeup of your participant population is the first step in selecting a TDF family. What is the average age of the participant population? Does it skew toward younger or older workers? What is the average deferral rate and account balance? What is the average compensation level? These and other variables may influence your selection decision.
Glide Paths. The term "Glide Path" refers to the formula that dictates the asset allocation mix of a target date fund. Each family of TDFs has a unique Glide Path structure that determines its potential risk/return profile. As a general rule, when assessing the Glide Paths of various TDF families, spend some time assessing the specifics of their asset allocations. Determine what the minimum and maximum equity and fixed income allocations of the funds are, and how they shift over time. Further, some Glide Paths freeze asset allocations at fixed percentages once the target date is reached, while others remain active, continuing to adjust allocations well into the retirement years -- long past their target date.
Custom or off-the-shelf TDFs. Some plan sponsors are now asking whether they should opt for a customized series of TDFs, which are designed to meet the specific needs of the company's plan participant population, or settle on an off-the-shelf TDF geared more for the general population. For most companies, however, the decision comes down plan size and cost. Custom TDFs are, by definition, more complex to administer, and require expertise that small to mid-size plans likely would not have the resources to support.
1Deloitte, Target Date Funds and Retirement Savings; March 2010 - https://www.dol.gov/sites/default/files/ebsa/researchers/analysis/retirement/deloitte2009-4.pdf
2Investment News, “Target date funds to capture 63% of 401(k) contributions by 2018,” March 26, 2014.
3Aon Hewitt news release, “Aon Hewitt Survey Finds Employers Boosting Efforts to Help Workers Save for Retirement,” October 30, 2013.
4PlanPILOT, LLC, “Target-Date Funds: It’s Time to Take a Closer Look.”; June 2013
* Target-date funds typically invest in other investments and are designed for investors who are planning to retire during the target date year. The fund's target date is the approximate date of when investors expect to begin withdrawing their money. A Target date fund's investment objective/strategy typically becomes more conservative over time primarily by reducing its allocation to equity investments and increasing its allocations in fixed-income investments. An investor's principal value in a target-date fund is not guaranteed at any time, including at the fund's target date.
Investing is subject to market risks including loss of principal.
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GE 126453 (06/2017)