Target Date Fund (TDF) options are plentiful and have become one of the most popular investment alternatives in qualified retirement plans. In fact, defined contribution retirement plans hold 67% of the over $1 trillion of TDF mutual fund assets.1
TDFs are popular with plan sponsors. Why? TDFs make investment decisions easy for plan participants who are not comfortable managing their investments. Plan sponsors also select TDFs as the plan’s default investment. TDFs are one of the options that provide certain fiduciary protections under the Department of Labor’s Qualified Default Investment Alternative (QDIA) rules. But with so many TDF options available, how does a plan sponsor make sure they’ve got the right fit?
ARE All Target Date Funds (TDFs) the Same?
What is a TDF? A TDF is a mutual fund or collective investment trust (CIT) that offers a long-term investment strategy appropriate for individuals of a certain age or intending to retire near a certain date. TDFs are typically named for the retirement date that is driving the fund’s investment strategy (e.g., “Retirement Fund 2030” or “Target Date 2030”). A TDF’s investment strategy is typically based on maintaining a higher allocation of stocks or equity in the TDF’s underlying funds when the target retirement date is still far away.
As the retirement date approaches, the TDF will rebalance to a higher proportion of bonds and cash instruments, which typically carry less investment risk. This automatic rebalancing feature makes TDFs appealing to plan participants who feel they lack the expertise to manage their retirement investments. The TDF does it for them, using an asset allocation strategy that is appropriate for someone of their same age.
Yet, not all TDFs are built the same. Even TDFs with the same target retirement date can differ as to the level of equity risk held in the TDF at any point throughout the life of the fund. For example, a 2035 TDF from one provider may currently hold 60% in equity funds, while another provider’s 2035 TDF is more conservative with a 40% equity allocation. The TDF’s glide path, the rate of change in the level of equities to more conservative investments, can vary significantly among TDFs, based in part on whether the fund manager has adopted a “to retirement” or “through retirement” philosophy.
To vs. Through TDFs
TDFs automatically rebalance to become more conservative as the target date approaches. But TDFs vary as to when they reach their most conservative point. A TDF designed to hit its most conservative point on the target retirement date is a “to retirement” investment. A TDF designed to hit the most conservative point some years after the target date is a “through retirement” investment. These are important distinctions depending on when a participant intends to distribute their assets from the retirement plan. Whether that’s immediately upon reaching retirement or at some point in the future. Whether a “to” vs. a “through” TDF is appropriate for an individual also depends on their age, risk tolerance, and availability of other retirement assets.
When selecting TDFs for a plan investment line-up, plan sponsors should consider which glide path is best for their employees. For example, if a plan sponsor also offers a defined benefit plan, the 401(k) plan may be viewed as a supplemental retirement benefit that could be exposed to more investment risk. In this case, a “through retirement” TDF may be appropriate because it will retain a larger equity allocation for a longer period. If the 401(k) is the sole retirement savings option offered by the employer, a “to retirement” TDF may better protect the principal from risk of large investment losses once participants reach their target retirement date.
In addition to comparing “to” vs. “through” glide paths, plan sponsors must also compare fund performance and expenses when selecting TDFs for their plan.
Plan Sponsor Responsibilities
Plan sponsors have the same fiduciary responsibilities when selecting and monitoring TDFs as they do for other plan investments. Sponsors should prudently evaluate options, benchmark the performance and fees, and provide participant education.
The Department of Labor provides a helpful tip sheet. This sheet helps plan sponsors understand the key items they should consider when establishing a process for selecting TDFs:
- Understand the fund’s underlying investments and glide path
- Review the fund’s fees and investment expenses
- Determine whether a custom or non-proprietary TDF fits your plan
- Develop effective employee communications
- Take advantage of available sources of information to evaluate TDFs
- Document your TDF selection and review process
Once they select a TDF series, plan sponsors have a fiduciary responsibility to monitor the TDFs on an on-going basis. In addition to monitoring fund performance and fees, plan sponsors will want to assess whether the chosen “to” vs. “through” philosophy is still appropriate for the plan and its participants.
Plan sponsors can seek the assistance of a retirement plan advisor to understand and compare their TDF options.
- Learn about the differences in “to” vs “through” TDFs.
- Benchmark and compare TDF options (such as proprietary TDFs vs. custom TDFs and CITs) to determine the best fit for the plan.
- Maintain records of the due diligence process followed in selecting and monitoring TDFs for the plan.
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1 Investment Company Institute (ICI), The US Retirement Market, Third Quarter 2017, December 2017
2 Department of Labor, Target Date Retirement Funds – Tips for ERISA Plan Fiduciaries, February 2013