By Cyril Tuohy
With target date funds being the overwhelming favorite among the qualified default investment alternatives offered by employer-sponsored retirement plans, the question for fiduciaries and plan advisors is what to look for in such funds.
Target date funds (TDFs) are more appropriate for plan sponsors with greater age dispersion among their employees. This is a group in which 401(k) assets represent the largest share of retirement savings and where employee turnover is lower, according to the published perspectives of three experts in investments and employee benefits. In contrast, a single balanced fund, lifestyle or target risk fund is better suited to an employer with less age dispersion, where significant retirement assets lie outside the qualified default investment alternatives (QDIA) plan and where employee turnover is higher.
That analysis is contained in a white paper titled “The QDIA Decision: Does Your Strategy Align with Plan Goals and Demographics?” The report was published by Jeffrey S. Coons, president and co-director of research at the asset management firm Manning & Napier in Fairport, N.Y., in collaboration with C. Frederick Reish and Bruce L. Ashton, partners at Philadelphia-based Drinker Biddle & Reath’s Employee Benefits & Executive Compensation Practice Group.
Fiduciaries, the paper notes, “are not required to be ‘right.’ They are required to gather and properly assess information to make an informed decision.”
Since the passage of the Pension Protection Act of 2006, TDFs have experienced rapid growth as a QDIA for millions of employees.
TDFs were the QDIA selection for 73.3 percent of plans surveyed by the Plan Sponsor Council of America in 2012. They were followed by balanced funds (10.6 percent), lifestyle funds (9.2 percent), professionally managed accounts (4.6 percent), stable value funds (1.7 percent) and money market funds (0.3 percent).
Designed for employees who have neither the patience nor the desire to spend much time thinking about how to allocate retirement assets, TDFs are the investment industry’s equivalent of the military’s “fire and forget” weapon.
All TDF investors have to do is to pick the fund with a matching retirement date and forget about the investment for the next 30, 20 or 10 years, or however long the employee plans to remain at work.
Rebalancing algorithms gradually move assets into safer, less volatile holdings the closer the employee approaches retirement.
But what might look easy for an employee or plan participant in terms of retirement plan selection is often a delicate balancing act for advisors paid to select TDFs from the growing number of options that plan sponsors offer, Shawn Sanderson, a senior investment consultant at Manning & Napier, told InsuranceNewsNet.
“Asset managers are coming in and offering more options with regard to TDFs and the advisor needs to decide what TDF families a plan sponsor might want to use,” Sanderson said.
The advisor’s role, he said, is “more important than ever” as asset managers and mutual funds offer more TDF options to plan sponsors and their fiduciaries.
Other variables that advisors need to consider before selecting a TDF are the planned retirement ages of employees, employee turnover, expected employee and employer contributions, employee behavior at retirement, and expected withdrawal levels, according to the Manning & Napier white paper.
TDF investors, along with everyone else, saw their holdings drop during the financial crisis. Yet workers who invested in a 2010 TDF, thinking such a fund was appropriate for retirement in 2010 after 30 years of service, were in for a shock as their holdings evaporated.
What to disclose in TDF plan documents with regard to asset allocation, how assets change over time and assumptions about withdrawal intentions following the retirement date has been under discussion at the U.S. Department of Labor (DOL) for the last four years.
Earlier this year, the DOL sought a new round of comments on how best to illustrate the retirement “glide path” of TDFs.
Regulators want plan participants to be more informed about maximum exposure to losses within a TDF so that investors aren’t led to believe this class of funds will automatically secure enough for retirement the year the employee retires.
But the investment management industry is pushing back, arguing that plan sponsors and fiduciaries are best served when plan participants are aware of the tradeoffs between investing too cautiously and not having enough in retirement, according to the Manning & Napier white paper.
Coons, in written testimony to the DOL, said that if plans emphasize the risk of capital losses and portfolio volatility “without corresponding information on potential returns,” plan participants could be influenced to invest too conservatively. The result could be an “incomplete risk-reward perspective.”
Cyril Tuohy is a writer based in Pennsylvania. He has covered the financial services industry for more than 15 years. Cyril may be reached at [email protected].
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