Most 401(k) plans that have qualified default investment funds
(QDIA's) have chosen target date funds as their default
investments. Target date funds change their mix of investments to
become more conservative over time in relation to a projected
Despite their popularity, target date funds are not well
understood by either the fiduciaries who select them or the
participants whose accounts are invested in them by default or by
choice. For example, two funds that are designed for participants
retiring in 2020 may have different proportions of fixed income and
equity investments and different assumptions about when the
participant will actually begin receiving pension payments.
Both the U.S. Department of Labor (DOL) and the Securities and
Exchange Commission (SEC) are taking steps to improve the
retirement community's understanding of target date funds. The
DOL has issued
proposed regulations and the SEC has proposed rules
requiring greater disclosure about target date funds. The DOL
also recently issued recommendations for plan fiduciaries to assist
them in fulfilling their fiduciary responsibilities when selecting
and monitoring these funds.
The DOL suggests that responsible fiduciaries review the
investment return information;
investment expenses, which may vary significantly;
principal strategies and risks; and
asset allocation, and how that will change over time, called the
The DOL also suggests reviewing how the fund's
characteristics align with employee ages and likely retirement
dates, and possibly discussing individual information such as
salary levels and turnover rates with prospective target date fund
A further recommendation that surprised many of us was that
fiduciaries should inquire whether a custom or non-proprietary
target date fund, which did not use only the vendor's
proprietary funds, would be a more appropriate investment. In our
experience, vendors recommend or insist upon using their
proprietary target date funds as part of popular pre-approved plan
packages, so this may not be a very practical suggestion. Any
custom product would also be more expensive, raising questions of
whether any additional benefits would outweigh the extra costs.
In addition to having an objective documented process for
selecting target date funds, the DOL suggests a documented process
for periodic review to see whether the funds should be continued or
replaced and effectively communicating information about the funds
to employees. We would add that fiduciaries also need to document
the reasons for their decisions at the time they are made to give
themselves maximum protection.
Last week, the SEC's Investor Advisory Committee urged the
SEC to expand its own target date fund disclosure requirements
to include the policies and assumptions used to manage risk over
the life of the fund and specific disclosure of glide paths.
Both the DOL and the SEC seem to be working towards facilitating
a better understanding of how target date funds work. There is
nothing to prevent fiduciaries from following their proposals and
recommendations before final guidance is issued. We think a prudent
fiduciary will do so, and will also be on the alert for new
guidance in this area.
The content of this article is intended to provide a general
guide to the subject matter. Specialist advice should be sought
about your specific circumstances.
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