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 retirement age.

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 following:

  • prospectuses and investment return information;
  • fees and investment expenses, which may vary significantly;
  • the fund’s principal strategies and risks; and
  • the fund’s asset allocation, and how that will change over time, called the “glide path”.

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 providers.

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.