A target date fund (TDF) is arguably the most important investment on a retirement plan menu. It allows all investors regardless of their level of sophistication to have a diversified investment that’s appropriate for their age and career timeline. Furthermore, a TDF takes a complex investment challenge and presents it in a simple solution that plan participants seem to understand.
As a result, TDFs have become the dominant investment trend in 401(k) and other defined contribution plans. However, they may still be underutilized by participants. According to Sway Research and Callan, TDFs comprised only 30% of total 401(k) assets, as of the end of 2019.
401(k) target date assets and contributions, 2014-2024 ($ billions, 2019-2024 estimated)
TDFs became hugely popular following the passage of the Pension Protection Act of 2006 (PPA), which defined the safe harbor for a default option — qualified default investment alternatives (QDIA) — and included TDFs. This allowed plan sponsors to select a more appropriate default for their plan than the traditional low-risk solutions like money market and stable value funds. Currently, TDFs are offered in 80% of plans and TDF assets are estimated to reach nearly $3 trillion by 2024.
This presents an opportunity for financial professionals to help plan sponsors and their participants better understand and make use of TDFs. Many plan sponsors might not have a solid understanding of the valuable role they play in preparing their employees for retirement. You can start the conversation by discussing how TDFs can be beneficial to plan sponsors and their participants alike, especially when coupled with automatic enrollment and auto escalation.
Benefits for plan sponsors:
Benefits for participants:
Benefits for financial professionals and consultants:
Despite the rapid growth and availability of TDFs, not all participants have benefited. Many participants have been invested in TDFs as plan sponsors have automatically enrolled new hires — but employees who joined the plan before automatic enrollment was adopted may still be in the same options they chose when the enrolled, or even in a default option from before the PPA. To help this group, you can encourage plan sponsors to do an “investment re-enrollment,” asking all employees to confirm their investment selections by opting out of the process and then moving those that don’t into age-appropriate TDFs.
Re-enrolling participants into a TDF is a powerful tool that may level the playing field for all participants, although it can be poorly understood by some plan sponsors. You can help educate them by addressing some of their chief concerns and misperceptions:
While an investment re-enrollment is primarily beneficial for plan participants, there are compelling benefits for plan sponsors, consultants and advisors as well. An investment re-enrollment that places employees into an age-appropriate investment like a TDF can help boost plan sponsors’ confidence that all their participants are on the road to a better retirement outcome.
The evaluation process for TDFs is different than for core menu options. Here is a quick primer on the unique factors to consider when evaluating TDFs:
While the QDIA regulations created certain fiduciary protections for the use of TDFs, plan sponsors are still obligated to prudently select and monitor them. The diverse nature of TDFs makes them difficult to compare across different managers’ series, but there are tools that can help.
Financial professionals can evaluate funds with Target Date ProView. Reach out to your American Funds representative for assistance running these reports.
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