Plan sponsors need to rethink their target-date fund decisions

Far too many benefits plans are exposing their close-to-retirement members to risky investment strategies that could seriously compromise their retirement financial status.

Why and how? The why: the plan designers are on autopilot, not thinking about the characteristics of the group. The how: they are choosing inappropriate target-date funds (TDFs) for plan members.

This alarming pronouncement comes courtesy of research by two Morningstar retirement planning experts.

They began with the theoretical justification for different TDFs. “TDFs adjust investments based on a participant’s age or projected retirement date, usually shifting from more equities to more bonds as participants get closer to retirement. Off-the-shelf TDFs are not customized but are offered with the same glide path to multiple plans,” Morningstar says.

They then examined available 2019 plan information, studying whether plan members tended to withdraw most of their 401(k) dollars upon retirement, or generally let it sit in their account after retirement, drawing down conservatively, and whether TDFs appeared to reflect plan members’ actual choices about how to deploy their funds.

“Across all plans, we find that 58% of defined-contribution plan assets are invested in off-the-shelf TDFs. Off-the-shelf TDFs are not customized but are offered with the same glide path to multiple plans.”

In other words, the plan administrators made little or no effort to see whether plan members were withdrawing upon retirement or holding on to it after they retired. And that would be important information to have when determining the asset mix of a portfolio at retirement age.

In 2013, the U.S. Department of Labor (DOL) published guidance for plan fiduciaries regarding TDFs. It advised them to “determine whether the characteristics of TDFs align well with the plan participant population.” Such items as salary levels, turnover rates, likely retirement dates, and employee ages should be considered, the DOL says. Plan sponsors should determine whether a “to” or “through” glide path is suitable for an individual, DOL asserts, because “if the employees don’t understand the fund’s glide path assumptions when they invest, they may be surprised later if it turns out not to be a good fit for them.”

The Morningstar research found that far too many plans don’t take individual paths into account. They simply load an off-the-shelf TDF into the plan and send the plan members on their way. So, instead of doing the prudent thing – selecting TDFs for plan members that align with their goals – it’s one-size-fits-all TDFs.

“Plan sponsors overwhelmingly select ‘through’ glide paths, which account for 86% of TDF assets,” Morningstar reports. “This implies that plan sponsors anticipate that their participants will draw down using these strategies in retirement.”

Problem is, plenty of folks want to extract their dough when they quit working. And if the market tanks (as it did recently) right before you exit the company, your portfolio value tanks right at the wrong time.

Related: Redefining retirement to the tune of $1.8 million in savings

Morningstar’s research is comprehensive and detailed, looking at trends by sector, by plan size, by take-or-wait decisions by members, and more. But the bottom line is clear: Plan sponsors have a responsibility to do better by their members. They need to help them enter retirement in the way that they have chosen, and portfolios need to be managed accordingly. Off-the-shelf is not appropriate given the significance of the situation.

“In general, the evidence suggests that many plan sponsors are not making major adjustments” based on plan member actions and objectives. The researchers offer three recommendations:

• Plan sponsors and advisors should regularly consider the key assumptions in their glide paths and their actual experience with participant behavior as the Department of Labor suggested in its guidance in 2013.
• The Department of Labor should consider if more guidance could help clarify the role that sponsors need to play, particularly in their review of and evaluation of glide paths, given the differences we see across sectors. The department could also recommend that plan sponsors consider TDFs alongside other QDIA options.
• The Department of Labor should consider promulgating additional guidance or even amending the safe harbor on the use of customized glide paths.