The Employee Benefits Security Administration (the "EBSA") has provided, on its website, tips for plan fiduciaries for investing in target date retirement funds ("TDFs"). The tips are intended to assist plan fiduciaries in complying with ERISA when selecting and monitoring TDFs and other investment options in 401(k) and similar participant-directed individual account plans. The tips are summarized as follows:
Target Date Fund Basics. TDFs may be attractive investment options for employees who do not want to actively manage their retirement savings. TDFs
automatically rebalance to become more conservative as an employee gets closer to retirement. The "target date" refers to a target retirement date, and often is part of the name of the fund.
Investment Strategy For TDFs. TDFs offer a long-term investment strategy based on holding a mix of stocks, bonds and other investments (this mix is called an asset allocation) that automatically changes over time as the participant ages. A TDF's
initial asset allocation, when the target date is a number of years away, usually consists mostly of stocks or equity investments, which often have greater potential for higher returns but also can be more volatile and carry greater investment risk. As the target retirement date approaches (and often continuing after the target date), the fund's asset allocation shifts to include a higher proportion of more conservative investments, like bonds and cash instruments, which generally are less volatile and carry less investment risk than stocks.
The Glide Path. The shift in the asset allocation over time is called the TDF's "glide path." It is important to know whether a target date fund's glide path uses a "to retirement" or a "through retirement" approach. A "to" approach reduces the TDF's equity exposure over time to its most conservative point at the target date. A "through" approach reduces equity exposure through the target date so it does not reach its most conservative point until years later. Within this general framework, however, there are considerable differences among TDFs offered by different providers, even among TDFs with the same target date. For example, TDFs may have different investment strategies, glide paths, and investment-related fees. Because these differences can significantly affect the way a TDF performs, it is important that fiduciaries understand these differences when selecting a TDF as an
investment option for their plan.
What to Remember When Choosing Target Date Funds.
• Establish a process for comparing and selecting TDFs. In general, plan fiduciaries should engage in an objective process to obtain information that will enable them to evaluate the prudence of any investment option made available under the plan. For example, in selecting a TDF you should consider prospectus information, such as information about performance (investment returns) and investment fees and expenses.
• Establish a process for the periodic review of selected TDFs. Plan fiduciaries are required to periodically review the plan's investment options to ensure that they should continue to be offered. At a minimum, the review process should include examining whether there have been any significant changes in the information fiduciaries considered when the option was selected or last reviewed. Similarly, if your plan's objectives in offering a TDF change, you should consider replacing the fund.
• Understand the fund's investments - the allocation in different asset classes (stocks, bonds, cash), individual investments, and how these will change over time. Have you looked at the fund's prospectus or offering materials? Do you understand the principal strategies and risks of the fund, or of any underlying asset classes or investments that may be held by the TDF? Make sure you understand the fund's glide path, including when the fund will reach its most conservative asset allocation and whether that will occur at or after the target date.
• Review the fund's fees and investment expenses. TDF costs can vary significantly, both in the amount and types of fees. Small differences in investment fees and costs can have a serious impact on reducing long term retirement savings.
• Inquire about whether a custom or non-proprietary target date fund would be a better fit for your plan. TDF vendors may offer a pre-packaged product which uses only the vendor's proprietary funds as the TDF component investments. Alternatively, a "custom" TDF may offer advantages to your plan participants by giving you the ability to incorporate the plan's existing core funds in the TDF, and by including component funds that are managed by fund managers other than the TDF provider itself, thus diversifying participants' exposure to one investment
• Develop effective employee communications. Have you planned for the employees to receive appropriate information about TDFs in general, as a retirement investment option, and about individual TDFs available in the plan? Disclosures required by law also must be considered. The Department of Labor published a final rule that, starting for most plans in August 2012, requires that
participants in 401(k)-type individual account retirement plans receive greater information about the fees and expenses associated with their plans, including specific fee and expense information about TDFs and other investment options available under their plans.
• Take advantage of available sources of information to evaluate the TDF and recommendations you received regarding the TDF selection. While TDFs are relatively new investment options, there are an increasing number of commercially available sources for information and services to assist plan fiduciaries in their
decision-making and review process.
• Document the process. Plan fiduciaries should document the selection and review process, including how they reached decisions about individual investment options.