In 1993, Barclay’s Global Investors released the first TDF. While there have been some dabbling in risk-based funds, this was the initial plunge into developing a fund targeted at an individual’s designed retirement time. The impetus was a provision in PPA building the skilled default investment choice (QDIA), the investment a plan sponsor uses as a default for moneys in participants’ accounts not normally specified for investment. According to the 2012 Janus/Plan Sponsor survey, approximately 75% of all defined-contribution plans have chosen target date money as their QDIAs.
Today, there exist an abundance of TDFs of many shapes and sizes. Virtually all of them have in their name a year (multiple of five) that is supposed to represent a participant’s expected retirement. Often, that is where the similarities end. The DOL paper suggests factors that a plan sponsor should think about in its fiduciary decision to choose a family group of target-date funds, as the QDIA often. Specifically, the paper points out investment strategies, glide paths (this is the move from a far more aggressive equity-heavy strategy definately not retirement to a more conservative strategy nearer to retirement), and investment-related fees. Plan sponsors should carefully think about this DOL assistance.
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While there is certainly nothing at all in the paper that shows that a plan sponsor must follow the DOL’s recommended steps, you might certainly believe that plan sponsors that achieve this may relatively well shield themselves from costly loss in litigation. No strategy is foolproof, but easily were on a jury or if I were a judge, and I noticed that a plan sponsor did exactly what the Department of Labor recommended, such proof would compel me.
I will add two more items to this list. First, lots of defined contribution recordkeepers are affiliated with or owned by asset management companies. A few of them is only going to take on a fresh client if their own proprietary TDFs are used as the plan’s QDIA. It may be acceptable to begin by using these proprietary TDFs as the plan’s QDIA, but when you use recordkeepers of this sort, you’ll have a contract for services for several years certainly. The contract will give you financial disincentives to change TDFs to those provided by another vendor. It aligns well with the DOL’s advice to not take part in such a contract.
Second, the DOL’s last piece of advice (of the eight) is to document the process. Documentation of processes is an excellent idea. It’s especially a great idea if you follow your own processes. However, lots of companies (see for example, Tussey v ABB) have lost or settled litigation when they did not follow their own documented processes.
Not using a noted process is bad, but documenting what you ought to, and will be doing and then doing another thing is most likely much worse. Several points that the DOL makes are particularly noteworthy. Consider, for example, a proprietary category of TDFs composed of high-expense actively-managed proprietary funds. In this full case, the TDF is essentially double-charging the plan individuals.
Each of the fundamental funds has a substantial investment expenditure and, at the same time, the overall account possess an additional investment expense. 25,000 compounded at 7% per 12 months for 35 years will collect to approximately 40% more than the same account balance compounded for 35 years at 6% per calendar year.
Put into more practical conditions, for a more youthful employee, the 40% implicit cost of much higher investment fees may be insurmountable. Finally, the paper highlights the importance of defined advantage (DB) plans in selection of TDFs. While it holds true that far fewer employees are included in DB plans than were 25 years ago, a substantial quantity still are.