WASHINGTON BUREAU — Target date fund (TDF) providers should make sure 401(k) plan sponsors and participants understand the risks involved with using the funds as default investment options, according to officials at the U.S. Government Accountability Office (GAO).
The U.S. Department of Labor also should take additional steps to ensure that individuals using target date funds to save for retirement understand the advantages and disadvantages of taking that approach, GAO officials say in a report on target date fund disclosures.
STABILITY: NOT A DEFAULT OPTION
Target date funds are investment funds that are supposed to be invested in such a way that asset allocations shift more toward fixed-rate investments as the targeted participants approach their anticipated retirement age.
The Labor Department has been looking at target date funds in connection with efforts to update guidelines on how 401(k) plan sponsors should handle plan participants who fail to say how they want their plan assets allocated.
In the past, many employers used savings accounts, money market funds or stable value funds backed by insurers as the default investment. Critics of that approach argued that the fixed-return investments had a low potential rate of return and failed to suit the needs of long-term retirement savers.
When Congress drafted the Pension Protection Act of 2006, it included a provision asking the Labor Department to create a list “qualified default investment alternatives” (QDIAs) that would make suitable default investment options.
Regulators included target-date funds on the list, but, just as stock prices were about to plummet, they left out stable value funds and other fixed-rate products sold by insurers.
Since the QDIA guidance was issued, target date funds have become “by far” the most popular QDIA, GAO officials say.
Many retirement plan participants were surprised to learn that target date funds aimed at older participants were as volatile as they proved to be, and some participants were surprised to find that target date funds could lose money.
In November 2010, the Labor Department proposed a QDIA regulation update that
calls for retirement plan participants to get more information about the target-date funds offered on plan investment menus.
In addition to updating the QDIA regulation, the proposal would update participant-level disclosure rules.
THE GAO CRITIQUE
Retirement plan sponsors and participants need more information about variations in TDF asset allocations and other TDF characteristics, GAO officials say.
The differences are largely the result of differences in objectives and fund manager investment philosophies, officials say.
“In the years approaching the retirement date, for example, some TDFs have a relatively low equity allocation – 35% or less — so that plan participants will be insulated from excessive losses near retirement,” GAO officials say.
Other target date funds aimed at participants nearing retirement keep 60% or more of assets in stocks, in an effort to generate higher returns and help retirees avoid depleting savings in old age, officials say.
The fund managers also differ in other ways, such as their inclination to use alternative assets and their assumptions about how plan participants will manage assets upon retirement, officials say.
“These investment differences and differences between assumed and actual participant behavior may have significant implications for the retirement security of plan participants invested in TDFs,” the GAP report said.
THE GAO RECOMMENDATIONS
GAO officials say the Labor Department should change QDIA disclosure documents to require plan fiduciaries to show that they have considered, to the extent possible, whether characteristics of plan participants other than age or target retirement date have been relevant factors in choosing a QDIA.
The Labor Department could also help plan sponsors be more thorough when selecting target date funds to be used as QDIAs, by, for example, giving sponsors information about the weaknesses of existing TDF benchmarks, officials say.
In the final TDF disclosure regulation, officials say, the Labor Department should expand the rules that require plan sponsors to give participants information about contribution and withdrawal rate assumptions. Sponsors also should make sure participants get information about the potential consequences of saving, withdrawing, or otherwise managing TDF assets in a way that differs from the TDF manager’s assumptions, officials say.
The Labor Department “raised a number of issues with our recommendations, and we amended one of them in response to their comments,” GAO officials say.