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TDF 2.0 Is Here. Who’s Ready?

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What You Need to Know

  • 5ForLife was just introduced by American Century, Lincoln Financial, Nationwide, Prime Capital, SS&C, Wilmington Trust and Wilshire.
  • The guaranteed income products increasingly being offered in the defined contribution space aren’t the same as those you may have seen in the retail space.
  • TDF 2.0 does present some interesting challenges for plan sponsors around issues like product selection and benchmarking.

Things are starting to get interesting in the target date fund space.

Traditional target date strategies (1.0) were largely about getting participants to retirement with glide paths and fancy asset allocations. The latest approaches (2.0) are focused on getting participants through retirement by embedding some type of guaranteed income product in the later vintages of the target-date fund strategy.

To be clear, TDF 2.0 isn’t exactly new. Raytheon Company was one of the first companies to introduce a default investment that had an allocation to a guaranteed income product (technically a Guaranteed Lifetime Withdrawal Benefit approach) roughly a decade ago, but uptake and product development in the space has been relatively slow  until recently.

It seems the passage of the Setting Every Community Up for Retirement Enhancement, or SECURE Act, and other factors have ramped up innovation in the target-date fund space. For example, last month Nationwide and Annexus Retirement Solutions announced their “Lifetime Income Builder.

And now we’ve got a new strategy that came out Wednesday called “Income America 5ForLife” through a consortium of (in alphabetical order) American Century Investments, Lincoln Financial Group, Nationwide, Prime Capital Investment Advisors, SS&C Technologies, Wilmington Trust, and Wilshire.  Exciting stuff!

I know what you’re thinking, is it really a good thing for participants to get an allocation to additional guaranteed income and does it really take seven companies to pull this off? 

Note, I’m trying to avoid the word “annuity” because it’s ambiguous from a strategy perspective (most annuities today aren’t used to generate guaranteed lifetime income), and let’s be honest, there’s some serious baggage with the term.

Does the New Approach Make Sense?

Let’s start with the first question, around whether including guaranteed income in a target date fund is a good thing for participants. I’m not going to get too deep in the weds here but generating retirement income from a portfolio is pretty complicated and guaranteed income can simplify things.

I get that people aren’t necessarily clamoring for guaranteed income (especially “annuities”… gasp!). But participants weren’t exactly psyched about target-date funds a decade ago, and now it’s a $2 trillion-plus (and growing) category.

Most surveys find people like the idea of insuring their nest eggs, and that’s what guaranteed income does. The guaranteed income allocation is usually only a part of the overall portfolio, and the buy-in typically starts 15 years-ish from retirement; although it’s going to vary significantly by product. 

Also, since it’s a default investment, participants can obviously opt-out if they don’t want it.

The guaranteed income products increasingly being offered in the defined contribution space aren’t the same products you might have bumped into the retail space either. These institutionally priced products typically have low fees, no surrender penalties, attractive payout rates, etc.  

TDF 2.0′s Complexity

One issue with including guaranteed income as part of a target fund is complexity, which gets to the second question: what’s the deal with the seven companies in this new product? 

Well, there’s lots of potential approaches to include guaranteed income (e.g., a Guaranteed Lifetime Withdrawal Benefit, a deferred annuity, etc.), and to be clear I don’t necessarily have a favorite, but whichever path you go down there’s going to be more moving parts than your 1.0 TDF strategies.

While you don’t necessarily need seven providers to pull of TDF 2.0, having more folks involved can actually be a good thing (more is more!). 

With respect to Income America 5ForLife, which for the record I have absolutely nothing to do with, you have a host of companies playing a variety roles, some fiduciaries, some not, but lots of folks making the complex (including guaranteed income in a target date fund) seem easy.  

As an aside, I do like the name “5ForLife,” since it seems relatively accessible to participants (you get 5% income for life) unlike the fancy terms us industry folks like to use to make us feel smart.

I’m not expecting TDF 2.0 to replace TDF 1.0, nor should it. There are lots of define contribution plans that don’t want (or need) a target date fund with guaranteed income, for a variety of reasons, but at the same time there are definitely some that do.

TDF 2.0 represents an expanding opportunity set for plan sponsors who want to help participants get through retirement. There’s a lot more potential flavors with TDF 2.0 around generating the income, glidepaths, etc., though, so I think there’s lots of potential room in the space from a product development perspective.  

Other Hurdles

TDF 2.0 does present some interesting challenges for plan sponsors, around issues like selection (which product type is right for a given plan?) and benchmarking (what should the peer group be and what metrics do you use to evaluate performance across vintages?).

These questions, and others, are obviously potential roadblocks to implementation. Here’s the thing, though, there’s already a number of consultants who can provide guidance, and I’m sure more will join the party shortly.

To be clear, I don’t really think that target date funds are the optimal “end game” when it comes to default investments given their lack of personalization. However, target date funds have clearly emerged as the preferred default investment of plan sponsors today. 

Therefore, new products that provide more explicit approaches to fund retirement spending (TDF 2.0!) represent a notable development in our industry, and I’m excited to see where this goes!

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David Blanchett is head of retirement research for Morningstar Investment Management LLC. Views expressed are his own and do not necessarily reflect the views of Morningstar Investment Management LLC. This blog is provided for informational purposes only and should not be construed by any person as a solicitation to effect, or attempt to effect transactions in securities or the rendering of investment advice.