Target Date Funds Under Scrutiny
The investment losses of target date funds in 2008 has drawn
the attention of both the politicians and the regulators. They
are particularly concerned about the losses incurred by
participants who are close to retirement age, for example, those
who are investing in the 2010 fund.
The average losses for 2010 funds in 2008 was approximately
25%, while the 2010 fund of one mutual fund company lost over
40%. Those are staggering losses for participants who were told,
in effect, that they were appropriately invested based on their
age. The Senate's Special Committee on Aging has recently held
hearings on target date funds, the reasons or the losses, the
descriptions and communications of the purpose and structure of
the funds, and other issues. In June, the Department of Labor
and the Securities and Exchange Commission held joint hearings
on similar issues.
What is the likely outcome?
While it appears that target date funds will continue to
enjoy the status of a qualified default investment alternative (QDIA)
and, as a practical matter, will continue to be structured in
much the same way, there will be a much greater focus on those
funds, including:
- What does the year (for example, 2010) in the name of
the fund really mean?
- How does the manager of the target date fund make
decisions about the operation of the fund?
- What information should be communicated to plan
fiduciaries and participants about the character and risk of
their funds
- What does that mean for plan sponsors and the officers
who serve as fiduciaries?
- Target date funds are now subject to the same scrutiny
as other mutual funds. They must be prudently selected and
monitored and, if they are not satisfactory, they must be
removed and replaced.
- When engaging in that process, plan sponsors should
focus primarily on the funds for their older employees, such
as the 2010 fund, 2015 fund and 2020 fund. That is
because—surprisingly—the greatest differences in the design
of the funds are for older employees. And, in those later
years, when account balances are the highest, the funds can
produce the greatest gains or the greatest losses.
- Plan sponsors should ask their advisers and providers,
at the least, the following two questions:
- Are my target date fund aggressive or conservative
when compared to the universe of target date funds?
- Are my target date funds designed for the glide
path to end at retirement or does the glide path
continue for years beyond that?
Equipped with that information, plan sponsors need to
decide whether the design of the target date fund is
appropriate for their participants.
As the preceding statement suggests, plan sponsors
need to focus on the needs of their participants. For
example, a law firm might use aggressive target date
funds because, by and large, the employees of a law firm
have flexibility to retire earlier, or retire later,
depending on the investment performance and size of
their 401(k) accounts. However, an employer with a
workforce where the employees lack that kind of
flexibility (or where there may be large layoffs in a
recession) may decide that large investment losses pose
a greater threat to its employees than any benefit that
would be gained from large investment gains. In other
words, those plan sponsors might select a conservative
target date line-up.
This is just the beginning of this story. There is much
more to come, including reports from those hearings and the
possibility of additional regulation and disclosure.
Any U.S. federal income tax advice contained in
this communication (including any attachments) is neither
intended nor written to be used, and cannot be used, to
avoid penalties under the Internal Revenue Code or to
promote, market or recommend to anyone a transaction or
matter addressed herein.
© 2009 Reish &
Reicher, A Professional Corporation. All rights reserved.
The REPORT TO
PLAN SPONSORS is
published as a general informational source. Articles are
general in nature and are not intended to constitute legal
advice in any particular matter. Transmission of this report
does not create an attorney-client relationship. Reish &
Reicher does not warrant and is not responsible for errors
or omissions in the content of this report.
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