However, there are plenty of 401(k) alchemists who try to fuse together the perfect asset mix in hopes of conjuring retirement security gold. Historically, the average annual return of the S&P 500 is approximately 10%. That’s since its inception in 1928 through the end of the 2017 calendar year. Not bad. Of course, that doesn’t guarantee the same performance for the set number of years I choose to invest from now until my impending retirement date. But still, not bad. As an investor in an employer-sponsored qualified retirement plan, do I really think I can do much better than that? Perhaps, but does that mean my employer is supplying me with the right investment choices and asset allocation combinations to ensure success? More importantly, for purposes of this post: what’s the plan fiduciary’s obligation to provide meaningful investment choices?
Obviously, 401(k) or 403(b) plan sponsors cannot guarantee retirement security or successful investment performance. Yet, as we’ve discussed before, plan fiduciaries have an obligation to select and regularly monitor the performance and cost of the investment choices the plan provides to its participant investors. A popular option is a target date fund (TDF), which provides an easy way for an employee to plan for retirement around a particular date. TDFs pursue a long-term investment strategy utilizing an asset allocation that the investment provider adjusts to grow more conservative over time. The idea is that as an investor approaches her retirement date, the mix of asset classes is adjusted to appreciate more slowly and more conservatively — shifting the strategy of aggressive growth to one focusing on slower development and maintenance. This trajectory is known as the fund’s “glide path.” TDFs are also designed to help investors avoid some common investment mistakes by diversifying across a mix of asset classes including stocks, bonds and cash.
Target date funds are generally made up of a diverse class of assets. They are designed to be a relatively safe and steady growth investment (to the extent that any investment based on market performance might be considered “safe” and “steady”) because the TDF provider will typically rebalance and adjust the fund to offset market oscillations. Since it assumes the investors' risk tolerance will grow more conservative as they age, the TDF will evolve with the investors as they close in on retirement. Thus, the biggest advantage of utilizing a TDF is that many investors find security in a complex choice being laid out for them in such a simplistic and seemingly effective fashion.
If you’re into foreshadowing, you might have sensed a “too good to be true” vibe from that last sentence. Because of its one-size-fits-all nature, it’s impossible for a TDF to factor in the individual risk tolerance of a particular investor. Also, the TDF’s glide path cannot take into account other sources of income, assets or debts to which the investor is subject over the course of her career. Another problem with TDFs is their proprietary nature. Often, investment providers look solely to their own fund families for the underlying investments in a target date fund. Because of this, it is possible that underperforming funds are built into the mix to increase profitability. From a fiduciary perspective, it’s not obvious for a plan sponsor to determine that the funds making up the TDF are “best-in-class” because of this baked-in arrangement.
The Department of Labor recognizes this conundrum for plan fiduciaries and has developed tips for choosing and monitoring target date funds. Like the selection of any plan investment choices, fiduciaries should first establish a process for comparing and selecting TDFs. This will include analyzing past performance, fees and how often the make-up of the TDF changes. A similar process for the ongoing review of TDFs should be developed as well. The DOL cautions that frequent turnover or a major overhaul in a TDF’s fund management could signal a reason to scrutinize the TDF and entertain a change.
The most difficult part of monitoring a TDF’s viability is to understand the allocation and success of different asset classes, as well as the individual investments making up each class. This is where the help of a trusted advisor comes into play. ERISA never requires plan fiduciaries to be experts in the stock market. However, the expectation to monitor investment choices within a qualified retirement plan (and make changes when necessary) is at the crux of what it means to uphold fiduciary obligations. Selecting competent and successful investment advisor partners will go a long way to ensuring those duties are fulfilled.
Figuring out what to save for retirement is a very difficult problem for every working American. TDF offerings can make it easier for some employees and it’s ultimately up to them to determine whether or not that strategy works. Most important for the plan’s fiduciaries is to make sure they are putting their participant investors in the best position to succeed in reaching their retirement goals by doing their due diligence and fulfilling their fiduciary obligations by properly selecting and monitoring TDFs, as they do with all of the plan’s funds.
For more information about TDFs and other retirement planning issues, please contact us.
Bret works with HR professionals to ensure they have a clear understanding of the rules governing all aspects of human resources. He works with employers to maintain compliance of health and wellness benefit packages under state and federal guidelines, including taxation and healthcare reform.
Bret works with HR professionals to ensure they have a clear understanding of the rules governing all aspects of human resources. He works with employers to maintain compliance of health and wellness benefit packages under state and federal guidelines, including rules of taxation and healthcare reform. Bret holds a bachelor of science in economics from the University of Kentucky and a law degree from the University of Pittsburgh, School of Law.
In our 2015 MarketPulse trend study, we introduce our first annual WellnessPulse benchmarking study, in which we survey our clients about their wellness programs and share key results. We also cover trends in executive compensation and benefits, health plan design, healthcare reform, social engineering and cyber risks, workers' compensation, and retirement benefits.
Download the PDF: MarketPulse 2015
Retirement planning is very different from planning for other benefits because the end goal is many years – even decades – away. It’s impossible to develop a foolproof plan that will guide a 25 year-old to her retirement 40 years later. But the practice of planning, the financial education obtained and the savings habits created along the journey can steer employees closer to reaching their retirement goals.
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