For business owners looking to build the ideal retirement plan for your employees, there can be a lot to consider. But when it comes to retirement plans and investment lineup development, one thing that should be a no-brainer is including a target date series.
Target date series offer perhaps the simplest, most straightforward way for your employees to choose their retirement account investments. That’s because your employees simply select a date (also called a vintage), within the series which lines up closest to the year they plan to retire. The fund automatically adjusts over time to maintain alignment with those investment goals. This is arguably the perfect option for those looking to “set it and forget it.” There’s no need to rebalance or select any underlying funds—the single target date fund provides that service. As time goes on, the plan automatically shifts the risk profile of the investments from aggressive to conservative as the target date approaches.
Remember, not all target date series are created equal. Given the same vintage, one fund manager may have a larger concentration in stocks, positioning it more aggressively when compared to another manager—meaning the choice of a target date series has additional risk factors to consider. Each manager's series has a unique formula to determine the right mix of stocks and bonds for each vintage. Also, the assumed retirement age can be different; it may be age 65, but more recently we’ve seen age 67.
When evaluating or implementing your plan’s target date series, an additional consideration is the election of a Qualified Default Investment Alternative (QDIA). Consider making your plan’s target date series the QDIA. This is the default investment that’s used when money is contributed to an employee's retirement account and the employee has not made an investment election. The money is automatically invested into the QDIA, and if the target date series is the QDIA, the money goes to the vintage, which lines up with the employee’s anticipated retirement date. The Department of Labor (DOL) opinion is that the target date series as the QDIA provides the opportunity for the best possible outcome for defaulted participants.
With that in mind, here are three things to think about when selecting a target date fund retirement plan:
1. Index vs. Active
While index funds offer a lower cost of ownership, the net return after fees is a better measurement when selecting a target date series for a retirement plan. This plan sponsor decision may be even more important for the target date series than the fund menu at large. This is where your Wealth Enhancement Group plan advisor can help. While the DOL does provide relief for plan sponsors when it comes to target date investment performance, that relief hinges on prudent process. Careful consideration of index versus active is prudent. In many cases, active managers outperform index managers, and the net performance after fees should be the measurement.
2. “To the Date” Strategy vs. “Through the Date” Strategy
The discussion of “to the date” and “through the date” is an important one when it comes to choosing a target date series. At the center of the discussion is the glide path or slope of the investment allocation. As participants age, the allocation changes to favor more bonds and reduce exposure to stocks.
With “to the date” funds, the allocation becomes static around the time that the participant reaches full retirement age (66 or 67). This is the point where equity exposure remains at its minimum for the remainder of the life of the fund.
With “through the date,” the minimum equity exposure occurs at the participant’s retirement age plus 10 or 15 years. The result is a higher equity allocation into retirement.
“To the date” funds tend to be more conservative (less market risk and more principal preservation) and put the onus on the plan participant to re-risk their portfolios going into retirement. “Through the date” funds tend to be more aggressive and can carry participants into retirement with more inflation protection (higher exposure to equities).
3. Single Manager vs. Multimanager Approach
The multimanager approach has a lot of merit when compared to the single manager approach. When constructing the plan’s investment menu, the approach should be to have the best in class when examining target date managers. Just like the core menu where a single fund family or manager may not be the best choice in every asset class, the same can be said for target date managers. The multimanager approach, while still in the minority among target date providers, is gaining traction. Customized solutions that create combined target date and risk strategies from the plan’s core menu are also on the rise.
In closing, when choosing a target date series, and especially where the choice will be the QDIA, the decision points summarized here should be considered carefully along with participant demographics. Remember, target date investors more often than not will set it and forget it, making this a 20-year or more investment for many plan investors. For more information on how to choose the right retirement plan for your company, reach out to one of the retirement plan consultants here at Wealth Enhancement Group.
This information was developed as a general guide to educate plan sponsors but is not intended as authoritative guidance or tax or legal advice. Each plan has unique requirements, and you should consult your attorney or tax advisor for guidance on your specific situation. In no way does advisor assure that, by using the information provided, plan sponsor will be in compliance with ERISA regulations.
An investment in a target date fund is not guaranteed at any time, including on or after the target date, the approximate date when an investor in the fund would retire and leave the workforce. Target date funds gradually shift their emphasis from more aggressive investments to more conservative ones based on the target date.
All investing involves risk including loss of principal. No strategy assures success or protects against loss.
AIF®, Series 7 & 63 Securities Registrations,1 Series 65 & 66 Advisory Registrations† Bill has more than 25 years of experience managing employer-sponsored retirement plans and individual retirement assets. He is responsible for maintaining a high-level of service for 401k and 403b clients, as well as nurturing the growth and development of this area. Beyond these specialties, his experience includes plan design consulting, administration, employee...Read More