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Target Date Funds

Target date funds (TDFs) are an integral part of many deferred compensation programs around the country. They offer many advantages, particularly for participants who are not inclined to actively engage in an investment strategy. One of the greatest advantages is that TDFs are designed to automatically rebalance as the participant gets closer to retirement. Many plan sponsors choose TDFs as the default investment option for their participants.
TDFs offer a long-term investment strategy using a mix of investments that change as the participant ages. The asset allocation strategy moves from a more aggressive, riskier approach in a participant’s younger years, to a more conservative, less risky approach nearing retirement. It is important for plan sponsors to know whether their TDFs use a “to retirement” or “through retirement” approach: the “to” approach will reduce equity exposure so that the TDF reaches its most conservative point at the target date; the “through” approach will use a strategy that reaches the most conservative asset allocation much later.

Because TDFs can vary widely in asset allocation strategies and fees, offering TDFs comes with some fiduciary responsibilities. To meet these responsibilities, plan sponsors should:

  • Engage in a process to objectively compare and select each fund. This will include an evaluation of the funds’ performance, fees and expenses; consideration of how well the TDFs align with plan participants’ ages and likely retirement dates; and whether the employer offers a pension plan.
  • Establish a periodic review process for the TDFs. In addition to reviewing the funds’ performances against their respective benchmarks, plan sponsors should also consider whether there have been any changes in the investment strategy or management team. If any of these elements do not meet established standards, it should be considered for replacement.
  • Understand the funds’ investments and how they will change over time. Do the funds use a “to” or “through” strategy? Knowing whether your participants are likely to withdraw their accounts at, or periodically throughout, their retirement will help you determine which approach is best for your plan.
  • Review the funds’ fees and expenses. Small differences in fees and expenses can seriously impact a participant’s ability to save long-term. Both the expenses for the TDF and the underlying funds should be considered, and plan sponsors should understand what the TDF fees are paying for—rebalancing, access to special funds or other benefits.
  • Review the suitability of proprietary versus custom funds. Some providers offer a pre-packaged series of TDFs, while others may offer custom options. Proprietary funds typically use average participant characteristics to match to a single TDF, managed by a single investment manager. Custom funds will use individual participant savings information to match to multiple TDF options, usually overseen by an investment management team.
  • Communicate, communicate, and communicate. It is important for your employees to understand how TDFs work, particularly if the TDFs use a “to” or “through” investment strategy.
  • Document the TDF selection and review processes. Documenting the decision processes made in selecting funds and other important aspects of your plan is important to show prudence and diligence in your fiduciary role.

With appropriate oversight, TDFs may offer many enhancements to your plan. In addition, offering a TDF as your default fund may help you increase plan participation. A qualified retirement plan advisor can help you navigate and manage your responsibilities for these and other funds in your plan.

The target date is the approximate date when investors plan on withdrawing their money. Generally, the asset allocation of each fund will change on an annual basis with the asset allocation becoming more conservative as the fund nears the target retirement date. The principal value of the funds is not guaranteed at any time including at and after the target date.

Last reviewed 6/1/2022

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