Greater retirement savings responsibility is shifting to individual Americans thanks to an evolution from defined benefit plans to defined contribution plans and uncertainty around Social Security. In addition, volatile capital markets and longer life expectancies are causing more Americans to be at risk of outliving their retirement savings.
Meanwhile, target-date funds have grown in popularity propelled by a combination of regulatory changes and plan participant behavior.
As part of the shift toward DC plans, the U.S. Department of Labor established target-date funds as one of three qualified default investment alternatives under the Pension Protection Act of 2006, giving these funds safe harbor status. Plan sponsors can now automatically enroll employees into retirement plans using “default investments that include a mix of asset classes consistent with capital preservation or longer-term capital appreciation or a blend of both.”
One of the biggest challenges for plan sponsors in this new era concerns the fact that most DC plan participants are “delegators” who do not have the time, interest or investment knowledge to direct their retirement savings, investment and income approaches.
As a result, the popularity of target-date funds has exploded in recent years given their safe harbor status, simplicity, age-based auto asset allocation and prevalence in employer DC plan investment menus. In fact, the universe of target-date fund families with a three-year track record has grown nearly five times since the start of 2006.
Importantly, this safe harbor status means that a large amount of decision-making control has been delegated to those target-date funds' investment managers, so plan sponsors need to fully understand what's under the hood of the target-date fund offering they select as their DC plan's default.