Which target-year fund is a participant’s default?

Imagine the responsible fiduciary of an individual-account retirement plan with participant-directed investment decides to use a set of target-year funds for the plan’s qualified default investment alternative.

Each of those funds describes its investment strategy with this: “The fund invests according to an asset-allocation strategy designed for investors planning to retire and leave the workforce in or within a few years of 20yy (the target year).”

How should a fiduciary select the age at which a default-invested participant is assumed to leave the workforce?

60? 62? 65? 67? 70? 73?

Assume the fiduciary does not know when the plan’s participants leave the workforce because almost all people who leave the employer go to work for another employer.

If the fiduciary knows that the plan’s participants all are knowledge workers, does that suggest anything about what leaving-work age the fiduciary ought to assume?

Whatever else a fiduciary might consider, is there some advantage to falling in with a recordkeeper’s norm?

Do recordkeepers have a norm?

Am I imagining a choice a plan’s fiduciary doesn’t practically have because a recordkeeper will require its customer to use the recordkeeper’s regime for sorting default-invested participants?

The fiduciary is considering setting which target year applies to a default-invested participant by assuming a few might plan to leave the workforce or otherwise begin a payout as young as 73 (even if most people work a few years longer).

Thus, a participant born in 1997 (now 28) would be defaulted into the 2070 fund.

A participant born in 1962 (now 63) would be defaulted into the 2035 fund.

Can anyone suggest a reason why the fiduciary should not decide that?

All good questions.  Target date funds are a popular choice for a plan's QDIA primarily because average investment performance over a longer time period is better than the performance of safe or capital preservation investments.  The target date concept appeals to those who are approaching retirement and don't want to incur investment losses.  This masks the underlying operation of a target date fund, and many are surprised to learn that different target date fund offerings yield widely ranging investment performance for the same target dates.  The fiduciary should do her homework to understand the mechanics of any target date fund offerings.

One big difference can be whether a target date portfolio for an age group is designed with an assumption that a participant will retire at normal retirement and take their account out of the plan (a "to retirement" investment strategy), or is the target date portfolio for an age group is designed with an assumption that the participant will continue to keep their account balance in the plan through out their retirement years (a "through retirement" investment strategy).  The latter will have a lower percentage of safe or capital preservation investments since the expectation is the assets will remain invested over a longer period of time.  Simplistically, one the investment mix of one target date provider for 55 year old participants may look like the investment mix of another target date provider's investment mix for 65 year old participants.

Note that the fiduciary typically is presented a choice of target date fund providers with input from the plan's financial adviser.  Recordkeepers easily can administer different target date fund families for different clients.  Recordkeepers can even administer a plan that has different target date funds from different fund families for different age groups.

None of this even touches lifestyle funds, asset allocation funds, and other similar products to package diversified portfolios.

This topic is wide and deep.

Paul I, thank you.

In my hypo, the fiduciary has selected which manager’s set of target-year funds are included in the plan’s designated investment alternatives. The fiduciary’s remaining decision is about how to sort a default-invested participant into a target year.

I’m imagining a fiduciary might find it’s prudent to use a target-year fund as the fund was designed to be used. (My hypo’s invented quotation about a fund’s investment strategy is adapted from a disclosure of the collective investment trusts of the investment manager with the biggest market share for target-year funds.)

Many fiduciaries’ defaults seem to aim at age 65 as a presumed normal retirement age. But for many individual-account retirement plans, ERISA § 3(24)’s construct of a normal retirement age has almost no practical effect.

BenefitsLink neighbors, even if 65 might approximate a retirement age for the U.S. general population, would you use a different assumption if you know the workforce you’re planning for all are highly educated knowledge workers?

If so, what age would you assume for the target?

I don't know the answer to your questions but if my participants are highly educated knowledge workers, why are they leaving their moneys in a QDIA and not investing the moneys where highly educated knowledge participants would otherwise invest the funds?  My experience with clients with these types of workers is that those workers are usually screaming for self-directed brokerage accounts and alternative investments and playing at being day traders.  I guess I would be more worried if my participants are less educated unsophisticated workers, in which case the longer employment horizon may be more applicable.  Sorry I didn't read all the comments etc. but just spewing my thoughts as I am going out the door....Have a nice weekend!

My point would be that fiduciaries likely are not offered the opportunity to choose an assumed retirement date.  That assumption typically is made by the investment manager that is choosing the investments and percentage mix of investments when building the target date series of funds.  Fiduciaries more typically are offered a choice from target date funds provided by various investment companies, and the assumed retirement age is baked into how the investment mix determined for each target age groups.

Artie M. and Paul I, thank you for helping me.

That a person is highly educated or is a knowledge worker (or is both) doesn’t always mean one knows how to select investments. Or, someone who does know might choose, whether rationally or otherwise, not to put one’s time on that activity. Moreover, even if 99% of the participants deliver affirmative investment directions, a plan’s fiduciary might set a default for the 1% who don’t. And should have a reasoning for the default one sets.

In my not-so-hypothetical, the fiduciary that selected the menu of designated investment alternatives also is the fiduciary that must decide the default investment.

The target-year funds’ investment strategy described above is from a disclosure for the Vanguard Target Retirement Trust funds. Those funds’ disclosures don’t say ‘this fund is for someone who will turn 65 (or some other age Vanguard assumed) in or near the target year.” Rather, Vanguard says: ‘The fund invests according to an asset-allocation strategy designed for investors planning to retire and leave the workforce in or within a few years of 20yy (the target year).’

If an individual affirmatively directs investment, the individual may decide her guess of when she expects to leave the workforce. But for a default-invested participant, the plan’s fiduciary must form its estimate or assumption.

If the fiduciary that decides which target-year fund in the set is a participant’s default assumes that the collective trustee’s description of the funds is truthful, I’m imagining it might be prudent to follow that description’s logic.

While that way is not the only way to meet 29 C.F.R. § 2550.404c-5, it at least has an explainable logic.

And all it asks of the default-deciding fiduciary is to form a reasoned guess about when a typical default-invested participant leaves the workforce.

I would just say that people do not know when they are going to retire when they are even 40 years old, let alone 25.  If you're getting to be 55 and 60 years old, absolutely you should be sharpening your pencil.  65 seems as good a guess as any is what I mean.  I also would say that your date of retirement probably is not as important as how long you're going to be among the living :).  So if you're life expectancy at 65 is 25 years (God bless!) then I would say your investment strategy would probably be the same whether or not you stop working. 

austin3515, thank you for your helpful observations. I can use them to improve my advice.

A fiduciary deciding a default target-year fund for a class of individuals might know nothing about any individual beyond the common fact of the year in which they were born.

So, even if a fiduciary considers mortality or longevity, it’s for the class of participants born in a year.

And guessing an age at which an imagined person “plan[s] to retire and leave the workforce” might involve a range of plausible assumptions.