May 26, 2009
Plan Sponsor Advisors is an investment advisory and retirement plan consulting firm that works exclusively with retirement plans throughout the United States advising approximately $10 billion in retirement plan assets and over 250,000 participants.
Target date funds were designed to provide participants with a simple choice to achieve a diversified portfolio.
Most target date funds operate off of actuarial assumptions of participant life expectancy which drives the high equity allocation at age 65. Unfortunately, some of the underlying assumptions built into most target date products is flawed.
Target date funds are built as asset accumulation vehicles, not distribution vehicles. And there is no evidence to indicate that even if they were, that participants would stay in target date funds throughout retirement. (Most participants take a distribution after leaving employment). Nor do target date funds take into consideration the impact of mandatory distributions at age 70 1/2.
In fact, participants are more likely to take relatively large distributions upon retirement (8% is a common number) which is likely to result in many participants running out of money well before their actuarial estimated life expectancy. Additionally, a high equity exposure at retirement date enhances risk as participants no longer have the ability to continue to contribute to the plan to make up for potential losses. In fact, their financial profile is radically changed from income generating to income consuming - something that target date funds do not generally take into account.
While participants need to have pre-built asset allocations to assist them in reaching a secure retirement, target date funds, as currently built, represent a flawed, though useful, way of achieving this objective. Plan sponsors should conduct extensive due diligence before using these products and investment managers should clearly disclose their assumptions used in designing these products.