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Bull’s-Eye on Target-Date Funds

Target-date funds have become increasingly popular with 401(k) plan investors in recent years. A target-date fund (“TDF”) is typically a mutual fund that contains a mix of underlying investments and automatically adjusts the asset allocation (stocks, bonds, cash equivalents) within the fund’s portfolio according to a selected “target date” such as retirement. As a participant approaches the “target date,” the fund moves its allocation to more conservative investments (e.g., bonds and cash) and away from riskier investments (e.g., equities).

Many plan sponsors have opted to use TDFs as their plan’s qualified default investment alternative (“QDIA”). A QDIA is a default investment option, chosen by a plan fiduciary, for those participants who fail to make an election regarding investment of their account balances. If the default option meets the QDIA requirements, the plan fiduciaries are protected from liability for investment losses in the default investment option chosen. Final DOL regulations expressly permit the use of TDFs as a QDIA.

Nonetheless, the DOL has recently expressed concern that the investment styles and strategies of TDFs can be very different, particularly because different TDFs use different “glide-paths” to adjust participant’s investments as they age. Thus, a proposed DOL regulation would amend the QDIA regulations to expand the information that must be disclosed in the required QDIA notice to participants and beneficiaries concerning investments in TDFs. A similar disclosure would be required to be provided to all participants as part of new fee disclosure regulations.

According to the proposed regulations, the following new disclosures regarding TDFs would be required:

  • An explanation of the TDF’s asset allocation, how the asset allocation will change over time, and the point in time when the TDF will reach its most conservative asset allocation (including a chart or table that illustrates the asset allocation over time and does not obscure or impede a participant’s or beneficiary’s understanding of the information);

     

  • If the TDF is named, or otherwise described, with reference to a particular date (e.g., a target date), an explanation of the age group for whom the alternative is designed, the relevance of the date, and any assumptions about a participant’s or beneficiary’s contribution and withdrawal intentions on or after such date;

     

  • A statement that the participant or beneficiary may lose money by investing in the TDF, including losses near and following retirement, and that there is no guarantee that the TDF will provide adequate retirement income;

     

  • A description of the right of the participants and beneficiaries on whose behalf assets are invested in a QDIA to direct the investments of those assets to any other investment alternative under the plan and, if applicable, a statement that certain fees and limitations may apply in connection with such transfer; and

     

  • An explanation of where the participants and beneficiaries can obtain additional investment information concerning the QDIA and the other investment alternatives available under the plan.

While no action is required yet, plan sponsors should check with their service providers and consultants to be sure that they will be prepared to respond when the regulations are finalized.