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 that automatically adjusts the asset allocation (stocks, bonds, and 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 the investment of their account balances. If the default option meets the QDIA requirements, the plan fiduciaries are protected from liability for investment losses within the default investment option. Final Department of Labor (“DOL”) regulations expressly permit the use of TDFs as a QDIA.
Nonetheless, the DOL has expressed concern that the investment styles and strategies of TDFs can be quite diverse, particularly because different TDFs use different “glide-paths” to adjust participants’ investments as they age. In 2011, the DOL issued proposed regulations that 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. Those regulations have not yet been finalized.
However, the DOL did recently post on its website some “tips” for ERISA plan fiduciaries to consider when selecting and monitoring TDFs. According to these tips, plan fiduciaries should take the following steps:
- Establish a process for comparing and selecting TDFs;
- Establish a process for the periodic review of selected TDFs;
- Understand the fund’s investments – the allocation among different asset classes (stocks, bonds, cash), its individual investments, and how these will change over time;
- Review the fund’s fees and investment expenses;
- Inquire as to whether a custom or non-proprietary target date fund would be a better fit for your plan;
- Develop effective employee communications;
- Take advantage of available sources of information to evaluate the TDF and recommendations you received regarding the TDF selection; and
- Document the process.
Following these tips will help protect plan fiduciaries from liability for having selected a particular TDF as their plan’s QDIA.