As a result of growth of individual account plans such as 401(k) plans, the responsibility for investment decision-making is increasingly being transferred from plan fiduciaries to plan participants. For participants who do not wish to assume the responsibility of active day-to-day management of their investments, target date funds ("TDFs") are an attractive investment option. TDFs are investment vehicles for which the investment allocation is continually adjusted in order to reduce the risk level of investments as the participant approaches his or her retirement date, or "target date." In addition to the growing popularity among participants, plan fiduciaries are increasingly opting to use TDFs as the qualified default investment alternative for participants who fail to make an investment election.
Reminding fiduciaries that TDFs have varying investment strategies, paths toward retirement, and fund-related fees, the United States Department of Labor ("DOL") recently released informal guidance for plan fiduciaries in the form of eight tips for selecting TDFs to offer in participant-directed individual account plans. The tips provided by the DOL are not exhaustive, but serve as a useful checklist for plan fiduciaries when carrying out their fiduciary duties. The tips are summarized as follows:
- Establish an objective process for comparing and selecting TDFs in order to evaluate the prudence of the investment options.
- Establish a process for periodic review of the TDFs selected and offered under the plan. At a minimum, this should include examining whether there were any significant changes in the investment information since the TDF was first selected or last reviewed.
- Review the TDF’s investments to understand how the allocations are made and will change over time, and whether the asset allocation reaches its most conservative point at the target retirement date, or at some later point.
- Review the fund’s fees and expenses, including any fees for investments in underlying funds that may charge separate fees and expenses. Much of this information should be provided to the plan fiduciary automatically pursuant to the plan-level fee disclosure obligations imposed upon service providers under Employee Retirement Income Security Act of 1974 ("ERISA") section 408(b)(2). Plan fiduciaries should carefully review any such disclosures upon receipt. For more information on these required disclosures, see our February 2012 Special Alert and our July 2010 issue.
- Analyze whether a TDF that uses the vendor’s proprietary funds as component investments (a non-customized TDF) or a TDF that may include component investments (a custom designed TDF) is a better fit for the Plan. We note that in evaluating the benefits of custom-designed TDF, a plan fiduciary should look carefully at the associated costs, compared to a non-customized TDF.
- Develop effective employee communications to ensure participants are generally informed about their investments. This includes the quarterly and annual participant-level fee disclosure required by law under ERISA section 404a-5. For more information on these required disclosures, see our February 2011, May 2012 and July 2012 issues.
- Take advantage of available sources of information to evaluate the TDF and recommendations you received regarding the TDF selection, including commercially available sources of information.
- Document the TDF selection and review process, including how individual investment option choice decisions were reached.