PLANSPONSOR Roadmap: ‘Retirement Class’ TDFs

Plan sponsors aiming to better serve their participants should include target-date funds in the plan lineup—and tailor them wisely, according to speakers at the second session of the Plan Sponsor Roadmap Livestream Series, held September 10.

The second in a four-part series, the session explored what plan sponsors and advisers can consider when deciding which TDF suite is appropriate for plan participants.

A full recording of the webinar can be viewed here.

A ‘Hot Topic’

Chuck Williams, the CEO of Finspire and the moderator of the session, laid out a few chief reasons TDFs have become a “hot topic.”

Employees have asked for a solution that helps them convert their lump sum into an income stream in retirement—“preferably guaranteed”—Williams explained. He added that employers are looking for help in maximizing the efficiency of their plans, given their companies’ financial constraints.

“[Those demands are] followed by legislative support, and then the product and solution innovations that … come out,” Williams said.

Teeing Up TDFs

Janet Yang, director of multi-asset and alternative strategies at Morningstar, said investor returns on TDFs are telling of the asset class’s strength as an investment choice.

“Unlike a lot of other categories where you see investors coming up short, that has not been the case with [TDFs], where workers have stayed invested,” Yang stated. “The actual returns … have just really outstripped expectations.”

According to Morningstar research shared by Yang, the target-date “experiment” has delivered so far. The thirty-seven target-date 2025 funds Morningstar tracks have at least 15 years of track record through 2024, and group returns outpaced expectations from commonly used target-date investing models from 2010.

Over the past 15 years, average allocations to equities within TDFs have increased due to low interest rates, higher life expectancies and greater growth potential, Yang explained.

“As plan sponsors, you all have a few different levers when it comes to these investments,” Yang continued. “One of them is asset allocation and the level of riskiness you deem appropriate for your population.”

Index-based funds generally outperformed both blended funds (in which active strategies make up 25% to 75% of a series’ underlying holdings) and active-based counterparts.

A passive fund tends to be a better option than active, according to Thomas Ming, managing director of Pensionmark Financial Group. Right now, active funds are doing particularly well because of a concentration in the technology sector, he explained. The fund providers can “tactically change” the allocation, rather than tracking indices. 

Integrating Income

Yang concluded her portion of the presentation by noting the recent crossover between TDFs and annuities.

“What we’ve been seeing … is a new wave of target-date strategies that incorporate annuities directly into the [TDF],” Yang said. “Over the last few years, more than a dozen of these have launched—and when we last looked, we’re at about $60 billion in assets.”

The advantage of keeping an annuity within a target-date option is that it eliminates the plan sponsor having to make complicated choices, Yang explained. Rather, the target-date provider of the plan sponsor’s choosing picks the type of annuity and conducts a due diligence check on the insurance company.

Choosing a built-in income annuity within a TDF begins with considering how a plan is built, according to Pensionmark’s Ming.

“What’s your average age, what’s the average deferral date and what’s the account balance?” Ming said he asks plan sponsors. He recommends plan fiduciaries consider plan demographics when making their TDF selection.

Plan design factors into the TDF decision too, according to Bryan Peebles, managing director of Strategic Retirement Partners.

“The old adage, ‘It’s all or nothing’ doesn’t work with something like [an annuity],” Peebles said, elaborating that plan participants do not have to place all their assets into an annuity. “You want to make sure you go in checking, ‘Okay, what are the distribution options within my 401(k),’ because usually it’s one of the things that’s overlooked on an ongoing basis.”

When choosing a qualified default investment alternative, plan sponsors should look at participation rates and plan design, including whether a plan has automatic enrollment, Peebles suggested. He said that when he speaks with plan sponsors about what he sees in the market, he tells them the top-performing plans focus on plan design.

“Everything should be based on plan health,” Peebles said. “You [have to] match where your participants are, where they need to be with the right investment options.”