Senate Committee Takes Aim at Target-Dates

The panel took a particularly close look 401(k) target date funds, which are designed to gradually shift to more conservative investments as workers approach retirement – and Committee Chairman Senator Herb Kohl (D-Wisconsin) also unveiled findings from a Committee investigation of 401(k) funds designed for people planning to retire in 2010, which, according to an  announcement , “revealed a wide variety of objectives, portfolio composition and risk within same-year target date funds.”  

“Despite their growing popularity, there are absolutely no regulations regarding the composition of target date funds,” said Kohl. “With more and more Americans relying on 401(k)s and other defined contribution plans as their primary source for retirement savings, we need to make sure their savings are well-protected with strong oversight and regulation.”

In an  announcement following the hearing, it was noted that, even though by authority of the Pension Protection Act of 2006, the U.S. Department of Labor (DOL) has issued regulations allowing target date funds to be used as a qualified default investment alternative (QDIA) in employer-sponsored retirement plans, there are no requirements regarding the composition of target date funds and the appropriate ratio of stocks and bonds as the fund nears its target.  

“Target date funds only made up roughly 3 percent of defined contribution savings in 2006, but are expected to increase to 20 percent in 2010,” according to the announcement, which went on to note that by 2015, “it is expected that more than one-third of all defined contribution savings will be in target date funds.”

In conjunction with the hearing, Kohl is sending letters to newly enshrined U.S. Secretary of Labor Hilda Solis and U.S. Securities and Exchange Commission Chairwoman Mary Schapiro, “urging them to immediately commence a review of target date funds and begin work on regulations to protect plan participants.”  

The hearing's lead witness, Jeanine Cook, testified about the difficulties Americans face as they head into retirement. Like millions of other Americans, she has experienced a decline in her housing and 401(k) investments in conjunction with diminishing job prospects.

Salisbury Testimony

Dallas Salisbury, president and CEO of the Employee Benefits Research Institute, highlighted some of the findings about target date funds that will be released in their March 2009 EBRI issue brief.   Specifically that of those 401(k) plan participants who were in plans that offered a target date fund, 36.9% had at least some portion of their account in target date funds in 2007, and among those identified as auto enrollees, approximately 88% of those investing in target date funds invested all of their assets in target date funds, regardless of their account balance.   "The one clear result of the target date fund use is that it shifts participant's asset allocations away from all or nothing allocations in equities across all ages," noted Salisbury in  testimony submitted for the committee.

In his testimony, it was noted that EBRI research has found that if 401(k) participants between the ages of 56 and 65 had been in the average target-date fund at the end of 2007, approximately 40% of the participants would have had at least a 20% decrease in their equity concentrations.   Furthermore, based on counterfactual simulations from years 2000 through 2006, inclusive, EBRI's data indicated that if all 401(k) participants had invested in target-date funds with the age-specific average equity allocations, their median 401(k) balances would have been larger at year-end 2006 for all four age cohorts analyzed.  

When the most aggressive target date funds were compared to actual participant directed decisions, the median 401(k) balances for three of the four age cohorts would have been larger had they been in target date funds, according to EBRI - and when the most conservative target date funds were compared to actual participant directed decisions, the median 401(k) balances for those up to age 45 would have been larger had they been in target date funds.   However, those over age 45 would have ended up with smaller median 401(k) balances if they had adopted target date funds.

The  February 2009 EBRI Issue Brief  also presents calculations on how long it might take for the 12/31/08 401(k) balances to recover to their 1/1/08 levels; at a 5 percent equity rate of return assumption, those with the longest tenure would need nearly two years at the median but approximately five years at the 90 ^th percentile. If the equity rate of return is assumed to drop to zero for the next few years, this recovery time increases to approximately 2.5 years at the median and 9 to 10 years at the 90th percentile.

Target-Date Users

Consequently, those that use target date funds relative to those that do not are more likely to be younger, have lower salaries, less tenure, have smaller account balances, and/or be in plans with a smaller number of participants. The average target date fund investor is about 2.5 years younger than those that do not invest in target date funds. They make about

$11,000 less on average in salary, have about 3.5 years on average less in tenure, have $25,000 on average less in their account, and are in plans with an average of 1,200 less participants.

"Advocates reach different conclusions on what all of the data should mean for future public policy. I will not enter that debate," Salisbury said.   "I will note, however, that 401(k) and other voluntary plans are currently meeting the explicit objectives of current public policies.   Different objectives would demand different laws and regulations, but the system should be judged first against current rules, and then the debate over whether the objectives and the rules should change can proceed. Voluntary does mean voluntary," he said.

Dean Baker, co-director of the Center for Economic and Policy Research (CEPR), discussed the decline in savings and equity among young and older baby boomers. In conjunction with this hearing, CEPR released a new  report  on how the housing crash is affecting boomer's retirement prospects. Ignacio Salazar, from SER- Jobs for Progress, testified about some of the challenges that older workers face in today's workforce, and how Workforce Investment Act (WIA) one-stop career centers are not doing a satisfactory job in training seniors.

Barbara Kennelly, of the National Committee to Preserve Social Security and Medicare, testified about how government programs, like Social Security and Medicare, are crucial to America's seniors, especially in a stagnant economy. She also mentioned the rising bankruptcies among seniors and highlighted some of the government's efforts in the stimulus to help older Americans as they retire.  

Finally, Deena Katz, a certified financial planner and associate professor at Texas Tech University, gave an overview of boomer financial history, and described the challenges and risks facing boomers as they enter retirement and begin to spend down their savings. She also offered steps that boomers and policy makers might consider to help attain a secure retirement, according to the committee report.