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By Daniel A. Notto

The U.S. Department of Labor (DOL) recently issued some tips to guide defined contribution (DC) plan sponsors when selecting a target-date fund as an investment option in their plan. The tips are sensible — one may be even a bit surprising. And they should probably be taken quite seriously, considering the source.

The DOL’s Employee Benefits Security Administration (EBSA) indicated a few years ago that it was preparing some guidelines for evaluating and comparing target-date funds. Since then, the need for guidance has only grown in importance, because target-date funds have become the most popular choice for a DC plan’s qualified default investment alternative (QDIA), and QDIAs may well hold the majority of DC plan assets within the next five years.

Process And Review

The key words in these tips are process and review. As is the case when selecting any plan investment option, the DOL suggests that plan fiduciaries establish a process for comparing and selecting target-date funds, as well as a process for periodically reviewing them.

Fiduciaries should also understand the fund’s investments and the glide path. Do you understand the strategy of the fund and the underlying investments in it? Does the glide path reach its most conservative asset allocation at the target retirement date or later on? There are many factors that can impact your decisions on what’s most appropriate for your employees.

The DOL’s other tips include reviewing the fund’s fees and investment expenses, developing effective employee communications, taking advantage of the growing body of commercially available information on target-date funds, and documenting the selection and review process — including how fiduciaries reached decisions about individual investment options.

These tips form a nice roadmap for evaluating target-date funds, but could prove time-consuming for plan sponsors at midsize or smaller companies that may not have enough in-house resources to develop and maintain a lot of processes and reviews. Many plans could use this as an opportunity to forge closer working relationships with a trusted financial advisor or consultant who can help guide them through a prudent process like the one outlined in the DOL’s tips.

A Welcome Nod To Customization

None of the above tips were unexpected. In fact, they’re well within the framework of good DC plan stewardship. But the DOL included one other tip that’s more forward-looking and confirms what we’ve been saying for some time now: plan sponsors should inquire about whether a custom or non-proprietary target-date fund would be a better fit for their plan.

We’ve been encouraging larger plans to adopt customization for several years now. More recently, customization has become financially feasible for a wider asset range of plans. And customization works hand in hand with all the other tips from the DOL.

Some plan sponsors might presume that customization would be riskier than simply picking an off-the-shelf strategy. But we believe the opposite is true. If the costs are reasonable relative to the plan’s size, target-date customization helps fiduciaries more closely align their plan’s goals with their participants’ retirement saving (and spending) behavior.

Customization can help diversify investment-provider exposure, and it allows for incorporation of a plan’s best-in-class fund options from the core menu or even the company’s pension plan. Customization also lets fiduciaries review all the target-date fund component investments individually and replace any underperformers without causing any hiccups to the target-date fund or the participant experience.

With these tips, the DOL has again taken an active part in helping American companies and their workers find better ways to save wisely for retirement. As the design, implementation and participant use of target-date funds keeps growing, these guidelines provide valuable support for plan sponsors as they continue to help improve retirement outcomes for their participants.

Daniel A. Notto is Senior Retirement Plan Counsel at AllianceBernstein.

Disclaimer: “Target date” in a fund’s name refers to the approximate year when a participant expects to retire and begin withdrawing from his or her account. Target-date funds gradually adjust their asset allocation, lowering risk as participants near retirement. Investments in target-date funds are not guaranteed against loss of principal at any time, and account values can be more or less than the original amount invested—including at the time of the fund’s target date. Also, investing in target-date funds does not guarantee sufficient income in retirement.

The views expressed herein do not constitute research, investment advice or trade recommendations and do not necessarily represent the views of all AllianceBernstein portfolio-management teams.

Source: Tips For Kicking The Tires On Target-Date Funds