Retirement Plans

Custom Target-Date Funds Gain Steam

More 401(k) plan sponsors are tailoring TDFs to their participants' particular needs.
David McCannDecember 4, 2014
Custom Target-Date Funds Gain Steam

Ever since the Pension Protection Act of 2006 eased restrictions on automatically enrolling employees in retirement plans, 401(k) plan sponsors have increasingly designated target-date funds as the default investments for those who don’t elect an asset allocation.

This year, 86% of large and midsize employers are using TDFs as their Qualified Default Investment Alternative (QDIA), according to a Towers Watson survey of 457 such employers. But there’s a lot more room for the TDF market to develop than the missing 14% would suggest. That’s because only 22% of plan sponsors have implemented a “custom” TDF (see chart at the end of the article).

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The basic TDF concept is that a participant’s investment gradually becomes more conservative as the target date (usually retirement) nears. With a standard TDF, the employer selects a single vendor’s product with pre-selected investment options as well as a predetermined “glide path” (i.e., the way investment allocations transition from equities to fixed income over time). “It’s designed to appeal to the average participant,” says Lorie Latham, director of Towers Watson Investment Services.

With a custom target-date fund, the plan sponsor can make these decisions. It can construct a glide path that takes into account factors particular to that sponsor, like the demographics of the employee population and whether there is a defined-benefit pension plan that at least some employees will benefit from in retirement. And the sponsor can determine what asset classes best fit as investment options for its plan participants.

Often, plans buy fund-management and administrative services from the same firm. But “the record keepers broadly claim to have an open-architecture mindset,” Latham says, so they may be willing to include funds managed by others in the TDF lineup.

“The purpose of ‘going custom’ is to really think about the various decision points and design the TDF around your specific plan objectives, benefits profile and participant demographics,” says Latham. “With the vast majority of participant assets accumulating in TDFs, I think plan sponsors are realizing they’ve got to get this right — to be thoughtful about factoring in their objectives rather than just buying something off the shelf.”

Indeed, on top of the 22% of plans that already offer a custom TDF, according to the Towers Watson survey, 27% say they may explore the move.

Interest in custom TDFs got a boost in February 2013, when the Department of Labor published a set of tips for plan sponsors that included a reminder not to rule them out. “Before that, they had some traction but it was limited,” Latham says. “This is part of the evolution of defined-contribution plans becoming the primary retirement vehicle, as a result of which plan sponsors are more and more willing to embrace sophisticated concepts and investment strategies that require bigger decision-making.”

The downsides? There are added costs and administrative tasks involved in creating a custom TDF. Latham says that generally, plans with at least $750 million in assets are, given their buying power, in a position to start thinking about the strategy. Also, the more decisions there are to be made, the more concern the plan sponsor may have about fiduciary liability.

Custom TDF chart

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