Defined Contribution Plans:
Key Information on Target Date Funds as Default Investments Should Be Provided to Plan Sponsors and Participants
GAO-11-118: Published: Jan 31, 2011. Publicly Released: Feb 23, 2011.
To promote the adoption of appropriate default investments by retirement plans that automatically enroll workers, in 2007 the Department of Labor (DOL) identified three qualified default investment alternatives. One of these options--target date funds (TDF)--has emerged as by far the most popular default investment. TDFs are designed to provide an age-appropriate asset allocation for plan participants over time. Because of recent concerns about significant losses in and differences in the performance of some TDFs, GAO was asked address the following questions: (1) To what extent do the investment compositions of TDFs vary; (2) what is known about the performance of TDFs; (3) how do plan sponsors select and monitor TDFs that are chosen as the plan's default investment, and what steps do they take to communicate information on these funds to their participants; and (4) what steps have DOL and the Securities and Exchange Commission (SEC) taken to ensure that plan sponsors appropriately select and use TDFs? To answer these questions, GAO reviewed available reports and data, and interviewed TDF managers, plan sponsors, relevant federal officials, and others.
Target date funds vary considerably in asset structures and in other ways, largely as a result of the different objectives and investment philosophies of fund managers. In the years approaching the retirement date, for example, some TDFs have a relatively low equity allocation--35 percent or less--so that plan participants will be insulated from excessive losses near retirement. Other TDFs have an equity allocation of 60 percent or more in the belief that relatively high equity returns will help ensure that retirees do not deplete savings in old age. TDFs also vary considerably in other respects, such as in the use of alternative assets and complex investment techniques. In addition, allocations are based in part on assumptions about plan participant actions--such as contribution rates and how plan participants will manage 401(k) assets upon retirement--which may differ from the actions of many participants. These investment differences and differences between assumed and actual participant behavior may have significant implications for the retirement security of plan participants invested in TDFs. Recent TDF performance has varied considerably, and while studies show that many investors will obtain significantly positive returns over the long term, a small percentage of investors may have poor or negative returns. Between 2005 and 2009 annualized TDF returns for the largest funds with 5 years of returns ranged from +28 percent to -31 percent. Although TDFs do not have a long history, studies modeling the potential long-term performance of TDFs show that TDFs investment returns may vary greatly. For example, while one study found that the mean rate of return for all individual participants was +4.3 percent, some participant groups could experience significantly lower returns. These studies also found that different ratios of investments affect the range of TDF investment returns and offer various trade-offs. While some plan sponsors conduct robust TDF selection and monitoring processes, other plan sponsors face challenges in doing so. Plan sponsors and industry experts identified several key considerations in selecting and monitoring TDFs, such as the demographics of participants and the expertise of the plan sponsor. Some plan sponsors may face several challenges in evaluating TDFs, such as having limited resources to conduct a thorough selection process, or lacking a benchmark to meaningfully measure performance. Although plan sponsors may use various media in an effort to inform participants about funds offered through the plan, some plan sponsors and others noted that participants typically understand little about TDFs. DOL and SEC have taken important steps to improve TDF disclosures, participant education, and guidance for plan sponsors and participants. For example, both agencies have proposed regulations aimed at helping to ensure that investors and participants are aware of the possibility of investment losses and have clear information about TDF asset allocations. However, we found that DOL could take additional steps to better promote more careful and thorough plan sponsor selection of TDFs as default investments, and help plan participants understand the relevance of TDF assumptions about contributions and withdrawals. GAO recommends that DOL take actions to assist plan sponsors in selecting TDFs to best suit their employees, and to ensure that plan participants have access to essential information about TDFs. DOL raised a number of issues with our recommendations, and we amended one of them in response to their comments.
Recommendations for Executive Action
Status: Closed - Implemented
Comments: The Department of Labor has published a document for plan fiduciaries that contains tips for the evaluation and selection of target date funds. This document incorporates the spirit of our recommendation, and includes key text that is almost exactly parallel to text in our report conclusions.
Recommendation: The Secretary of Labor should direct the Assistant Secretary of the Employee Benefits Security Administration to amend the qualified default investment alternatives (QDIA) regulations so that fiduciaries are required to document that they have considered, to the extent possible, whether other characteristics of plan participants, in addition to age or target retirement date, are relevant factors in choosing a QDIA.
Agency Affected: Department of Labor
Comments: The Department of Labor has taken action related to this recommendation, but has not taken the specific action recommended. In February 2013, the agency published a document for plan fiduciaries - "Target Date Retirement Funds: Tips for ERISA Plan Fiduciaries" - that contains tips for the evaluation and selection of target date funds (TDF). In this guidance, the agency highlighted the importance of understanding how a TDF's asset allocation changes over time. The agency specified, for example, that some TDFs carry higher risk near the retirement date, and assume that a participant will not cash out at retirement. Other TDFs, the agency noted, are more conservative near the retirement date, assuming that participants will cash out upon retirement. Failure to understand these differences may result in unpleasant surprises, the agency noted. However, the agency has not yet established a requirement that such relevant information be provided to plan participants.
Recommendation: The Secretary of Labor should direct the Assistant Secretary of the Employee Benefits Security Administration to provide guidance to plan sponsors regarding the limitations of existing TDF benchmarks and the importance of considering the long-term TDF investment allocations and assumptions used in developing the TDF asset allocation strategy.
Agency Affected: Department of Labor
Comments: Employee Benefits Security Administration (EBSA) reported that, as a result of an effort by the SEC to test investor understanding of target date funds (TDF) and TDF advertisements, it published a Federal register notice in June 2014 soliciting input on the implications of SEC's research on Labor's target date fund rule. EBSA stated that in light of the need to coordinate with SEC and the uncertainty regarding the timing and substance of SEC's actions, Labor cannot identify a completion date at this time. However, EBSA indicated that it would consider GAO's recommendation in preparing final amendments to the QDIA and participant-level disclosure regulations.
Recommendation: The Secretary of Labor should direct the Assistant Secretary of the Employee Benefits Security Administration to, in its final regulation on target date disclosure, expand the requirement that plan sponsors provide information regarding key assumptions concerning contribution and withdrawal rates by requiring that participants receive a statement regarding the potential consequences of saving, withdrawing, or otherwise managing TDF assets in a way that differs from the assumptions on which the TDF is based.
Agency Affected: Department of Labor