Congressional Leaders Ask GAO to Review 401(k)s’ Use of Target-Date Funds

Democrats express concern over prior administration's regulatory actions

Stephen Miller, CEBS By Stephen Miller, CEBS May 14, 2021
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Congressional Leaders Ask GAO to Review 401(k)s’ Use of Target-Date Funds

The chairpersons of two of the leading retirement plan oversight committees in Congress are calling for a review of target-date funds.

Sen. Patty Murray, D-Wash., chairwoman of the Senate Committee on Health, Education, Labor and Pensions, and Rep. Robert Scott, D-Va., chairman of the House Committee on Education and Labor, recently wrote to the head of the Government Accountability Office (GAO), asking that the agency review the use of target-date funds (TDFs) in 401(k) and similar defined contribution retirement plans.

"The employer-provided retirement system must effectively serve its participants and retirees, and we are concerned certain aspects of TDFs may be placing them at risk," the committee chairs' May 6 letter to Gene Dodaro, Comptroller General of the U.S., stated. "TDFs are often billed as 'set it and forget it' investments, yet expenses and risk allocations vary considerably among funds. The millions of families who trust their financial futures to target-date funds need to know these programs are working as advertised and providing the retirement security promised."

The letter expressed concern over actions by the Department of Labor under the prior administration that, Murray and Scott wrote, "paved the way for the use of potentially higher risk and more lightly regulated 'alternative' assets, such as private equity." The letter added, "Little is known about the extent to which TDFs offered in employer-provided retirement plans include alternative assets and how those TDFs with alternative assets impact participants' fees and returns."

[Related SHRM article: DOL Gives OK to Private Equity in Diversified 401(k) Funds]

The committee chairs asked the GAO to answer questions including:

  • What steps have TDF providers taken to mitigate the volatility of TDF assets?
  • How does the asset allocation and fee structure vary across those TDFs used as default options in 401(k) plans, and how do those compare with other investment products?
  • How are TDFs marketed and advertised, and are participants "sufficiently aware of the cost and asset allocation variation among TDFs?"
  • What are possible legislative or regulatory options that would bolster the protection of plan participants nearing retirement or who are retired and also achieve the intended goals of TDFs?

Reviewing the Basics: Target-Date Funds

A target-date fund is an investment that automatically resets the asset mix (stocks, bonds, cash equivalents) in its portfolio according to a predetermined "glide path," becoming more conservative (lowering portfolio risk) as it nears the year in which the participant expects to retire. 

The indicated year is usually reflected in the investment's name. A TDF for an older worker about to retire (such as a "2021 Fund") would have a lower percentage of stocks in its asset mix and more bonds and cash equivalents, while a TDF for a younger worker (such as a "2060 Fund") would have a higher percentage of stocks and fewer bonds or cash equivalents. Stocks are far more volatile than bonds and can be subject to steep short-term selloffs that can last several years, but provide long-term opportunities for substantial capital growth.

Some TDFs are designed to maintain a higher percentage of assets in stocks through the retirement date, so that the portfolio retains the potential to grow during the participants' retirement years. That's why it's important to compare the glide paths of TDFs offered by different brokerage and mutual fund companies when selecting a TDF series that best meets the needs of a particular employee population.

Plan Sponsors' Fiduciary Responsibility

According to Carol Buckmann, a partner with law firm Cohen & Buckmann P.C. in New York City, "Many fiduciaries responsible for selecting their 401(k) plan's target-date funds don't understand how these funds work. ... Lawsuits challenging target-date fund selection are on the rise, and plan fiduciaries need to be able to defend their choices in response to these suits."

Buckmann wrote that while many fiduciaries think that TDFs are a safe solution for participants who don't make their own investment choices, "all investment options have varying degrees of risk."

To protect themselves, she advised employers whose plans have TDFs to take steps such as:

  • Make sure that the plan's investment policy statement includes provisions on selecting and monitoring TDFs.
  • Compare the proprietary TDFs offered by the financial firm providing administrative services to the plan with other available alternatives.
  • Understand the different fees and compare fund family fees, bearing in mind that TDFs have multiple layers of fees.

Conflicted Interests?

"It will be interesting to see what the GAO does and if it responds," said Ronald Surz, president of Target Date Solutions, a provider of customized TDFs for employer-sponsored plans.

He argued that investment managers are "not disclosing the conflict of interest in 'proprietary' TDFs, where most if not all of the underlying funds are managed by the TDF provider."

Others argue that TDFs have been effective investments. 

According to Christine Benz, director of personal finance at investment data firm Morningstar, "In the early days of target-date funds, it wasn't uncommon for the funds to levy an additional management fee, above and beyond what the underlying funds charge. But most such fees have ebbed away, and the underlying fund fees have dropped, too."

In 2020, she noted, "the average asset-weighted fee for target-date funds was just 0.52 percent, down from 0.73 percent five years ago and almost half of what it was a decade earlier."

Barron's reported that target-date funds "did well in 2020." The average return of a 2020 target-date fund—with a mix of stock and bond holdings adjusted to reduce risk for those with a 2020 retirement date—was a gain of 10.8 percent. 

The S&P 500 index of large stocks, with greater downside risk from stock market volatility, finished 2020 with a gain of 16.26 percent.

“The COVID-19 pandemic taught us that target-date funds are perfectly suited for individuals who feel apprehension about market volatility,” Randy Welch, managing director and portfolio manager at Principal Global Asset Allocation, told 401k Specialist magazine.

“During the pandemic, we saw that people who stayed in their target-date funds saw a very positive result by the end of December, especially compared to self-directed investors who panicked and jumped out of the market,” Welch said.

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