Target-Date Investments

Transparency Has Significant Value

Sway Research reported that assets under management (AUM) for target-date investments expanded in 2018 - mutual fund solutions declined 1.9 percent while collective investment trust (CIT) solutions increased 6.1 percent, leading to overall growth in target-date solutions from $1.75 trillion (year-end 2017) to $1.77 trillion as of year-end 2018). Passively managed solutions increased from 51.2 percent to 53.3 percent of all target-date investments.¹ We are talking real money here – almost $1 trillion of the more than $6 Trillion of assets in tax-qualified, individual account, retirement savings plans.

Only a minority of plan fiduciaries know, at any given time, the specific allocation of assets within their target-date investments. Even fewer participants know how those monies are actually invested.

On a number of occasions, I have suggested plan sponsors consider changing their Qualified Default Investment Alternative (QDIA) from a series of target-date funds (TDF) to a target-date model (TDM) series.² A TDM is a no-cost, electronic investment instruction where a participant’s assets are allocated across the core investment options – mimicking a target-date fund’s glide path and landing points.

I have many reasons for suggesting plan sponsors consider TDMs, including but not limited to:

• Lower expenses: Target date models typically have lower costs because:
  - Most target-date investments have an added layer of fees, and
  - Offering 10 - 12 target date funds diverts assets from the underlying core investments, while TDM’s concentrate assets in those underlying core investments, 
• Models offer additional value through open architecture, 
• The target-date allocation applies to all account assets, 
• Models are easier to understand compared to target-date funds³, and 
• Models offer far greater transparency/disclosure for participants:
  - Rebalancing is accomplished via an asset transfer among the core investment options, and is confirmed to participants with a specific confirmation, and
  - Quarterly statements reflect both the model allocations and the actual dollars and cents allocation to each core investment option. 

Two other reasons I have not mentioned previously include “bias” and “litigation.” There may be more.

Bias in Selecting Target-Date Funds
Like TDFs, a TDM series typically deploys models in increments of five calendar years – traditionally ending in “0” or “5”. Unlike the TDFs, TDMs can easily accommodate a unique allocation for each year of birth. So, a fiduciary may ultimately migrate to unique allocations (glide path, landing point, etc.) for each year of birth to avoid the “0” bias identified where participants select their own target-date fund.⁴ Clearly, life expectancy (including the expected period of retirement) also varies based on other factors – gender, race, ethnicity, educational level, occupation, etc. So, while no fiduciary has adopted additional customization with respect to asset allocation, a TDM series can also reflect those differences in mortality/life expectancy.

Litigation – Actual Knowledge Standard
Meeting the Department of Labor (DOL) disclosure requirements may be insufficient to avoid litigation challenges. From that perspective, target-date models have it all over target-date funds when it comes to transparency regarding the investment allocation. ERISA⁵ provides for a statute of limitations with regard to actual knowledge: “three years after the earliest date on which the plaintiff had actual knowledge of the (fiduciary) breach or violation.” Recently, the Ninth Circuit decided on a new variant of that “actual knowledge” standard in determining when ERISA’s statute of limitations begins to run.⁶ In the Ninth Circuit, the statute of limitations period may not start coincident with the fiduciary meeting mandated disclosure requirements. In this litigation, the participant sued the fiduciaries over their investment decisions within a customized target-date fund series. The participant claims a lack of “actual knowledge,” despite receiving all mandated disclosures, will defeat application of ERISA’s statute of limitations.

Plan sponsors may wish to discuss with counsel any changes in mandated disclosures so that they serve to document “actual knowledge.” Further, plan sponsors may wish to discuss the need/advisability of amending the plan to include reasonable time limits within which claims must be filed and/or suit must be brought to avoid being denied or challenged as untimely.⁷

Of course, if the plan used a target-date model series as the QDIA, every quarterly statement will reflect the underlying allocation – such quarterly statements may meet the “actual knowledge” requirement, even in the Ninth Circuit.

We are providing this information to you solely in our capacity as individuals with knowledge and experience in the industry and not as legal advice. The issues presented here may have legal implications. We recommend discussing these matters with your legal counsel before choosing a course of action. This publication was prepared to support the informational needs of the Plan Sponsor Council of America on the issues discussed. If this is shared, recipients should understand that (1) the memo focuses on the needs of our association and the issues of interest to association members, and (2) it is not (and you/others should not use it as a substitute for) legal, accounting, actuarial, or other professional advice.

IRS CIRCULAR 230 NOTICE: Any advice contained in this publication was not intended or written by the Plan Sponsor Council of America to be used, and cannot be used by the recipient or any other person, for the purpose of avoiding any Internal Revenue Code penalties that may be imposed on such person [or to promote, market or recommend any transaction or subject addressed herein]. Recipients of this publication should seek advice based on their particular circumstances from an independent tax advisor.

¹Sway Research, 2019. Top 10 providers include Vanguard ($649B), Fidelity ($245B), T. Rowe Price ($223B), BlackRock ($151B), American Funds ($104B), J.P. Morgan ($85B), Principal ($56B), SSgA ($51B), Nuveen ($45B), and American Century ($21B), 3/4/19. Accessed 3/5/19 at: http://www.swayresearch.com/news See also: Investment Company Institute, Retirement Assets Total $29.2 Trillion in Third Quarter, 12/20/18. Target Date Funds in retirement plans have increased from $2 Billion as of 12/31/98 to $807 Billion as of 9/30/18. More than 2/3rds of all target date fund assets under management are in defined contribution retirement savings plans. Accessed 3/5/19 at: https://www.ici.org/research/stats/retirement/ret_18_q3

²R. Surz, J. Towarnicky, Target Date Model Portfolios, DC Insights Magazine, PSCA, Fall 2018. “Using a plan’s core lineup to create target date models can provide lower cost and higher transparency.” See also: J. Towarnicky, Default Is Not Mine — I Only Live Here: Considerations regarding target-date funds as the plan QDIA, DC Insights Magazine, PSCA, Winter 2017. See also: J. Towarnicky, S&P STRIDE Target Date Funds: Making STRIDEs in Evaluating the Performance of Retirement Solutions, 10/31/17, Accessed 12/27/18 at: https://www.indexologyblog.com/2017/10/31/sp-stride-target-date-funds-ma... J. Towarnicky, Rethinking Rebalancing, 10/3/18, Accessed 12/27/18 at: https://www.psca.org/blog_jack_2018_44 J. P. Morgan Chase, Smartretirement® Participant Communications, 2018.

³J.P. Morgan suggests plan sponsors make substantial investments in an extensive target date fund education program – education that is generally unnecessary for target date models. They justify this investment by noting: “Despite efforts to educate participants on the benefits of target date funds (TDFs), many lack even the most basic knowledge of what target date funds are and how they work.” “Nearly ½ of participants select more than one target date fund vintage because they think it’s a more diversified approach.” “Only 29% of current target ate fund users correctly identified that a target date fund offers no guarantees.” Accessed 12/29/18 at: https://am.jpmorgan.com/us/en/asset-management/gim/adv/sr-advisor-partic...

⁴X. Liu, W. Zhang, A. Kaira, The Costly Zero Bias in Target Retirement Fund Choice, 8/4/18. “… The effect we document demonstrates that investors, specifically those born in years ending 8, 9, 0, 1 and 2 are subject to the “zero” bias in their target retirement fund choice. This bias significantly impacts their contributions and retirement wealth. … 401(k) plan menu designers should take this bias into consideration, emphasize the implications of the choices made at the point of decision, and nudge investors into making selections that maximize financial well-being. Accessed 12/27/18 at: https://papers.ssrn.com/sol3/papers.cfm?abstract_id=3214811

⁵29 USC §1113(2)

⁶Sulyma v. Intel, Corp., 9th Cir., No. 17-15864, 11/28/18. “… The key is that … the limitations period begins to run once the plaintiff has sufficient knowledge to be alerted to the particular claim. … we emphasize that … the plaintiff must have actual knowledge, rather than constructive knowledge. … “[t]he statutory phrase ‘actual knowledge’ means what it says: knowledge that is actual, not merely a possible inference from ambiguous circumstances.” … section 1113 uses this statutory phrase, and Congress removed the constructive knowledge provision from the statute in 1987. This amendment strongly suggests that Congress intended for only an actual knowledge standard to apply. … we hold that the phrase “actual knowledge” means the plaintiff is actually aware of the facts constituting the breach, not merely that those facts were available to the plaintiff. To prevail on a statute of limitations defense on a section 1104 claim, as here, therefore, the defendant must show that there is no dispute of material fact that the plaintiff was actually aware that the defendant acted imprudently. …”. Accessed 12/27/18 at: http://cdn.ca9.uscourts.gov/datastore/opinions/2018/11/28/17-15864.pdf

⁷See: J. Heimeshoff v. Hartford Life & Accident Insurance, 134 S.Ct. 604 (2013) “… A participant in an employee benefit plan covered by the Employee Retirement Income Security Act of 1974 (ERISA) … may bring a civil action under § 502(a)(1)(B) to recover benefits due under the terms of the plan. … Courts have generally required participants to exhaust the plan's administrative remedies before filing suit to recover benefits. ERISA does not, however, specify a statute of limitations for filing suit … Filling that gap, the plan at issue here requires participants to bring suit within three years after "proof of loss" is due. Because proof of loss is due before a plan's administrative process can be completed, the administrative exhaustion requirement will, in practice, shorten the contractual limitations period. The question presented is whether the contractual limitations provision is enforceable. We hold that it is. …”