Defined Contribution

What Workers Get—and Don't Get—About Target-Date Funds

By Seth J. Masters December 27, 2011

Target-date funds have gained strong approval among US defined contribution (DC) plan participants who use them, as I have written before. But results from our seventh annual survey suggest that many US DC plan participants still have some mistaken notions about what target-date funds are…and are not.

First, we asked participants who invested in target-date funds why they did so. The most-cited reason was that target-date funds keep their account balance appropriately invested to and through retirement. This seems to indicate that there’s a general understanding—at least among target-date fund users—of the funds’ diversified composition and of the automatic adjustment of that composition as participants age.

Second, we asked all of our survey respondents (whether or not they invest in target-date funds) what the “date” in a target-date fund’s name means. Nearly three-fourths of them chose one of two correct answers:

• A target-date fund is for someone retiring near a specific year (2030, for example) and withdrawing his or her savings gradually through retirement, or

• The date signifies someone retiring around a particular year and rolling his or her savings into an IRA account.

Although some financial services firms claim that many participants take their DC savings and spend it all at or near retirement, only 13% of our respondents answered that the date indicated someone retiring near that year and taking cash distribution to spend immediately.

Third, we asked about the age-appropriate changes in the investment mix of target-date funds. Nearly three-fourths correctly said it was “true” that target-date funds become more conservative as you get closer to retirement. Roughly 60% also understood that, at retirement, target-date funds are invested in a mix of stocks and bonds.

So it seems that a healthy majority of workers get the target-date concept, which says a lot about the industry’s efforts at participant education and communication. But when we posed a true-or-false question that stated, “Target-date funds guarantee that you will meet your income needs in retirement,” over half of our respondents said that’s true…which it most definitely is not. Another 19% said they don’t know, which is also worrying (Display).

Clearly, there’s a need for greater education, communication and disclosure—for doing more and doing it better. But I believe this “guarantee” misperception reflects a strong dose of wishful thinking. It points to what participants truly want: a steady retirement income stream that they can count on.

And that’s exactly what our survey more directly revealed. We asked our respondents what features and benefits were important to them when thinking about retirement investment options. While they could select as many choices as they wished from a varied list, two-thirds chose a steady income stream in retirement as their clear favorite.

How to deliver a steady income in retirement is a key question today within the retirement industry, and a subject I’ll address in my next few postings.

“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.

What Workers Get—and Don't Get—About Target-Date Funds
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