Target-date funds are one of the fastest-growing segments of the retirement plan market, with more than $1 trillion in assets, but most plan sponsors don’t know if their employees understand what they are investing in or how their workers plan to use their money when they leave the plan and enter retirement.
In a survey of TDF investors, Vanguard found that a “healthy majority have a good understanding of how these things are structured and the philosophy behind them,” says John Croke, a senior product manager in the Vanguard portfolio review department.
“It was a little better than expected,” says Croke. “We would have thought it would have been half the population.”
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Nevertheless, about 20% of investors thought that TDFs were a source of guaranteed retirement income.
Plan sponsors have done a much better job of educating plan participants about target-date fund strategies, Croke says, but there’s still more to do moving forward.
When Vanguard asked survey participants how they planned to use their accumulated TDF assets in terms of other sources of retirement income, only a tiny percentage of participants said they expected to disinvest from the market at retirement and purchase annuities or put their assets into a money market fund.
“The vast majority of folks will continue to be invested in the market, gradually drawing down from these strategies to fund their retirement incomes,” says Croke.
People are living longer, with 65-year-old men expected to live at least 20 years in retirement and women expected to live 20 to 30 years in retirement.
“That is a time horizon from an investing perspective that you don’t want to get too conservative too early in the retirement years,” he says.
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Many TDF investors lost much of their assets during the Great Recession, in large part because they weren’t educated about TDF glide paths and how conservative their investments were supposed to be by the time they reached their target retirement date.
“To” glide paths gradually get more conservative until the target retirement date is reached. “Through” glide paths take an investor through retirement, meaning a high percentage of assets are still invested in equities at the target retirement date to help generate income through retirement.
“We as an industry, as a plan sponsor community, didn’t do enough of a good job before the financial crisis explaining how these products work, continuing to hold exposure to the equity market through retirement and after retirement,” Croke says.
In the past, people thought they had to cash out of their retirement assets the moment they retired to put them into a safe basket of CDs, treasuries and money market funds.
“The truth is you have to have exposure to the equity market to preserve purchasing power to allow them to keep up with healthcare expenses, food and utilities and the other things that put a demand on income in retirement,” he says.
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In its survey, Vanguard found that the majority of investors expect their employer-sponsored retirement plan to be the primary source of their income in retirement. Most people don’t plan to withdraw their assets or buy an annuity at retirement. Instead they plan to take systematic withdrawals or spend their savings as needed in retirement, a mindset jibes well with a “through” glide path.
According to Vanguard’s 2014 recordkeeping data, 88% of plan sponsors offered TDFs at the end of 2014 and 64% of participants had all or part of their defined contribution accounts invested in TDFs.
Vanguard’s data also shows that when people do withdraw money from their workplace accounts, the majority roll that money into an IRA.
“This notion that people should run from the equity markets the second they leave the workforce is not something we are seeing with the data and with people’s expectations; and I think as people continue to build comfort and awareness around that, should we have another 2008-2009 type of event, people will be a little less unsettled in their target-date experience than what they experienced the prior go around,” he says.
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Croke attributes the huge growth of target-date funds on more employers offering TDFs as their qualified default investment alternative and the increased use of automatic enrollment to get people investing in retirement even if they aren’t motivated to learn anything about their workplace retirement plan.
Currently, younger people make up the bulk of TDF investors, but as more companies offer re-enrollment to older employees who haven’t touched their accounts in years or who have extreme allocations in their portfolios, it will even out.
The beauty of TDFs is that they were designed to “fix the bad kind of inertia,” says Croke. “Getting people out of extreme allocations like company stock or stable value and on the back end, by getting people into one-stop-shop investment solutions, they tend to stick with it. We don’t see them tactically moving in and out of investment products like we see in the general population.”
Paula Aven Gladych is a freelance writer based in Denver.
