Target-date funds are more likely to be used by younger retirement plan participants who have lower account balances and have been at their jobs for less time, according to a study released Thursday by the Employee Benefit Research Institute.

The trend towards younger target-date fund participants is due to the fact that new employees are more likely to be automatically enrolled in their employer’s 401(k) plan, where target-date funds are often the default option, the study said.

The study uses the data in the EBRI/ICI Participant-Directed Retirement Plan Data Collection Project, which in 2007 had 21.8 million participants from 56,232 plans across a spectrum of plan administrators.

The share of 401(k) plan participants using target-date funds increased from 25% in 2007 to 31% in 2008, the study reports. Future growth is expected as participants in target-date funds remain in them and as new participants sign up for them or are auto-enrolled.

Because of the growing popularity of these funds, their design, especially the investment allocation or “glide path”, is critical. 

Mike Alfred, the chief executive officer of BrightScope, which rates 401(k) plans, is worried about plan sponsors auto-enrolling participants in target-date funds.

“Target date funds are a huge concern of the Department of Labor and the Securities and Exchange Commission right now both because of how they’re marketed and the process used by employers to evaluate and choose the plans,” he said in a recent interview.

Alfred said that most plan sponsors don’t really have a process to pick 401(k) plans for the employees and even if they do they don’t have a real choice at the record keeper level. Generally, the providers tie the hands of employers by forcing them to pick their funds.

“The problem then is if you are auto-enrolling into plan funds and you’re a plan sponsor you have a fiduciary responsibility, but you don’t really have a choice,” he said. “If something goes wrong for participants they’re in trouble, but you as a sponsor can have trouble as well if you have a fiduciary breach or violation.”

The Department of Labor is in the process of putting together a checklist to help plan sponsors evaluate and choose target date funds, Alfred said. But the plan sponsors may follow that checklist and find the funds from their providers don’t fit the criteria. “So either the plan sponsors leave the providers or providers become more flexible in offering other target date funds in their plans,” he said.

The good news is that of those employees that were auto-enrolled in target-date funds last year, few declined to participate after they were automatically enrolled, according to Towers Watson survey released last month. Eighty five percent of companies report that less than 10% of employees opted out of the 401(k) plan.

EBRI's survey found that out of those participants who had an allocation to target-dates in 2007, 93.9% still had some of their account balance allocated to a target-date fund in 2008.  Meanwhile, nearly 10% of participants who were in a plan in 2007 that offered target-dates, but did not use them in 2007 were using them in 2008.

In addition, participants with the lowest salaries were more likely to stay in target-dates and to have begun using them in 2008. Ebri found that the participants most likely to stop using target-dates and least likely to start using them if they have not already done so are those who have been at their jobs the longest and have the highest account balances. Of those participants in 2007 with 30 or more years of tenure who had some of their account balance allocated to target-dates, 85.8% continued to have some assets in target-dates in 2008, compared with participants in 2007 with two to five years of tenure, where 95.5% remained allocated to target-dates in 2008 after having done so in 2007.

The average age of participants using target-dates in 2007 was 43.1 and in 2008 it was 42.4, compared with 45.6 and 46.2 for those participants not using TDFs. 


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