On May 6, 2021 Senator Patty Murray, D-Wash., Chair of the Health, Education, Labor, and Pensions (HELP) Committee, and Rep. Robert C. “Bobby” Scott, D-Va., Chair of the House Education and Labor Committee, sent a letter to Gene Dodaro, Comptroller the GAO. It sought answers to 10 questions dealing with concerns that some aspects of TDFs may be placing American retirement savers at risk.
I wrote about these 10 questions in general, commending Chairpersons Murray and Scott for taking the initiative in this very important area. In this article, I respond specifically to their request for recommendations in the 10th and final question, which is:
What are possible legislative or regulatory options that would not only bolster the protection of plan participants, who are nearing retirement or are retired, but also achieve the intended goals of TDFs?
Recommendation
I recommend that Congress require clear and simple disclosures of TDF risk at the target date, developing rules/standards for straightforward risk assignments to negligible, moderate, and severe risk of loss at the target date.
Congress should appoint a committee to develop these standards, and investment companies should be required to report the resulting risk assignment in fund names: for example, “The ABC 2050 Fund with Moderate Risk of Loss at the Target Date.”
In my opinion, only Negligible Risk TDFs should be chosen as Qualified Default Investment Alternatives (QDIAs), with moderate and extreme versions offered as options to non-defaulted beneficiaries. Congress might not want to mandate acceptable risk for QDIAs, but it should at least require a standardized risk disclosure that it regulates.
Achieving the intended TDF goals
Question No. 10 asks for a recommendation that will “also achieve the intended goals of TDFs. Congress needs to clarify these intended goals because widely disparate goals are being marketed. I believe that the goals of TDFs are to deliver accumulated contributions plus a reasonable return at the target date and to protect against losses especially near the target date.
Professor Craig Israelsen opines, “A target-date fund that fails to protect account value as the target date approaches has failed in its primary task.” The Federal Thrift Savings Plan (TSP), at $770 billion the largest defined contribution plan in the world, sets a standard for this safety by ending less than 30% in risky assets at the target retirement date.
But most TDF providers don’t agree with TSP’s emphasis on safety. Most TDFs end more than 90% in risky assets at the target date (55% equities plus 35% risky long-term bonds), taking the view that because beneficiaries haven’t saved enough they need to seek high return from their TDF investments.
The commonly marketed TDF goals are to replace pay and manage longevity risk, but these are goals that require adequate savings rather than investment return—they are mere hopes rather than realistic goals.
I discuss this retirement crisis of inadequate savings in the next section because it is real, and it needs to be addressed with something more sensible than high-risk investing.
The retirement crisis
Baby boomers are the first generation to be responsible for their own risk decisions. Previous generations enjoyed defined benefit plans that provided lifetime annuities.
The Retirement Crisis is real. Most baby boomers have in fact not saved enough; 70% of baby boomers, which is 55 million people, have saved less than $300,000. But an SEC report advises that the solution is not to increase investment risk. Rather, the solution is to modify behavior by encouraging beneficiaries to save more, including routine retirement readiness reporting.
Inadequate savings do not warrant increased investment risk. Quite the contrary, lifetime savings need to be protected at the target date no matter how small because that’s all there is; after all, paychecks have stopped, and excessive risk at the target date could be the next big 401(k) scandal.
Most of our 78 million baby boomers will spend much of this decade in the Risk Zone when investment losses can irreparably spoil the rest of life. It is a risk with the potentially dire consequence of depleting lifetime savings that cannot be replenished with paychecks, nor is there enough time remaining to recover with investment gains. I wrote the book, Baby Boomer Investing in the Perilous Decade of the 2020s, to warn my fellow baby boomers and help them protect their lifetime savings. Even “poor” baby boomers can live reasonably well in this country, but investment losses hurt a lot.
After the target date: Decumulation
Although most beneficiaries withdraw their savings when they retire, some retirees remain in the plan to take advantage of efficiencies, so decumulation is an important glide path consideration.
TSP level risk at the target date cannot support a 30-year retirement, especially with interest rates near zero. Accordingly, research conducted by Professor Wade Pfau and Michael Kitces recommends re-risking beyond the target retirement date as shown in the following graph of a U-shaped glide path that is both ‘To” and “Through” in TDF terminology. This innovation is not popular, yet.
Learning from the previous mistake
On June 18, 2009, the SEC and DOL held an all-day Hearing on Target Date Funds and Similar Investment Options to better understand the losses of 2010 funds in 2008, with the intention of avoiding a recurrence in the future. Subsequently, opinions were sought on incorporating a risk disclosure into fund names, since it was determined that fiduciaries need clear and prominent risk information.
One such thought was to include the ending equity allocation in the fund name. For example, the “XYZ 2050 Fund Ending 60% in Equities.” The response was overwhelmingly negative, contending that there is more to risk than equity exposure, which is certainly true today since long-term bonds are very risky. Congress can remedy this mistake by authorizing the development of a standardized TDF Risk Score and requiring that this score be prominently disclosed. In other words, a good idea was squelched on a technicality.
After the 2009 hearings, nothing happened until the February 28, 2013 release of the Department of Labor Target-Date Fund “Tips” for Plan Fiduciaries. Although somewhat helpful, “tips” are mere suggestions. Shockingly, the “tips” fail to mention, warn and quantify sequence of return risk, as well as the Risk Zone, for the many unsophisticated defaulted investors who seek a “dignified retirement.” In the future, DOL should educate fiduciaries about these particularly harmful risks.
One of the DOL tips advises matching the TDF to workforce demographics. The only demographic that all defaulted beneficiaries have in common is financial illiteracy. These naïve participants need protection.
The Duty of Care is akin to our responsibility to our young children; we are accountable for protecting them from harm
TDFs for Non-defaulted Beneficiaries
Although most assets in TDFs are from defaulted beneficiaries where the TDF is the QDIA, some non-defaulted beneficiaries choose to invest in TDFs. These non-defaulted beneficiaries are best served by a family of TDF glidepaths with varying risks, so they are not limited to one-size-fits-all.
Conclusion
Hopefully, this new initiative will have a more meaningful impact by learning from the 2009 mistake. Some measure of risk at the target date should be prominently disclosed. If it’s not equity exposure, what is it? Surely a task force of professionals can find the right measure.
Fiduciaries need to know because the best fiduciary protection is beneficiary protection. Kudos to Chairpersons Murray and Scott for being proactive in taking this initiative. I hope the GAO will consider my recommendations.
Ron Surz is President of Target Date Solutions and CEO of GlidePath Wealth Management. He can be reached at Ron@TargetDateSolutions.com.