The ERISA Advisory Council is currently conducting hearings on Qualified Default Investment Alternatives (QDIAs) in savings retirement plans. What is the Council and why do 401(k) participants care?
Section 512 of ERISA provides for the establishment of an Advisory Council on Employee Welfare and Pension Benefit Plans, known as the ERISA Advisory Council. The duties of the council are to advise the Department of Labor and submit recommendations to the Secretary of Labor. The Council plays an important role in shaping policies and regulations that impact employee benefit plans.
Some of the reasons that 401(k) participants care about Council recommendations include:
- Potential for new plan features: As policymakers look to strengthen the retirement system, it may result in new plan options or features becoming available to 401(k) participants.
- Consumer protections: The council’s work highlights the importance of maintaining strong protections for retirement savers, which benefits all plan participants.
- Overall system improvements: Any efforts to strengthen and expand the retirement savings system can potentially benefit current 401(k) savers through a more robust and secure retirement landscape.
I have submitted recommendations to the Council regarding the most popular QDIA: target date funds (TDFs). You can read my entire submission Here. At $4.5 trillion and growing, target date funds (TDFs) are very important and in need of serious improvements, especially near their target dates where Baby Boomers are currently exposed to substantial sequence of return risk.
There should be a “do no harm” Hippocratic Oath for TDFs, but there definitely is not currently. In the following I summarize my recommendations for:
- A revolutionary U-shaped glidepath that is very safe at the target date and then re-risks in retirement,
- Two risk-customized benchmarks for evaluating the performance of TDFs based on the fiduciary’s risk choice, and
- Personalization that might be supported by artificial intelligence.
I’ve published extensively on these topics in 401(k)Specialist.
U-shaped Glidepath
There is little disagreement about risk for young people, and great disagreement for those near retirement. But there shouldn’t be disagreement because most TDF providers say they use academic lifetime investment theory. If they actually did use the theory, they would all be very safe at their target dates, with 80% in risk-free assets, but they are actually 90% in risky assets. They are taking excess risk for those near retirement relative to academic theory.
Academics have also addressed the decumulation glidepath, advising re-risking in retirement to extend the life of assets.
In other words, academic theory recommends a U-shaped glidepath like the following.
Better benchmarks
Einstein advised keeping everything as simple as possible. The most important part of glidepaths is near their target date, since they’re all pretty much the same for young people. Most TDFs are high risk near their target date, which argues for a high-risk benchmark. But a few TDFs, like the Federal Thrift Savings Plan (TSP) are very safe, which argues for a low-risk benchmark for these plans. So I wrote A Modest Proposal for Just Two Target Date Fund Benchmarks
Personalization
Investing is personal. Some TDF providers have launched personalized target date accounts (PTDAs), integrating glidepaths with account management. This can work well for non-defaulted participants because they want to engage. They can also benefit fiduciaries by giving them the flexibility they need to tailor their QDIA to workforce demographics.
Conclusion
The following is exactly how I concluded my recommendations to the ERISA Advisory Council.
Despite a mostly “status-quo” strategy across the TDF industry, and a product that lacks significant innovation, assets under management have grown substantially as a result of the Department’s “endorsement” in the QDIA regulations. The TDF industry has not evolved in the past 16 years, largely because it is an oligopoly dominated by just a few firms. Oligopolies are never good for innovation.
The Government Accountability Office (GAO) report on target date funds highlights significant challenges and issues but fails to make substantial recommendations that would increase transparency and reduce risk.
TDF participants need better protection, especially our 78 million Baby Boomers. A stock market crash will happen. A crash in this decade will be in the Risk Zone for most Baby Boomers. Another crash like 2008 would decimate baby boomers in TDFs.