02.23.11

GAO: Similar Target Date Funds Vary Widely, Increased Scrutiny Needed to Assist Participants and Plan Sponsors

WASHINGTON, D.C. – As target date funds are becoming an increasingly popular investment option in 401(k) and other retirement plans, the Government Accountability Office (GAO) found that wide variations in objectives of target date funds with the same target date could result in significant differences in retirement security at the end of a career. 

In 2007, the Department of Labor allowed employers and other plan sponsors to make target date funds a default investment option for their participants. Since then, target date funds have emerged as the most popular default investment option. GAO said that the lack of clear information on investment strategies could put retirees in riskier investments than they were led to believe. 
“While these new options promised to help workers invest more wisely over a career, GAO’s investigation shows that target date funds are not all created equally,” said U.S. Rep. George Miller (D-Calif.), the senior Democrat on the House Committee on Education and the Workforce. “Employers who choose options for their employees and workers building their retirement security need clear and complete information in order to make the best choice. GAO raises serious concerns and highlights the need for employers to undertake a higher level of due diligence in order to fulfill their duties under the law to act in best interest of workers.”

“The GAO’s report shows that participants that choose target date funds might not be fully aware of how these funds work,” Senator Herb Kohl said. “They are complicated investments that vary wildly in design and risk. I think it is clear that both plan sponsors and participants need more information to better understand these funds and protect participants’ financial interests.” Kohl is the Chairman of the Senate Committee on Aging.

The difference in investment strategies of similar target date funds was highlighted during the recent financial crisis. Dramatic losses occurred in some 2010 target date funds, even though participants expected their investments to be more conservatively invested that close to retirement. The GAO found that the returns of the largest 2010 target date funds, with at least five years of returns, ranged from a 31 percent loss to a 28 percent gain.  

Target date funds adjust investments towards more conservative asset allocations automatically as the accountholder gets closer to retirement or the ‘target retirement date’ set forth in the fund. However, the GAO uncovered significant differences in investment strategies among the most popular funds they reviewed with the same target retirement date. For instance, allocations of volatile stocks and equities ranged from 33 percent to 65 percent of the investments at the target retirement date. In other words, although these funds have the same target retirement date, some participants may be exposed to riskier investments than they may know. 

The GAO recommended that the Department of Labor, which oversees employer-provided retirement plans, modify a proposed regulation to require increased consideration of target date fund assumptions, and assist plan sponsors in understanding the differences in a fund’s long-term strategies and asset allocations. 

The GAO also found:

• Target date funds charge extra fees, ranging from 19 to 171 basis points.
• Target date fund managers make widely different assumptions about participant behavior including when and how participants use their savings during retirement.
• Many employers are ill-equipped to select target date fund options for their employees, including shopping around for potentially better options outside their service provider’s recommendation. 
• Participants, and especially defaulted participants, do not receive clear explanations about key target date fund assumptions.
• Studies show that target funds are not necessarily the best performing default investment that a plan sponsor can choose.