Understanding Target-Date Funds: Are They the Best Choice for Your Employees?
If you’ve spent time researching 401(k) investment options for your company, you’ve likely encountered target-date funds (TDFs). Frequently used as default investment options in retirement plans, TDFs offer a simplified, hands-off approach by automatically adjusting asset allocations based on an employee’s expected retirement date.
But are target-date funds truly the best choice for your workforce?
As an employer committed to offering competitive and compliant retirement benefits, it’s essential to weigh both the advantages and limitations of these popular funds. At Maxus Plan Solutions, we’re here to help you navigate the complexities of TDFs and determine if they’re the right fit for your employees.
What Are Target-Date Funds?
Target-date funds are mutual funds or collective investment trusts designed to reduce investment risk as an employee approaches retirement. Each fund is named for a target year—typically in five-year intervals (e.g., 2030, 2040, 2050).
Over time, the fund automatically transitions from growth-oriented assets (such as stocks) to more conservative holdings (like bonds and cash equivalents). This gradual reallocation, known as the glide path, makes investing easier for individuals who prefer not to actively manage their portfolios.
Benefits of Target-Date Funds
1. Simplicity and Convenience
Employees select a single fund based on their anticipated retirement year. The fund’s asset allocation is managed and adjusted automatically, encouraging greater plan participation among those unfamiliar with investing.
2. Automatic Diversification
TDFs spread investments across multiple asset classes, helping mitigate risk by avoiding overconcentration in any one area.
3. Professional Management
Investment professionals handle fund rebalancing and asset allocation adjustments, reducing the burden on employees with limited financial knowledge.
4. Fiduciary Protection for Employers
TDFs can qualify as a Qualified Default Investment Alternative (QDIA), helping plan sponsors fulfill fiduciary responsibilities and limit liability related to plan oversight.
Risks and Drawbacks to Consider
1. One-Size-Fits-All Approach
TDFs assume that everyone targeting the same retirement year has similar financial needs and risk tolerance—which isn’t always the case.
2. Different Glide Path Strategies
Not all TDFs are created equal. Some become conservative quickly, while others maintain stock exposure well into retirement. Understanding these differences is crucial for proper alignment.
3. Higher Fees
TDFs may carry higher management fees than simple index funds. If the fund underperforms, those costs can reduce overall retirement savings.
4. Market Exposure Near Retirement
Even near the target date, TDFs can remain exposed to market downturns. If a recession occurs close to an employee’s retirement, their savings could be at risk.
How to Evaluating Target-Date Funds for Your Company
When deciding whether TDFs are the right default investment choice for your workforce, consider these factors:
- Employee Demographics: Evaluate the age distribution, financial literacy, and risk tolerance of your employees.
- Cost Efficiency: Compare fund fees carefully, focusing on long-term value.
- Glide Path Strategy: Choose funds whose risk reduction strategies align closely with your employees’ retirement planning goals.
- Performance Track Record: Analyze historical returns of various TDF options, recognizing that past performance doesn’t guarantee future results.
How Maxus Plan Solutions Can Help
At Maxus Plan Solutions, we offer expert guidance to help employers build retirement plans that work. Our services include:
- Customized Plan Design: We tailor strategies to your company’s size, industry, and goals.
- Fund Review Support: We assist in reviewing performance and cost metrics for TDFs as part of your plan design process, in coordination with your financial advisor and recordkeeper.
- Compliance Guidance: We help ensure your plan structure meets regulatory standards while leaving investment selection and advice to the appropriate professionals.
- Employee Communication Support: While we don’t provide financial education directly, we help you coordinate with your plan advisor and recordkeeper to make useful tools and materials available to employees.
Final Thoughts: Are Target-Date Funds Right for You?
Target-date funds offer simplicity, professional management, and diversification—making them attractive default options for many retirement plans. However, they’re not perfect for every situation.
The best approach is a well-informed one: choose high-quality funds, educate your employees, and work with experienced retirement plan advisors.
Ready to explore how target-date funds could fit into your 401(k) strategy? Contact Maxus Plan Solutions today—let’s build a retirement plan that truly serves your employees and supports your company’s goals.