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Blog > Target-Date Funds: The next generation, but not a silver bullet

 

Target-Date Funds: The next generation, but not a silver bullet


Target-date funds are the new normal.
Industry data indicates 72% of plan sponsors selected target-date funds as the qualified default investment alternative within in their respective plans. Despite wide-spread utilization, a surprising number of plan participants misunderstand this investment vehicle. A recent study by AllianceBernstein revealed more than a third of participants believe investing in target-date funds guarantees they will meet their income needs in retirement.

 

This misconception highlights the need for participant financial education and planning, yet it also raises another question: Should target-date funds include guaranteed income within their overall structure?

 

One of the most significant risks associated with being underfunded in retirement is longevity risk - or outliving the money one has saved. As a result, a key objective of a well-structured investment strategy should be providing a guaranteed income stream in a retiree's later years.

 

There is much work being done on the next generation of target-date funds. These target-date funds of the future would be structured with glide paths that include the purchase of annuity-like units, designed to hedge longevity risk. Units would be purchased within the target-date fund when a participant reaches age 50, continuing to accumulate until the participant reaches the plan's normal retirement age, retirement, or terminates employment.

 

Upon reaching retirement, the participant would initially liquidate assets within the target-date product to meet spending needs. After age 80, the longevity-hedged annuities accumulated would convert to a guaranteed monthly income stream, ideally including an inflation-adjustment.

 

Currently the marketplace is struggling with how to deliver such a solution in a format that is diversified, portable, and low-cost.  As the industry evolves and the need for retirement income solutions clarifies further, we look forward to these "next generation" target-date funds becoming regular components of well-designed investment menus. 

 

In the meantime, the need for participant financial education remains. It is up to plan sponsors to tailor their communication approaches in ways which encourage plan participants to do more than passively enroll, but rather actively engage in managing their overall financial plan. Increased awareness, ongoing financial education, and access to financial tools and resources assists participants in creating financial plans that work for them now and in the future.