A follow-up to my last note on the proposed rule released recently by the Department of Labor (DOL) that would amend both the qualified default investment alternative (QDIA) regulation and the participant-level disclosure regulation: The DOL commented in its proposal that many target date funds, with dates of 2010 and 2015, still had up to half of their portfolios invested in equities. This allocation, coupled with the significant market volatility and decline in 2008, led investors who were nearing retirement to significant losses. The DOL goes further to note that many of the funds did not significantly reduce their equity allocations until five or more years after their target dates.

To" versus "Through target date funds

This concept is very important and is an area that must be understood by both the plan sponsor that introduces target date funds as an investment in a retirement plan as well as by the investor or plan participant. As a target date fund winds down to its terminal point, the allocation to equity should gradually reduce by design. A confusing area is that if the fund states its target is 2010, one would assume that 2010 is the date that the fund hits its most conservative allocation. Well, for some target date funds that is not exactly true.

Yes, there really are two types of target date funds

One type of target date fund reduces its allocation until it hits the target date or retirement date. This fund is a To type of fund, meaning that when it hits the retirement date, it will be at its most conservative allocation, with a significant portion of the fund assets in cash and bonds.

The other type of target date fund is a Through fund. It reduces its allocation, not to the target date, but to a point a number of years after the actual date of the fund. In this type of fund, it assumes that the assets will need to continue to grow for a number of years after the actual date of retirement. This is most likely more realistic, but may be not understood by those investing in these funds.

In the examples above, see the point labeled Target Hit, in the To type of fund, which is where the fund is at its most conservative allocation. In the Through fund, this is a number of years further out thus the fund may still be reducing its equity allocation at the point where the target date in the fund's name is hit.

For participants to have a better understanding of the To" versus the "Through target date fund, the DOL required that disclosures must place an emphasis on this distinction in very clear terms. This should be both written in the description or objective of the fund and also displayed in the glide path presented.

In addition, as a plan sponsor and fiduciary, it is important to understand the types of funds offered and to review any current and future communications for your employees. Make sure that the type of target date funds you have in your plan is clear to you and your employees.

The DOL release can be found here.