Target date funds (TDFs) as qualified default investment alternatives (QDIAs) have significantly shaped retirement investing. As of June 2024, target-date assets total a staggering $3.8 trillion. TDFs popularity stems from their simplicity, low cost, and investment sensibility (risk reduction coincides with aging and retirement). How did we get here, and where are we headed?
Qualified Default Investment Alternatives (QDIAs)
- Pension Protection Act of 2006 (PPA 2006): Established the Qualified Default Investment Alternatives (QDIAs) regulatory framework. The three QDIAs are investment options within retirement plans that aim to meet specific regulatory standards to protect plan sponsors from fiduciary liability for investment outcomes. This was crucial in encouraging employers to auto-enroll employees in retirement plans without fearing legal repercussions from the investment choices made on behalf of uninformed or disengaged employees.
- Criteria and Types: An investment must meet criteria such as being diversified to minimize the risk of large losses and designed to provide varying degrees of long-term appreciation and capital preservation to qualify as a QDIA. TDFs, managed accounts, and balanced funds are the only three types of investments that qualify.
- Impact on Retirement Savings: The introduction of QDIAs has led to higher participation rates in retirement plans through auto-enrollment and higher saving rates through auto-escalation. It made it easy for employees to accumulate for retirement. Furthermore, it has democratized access to professional investment management that might have been out of reach for the average investor.
Target Date Funds (TDFs)
- Origins in the 1990s: TDFs emerged in the early 1990s. As the target retirement year approaches, these funds are structured to automatically adjust the allocation of assets—from a more aggressive allocation to stocks to a more conservative allocation to bonds. The beauty is the automated investment management approach of gradual and systematic “glides down” the risk spectrum over a participant’s working years and beyond.
- Growth and Popularity: TDF adoption took off dramatically after the PPA 2006. This legislation recognizes the need for all workers to save and invest for retirement. Automatic enrollment and automatic escalation became commonplace as TDFs became the go-to multi-asset investment default option over the past 18 years.
Evolution to Personalized Target Date Funds
More recently, the industry has finally taken steps to leverage technology to add personalization to retirement investing. We now see an evolution towards personalized target date solutions that consider individual circumstances such as exact date of birth, current salary, account value, employee deferral, and employer contributions. Personalized information also enables a more accurate projection of Social Security Income at the normal retirement age. Today, we have the next-generation allocation algorithms to infuse these personal factors to align investment risk for each participant better.
The success of TDFs as QDIAs reflects a broader trend in relying on automation leveraging readily available participant census information to personalize everyone’s retirement investment. This evolution continues to influence the capability and development of new and improved retirement investment solutions in defined contribution retirement plans.