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Making Better Decisions: Why is a prudent process necessary when selecting your plan’s Target Date option?

By Dorann Cafaro

target date fundsTarget Date Funds (TDF) have gained in popularity over the last 10 years because of many plan sponsors choosing a TDF as their qualified default alternative (QDIA) option under the 2006 Pension Protection Act (PPA). In the early years, designing and using a prudent process did not seem very important. What was important was that the choice met one of the three definitions for a QDIA under the PPA’s safe harbor exemption as follows:

  1. A mix of investments taking into account the characteristics of a group of employees as a whole rather than each individual, such as a balanced account option
  2. A mix of investments taking into account an individual’s age or retirement date such as a target date fund option
  3. An investment service that allocates among existing plan options taking into account the individual’s age or retirement date such as a professionally managed account

In fact, in those early years many plan sponsors were not given much if any real choice on their record-keeping platform. They often accepted the record-keeper’s proprietary target date option believing this would meet the PPA’s guideline for a QDIA and perhaps there was little understanding generally of any difference between TDF options.

What changed? The stock market went down and it was apparent that not all Target Date Funds were the same as some went down dramatically particularly in what was considered the most “conservative” vintages usually held by those nearing retirement. In 2013 in response to rising concerns over these vast differences in performance in a down market the DOL published “Target Date Retirement Funds – TIPs for ERISA Plan Fiduciaries”.  This provides guidance on what to remember when choosing TDFs. The key recommendations were as follows:

  1. Establish a selection process
  2. Establish a periodic review process
  3. Understand the investment you are using
  4. Document the process
  5. Inquire whether a custom or non-proprietary TDF would be a better fit for your plan

The DOL TIPs emphasize the need for a process and since this is a fiduciary activity it must be a prudent process. It is also important to note that these DOL TIPs re for selecting and monitoring the TDF option regardless of whether or not this TDF is used as the plan’s QDIA. Once the DOL published their guidance they began including a request for a copy of the documentation used in the plan’s selection process during their audit visits.

In summary you now know that a prudent process is necessary for both the selection and the monitoring of your plan’s Target Date Funds . You also know that it is more complex than just a note in the minutes identifying your choice, even if you have delegated the selection to an adviser and are accepting an adviser’s recommendation. It is all about how your fiduciary decision was made and how well you have documented the process. This includes fully understanding the details of your Target Date Funds selection, including its actual holdings.

Have you a clear written process for investment decision-making? If not you will want to start listing the steps taken and the order in which they were taken to reach your TDF selection decision.  The same applies to your on-going TDF monitoring process.  You will want to keep your documented process available should a DOL auditor ask for a copy. And remember that you need to document the process you went through to reach your TDF decision regardless of whether or not it is your QDIA.

Over the next several articles we will provide additional help and step-by-step guidance to making better decisions so you will have not only a process in place for your TDF option but will be able to document your prudent decision-making for all your plan’s investment selections. This will be important for reducing liability risk under the new DOL Conflict of Interest Regulation to particularly in volatile markets when liability tends to increase.

Make today a better decision-making day!

Dorann Cafaro

Dorann Cafaro

Dorann is a retirement consultant dedicated to fiduciary protection of plan fiduciaries (sponsors, committee members, fiduciary advisors) and SmartPension DB plans. She is working closely with Bdellium to provide fiduciaries with decision-support tools. Dorann was the founder of Cafaro Greenleaf, with roots going back as far as 1981 with long term partner and daughter Jamie Greenleaf. Dorann was Senior Vice President of Fiduciary Benchmarks, an Executive Vice President for National Retirement Partners, a leading national network of independent retirement experts now an LPL company. Dorann has been nationally recognized throughout the retirement industry, a frequent and keynote speaker on the retirement industry at national conferences and seminars. She was inducted to the PLANADVISER's Hall of Fame in 2011, named Retirement Advisor of the Year by PLANSPONSOR magazine 2006, and 401k Wire's 50 most influential people in the 401k retirement industry for 2006 to 2011 and has testified in front of the USDOL.
Dorann Cafaro
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