Participants Lack Understanding of TDFs, Unsure About Withdrawal Needs

While target-date funds are designed to make participants’ lives easier by rebalancing and re-allocating investments in their retirement accounts automatically over time, a recent survey conducted by MFS Investment Management found that a significant number of investors lack a basic understanding of how the funds work. 

More than half of retirement plan participants currently invest using TDFs, according to the 2023 MFS Global Retirement Survey, but only one-third of those younger than 45 and only 19% of older workers own a single TDF, which is how these funds are designed to be used. 

A majority of participants are using either multiple TDFs or combining them with other investment options.  

“The workers who own a single target-date fund are likely those participants who were defaulted into the age-appropriate funds and then took no further action,” says Jeri Savage, lead retirement strategist at MFS. “The rest of the workers have either selected to combine target-date funds with something else, maybe not quite understanding the role of a target-date fund.” 

Participants age 50 and older also demonstrated confusion about how target-date funds work in the decumulation phase of retirement. For example, 54% of older participants incorrectly answered a series of questions: 54% said TDFs provide a guaranteed stream of income in retirement, 47% said TDFs provide a guaranteed rate of return and 48% said they invest entirely in cash or other low-risk investments for retirement. 

How to Diversify 

Participants younger than 45 were the most likely to be invested in a TDF, the report showed.  

“I think we spend so much time as an industry talking about the benefits of diversification that people think they need to hold more than one option to be diversified,” Savage says. “When it comes to target-date funds, there needs to be a little bit more emphasis on what the fund is and that it already is a diversified portfolio that doesn’t need to be combined with other things.” 

For participants who are not using TDFs, 37% said they prefer to choose the funds they invest in, and 29% said they do not understand the benefits of TDFs.  

The survey also revealed a lack of consensus on what to do with TDF investments in retirement. When asked if participants will continue to invest in a TDF when they retire, 16% said they would continue to use TDFs for all of their retirement assets. Only 11% said they would sell their TDF and use other investments, 27% said they would ask an adviser what to do and 18% said they will move their assets into their plan’s managed account option when they are closer to retirement. 

The MFS report stated that further innovation in TDFs may help, but advice will be a critical component of a holistic retirement income solution.  

Withdrawal Confusion 

When thinking about retirement income, one out of four participants surveyed said they are unsure about their withdrawal needs, according to MFS. 

Workers also have some unrealistic expectations about the rate of return they expect to gain on their retirement savings, after fees, as the average return expectation was about 5.7%, while the average expected withdrawal rate per year in retirement was about 5.6%.  

“[Expectations are] all over the board, which suggests that participants have no idea what their investments are doing and how much they should earn from their investments in retirement,” Savage says. “Then, similarly, they don’t know what the right amount is to withdraw.” 

The results also exhibited a disconnect between what is important to participants and their own actions. For example, 67% said being able to leave assets in their employer plan after they retire is important, but only 12% said they actually intend to leave savings in their employer’s plan upon retiring.  

Changing Strategies due to Markets 

Because of inflation and the market events of the past few years, retirement anxiety has increased. The study found that 76% of workers younger than 45 believe they will need to save more than they had planned. Additionally, 58% of those younger 45 and 61% of those older than 45 said the last three years have made them more conservative with their retirement savings.  

Savage says becoming more conservative may suggest that people replaced their equity allocation in favor of more fixed-income strategies, or they may have even increased contribution rates if they feel they need to work longer and save more.  

As a whole, Savage points out that from a sentiment perspective, younger participants responded more negatively and conservatively to market events and the impact of the COVID-19 pandemic, for example, than those who are closer to retirement. A majority of those younger than 45 said they feel they need to save more than they planned, and 58% predict they will need to work longer than they planned.  

The survey was conducted online from March 22 through April 6, gathering insights from 1,000 U.S. participants older than 18 who are employed at least part-time and actively participate in a workplace retirement plan.