Younger Participants Are Increasingly Using TDFs

The Employee Benefit Research Institute (EBRI) and Investment Company Institute (ICI) have found that participants are increasingly using target-date funds (TDFs) to save for retirement—especially younger participants.

A new report by the two organizations found more 401(k) plan participants are using the funds than in the past. EBRI and ICI examined year-end 2018 data from the EBRI/ICI 401(k) database—which follows millions of 401(k) plan participants as a means to examine how these participants manage their plan accounts—and found that 56% of participants in the database held target-date (or lifecycle) funds. That’s up almost 200% in 12 years. TDFs also held 27% of total 401(k) plan assets in the database.

Younger 401(k) participants were more likely to hold TDFs than older participants. According to the report, at year-end 2018, 62% of plan participants in their 20s and 61% of those in their 30s owned TDFs, compared with 50% of participants in their 60s.

Additionally, 51% of 401(k) plan assets owned by participants in their 20s were invested in TDFs, versus 23% for those in their 60s. Almost half (41%) of participants in their 30s held plan assets in TDFs, with the number lowering significantly for participants in their 40s—to 28%.

Perhaps unsurprisingly, younger plan participants who held assets in target-date funds had higher allocations to equities than older groups. Among participants in their 20s, those holding TDFs invested 87% of their plan assets in equities.

Plan participants in their 20s also had a higher concentration of their accounts in target-date funds than older TDF investors. Eighty-eight percent of younger plan participants with TDFs held more than 90% of their accounts in these funds, with only two-thirds of TDF investors in their 50s and 60s holding such a high concentration.

The EBRI and ICI report studied how 401(k) participants are investing their TDFs, finding that most follow investing approaches that are appropriate for their age group. For example, among 401(k) plan participants with one TDF, 91% of those in their 20s held a TDF that had asset allocations in conjunction with their age. Overall, the vast majority (88%) of participants with TDFs held one age-appropriate TDF.

Additionally, participants tend to be using a TDF in accordance with their retirement date. For example, 83% of 401(k) plan participants holding a 2040 TDF were in line with reaching age 65 in 2040, and 96% of investors in the 2035 funds were also appropriately aged.

The firms said the heightened usage of TDFs can be attributed to the funds’ increased accessibility over time. For example, in 2006, 57% of plans offered TDFs to their participants. In 2018, that number rose to 79%. And now, 56% of participants use the funds, compared with just 19% in 2006.

But that growth has also led to scrutiny. In May, the chairwoman of the Senate Health, Education, Labor and Pensions (HELP) Committee and the chairman of the House Education and Labor Committee asked the Government Accountability Office (GAO) to conduct a review of TDFs.

They say that while TDFs are billed as offering participants retirement security by placing their assets in an age-appropriate glide path that grows more conservative as they approach retirement, the funds might actually be placing some participants at risk. Specifically, they say expenses and risk allocations vary considerably among funds.

An academic paper released in May also took aim at TDFs, saying they can take advantage of investors who aren’t paying attention to their accounts.

Past research has also shown that some investors aren’t using the vehicles as they are intended to be used. A combination of investor overconfidence and a desire for greater diversification can drive misuse.