GAO Recommends DOL Update TDF Guidance

The rise of collective investment trusts as a preferred defined contribution investment vehicle to put participants into target date funds has gotten the attention of the country’s Congressional watchdog.

The Government Accountability Office released a report this week noting the increased popularity of target-date funds and recommended that the Department of Labor update its regulatory guidance to reflect changes in the market as it relates to CITs and the difference between TDFs with “to” and “through” glidepaths.

The report, published in March but publicly released on April 29, was conducted at the request of Senators Patty Murray, D-Washington; Bernie Sanders, I-Vermont; and Representative Robert Scott, D-Virginia.

The GAO explained that the growth in the use of automatic enrollment by defined contribution plans is a key factor in the growth of TDFs, especially among younger workers. According to the report 42% of 401(k) participants had access to TDFs in 2006, compared to 84% in 2020. Citing data from the Investment Company Institute and the Employee Benefit Research Institute, 59% of participants were invested in TDFs as of 2020. People in their 20s had 51% of their retirement assets in TDFs, compared to 23% of those in their 60s.

The GAO likewise attributed TDFs popularity with younger workers to automatic enrollment, since TDFs normally serve as a default investment: “In addition, participants that are automatically enrolled into TDFs are often younger and newer employees, which contributes to younger participants holding TDFs at higher percentages than older participants.”

Given the popularity of the investment structures, especially as a default, GAO noted that understanding of TDFs is quite low, especially as it relates to how different TDFs compare to one another. Citing Morningstar data, the report said that in 2022, 79% of inflows to TDFs were to TDFs structured using CITs as the underlying investment vehicles.

Mutual funds are regulated by the Securities and Exchange Commission, while CIT providers, which are often banks or trust companies, can be often be regulated by the Office of the Comptroller of Currency as well as the IRS and DOL.

CITs often have lower fees than mutual funds, in part because they  have the same disclosure requirements that the SEC imposes on mutual funds.

Apart from the questions raised by the use of different investment vehicles, the investment strategy of TDFs varies based on whether the funds in them are invested “through” the date a participant is expected to retire, which tend maintain higher equity exposure through retirement; and “to” TDFs, or those that reach their most conservative allocation at the target date. In other words, “through” funds tend to have a less conservative glidepath than do “to” funds. The report noted that the median equity exposure at the target retirement date for “through” funds was 46%, compared to 38% for “to” funds.

The report noted that the SEC and DOL worked together in 2010 and 2014 to update guidance on TDFs that would have required them to show an illustration of their glidepath, explain what their target date means, and when their allocation is at its most conservative, among other requirements. However, this project never resulted in a final rule.

Instead, the DOL relies on an investor bulletin from 2010 and a plan bulletin from 2013 as sub-regulatory guidance. The plan bulletin describes the factors sponsors should consider when selecting a TDF, and the investor bulletin provides basic information about TDFs.

The GAO report argues that these bulletins are insufficient because they do not account for the difference between CIT and mutual fund based TDFs. GAO also argues that neither bulletin offers a sufficient overview of “to” vs “through” TDFs, and that the plan bulletin offers an unintentional endorsement of “to” funds over “through” by saying that stocks are more volatile than bonds without mentioning that stocks can outperform bonds.

The offending text cited by the GAO from the plan bulletin reads:

“Some funds keep a sizeable investment in more volatile assets, like stocks, even as they pass their ‘target’ retirement dates. Since these funds continue to invest in stock, your employees’ retirement savings may continue to have some investment risk after they retire. These funds are generally for employees who don’t expect to withdraw all of their 401(k) account savings immediately upon retirement, but would rather make periodic withdrawals over the span of their retirement years. Other TDFs are concentrated in more conservative and less volatile investments at the target date, assuming that employees will want to cash out of the plan on the day they retire.”

The DOL rejected the recommendations of the GAO and maintains that existing guidance is adequate and that the language of the plan bulletin is even-handed, according to the report, and cited other regulatory priorities such as implementing the SECURE 2.0 Act of 2022.