[Senate Prints 111-34]
[From the U.S. Government Publishing Office]


                    
111th Congress 
 1st Session                COMMITTEE PRINT                     S. Prt.
                                                                 111-34


 
                     TARGET DATE RETIREMENT FUNDS:
       LACK OF CLARITY AMONG STRUCTURES AND FEES RAISES CONCERNS

                               __________

                     Summary of Committee Research

                            prepared by the

                             MAJORITY STAFF

                                 of the

                       SPECIAL COMMITTEE ON AGING

                          UNITED STATES SENATE

                   ONE HUNDRED AND ELEVENTH CONGRESS

                              October 2009

[GRAPHIC] [TIFF OMITTED] TONGRESS.#13

For Sale by the Superintendent of Documents, U.S. Government Printing Office
Internet: bookstore.gpo.gov  Phone: toll free (866) 512-1800; (202) 512ï¿½091800  
Fax: (202) 512ï¿½092104 Mail: Stop IDCC, Washington, DC 20402ï¿½090001

                       SPECIAL COMMITTEE ON AGING

                     HERB KOHL, Wisconsin, Chairman
RON WYDEN, Oregon                    BOB CORKER, Tennessee, Ranking 
BLANCHE L. LINCOLN, Arkansas             Member
EVAN BAYH, Indiana                   RICHARD SHELBY, Alabama
BILL NELSON, Florida                 SUSAN COLLINS, Maine
BOB CASEY, Pennsylvania              ORRIN HATCH, Utah
CLAIRE McCASKILL, Missouri           GEORGE LeMieux, Florida
SHELDON WHITEHOUSE, Rhode Island     SAM BROWNBACK, Kansas
MARK UDALL, Colorado                 LINDSEY GRAHAM, South Carolina
MICHAEL BENNET, Colorado             SAXBY CHAMBLISS, Georgia
KIRSTEN GILLIBRAND, New York
ARLEN SPECTER, Pennsylvania
AL FRANKEN, Minnesota
                     Debra Whitman, Staff Director
          Jack Mitchell, Chief of Oversight and Investigations

                              Prepared By:
                     Jason Holsclaw, Majority Staff
                       Jeff Cruz, Majority Staff
                     Ashley Glacel, Majority Staff

                                  (ii)
                            C O N T E N T S

                              ----------                              
                                                                   Page
Foreword.........................................................     1
Select Aging Committee Hearings..................................     2
Aging Committee Majority Staff Information Paper.................     5
Executive Summary................................................     5
Introduction.....................................................     6
Background.......................................................     7
Pension Protection Act of 2006 Encourages Automatic Enrollment 
  Policies.......................................................     8
Adoption of Automatic Enrollment Has Grown Considerably With 
  Plans Overwhelmingly Adopting Target date Funds as Default 
  Investment.....................................................     9
Although Popular Investment Tools, Design and Transparency of 
  Target date Funds Raise Concerns...............................    11
Agencies Taking Steps to Evaluate Target date Fund Concerns......    18
Conclusion.......................................................    18
Acknowledgments..................................................    20
                                FOREWORD

                              ----------                              

    The Special Committee on Aging (Aging Committee) has a long 
history of examining various aspects of both the defined 
benefit and defined contribution pension industry. Most 
recently, the Aging Committee held hearings reviewing the 
recession's effect on older American's retirement income, 
including whether individuals have adequate pension benefits 
and coverage as well as whether retirement-related federal 
government programs--such as the Pension Benefit Guaranty 
Corporation and the Social Security Administration--are 
performing effectively.
    Since the economic downturn, I have become increasingly 
concerned that plan sponsors and participants may not be 
receiving adequate information regarding the risk associated 
with certain 401(k) products, such as target date retirement 
funds--investment vehicles designed to automatically adjust to 
more conservative investments as one approaches retirement. 
Today, more and more companies are automatically enrolling 
their workers into these types of plans due to Department of 
Labor's ruling that these funds qualify for ``safe harbor'' 
relief from fiduciary liability. In fact, many have suggested 
that these funds will be the retirement savings vehicle for the 
vast majority of Americans in the future.
    While well-constructed target date funds have great 
potential for improving retirement income security, it is 
currently unclear whether investment firms are prudently 
designing these funds in the best interest of the plan sponsors 
and their participants. In fact, an Aging Committee 
investigation conducted in early 2009 found significant 
differences in the asset allocations and equity holdings within 
these funds, raising questions about whether plan sponsors and 
participants understand the underlying assumptions and risk 
associated with these products. Therefore, I requested that the 
U.S. Department of Labor and the U.S. Securities and Exchange 
Commission examine these funds, and I commend the agencies for 
taking steps to do so.
    The Aging Committee's hearing on October 28, 2009, together 
with this staff information paper represent an attempt to 
outline concerns related to target date funds. This staff 
report summarizes the Aging Committee's actions to date and 
presents findings from various sources, including Committee 
hearings, government reports, and academic research.
    My hope is that this paper will assist Members of Congress, 
their staffs, and the general public in better understanding 
the potential benefits and challenges associated with these 
types of investment funds.

                                                HERB KOHL, Chairman

                    SELECT AGING COMMITTEE HEARINGS

                              ----------                              

Senate Special Committee on Aging hearings
    On October 24, 2007, the Senate Special Committee on Aging 
held a hearing on ``Hidden 401(k) Fees: How Disclosure Can 
Increase Retirement Security,'' which examined the effect 
hidden 401(k) fees can have on retirement savings and the need 
for simple and clear disclosure. The Committee heard testimony 
from: Barbara Bovbjerg, Director of Education, Workforce and 
Income Security Issues, GAO; Bradford Campbell, Assistant 
Secretary of Labor, the Employee Benefits Security 
Administration; Jeff Love, Director of Research, AARP; Mercer 
Bullard, assistant professor, University of Mississippi School 
of Law; Michael Kiley, President, Plan Administrators, Inc.; 
and Robert Chambers, Esq., Partner, Helms, Mulliss & Wicker LLC 
and Chairman of the American Benefits Council.
Legislative Action:
        Increasing the Transparency of Pension Fees. Under 
        ERISA, there are currently no requirements to clearly 
        disclose the record keeping and investment fees charged 
        for managing a 401(k) account. Yet, a small difference 
        in fees, when compounded annually, results in large 
        difference in final retirement savings. In the 111th 
        Congress, Rep. George Miller (D-CA, 7th Congressional 
        District) introduced H.R. 1984, the 401(k) Fair 
        Disclosure for Retirement Security Act, and Senators 
        Tom Harkin (D-IA) and Herb Kohl (D-WI) introduced S. 
        401, the Defined Contribution Fee Disclosure Act, to 
        amend ERISA to require the disclosure of fees to both 
        plan sponsors and participants. If passed, this 
        legislation could increase overall retirement security 
        without cost to the American taxpayers. The House bill 
        passed through the House Committee on Education and 
        Labor in June 2009.

    On April 30, 2008, the Senate Special Committee on Aging 
held a hearing entitled, ``Leading by Example: Making 
Government a Role Model for Hiring and Retaining Older 
Workers'' evaluating the federal government's efforts to hire 
and retain older workers. The Committee heard testimony from: 
Barbara Bovbjerg, Director, Education, Workforce and Income 
Security Issues, US Government Accountability Office, Robert 
Goldenkoff, Director, Strategic Issues, US Government 
Accountability Office, Nancy Kichak, Associate Director, 
Strategic Human Resources Policy, Office of Personnel 
Management, Thomas Dowd, Administrator, Office of Policy 
Development and Research, Employment and Training 
Administration, US Department of Labor, Max Stier, President 
and CEO, Partnership for Public Service, Chai Feldblum, Co-
Director, Workplace Flexibility 2010.
Legislative Action:
        Remove the pension penalty for seniors to continue 
        working in a phased retirement:  In the 111th Congress, 
        Senator Herb Kohl (D-WI) joined Senator George 
        Voinovich (R-OH), the ranking member of the Senate 
        Homeland Security and Governmental Affairs Committee's 
        Subcommittee on the Oversight of Government Management, 
        the Federal Workforce and the District of Columbia, in 
        introducing S. 469 the Incentives for Older Workers 
        Act, which includes a provision that removes the 
        penalty under defined benefit pension plans that 
        reduces the pension of full-time workers who take a 
        lower salary while reducing their hours in a phased 
        retirement. This penalty affects more than three 
        million Americans in private pension plans that are 
        calculated, in part, by their final year pay.

    On July 16, 2008, the Senate Special Committee on Aging 
held a hearing entitled ``Saving Smartly for Retirement: Are 
Americans Being Encouraged to Break Open the Piggy Bank'' to 
examine the reported increase in leakage and to explore ways to 
protect American's retirement savings. The Committee heard 
testimony from: Christian Weller, Senior Fellow, Center for 
American Progress; Mark Iwry, Principal, Retirement Security 
Project; David John, Principal, Retirement Security Project; 
Gregory Long, Executive Director, Federal Retirement Thrift 
Investment Board; John Gannon, Senior Vice President, Financial 
Industry Regulatory Authority; Bruce Bent, Chairman, The 
Reserve.
Legislative Action:
        Reducing the ``Leakage'' of Pension Savings. In 
        conjunction with the July 2008 hearing, the Aging 
        Committee requested that the U.S. Government 
        Accountability Office (GAO) study the extent to which 
        Americans tap into their accrued retirement savings 
        prior to retirement. In August 2009, GAO issued 401(k) 
        Plans: Policy Changes Could Reduce Long-term Effects of 
        Leakage on Workers' Retirement Savings, which suggested 
        that Congress consider changing the requirement for the 
        six-month contribution suspension following a hardship 
        withdrawal, as well as recommended that the Secretary 
        of Labor promote greater participate education on the 
        importance of preserving retirement savings, and that 
        the Secretary of the Treasury clarify and enhance loan 
        exhaustion provisions to ensure that participants do 
        not initiate unnecessary leakage through hardship 
        withdrawals. In conjunction with the 2008 hearing, 
        Senators Charles Schumer (D-NY) and Herb Kohl (D-WI) 
        introduced S. 3278 in the 110th Congress, to limit the 
        number of 401(k) loans to three and prohibit the 
        widespread use of 401(k) debit cards.

    On February 25, 2009, the Senate Special Committee on Aging 
held a hearing entitled ``Boomer Bust? Securing Retirement in 
Volatile Economy,'' which examined the economic downturn's 
effect on retirement security, particularly for those on the 
brink of retirement. The Committee heard testimony from: 
Jeanine Cook, a Baby Boomer from Myrtle Beach, South Carolina; 
Dallas L. Salisbury, President & CEO, Employee Benefits 
Research Institute; Dean Baker, Co-Director, Center for 
Economic and Policy Research; Ignacio Salazar, President & CEO, 
SER--Jobs for Progress; Barbara B. Kennelly, President & CEO, 
National Committee to Preserve Social Security and Medicare; 
Deena Katz, CFP, Associate Professor, Texas Tech University, 
and Chairman, Evensky & Katz.
    On May 20, 2009, the Special Committee on Aging held a 
hearing entitled ``No Guarantees: As Pension Plans Crumble, Can 
PBGC Deliver,'' to consider whether the federal government's 
Pension Benefit Guaranty Corporation (PBGC) has the capability 
to fulfill its mission to insure the pensions of nearly 44 
million Americans, at a time when several of the country's 
largest automobile companies are teetering on the edge of 
bankruptcy. The question of PBGC's governance came amidst 
allegations of mismanagement by the agency's former director, 
Charles E.F. Millard, who deviated from PBGC's conservative 
investment strategy just before the market downturn. In 
addition, the PBGC Inspector General alleged that Millard 
improperly influenced the procurement process surrounding the 
restructure of the Corporation's investments. The Committee 
heard testimony from: Dallas L. Salisbury, President and CEO, 
Employee Benefits Research Institute; Barbara Bovbjerg, 
Director, Education, Workforce and Income Security, U.S. 
Government Accountability Office; Rebecca Anne Batts, Inspector 
General, Pension Benefit Guaranty Corporation; Vincent 
Snowbarger, Acting Director, Pension Benefit Guaranty 
Corporation; and Charles E.F. Millard, Former Director, Pension 
Benefit Guaranty Corporation.
Legislative Action:
        Strengthening the Pension Benefit Guaranty 
        Corporation's Governance Structure. In May 2009, PBGC 
        reported an accumulated deficit of about $33.5 billion. 
        Moreover, the hearing revealed that the PBGC Board of 
        Directors had not met since February 2008 despite the 
        economic downturn, and that PBGC lacked certain 
        procurement safeguards. On the basis of the Committee's 
        findings, Senators Herb Kohl (D-WI), Russ Feingold (D-
        WI), Claire McCaskill (D-MO), and Michael Bennet (D-CO) 
        introduced S.1544, which expands and strengthens PBGC 
        governance and oversight, in part, by expanding the 
        PBGC's board of directors, redefining the Inspector 
        General's reporting structure, and adding additional 
        procurement safeguards.

            AGING COMMITTEE MAJORITY STAFF INFORMATION PAPER

                              ----------                              

Executive Summary
    Target date retirement funds--also referred to as lifecycle 
funds--are a type of mutual fund that automatically rebalances 
to a more conservative asset allocation as the participant 
approaches their retirement target date. These funds offer 
investors certain advantages generally not offered by other 
types of investment vehicles by purporting to offer 
participants a beneficial long-term asset allocation strategy, 
while lowering financial risk as participants approach 
retirement. Since the Department of Labor designated target 
date funds as an appropriate investment default option in 
response to the enactment of the Pension Protection Act of 
2006, more than $140 billion in net monies have entered into 
target date funds, and 96 percent of plans that offer automatic 
enrollment policies are using target date funds.
    Although target date funds have proved popular with 
participants and have won the approval of many investment 
professionals, the losses suffered by target date funds during 
the economic downturn raised concerns about the design and 
transparency of these funds. For example, an Aging Committee 
investigation found that the allocation of assets among stocks, 
bonds, cash-equivalents varied greatly among target date funds 
with the same target retirement date, with select firms' 2010 
target date funds' equity holdings ranging anywhere from 24 to 
68 percent. It was also unclear to what extent plan sponsors 
educate their participants on these funds, as well as how 
fiduciary standards would be enforced.
    In response to the Aging Committee's concerns, officials 
from the Department of Labor's Employee Benefit Security 
Administration (EBSA) and the Securities and Exchange 
Commission (SEC) held a joint hearing on June 18, 2009, to hear 
testimony on the investment of 401(k) and other retirement 
plans in target date type plans in an effort to determine the 
need for additional guidance. Witnesses at the hearing 
addressed how target date fund managers determine asset 
allocations and changes to asset allocation; how they select 
and monitor underlying investments; the extent to which the 
foregoing, and related risks, are disclosed to investors and 
the adequacy of that disclosure; and the approaches or factors 
to compare and evaluate target date funds. At the time of this 
writing, EBSA and SEC were continuing to coordinate and 
evaluate what steps should be taken to address target date 
funds, specifically for those funds used as default options and 
directed at a less financially-sophisticated participant.
Introduction
    Since they were first introduced several decades ago, 
401(k) plans have become the principal retirement savings 
vehicle for millions of U.S. workers. According to the Bureau 
of Labor Statistics, 51 percent of workers in the private 
sector participated in an employer-sponsored retirement plan of 
some kind in 2007.\1\ Only 20 percent of all private-sector 
workers were covered by traditional pensions--also called 
defined benefit or ``DB'' plans--whereas 43 percent 
participated in 401(k) plans and other defined contribution 
plans (DC).\2\ Twelve percent of workers participated in both 
types of plans.\3\
---------------------------------------------------------------------------
    \1\ Patrick Purcell and John Topoleski, 401(k) Plans and Retirement 
Savings: Issues for Congress, R40707, Congressional Research Service, 
July 14, 2009.
    \2\ Employers may sponsor defined benefit (DB) or defined 
contribution (DC) plans for their employees. DB plans promise to 
provide a benefit that is generally based on an employee's years of 
service and salary. (See 29 U.S.C.  1002(35).) DB plans use a formula 
to determine the ultimate pension benefit participants are entitled to 
receive. Moreover, an employer bears the investment risk, and must 
ensure that the pension plan has sufficient assets to pay the benefits 
promised to workers and their surviving dependents. Under a DC plan, 
such as a 401(k) plan, employees have individual accounts to which the 
employee, employer, or both make contributions, and benefits are based 
on contributions, along with investment returns (gains and losses) on 
the accounts. (See U.S.C.  1002(34).) Not all DC plans are 401(k) 
plans, but 401(k) plans hold about 67 percent of DC plan assets. Other 
DC plans include 403(b) plans for non-profit employers, 457 plans for 
state and local governments, and miscellaneous other DC plans. 
Increasingly, 403(b) plans and 457 plans operate similarly to 401(k) 
plans. In this report the terms ``401(k)'' plan and ``defined 
contribution'' plan are used interchangeably unless a distinction is 
noted in the text.
    \3\ U.S. Department of Labor, Bureau of Labor Statistics, National 
Compensation Survey: Employee Benefits in Private Industry in the 
United States, March 2007, Summary 07-05, August 2007. The sample 
represented 108 million workers.
---------------------------------------------------------------------------
    Unlike employees with more traditional defined benefit 
pensions, most employees with defined contribution plans--such 
as 401(k) plans--choose to participate in their employer's 
plans and generally decide the amount they want to contribute 
and how to invest it. Thus, they bear the responsibility for 
funding and managing their investments in a way that seeks to 
achieve sufficient benefits in retirement. The worker's account 
balance at retirement will depend on how much the individual 
contributed to the plan over the years and on the performance 
of the assets in which the plan is invested.
    The majority of assets held in DC plans are invested in 
stocks and stock mutual funds, and as a result, the decline in 
the major stock market indices in 2008 greatly reduced the 
value of many families' retirement savings.\4\ According to the 
Federal Reserve Board, assets held in DC plans fell from $3.73 
trillion at year-end 2007 to $2.66 trillion at year-end 2008, a 
decline of 28.7 percent.\5\ The decline would have been even 
greater if not for ongoing contributions to the plans by 
workers and employers. Furthermore, the rise in unemployment 
resulting from the downturn has had a detrimental impact on 
retirement savings, due to participants' need to use their 
accrued retirement savings. The removal of retirement savings 
prior to retirement--a phenomenon referred to as leakage--can 
affect a participants ultimate preparedness for retirement, 
especially when the funds are removed and not replaced.
---------------------------------------------------------------------------
    \4\  On October 11, 2007, the Standard & Poor's 500 Index of common 
stocks reached an intra-day high of 1,576, an all time record for the 
index. On March 6, 2009, the S&P 500 fell to an intra-day low of 667, a 
decline of 57.7 percent from its all-time high. Over the next three 
months, stock prices climbed 41 percent. The S&P 500 closed at a value 
of 943 on June 1, 2009. This was 40 percent lower than the index's 
highest level in October 2007. By July 7, the S&P 500 had fallen to 
881.
    \5\ Board of Governors of the Federal Reserve System, Flow of Funds 
Accounts of the United States: Flows and Outstandings, Fourth Quarter 
2008, March 12, 2009, p. 113.
---------------------------------------------------------------------------
    The economic downturn has shed light on concerns affecting 
the retirement system in the United States. This report 
highlights issues specifically related to the composition and 
use of target date retirement funds. The following information 
presented in this report is based on an Aging Committee 
investigation, government reports, literature reviews, 
interviews with financial experts and government officials, and 
industry analyses. As part of this review, the Aging Committee 
also collected and reviewed information on EBSA's enforcement 
practices to determine the extent to which EBSA focuses on 
target date funds' composition and transparency. The Aging 
Committee also reviewed information highlighting the Securities 
and Exchange Commission compliance and enforcement efforts 
related to target date funds.
Background
    Private-sector pension plans are generally classified 
either as defined benefit or as defined contribution plans. 
Defined benefit plans generally offer a fixed level of monthly 
retirement income based upon a participant's salary, years of 
service, and age at retirement, regardless of how the plan's 
investments perform. In contrast, defined contribution plans, 
such as 401(k) plans, benefit levels depend on the 
contributions made to the plan and the performance of the 
investments in individual accounts, which may fluctuate in 
value. Named after section 401(k) of the Internal Revenue Code, 
traditional 401(k) plans allow workers to save for retirement 
by diverting a portion of their pretax income into an 
investment account that can grow tax-free and be withdrawn 
without penalty after age 59\1/2\.\6\
---------------------------------------------------------------------------
    \6\ The Internal Revenue Code, as amended, exempts certain early 
distributions from the penalty if the distributions are made to a 
beneficiary or estate on or after death; made on account of total and 
permanent disability; made as part of a series of substantially equal 
periodic payments over the life expectancy of the owner or life 
expectancies of the owner and the beneficiary; equal to or less than 
deductible medical expenses (7.5 percent of adjusted gross income); 
made due to an IRS levy of the plan; made to individuals called to 
active duty after September 11, 2001, and before December 31, 2007; 
made to a participant after separated from service with an employer in 
or after the year that he or she reaches age 55; made to an alternate 
payee under a qualified domestic relations order; dividends from 
employee stock ownership plans; or made to an individual whose main 
home was located in a designated hurricane disaster area and who 
sustained an economic loss by reason of the hurricane. Additionally, 
some plan sponsors offer Roth 401(k) plans that allow plan participants 
to make elective after-tax contributions through payroll deduction. 
403(b) plans are similar to 401(k) plans, in that they typically permit 
both sponsors and participants to make pre-tax contributions, but are 
designed for public education entities and tax-exempt organizations 
that operate under I.R.C.  501(c)(3). Participants in these plans are 
generally limited to investing in annuity contracts issued by insurance 
companies and custodial accounts invested in mututal funds.
---------------------------------------------------------------------------
    Employers and employees may make pretax contributions, up 
to certain limits, to individual participant accounts. In 2009, 
participants may contribute up to $16,500 per year. The 401(k) 
account balance is a function of both the contributions made to 
the accounts over a career as well as the investment 
performance of the account. About one-half of all U.S. workers 
participate in some form of employer-sponsored retirement plan. 
Participation in 401(k) plans rose steadily from fewer than 8 
million participants in the mid-1980s to over 70 million 
participants in 2006--the most recent year for which data were 
available. The assets in 401(k) plans also increased 
significantly over the same time period, from less than $100 
billion to over $3 trillion.\7\ Current law limits participant 
access to their retirement savings in their employer-sponsored 
retirement plans so that the favorable tax treatment for 
retirement savings is limited to savings that are, in fact, 
used to provide retirement income. Only under certain 
circumstances do federal regulations allow 401(k) plan sponsors 
to provide participants with access to their tax-deferred 
retirement savings before retirement.
---------------------------------------------------------------------------
    \7\ For 2006 estimates, see Investment Company Institute, ``The 
U.S. Retirement Market, 2007,'' Research Fundamentals, vol. 17, no. 3 
(2008).
---------------------------------------------------------------------------
    The Internal Revenue Service (IRS), within the Department 
of the Treasury, and EBSA are primarily responsible for 
enforcing laws that govern defined contribution plans. IRS 
interprets and enforces provisions of the Internal Revenue Code 
that apply to tax-qualified pension plans. EBSA enforces the 
Employee Retirement Income Security Act of 1974's (ERISA) 
reporting and disclosure provisions and fiduciary 
responsibility which, among other things, concern the type and 
extent of information provided to plan participants. In 
addition, the SEC is responsible under federal securities laws 
for regulating and examining entities registered with SEC, such 
as investment advisors, managers, and investment companies that 
often provide services to pension plans. While the SEC does not 
draw authority from ERISA, the SEC coordinates with EBSA for 
consultation and exchange of information as directed by a 
Memorandum of Understanding signed in July 2008.\8\
---------------------------------------------------------------------------
    \8\ Department of Labor and the U.S. Securities and Exchange 
Commission. Memorandum of Understanding Concerning Cooperation between 
the U.S. Securities and Exchange Commission and the U.S. Department of 
Labor, July 29, 2008.
---------------------------------------------------------------------------
Pension Protection Act of 2006 Encourages Automatic Enrollment Policies
    To encourage retirement savings, Congress enacted the 
Pension Protection Act of 2006 (PPA), which, in part, removed 
impediments to employers adopting automatic enrollment 
policies, including exemptions from legal liability for market 
fluctuations. In encouraging employers to adopt automatic 
enrollment, PPA directed the Department of Labor to assist 
employers in selecting ``default investments'' that best serve 
the retirement needs of workers who do not direct their own 
investments.
    DOL's final regulation provided safe harbor relief from 
fiduciary liability for investment outcomes if employers met 
certain criteria, one of which being that assets must be 
invested in a ``qualified default investment alternative'' 
(QDIA) as defined in the regulation.\9\ However, it does not 
identify specific investment products. Rather, the regulation 
describes mechanisms for investing participant contributions. 
DOL noted that the intent is to ensure that an investment 
qualifying as a QDIA is appropriate as a single investment 
capable of meeting a worker's long-term retirement savings 
needs. The regulation also states that a QDIA must be managed 
by either an investment manager, plan trustee, plan sponsor or 
a committee comprised primarily of employees of the plan 
sponsor that is a named fiduciary, or be an investment company 
registered under the Investment Company Act of 1940.
---------------------------------------------------------------------------
    \9\ 29 CFR Part 2550; RIN 1210-AB10; Default Investment 
Alternatives under Participant Directed Individual Account Plans, 
Federal Register / Vol. 73, No. 84 / Wednesday, April 30, 2008. The 
final regulation provides for four types of QDIAs: 1) a product with a 
mix of investments that takes into account the individual's age or 
retirement date (an example of such a product could be a lifecycle or 
targeted-retirement-date fund); 2) an investment service that allocates 
contributions among existing plan options to provide an asset mix that 
takes into account the individual's age or retirement date (an example 
of such a service could be a professionally-managed account); 3) a 
product with a mix of investments that takes into account the 
characteristics of the group of employees as a whole, rather than each 
individual (an example of such a product could be a balanced fund); and 
4) a capital preservation product for only the first 120 days of 
participation (an option for plan sponsors wishing to simplify 
administration if workers opt-out of participation before incurring an 
additional tax). A QDIA generally may not invest participant 
contributions in employer securities.
---------------------------------------------------------------------------
    One of the product mechanisms DOL elected as a QDIA was the 
target date fund--also referred to as lifecycle funds--a type 
of mutual fund that automatically rebalances its asset 
allocation following a predetermined pattern over time to a 
more conservative asset allocation as the participant's target 
date for retirement approaches. As the participant nears 
retirement age, the investment allocation is shifted away from 
higher-risk investments, such as stocks, and moved toward 
lower-risk investments, such as bonds and cash equivalents. The 
asset allocation path that changes over time is known as the 
glide path, which is based on the number of years to and beyond 
the target date. A target date fund is a lifecycle fund 
designed to achieve a particular (generally conservative) mix 
of assets at a specific date in the future, which is usually 
the year when the participant expects to retire. These funds 
are named accordingly (e.g. 2010 Target date Fund).
Automatic Enrollment Has Grown Considerably With Plans Overwhelmingly 
        Adopting Target date Funds as Default Investment
    According to the U.S. Government Accountability Office 
(GAO), defined contribution plan sponsors are increasingly 
adopting automatic enrollment policy plans (in which workers 
``opt-out'' of plan participation rather than ``opt-in'') to 
encourage their employees to save for retirement.\10\ Available 
data indicate that plans with automatic enrollment policies are 
overwhelmingly adopting target date funds as their default 
investment. For example, 87 percent of Vanguard group plans 
with automatic enrollment had target date funds as a default 
investment at the end of 2008, compared to 42 percent in 
2005.\11\ (See table 1.)
---------------------------------------------------------------------------
    \10\ Automatic enrollment is a practice where an employer enrolls 
eligible employees in a plan and begins participant deferrals without 
requiring the employees to submit a salary deferral request.
    \11\ GAO, RETIREMENT SAVINGS: Automatic Enrollment Shows Promise 
for Some Workers, but Proposals to Broaden Retirement Savings for Other 
Workers Could Face Challenges, GAO-10-31. (Washington, D.C.: October 
2009).
[GRAPHIC] [TIFF OMITTED] T3067.001

    Conversely, the use of balanced funds, money market funds, 
and stable value funds default investments have declined 
significantly.\12\ GAO stated that this trend toward target 
date funds as a default investment vehicle is corroborated by 
data from Fidelity investments, which showed that, as of March 
2009, 96 percent of plans with an automatic enrollment policy 
used target date funds, up from 57 percent at the end of 2005.
---------------------------------------------------------------------------
    \12\ Both money market and stable value funds were often used as 
default investment before PPA because employers were concerned about 
legal liability investments they had chosen declined in value as a 
result of market fluctuations. As a as result, they invested workers' 
contribution in such low risk, low-return default investments.
---------------------------------------------------------------------------
    In addition, the Employee Benefit Research Institute (EBRI) 
reported in March 2009 that workers who were considered to be 
automatically enrolled in a 401(k) plan were more likely to 
invest all their assets in a target date fund. The study 
indicated that except for participants in the largest plans 
(more than 10,000 participants), more than 90 percent of those 
automatically enrolled into target date funds had all of their 
allocation in target date funds.\13\ Most recently, EBRI 
reported that for year-end 2008, nearly seven percent of 401(k) 
assets in plans they reviewed were invested in lifecycle 
funds.\14\ Moreover, EBRI reported that almost 44 percent of 
participants under age 30 had assets in a target date fund.\15\
---------------------------------------------------------------------------
    \13\ Craig Copeland, Use of Target date Funds in 401(k) Plans, 
2007, Issue Brief 327, Employee Benefit Research Institute, 
(Washington, D.C.: March 2009). EBRI's analysis was based on 
information maintained by the Employee Research Institute/Investment 
Company Institute database.
    \14\ Jack VanDerhei, EBRI; Sarah Holden, ICI; and Luis Alonso, 
EBRI; 401(k) Plans Asset Allocation, Account Balances, and Loan 
Activity in 2008, Issue Brief No. 335, Employee Benefit Research 
Institute, (Washington, D.C.: October 2009).
    \15\ EBRI, Issue Brief 327.
---------------------------------------------------------------------------
    The research firm Morningstar, Inc. also noted in September 
2009 that the popularity of target date funds remained 
relatively unaffected by the recent economic downturn. They 
suggest that cash flows were on track to set a record, 
accumulating at an annualized rate of $60 billion over the 
first seven months of the year. In total, more than $140 
billion in net monies have entered into the target date funds 
since the start of 2007, according to the firm.\16\
---------------------------------------------------------------------------
    \16\ Morningstar, Inc. Target date Series Research Paper: 2009 
Industry Survey. September 9, 2009.
---------------------------------------------------------------------------
Although Popular Investment Tools, Design and Transparency of Target 
        date Funds Raise Concerns
    Although target date funds have proved popular with 
participants and have won the approval of many investment 
professionals, the losses suffered by target date funds during 
the economic downturn raised concerns about the design and 
transparency of these funds. In early 2009, the Aging Committee 
conducted an investigation of these funds, which revealed that 
the date in the name of the target date fund was not consistent 
with the design of the fund, making these funds difficult for 
investors to evaluate and compare. In fact, the Aging Committee 
found that allocation of assets among stocks, bonds, cash-
equivalents varies greatly among target date funds with the 
same target retirement date, with firms' 2010 target date 
funds' equity holdings ranging anywhere from 24 to 68 percent. 
(The Aging Committee's review of select, large 2010 target date 
funds found that many funds had equities exposure at or well 
over 50 percent.) Since that time, a study by the investment 
research firm, Morningstar, Inc., corroborated the Aging 
Committee's findings, noting that among target date 2010 funds, 
stock allocations ranged from 26 percent of assets to 72 
percent of assets.\17\ As a comparison, in January, 2009, the 
Thrift Savings Plan's ``L2010 Fund'' for federal employees who 
plan to retire in 2010 held 70 percent of its assets in bonds 
and 30 percent in stocks.\18\ Similarly, the Dow Jones Target 
Date Indexes propose that a fund's asset class allocation 
should have an equities exposure of approximately 28 percent at 
the target date.\19\ In December 2008, the average 2010 fund 
had more than 45 percent of its assets invested in stocks.\20\
---------------------------------------------------------------------------
    \17\ Morningstar, Inc. Target date Series Research Paper: 2009 
Industry Survey. September 9, 2009.
    \18\ CRS, R40707.
    \19\ According to Dow Jones over the life of each target index the 
relative risk of the index will range from a more aggressive portfolio 
that incurs approximately 90 percent of the risk of the composite stock 
market index (Stock CMAC) in the beginning to a conservative portfolio 
that incurs approximately 20 percent of the risk of the stock CMAC 10 
years after the index reaches its ``target date''. The Dow Jones 
``Today'' Index aims to hold risk constant at 20 percent of the risk of 
the stock CMAC and is a benchmark for a conservative, balanced 
portfolio an investor might hold 10 years after reaching retirement.
    \20\ Patrick Purcell and John Topoleski, 401(k) Plans and 
Retirement Savings: Issues for Congress, R40707, Congressional Research 
Service, July 14, 2009.
---------------------------------------------------------------------------
    Fund performance also varied greatly during the bear market 
of 2008. The S&P Target date 2010 Index Fund, a benchmark of 
fund performance, fell 17 percent in 2008. The fund holds 60 
percent of its assets in bonds and other fixed-income 
securities and 40 percent in equities. The Deutsche Bank DWS 
Target 2010 Fund fell just 4 percent in 2008, whereas 
Oppenheimer's Transition 2010 fund fell 41 percent. For the 
federal Thrift Savings Plans, shares of the ``L2010 Fund'' fell 
10.5 percent in 2008.
    Because of the losses resulting from the financial 
downturn, industry experts have raised concerns about 
investors' understating of the construction of the glide path 
and its effect on the funds asset allocation. There are varying 
opinions on whether a target date fund is designed to terminate 
at the time of retirement or is intended to account for a 
participant's post-retirement needs. Documentation provided to 
the Aging Committee by select firms indicated that many of 
these funds were designed to take into account and mitigate (1) 
market risk, (2) longevity risk, and (3) inflation risk.\21\ 
Many of the firms' materials suggested that these funds were 
not intended for a participant to cash out their retirement 
savings at the projected retirement date. Instead, the funds 
were designed to provide income for the years during retirement 
as well. However, it is unclear whether participants were aware 
of this plan design.
---------------------------------------------------------------------------
    \21\ Market risk is the risk of adverse market movements. Longevity 
risk is the risk of outliving one's savings. Inflation risk is the risk 
that inflation can eat away at the purchasing power of accumulated 
savings possibly very rapidly.
---------------------------------------------------------------------------
    While there are valid arguments to support different 
approaches to constructing a glide path, individuals' behavior 
at retirement may minimize certain financial risks. According 
to recent research, it is common for an individual to take a 
lump-sum distribution of their assets at the time of 
retirement. For example, a study by the Vanguard Center for 
Retirement Research estimated in that 2008 about half of 
retired households between the ages of 55 to 75 tapped into 
their long-term accounts, typically as a large, one-time 
withdrawal generally to address living expenses. Only two out 
of ten households spent down their accounts on some type of 
systematic or regular income payment program.\22\ Moreover, a 
survey conducted by Investment Company Institute found that 54 
percent of respondents took some or all of their balance as a 
lump-sum distribution, and of those respondents, 86 percent 
rolled over some or all of the balance to an Individual 
Retirement Account or otherwise reinvested the assets. The 
remaining 14 percent spent all the proceeds of the 
distribution.\23\ Because many participants take such 
withdrawals, the need for a more aggressive asset allocation to 
manage for risks like longevity may be minimized, because 
participants' often do not maintain their assets in their 
target date fund throughout their retirement. Therefore, 
participants--especially those who are less sophisticated and 
defaulted into these funds--may lock in large losses such as 
those experienced in 2008.
---------------------------------------------------------------------------
    \22\ Gary R. Mottola and Stephen P. Utkus, Vanguard Center for 
Retirement Research, Spending the Nest Egg: Retirement Income decisions 
among older investors, Volume 35, October 2008. The results in this 
report are based on a national online panel survey of older Americans, 
age 55-75, with $50,000 or more of accumulated financial assets. A 
total of 1,478 respondents participated in the survey, which was 
conducted in May 2008.
    \23\ Investment Company Institute. 2009 Investment Company Fact 
Book: A Review of Trends and Activity in the Investment Company 
Industry, 49th Edition, 2009.
---------------------------------------------------------------------------
    In addition to potential design weaknesses and participant 
misunderstandings, the fees associated with target date funds--
as well as all 401(k) plans--can have a significant impact on 
the amount of income saved for retirement. For example, a 1-
percentage point difference in fees can signicantly reduce the 
amount of money saved for retirement. Assume an employee of 45 
years of age with 20 years until retirement changes employers 
and leaves $20,000 in a 401(k) account until retirement. If the 
average annual net return is 6.5 percent--a 7 percent 
investment return minus a 0.5 percent charge for fees--the 
$20,000 will grow to about $70,500 at retirement. However, if 
fees are instead 1.5 percent annually, the average net return 
is reduced to 5.5 percent, and the $20,000 will grow to only 
about $58,400. The additional 1 percent annual charge for fees 
would reduce the account balance at retirement by about 17 
percent.
    According to a September 2009 report by Morningstar, Inc., 
the average expense ratios vary widely,\24\ ranging from 0.19 
percent to 1.82 percent, a difference of 163 basis points.\25\ 
(See table 2.) The research firm noted that more than half the 
target date fund industry has annual expense ratios exceeding 1 
percent.\26\ However, Morningstar indicated that target date 
fund expense ratios will more than likely decline in the coming 
years, in part, due to the wide price gap between funds.
---------------------------------------------------------------------------
    \24\ Expense ratios are fees and expenses incurred by mutual fund 
investors, such as the management fee (the amount the fund's investment 
adviser charges for managing the fund), the fund's other operating 
expenses (such as fund accounting or mailing expenses).
    \25\ A basis point is a unit that is equal to 1/100th of 1 percent, 
and is used to denote the change in a financial instrument. For 
example, 1 percent change = 100 basis points, and 0.01 percent = 1 
basis point. The basis point is commonly used for calculating changes 
in interest rates, equity indexes and the yield of a fixed-income 
security.
    \26\ Morningstar, Inc. Target date Series Research Paper: 2009 
Industry Survey. September 9, 2009.
[GRAPHIC] [TIFF OMITTED] T3067.002

    BrightScope, Inc. also found that target date funds have 
higher expense ratios than the rest of the core portfolio in 
401(k) plans. Their data assessment suggest that target date 
funds have internal fees that are between 10 to 25 percent more 
expensive than other funds on the core menu, which they suggest 
may be partially explained by management overlay fees--
management fees layered on top of the underlying funds' expense 
ratio.\27\ (See fig. 1.)
---------------------------------------------------------------------------
    \27\ BrightScope, Inc. is an independent provider of 401(k) ratings 
and financial intelligence to plan sponsors, advisors, and participants 
in all 50 states. BrightScope's data is based on investment menus for 
6,978 small plans, 4,201 mid-sized plans and 1,667 large plans.
[GRAPHIC] [TIFF OMITTED] T3067.003

    In addition to varying expense ratios within target date 
funds, pension plan service providers or the various outside 
companies may also charge fees which are deducted from an 
individual's savings. These fees for services are either 
``bundled'' or ``unbundled.'' Bundled providers are typically 
large financial services companies whose primary business is 
selling investments. They bundle their proprietary investment 
products with affiliate-provided plan services into a package 
that is sold to plan sponsors. In contrast, unbundled or 
independent providers are primarily in the business of offering 
administrative services with a ``universe'' of unaffiliated, 
non-proprietary investment options. Bundled providers disclose 
the cost of the investments to the plan sponsor, but do not 
disaggregate the costs of the administrative services, whereas 
unbundled providers disclose both since the costs are paid to 
different providers. According to a House Committee on 
Education and Labor report, many participants do not have a 
clear understanding of fees and expenses charged by service 
providers.\28\ In fact, some of the fees are not even known to 
the plan sponsor because they are directly paid by service 
providers.\29\
---------------------------------------------------------------------------
    \28\ 401(k) Fair Disclosure and Pension Security Act of 2009, Mr. 
George Miller of California, from the Committee on Education and Labor, 
U.S. House of Representatives, Report together with Minority Views [To 
accompany H.R. 2989] Report 111-244, Part 1. July 31, 2009.
    \29\ In an effort to increase fee transparency, Sens. Tom Harkin 
(D-IA) and Herb Kohl (D-WI) in the 11th Congress, introduced S. 401, 
the Defined Contribution Fee Disclosure Act, to amend ERISA to require 
the disclosure of fees to both plan sponsors and participants. In 
addition, Rep. George Miller (D-CA, 7th Congressional District) 
introduced H.R. 1984, the 401(k) Fair Disclosure for Retirement 
Security Act. 
---------------------------------------------------------------------------
    While target date funds that are mutual funds include 
several layers of investor safeguards--such as regulatory and 
disclosure requirements under the federal securities laws--
mutual fund companies that offer target date funds are not 
subject to the fiduciary requirements of ERISA. Rather, a 
plan's fiduciary--usually the employer who sponsors the plan--
selects and monitors target date funds for use in the plan's 
investment lineup. However, plans sponsors generally do not 
have a choice in selecting the underlying funds, and instead 
must choose from a portfolio of propriety funds typically 
constructed by the firm. In fact, nearly 92 percent of 
companies offering target date funds used a packaged product, 
according to a survey from the Profit Sharing/401(k) Council of 
America. As a result, some investment firms may include low 
performing funds in their portfolio in an effort to garner more 
assets.
    Under ERISA, mutual fund companies are generally not 
subject to fiduciary rules since mutual funds are regulated by 
the Investment Company Act of 1940. However, in March 2009, 
Avatar Associates, an investment manager, suggested in a letter 
to the Department of Labor that mutual funds that offer a 
target date fund should be subject to ERISA. In its request for 
an advisory opinion, Avatar argued that ERISA never expressly 
addressed whether mutual fund companies that use proprietary 
funds to create target date funds and other fund-to-funds 
accounts should be exempt from ERISA's fiduciary obligation. 
Moreover, Avatar suggested that there is an embedded conflict 
of interest when mutual funds include their own proprietary 
funds in their target date funds, noting concerns of self-
dealing.\30\ At the time of this writing, DOL was reviewing the 
merits of Avatar's request.
---------------------------------------------------------------------------
    \30\ Self-dealing is a form of conflict of interest that involves 
the conduct of a trustee, an attorney, or other fiduciary that takes 
advantage of his or her position in a transaction and acting for his or 
her own interests rather than for the interests of the beneficiaries of 
the trust or the interests of his or her clients.
---------------------------------------------------------------------------
Agencies Taking Steps to Evaluate Target date Fund Concerns
    On the basis of the Aging Committee's findings, Chairman 
Kohl requested that Secretary of Labor Hilda Solis and 
Chairwoman Mary Schapiro of the Securities and Exchange 
Commission direct their agencies to take action to review the 
design, composition, and disclosures associated with target 
date funds.\31\ In response to the Aging Committee's concerns, 
EBSA and SEC held a joint hearing on June 18, 2009, to hear 
testimony on the investment of 401(k) and other retirement 
plans in target date type plans to determine the need for 
additional guidance. Witnesses at the hearing addressed how 
target date fund managers determine asset allocations and 
changes to asset allocation; how they select and monitor 
underlying investments; the extent to which the related risks 
are disclosed to investors and the adequacy of that disclosure; 
and the approaches or factors to compare and evaluate target 
date funds.
---------------------------------------------------------------------------
    \31\ U.S. Senate Special Committee on Aging. See http://
aging.senate.gov/letters/targetdatedol.pdf and http://aging.senate.gov/
letters/targetdatesec.pdf.
---------------------------------------------------------------------------
    Prior to the June 2009 hearing, the ERISA Advisory Council 
studied the issues related to target date funds and concluded 
that the Department of Labor should provide more specific 
guidance as to the complex nature of target date funds and the 
methodology necessary for plan fiduciaries who are responsible 
for selecting and monitoring these funds as a prudent 
investment alternative in a defined contribution plan. The 
Council also recommended that DOL should develop participant 
education materials and illustrations to enhance awareness of 
the value and the risks associated with these funds.
    At the time of this writing, EBSA and SEC were continuing 
to coordinate and evaluate what steps should be taken to 
address the differences and risks associated with target date 
funds, specifically for those funds used as default options and 
directed at a less financially sophisticated participant.
Conclusion
    Automatic enrollment of workers in 401(k) plans has proven 
to be an effective means of increasing plan participation 
rates. Because such policies are being increasingly adopted by 
defined contribution plan sponsors in the wake of the Pension 
Protection Act of 2006, many additional workers will be brought 
into plans that might not otherwise have participated, and will 
be defaulted into target date retirement funds. Despite the 
potential for increasing savings, several of the concerns with 
target date funds mentioned in this report--including plan 
design and transparency--have led plan sponsors and 
participants to misunderstand these products, and in some cases 
suffer large losses. Moreover, it is vital that action be taken 
to ensure that the fees associated with certain target date 
funds are disclosed, as well as steps to clarify the fiduciary 
responsibility of not only plan sponsors, but also those 
companies that construct these funds.
    As the Aging Committee explores ways to strengthen target 
date funds, additional questions should be explored to 
determine the merits of qualified default investment 
alternatives. Therefore, in August 2009, Chairman Kohl 
requested that the GAO review the appropriateness of the funds 
classified as QDIAs, including target date funds and suggest 
measures to increase transparency.
    The Aging Committee anticipates GAO will release a report 
addressing these questions in the fall of 2010.

                            ACKNOWLEDGMENTS

                              ----------                              

    The Aging Committee would like to thank the following 
individuals for their research and technical assistance:
    Ryan Alfred, BrightScope, Inc.
    Mike Alfred, BrightScope, Inc.
    Michael Hartnett, Senior Analyst, U.S. Government 
Accountability Office
    David Lehrer, Assistant Director, U.S. Government 
Accountability Office
    Jonathan McMurray, Senior Analyst, U.S. Government 
Accountability Office
    Patrick Purcell, Specialist in Income Security, 
Congressional Research Service
    John Rekenthaler, Vice President of Research, Morningstar, 
Inc.
    Dallas Salisbury, Chief Executive Officer, Employee Benefit 
Retirement Institute
    John J. Topoleski, Analyst in Income Security, 
Congressional Research Service