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Economic and Market Commentary

Coming Next to DC Plans: Personalized Target Date Funds

The leading strategy in defined contribution plans is ripe for a major upgrade.

Summary

Things just got a lot more personal for retirement plans. TDFs are getting an upgrade.

The target date fund (TDF), the investment vehicle at the center of most Americans’ retirement savings plans, is getting an upgrade.

These funds, which dial down riskier allocations over a “glide path” as participants approach retirement, are hugely popular. They offer participants simple, low-cost and relatively easy access to professional and dynamic investment management.

TDFs got a big boost from the Pension Protection Act of 2006, which designated them as a qualified default investment alternative (QDIA). This allowed plan sponsors to auto-enroll employees into TDFs and auto-escalate contribution levels annually.

The result: TDFs attracted more than 60% of 401(k) contributions in 2021, driving up total assets to more than $3.5 trillion, according to Cerulli. They estimate nearly $4 trillion in TDF assets by the end of 2027.

Despite their success, TDFs are ripe for improvement. Today, the only factor used to select a participant’s TDF is the participant’s age. Other parameters – such as salary, wealth, and contribution rates – reflect national averages and don’t represent most individual plan participants accurately.

The next generation of TDFs will consider the unique attributes of each participant – not only age but also their balance, salary, and the percentage of compensation they and their employers contribute to the plan. The goal: an asset allocation better calibrated to the risk and return needs of individual participants.

Improving outcomes

Personalized TDFs are a natural next step for the industry. We believe they blend the best attributes of off-the-shelf and custom TDFs. Personalized TDFs should help improve retirement readiness by better aligning each participant’s unique risk and return objectives in an individualized portfolio. Indeed, PIMCO research shows that for most families, variables such as income and assets have significant asset allocation implications. Systematically incorporating these factors should enhance a dominant component of most Americans’ retirement toolkit.

Easy implementation

For plan sponsors, implementation is painless – it’s as simple as adding a traditional TDF to a plan menu. Benchmarking and due diligence of personalized TDFs are also straightforward because they are built using their corresponding off-the-shelf counterparts as building blocks. Sponsors can use the same benchmarking processes used for evaluating and monitoring traditional TDFs.

The advent of personalized TDFs stems from advances in technology, data, and analytics. Information readily available on recordkeeping platforms drives the personalization. The result is a simple, low-cost and enhanced “personalized” glide path for each DC participant in a plan.

PIMCO is an early mover in the personalized TDF arena, but we expect many in the industry will follow suit.

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