Role of Target-Date Funds Within Hybrid-Defined Contribution Plans

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Target-Date Funds

Role of Target-Date Funds Within Hybrid-Defined Contribution Plans

David Dierking Jan 02, 2018

While TDFs work out well as qualified default investments in these plans, they still lack a personal touch when it comes to an individual investor’s needs and objectives. This article explores how a TDF in combination with an individually managed account might produce superior risk-adjusted returns.

Click here to help better understand the importance of how your TDF’s allocation changes over time.

The Role of QDIAs With Defined Contribution Plans

The Pension Protection Act of 2006 stipulates that a QDIA can be a target-date fund, balanced or individually managed account, although TDFs are the most popular choice by far. This is mainly due to TDFs changing their asset allocations to become more conservative as retirement approaches, but consideration must be given to the fact that investor assets must be managed not just to retirement, but through retirement.

To learn more about how customized target-date funds can be advantageous, click here.

How to Construct Your Own Hybrid QDIA

This type of setup could take a few different forms. It could be age-based, where an investor could use a TDF in the early years and switch over, either partially or totally, to a managed account once a certain age is reached. It could also be asset-based, where once an account has accumulated enough assets to meet anticipated retirement needs, a managed account would be used to help keep things on track from there. It’s the combination of a low-cost, risk-appropriate investment option with individualized attention that could reap the greatest benefits.

To learn more about target-date funds, in general, check out our Target-Date Funds section.

Considerations for a Target-Date Fund/Managed Account Combination

In addition, the hybrid QDIA can be used successfully by investors at any point in the life cycle. Early stage investors get invested in a low-cost, broadly diversified portfolio. Near-retirees can use the managed account aspect to ensure that their accumulated wealth will meet their retirement needs. Retirees received individualized attention to make sure that all personal financial needs are being addressed.

One challenge of setting up a hybrid QDIA is that, for most, it won’t be a viable option as managed accounts have been adopted by fewer than 10% of plan sponsors. Investor engagement will be key in the success of any hybrid QDIA. If a lack of engagement is what led to selecting a TDF in the first place, investors might fail to leverage the full advantages of an individually managed account.

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