Monday, February 28, 2011

If Not Target Date, Then What?

Last week, I wrote about a major problem with Target Date Funds (TDFs). I suggested that for many people, the targeting, and therefore the asset allocation, is incorrect. So, what would make it better?

The short answer, in my opinion, is that workers need to defer more income. And, the government needs to abet this process. Under current law, many individuals are limited in the amounts they can defer to a 401(k) plan. This occurs for one of a number of reasons:

  • An individual bumps up against the statutory deferral limit of $16,500 ($22,000 including catch-up for those who will attain age 50 or older in that year)
  • An individual bumps upon against a plan limit (usually put in place to assist in passing ADP and ACP testing (nondiscrimination testing for 401(k) plans))
  • An individual defers as much money as the plan allows (or some other significant amount) and the plan is not able to pass ADP testing, so amounts are refunded
Those three reasons usually relate to higher paid people. For the lower-paid, they often cannot afford to defer enough.

I suggest that unless Congress (and the President) do something to both promote and provide an incentive for employers to sponsor more and more generous retirement plans, then employees need to better understand the plight that they face. Perhaps the government shouldn't build the model (suggesting outsourcing it here), but workers need to better understand how much they really need to save. Individuals need to be able to model their scenarios based on reasonable assumptions. They need to be able to input one-time and limited-time expenses. There should be suggestions as to assumptions with education as to why those assumptions (or range of assumptions) may be appropriate.

Then, perhaps, workers will understand when they will be able to retire. And, then and only then, might TDFs become appropriate as default investments (QDIAs) in 401(k) plans. 

Since ERISA was signed into law in 1974, the federal government, in my opinion, has done everything in its powers to gut the retirement income security system it claimed to be protecting. It's time for them to step up and tell the people how bad they've made it.

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