U.S. money and building columns collage Data shows 9 out of 10 sponsors use TDFs as theirQDIA. Are all those sponsors, and the tens of millions of saversinvested in the funds, missing the boat? (Photo:Shutterstock)

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Target-date funds have revolutionized the 401(k) market over thepast decade. With well more than $1 trillion held in mutual funds,and hundreds of billions more in collective investment trusts, TDFsare by far the favored qualified default investment alternative ofplan sponsors large and small. Data from various recordkeepersshows nine out of 10 sponsors use TDFs as their QDIA.

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But are all those sponsors, and the tens of millions of saversinvested in the funds, missing the boat?

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Jason Shapiro, director, investments, at Willis Towers Watson,thinks sponsors and savers have better options than traditionalTDFs. And he says those alternatives are available to all, not justlarge and mega sponsors.

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"We don't want to be prescriptive," said Shapiro. "There are alot of different ways for sponsors to structure plans for an eye tobetter retirement outcomes. But the ideas are out there, and wethink each has merit and can be implemented in most plans."

1. Managed accounts

Shapiro says managed accounts, which use data inputs beyond theage of a participant to create personalized savings strategies, arenow offered in about half of retirement plans.

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But while there has been growth in the offering of managedaccounts, adoption is still low—around 9 percent when plans dooffer them.

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Cost-conscious sponsors may be playing defense in a litigiousworld by defaulting savers into TDFs, and not managed accounts,says Shapiro.

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And some have been critical of managed accounts because thelevel of participant engagement needed to make the model costefficient often isn't there.

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"Adoption is low because sponsors and not defaulting savers intothem—participants have to opt in," said Shapiro. "If you defaultedmore participants in to managed accounts, it could be argued therewould be less engagement overall, and less customization.

2. Hybrid model

Empower and Fidelity are among the record keepers that haverolled out a hybrid QDIA that defaults TDF savers into a managedaccount in their 50s.

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The elevator pitch: the individual gets personalized savingsadvice near and in retirement, when they most need it.

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A paper authored by Shapiro shows the wide disparity ofreturn-seeking assets in TDFs and managed accounts.

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A 55-year old invested in a TDF would hold between 50 percentand 75 percent in return-seeking assets. In the hybrid model, thesame saver could hold between 42 percent and 95 percent inreturn-seeking assets after being routed to a managed account,indicating the higher level of personalization to the individual'sneeds.

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The low engagement knock doesn't apply to the hybrid model, saysShapiro.

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"Savers in their 50s will be more engaged in the customizationof their accounts," he said. "The overall numbers on managedaccount engagement are skewed because they account for all theuniverse of savers—the 28-year old that may not be engaged withtheir account, and the 55-year old that is."

3. The "unwrapped" TDF

The unwrapped TDF—Shapiro says it's a term coined by WillisTowers Watson—allows a sponsor to customize a target date series toits workforce's demographics, but doesn't involve the high costsand in-house labor of customization.

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"There's a level of operational, hands on support needed forcustomization," said Shapiro. "And there are trust and custodycosts. It can cost up to $20,000 to create a new fund, depending onthe asset classes, and for and entire TDF suite, that can mean upto $300,000 in costs. That's why custom TDFs are typically seen inlarger plans."

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But the unwrapped model, which is seen more often in theadvisor-driven small and midsized market, allows sponsors to buildcustom glide paths with a record keeper's model portfolio ormanaged account solutions.

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"It creates an experience for a participant that is very similarto a traditional TDF, but done in a way that is more like a managedaccount," said Shapiro. "It's personalized at the plan level—youget customization along the glide path that you would not get in atraditional TDF. And you avoid the costs of customization."

4. Weaving alternative assets into TDFs

Shapiro recently co-authored a paper exploring the potential ofalternative assets—private equity, hedge funds, and real estateinvestment trusts—to grow retirement income in TDFs.

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The findings were appealing. Diversifying TDFs with alternativesreduced risk considerably, and the median increase in retirementincome was 17 percent.

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Only eight of the 41 TDF managers tracked by Morningstar includealternatives in their funds.

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Others in industry are calling for the type of diversificationin 401(k) plans that is used in public and private pensions.

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But the reality is change won't happen over night. "Seriousinnovation" will be needed from investment providers, saysShapiro.

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Nick Thornton

Nick Thornton is a financial writer covering retirement and health care issues for BenefitsPRO and ALM Media. He greatly enjoys learning from the vast minds in the legal, academic, advisory and money management communities when covering the retirement space. He's also written on international marketing trends, financial institution risk management, defense and energy issues, the restaurant industry in New York City, surfing, cigars, rum, travel, and fishing. When not writing, he's pushing into some land or water.