DOL Releases Informal Guidance Addressing Fiduciary Responsibilities With Respect to Target Date Funds

The Tax Management Transfer Pricing Report ™ provides news and analysis on U.S. and international governments’ tax policies regarding intercompany transfer pricing.

By Joseph S. Adams, Esq., Ashley McCarthy, Esq., and Karen A. Simonsen, Esq.  

McDermott Will & Emery, Chicago, IL and New York, NY


Many plan fiduciaries have decided to use target date funds (TDFs) as their plan's qualified default investment alternative under U.S. Department of Labor (DOL) regulations. The rapid growth of assets in TDFs, along with the widely varying performance of TDFs in the most recent financial downturn, has caused both the DOL and the U.S. Securities and Exchange Commission (SEC) to continue to examine the need for further rulemaking regarding TDFs. In 2010, the DOL and SEC issued a joint Investor Bulletin regarding TDFs. Also in 2010, the SEC proposed regulations intended to enhance the marketing disclosure requirements for TDFs. On April 11, 2013, an SEC subcommittee generally approved non-binding recommended changes to the 2010  proposal designed to provide investors and retirement plan consultants with the information they need to make accurate, comparable evaluations of TDF operations and risks. Last year, the DOL reopened the comment period for proposed amendments relating to enhanced participant disclosures concerning TDFs; the DOL is expected to finalize those regulations by the end of 2013.

New Guidance Regarding TDFs  

Recently, the DOL issued new guidance (Guidance) regarding TDFs. The new Guidance is technically framed as a series of non-binding "tips" for plan fiduciaries and does not constitute formal guidance. However, the DOL uses mandatory language in setting forth several of these tips, suggesting that plan fiduciaries should carefully analyze the DOL's position on TDFs set forth in the Guidance.

Conduct Due Diligence Before Selecting a TDF  

The Guidance emphasizes that the fiduciary duty to obtain and assess information about the prudence of an investment option extends to all investment options, but TDFs have characteristics that require additional analyses. In particular, the Guidance recommends that prior to selecting a TDF, plan fiduciaries should:

  •   Consider the TDF's prospectus information (e.g., information about investment returns and investment fees and expenses).
  •   Consider how well the TDF's characteristics align with eligible employees' age and likely retirement dates, and potentially consider other characteristics of the participant population, such as participation in a traditional defined benefit plan offered by the plan sponsor, salary levels, turnover rates, contribution rates and withdrawal patterns.


Establish a Process for Periodic Review of TDFs  

Plan fiduciaries are obligated to periodically review the investment options available under the plan to ensure the options remain prudent. The Guidance suggests that plan fiduciaries should be particularly attuned to significant changes in the TDF's investment strategy or management team. In addition, because substantiation is so important to establishing procedural prudence, plan fiduciaries should document their review process with respect to TDFs.

Understand the TDF's Glide Path and How It Will Change Over Time  

The Guidance notes that plan fiduciaries should be aware of the different "glide paths" that TDFs utilize to execute their investment strategies, i.e., (1) the "to retirement" approach, under which the TDF attains its most conservative asset allocation on the target date, and (2) the "through retirement" approach, under which the TDF does not attain its most conservative asset allocation until years after the target date. Rightly or wrongly, some commentators have interpreted the Guidance's discussion of the continued equity exposure of "through retirement" TDFs as suggesting that the DOL has a slightly negative view of "through retirement" TDFs. However, plan fiduciaries may select either glide path approach, provided they properly analyze TDF candidates, consider the relevant circumstances and clearly communicate to employees which approach is used by the plan's TDFs.

Review the TDF's Fees and Expenses  

Plan fiduciaries should be aware of the investment fees and expenses associated with different TDFs, including sales loads and the fees and expenses for both the TDF itself as well as the underlying funds in which the TDF invests.

Consider Custom and/or Non-Proprietary TDFs  

Perhaps the most surprising aspect of the Guidance was the discussion of proprietary versus custom/non-proprietary TDFs.  The Guidance began by noting that some vendors offer pre-packaged TDFs composed solely of proprietary investment components offered by the vendor. The Guidance continued by suggesting that, rather than using proprietary TDFs, it may be preferable in some cases for plan fiduciaries to utilize custom TDFs (because they permit the plan to incorporate its existing core funds into the TDF investment mix) or non-proprietary TDFs (because they include investment components that are managed by fund managers other than the TDF vendor). The Guidance acknowledges that "there are some costs and administrative tasks involved in creating a custom or nonproprietary TDF, and they may not be right for every plan, but you should ask your investment provider whether it offers them" (emphasis added).

Develop Effective Employee Communications  

The Guidance urges plan fiduciaries to develop employee communications that provide general information about TDFs and how they operate, as well as particular information about the individual TDFs available under the plan. In addition, as noted earlier, the DOL is currently considering proposed regulations under which plan fiduciaries will be required to provide additional disclosures regarding TDFs.

What the Guidance Means for Plan Fiduciaries  

In light of the Guidance, plan fiduciaries may wish to reexamine their procedures for selecting and monitoring TDFs.  In particular, plan fiduciaries should:

  •   Review the prospectus and other available information regarding the investment performance, fees and expenses associated with different TDFs to ascertain which TDFs represent prudent investments
  •   Examine characteristics of their participant population and determine whether and how these characteristics affect the plan's investment objectives
  •   Determine whether the TDFs that are currently available under the plan utilize a "to retirement" or a "through retirement" glide path, and consider whether the utilized approach is appropriate for plan participants as a whole
  •   Consider whether a custom or non-proprietary TDF would be better suited to the plan's objectives than a proprietary TDF marketed by the current TDF vendor
  •   Review the plan's employee communications to ensure they clearly and accurately convey the investment philosophy that informs TDFs generally and provide pertinent quantitative and qualitative information about the specific TDFs available under the plan
  •   Review periodically the TDFs available under the plan, using the monitoring criteria established by the plan fiduciary for all investment options and the criteria unique to TDFs, and document that review

Please contact your regular McDermott Will & Emery lawyer or one of the authors for assistance with questions regarding the Guidance.

For more information, in the Tax Management Portfolios, see Maldonado and Daley, 362 T.M., Security Law Aspects of Employee Benefit Plans,  and in Tax Practice Series, see ¶5530, Fiduciary Duties and Prohibited Transactions.

© 2013 McDermott Will & Emery

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