Advisers remain concerned about target date fund ‘advice’

WASHINGTON — As the first anniversary of the Pension Protection Act approaches, financial advisers remain wary of target date mutual funds.
A key provision of the act, which became law on Aug. 17, 2006, cleared the way for companies to begin enrolling workers automatically in 401(k) plans.
Many companies are choosing target date funds, which typically get more conservative over time and provide more income as the investors’ retirement date approaches, as the default option for workers who do not pick a specific investment option.
While advisers generally give the Pension Protection Act high marks, some worry that a provision in the act, which allows fund companies to offer advice to 401(k) participants, will make it more difficult for them to work with participants and small business owners. Specifically, they worry that target date funds, the vehicle through which that advice is provided, will pit them against large financial services companies that are overseeing retirement plans.
“It’s hard to argue that there won’t be some shift in the marketplace,” said Michael Kitces, director of financial planning at Pinnacle Advisory Group Inc. in Columbia, Md., which manages 401(k) plans for businesses with five to 10 employees. “The question becomes whether and to what extent major 401(k) providers are going to get directly into the investment advice business or the overall financial planning business.”
More companies to offer advice
Only 12% of 146 large companies surveyed late last year by Hewitt Associates LLC, a Lincolnshire, Ill.-based human resources consulting firm, offered in-person investment advisers to their employees for their respective retirement plans.
That figure is sure to increase, said Department of Labor assistant secretary Bradford Campbell.
“The surveys we’ve seen show that if they’re not doing it, they’re planning on doing it in the next few years,” he added.
Meanwhile, 57% of the firms surveyed offered target date funds, and Hewitt predicts that that percentage will rise to 70% by yearend.
“That’s where the big trend is,” said Alison Borland, a senior benefits consultant at Hewitt, which released its survey last month.
Employers are clearly embracing target date funds.
Assets in these funds totaled $153 billion at the end of June, up 72% from $89 billion 12 months earlier, according to market research firm Cerulli Associates Inc. of Boston.
Critics contend that target date funds rely too much on equities and don’t use enough non-traditional assets such as real estate, emerging-market investments and high-yield bonds.
The funds also may make incorrect assumptions about 401(k) participant behavior, such as loans and inadequate contributions.

Equity overload
Heavy reliance on target date funds as the sole method of allocating assets for employees is a problem, Mr. Kitces believes.
“They’re not being used correctly,” he said. Instead of investing total assets into target date funds, people are using those funds as one of a number of investment options, he said.
In addition, target date funds invest more conservatively as workers reach retirement age, said Rusty Cagle, president and founder of ASE Wealth Advisors Inc. in Greenville, S.C., a company that manages $400 million in defined contribution plans for businesses.
“That’s not when your life’s over,” Mr. Cagle said. “Most people are just beginning a new life” at retirement, and they need more-aggressive equity investments, he added.
To be sure, some advisers view target date funds as the wave of the future.
“If your shtick is mutual fund guru to a 401(k), that’s going to fade,” predicted Joe Birkofer, a principal of Legacy Asset Management Inc. in Houston, which manages some $70 million in about 60 401(k) plans offered by small businesses.
Many of the small businesses Mr. Birkofer works with are moving out of other types of mutual funds and into target date funds. Within the next five years, companies will routinely adopt target date funds, he predicts.
“It’s going to be a golden era for guys like me who focus on plan design, fiduciary functionality and retirement saving coaching,” he added.
The movement toward target date funds is beneficial because it is “probably the thing that will make participation in those 401(k) plans go up quite a bit,” said Ron Miller, principal of Resource Management LLC in Waimanalo, Hawaii.
Mr. Miller is working with several 401(k) plans for small companies. He became an accredited investment fiduciary analyst last fall with an eye toward managing more plans for small firms.
Separately, the Pension Protection Act’s provision permanently removing income limits on conversions to Roth 401(k)s, which takes effect in 2010, is leading many advisers to counsel their clients to fund non-deductible 401(k)s now so that they can move the money to the Roth plans later.
“I believe we’re going to see a tremendous increase in taxes over the next 10 to 15 years,” said Thom Hall, a partner at Financial Strategies Institute of Midvale, Utah. He usually does not advise making contributions to non-deductible retirement savings plans, but he has changed his strategy. “You’re much better off to pay the bill now when it’s smaller than to pay it later on when there’s more money and the tax rate is higher,” Mr. Hall reasons.