The Flaws of Target-Date Funds in Optimizing a Credit Union Executive’s Retirement Income

Home  >>  ACT White Papers  >>  The Flaws of Target-Date Funds in Optimizing a Credit Union Executive’s Retirement Income

The Flaws of Target-Date Funds in Optimizing a Credit Union Executive’s Retirement Income

Both of these statements are accurate: 

  1. Almost 80% of credit union 401(k) plan participants have all or some of their retirement savings in a target-date fund (TDF), and they’re only gaining more popularity since they were first introduced in 1994. 
  2. Target-date funds are the wrong investment vehicle for most credit union executives.

If this isn’t adding up for you, let us explain. TDFs are an attractive option because they offer a self-balancing portfolio based on an investor’s projected retirement date and automatically taper risk as that date approaches. These are particularly appealing to employees who don’t want to self-manage their investments. 

However, the significant flaw of TDFs is that they offer a one-size-fits-all approach to retirement planning, which doesn’t recognize the more complex needs of credit union executives. TDFs are generally not aligned with the executive’s consumption date of those funds, and as a result, may be too conservative for an executive’s needs. Why? Executives in the C-suite typically have more than one form of retirement income, unlike the average rank-and-file employee who only holds a 401(k). For example, executives may also have accrued leave, bonuses, a split-dollar plan, or 457(b), all of which they should consider in their long-term retirement planning process.

These other investment vehicles also have different tax and distribution timing considerations. Thus, it is helpful for executives to take a customized approach to their retirement planning rather than a traditional one that may not optimize the full potential of their savings and benefits. In our latest white paper, “Target-Date Funds—The Wrong Investment Vehicle for Many Credit Union Executives,” we dive into the data that supports this and how executives can avoid missing out on a significant amount of retirement income.

 

Retirement Date Vs. Consumption Date

A significant and distinctive factor is that TDFs align with an employee’s projected retirement date. Often referred to as the “glide path,” it makes sense to reduce your risk closer to your retirement to protect your savings if that’s when you plan to use them. This is, however, assuming that as an executive, you will consume those assets as soon as you retire. With several different investment vehicles available to you, each with different taxation and distribution frequencies, you may find you won’t consume any of your 401(k) funds until several years into your retirement or only when you must begin required minimum distributions at age 72. 

If you find this is true for you through the planning process, your TDF may not be allocating risk appropriately according to the projected date you’ll consume those funds. 

Risk Allocation Based on Consumption Date

Risk allocation is the second flaw overlooked in TDFs. If your TDF is only considering your retirement date, this could mean your allocations are far too conservative to support your needs later in retirement. These allocations can be suitable for younger employees under age 50 because they predominantly focus on investing in equities, which is an effective solution for investors with a longer time horizon to save. However, the challenge is when an executive over 50 experiences automatic rebalancing that reduces their equity investments as they get closer to retiring. This feature of TDFs again fails to recognize the unique timing of asset consumption of executives with multiple sources of retirement income.

Additionally, the white paper outlines an example of a typical credit union executive using hypothetical scenarios and Monte Carlo analysis to demonstrate how significant savings could be left on the table without a customized approach to their financial planning.

Read the full TDF report and learn more about why customized strategies can help you realize the full potential of your retirement benefits and income.

Comments are closed.