Summer 2022 Fiduciary Commentary
Target Date Fund Lawsuits on the Rise
A recent swarm of lawsuits has been challenging many of the nation’s largest 401(k) plans and its fiduciaries’ decision to utilize an underperforming target date fund product. The complaints allege ERISA violations by utilizing the BlackRock LifePath TDF that has purportedly underperformed compared to peers and various benchmarks. BlackRock is not a defendant in these suits.
Miller Shah LLP, as the sole or lead attorney, filed the lawsuits in U.S. District Courts in July and August of this year against many of the nation’s largest companies including Microsoft, Genworth Financial, Marsh & McLennan, Capital One Financial Citigroup, Cisco Systems, and others. The claims asserted that the BlackRock product performed significantly worse than many other TDFs and that the funds “could not have supported an expectation by prudent fiduciaries that their retention in the plan was justifiable.”
The BlackRock TDF pulled in $25 billion in new assets last year and was ranked as the fourth largest TDF in size behind Vanguard, Fidelity, and T. Rowe Price at the end of 2021. The common feature among the top TDF managers was low fees. In fact, a recent Morningstar TDF report found “Low fees … continue to drive target-date mutual fund flows”, so it’s not surprising that the top TDFs maintain very low costs. The BlackRock LifePath series had an asset management fee of just 0.09%. These trends are a result of solid legal precedence over the last two decades where numerous claims have been filed and settlements won alleging fiduciaries were not maintaining an adequate process to ensure fees were reasonable. However, the plaintiffs stated the TDF product was a result of fiduciaries who “chased low fees” over performance.
The plaintiffs claim that BlackRock’s TDF product underperformed relative to competitors and certain benchmarks. However, there is a significant BlackRock characteristic that helps explain its performance results. First, it’s important to distinguish the divergent methods TDFs manage their asset allocation over time, often referred to as its “glide path” in TDF-speak. A TDF can be managed as either a “To” or a ”Through” style. A “To” design is intended for a saver who expects to invest in the TDF fund up until retirement, while a “Through” style is for the investor who plans to continue to invest in the product after retirement and withdraw funds gradually. So, a ‘To’ glide path becomes primarily a fixed asset allocation at the retirement date and for as long as the participant stays in that fund after their retirement date. “A ‘Through’ product’s glide path (as seen below) continues to be managed after retirement and gradually becomes more conservative for many years after the target date. This is a critical distinction in the style of target date fund products that has a significant effect on the product’s management, asset allocation, and performance.
The BlackRock product is managed as a “To” retirement date product. “To” managers typically maintain a more conservative asset allocation in their near-term funds (2020, 2025, 2030, etc.) to ratchet down risk as the retirement date approaches in contrast to “through” managers that have a longer time horizon that extends perhaps 20 to 30 years after that retirement date. Thus, BlackRock’s asset allocation in the TDF series are managed to a shorter time period than its “through” product counterparts. Generally, the “To” managers are inherently more conservative than the “Through” managers. This more conservative positioning of the “To” managers, will typically result in a lower percentage of equities and not surprisingly, often produce lower returns in an equity bull market.
The plaintiffs argue that BlackRock’s fund underperformed primarily by its comparison to other TDF funds that included those managed with a strikingly different style. The comparison included funds managed with a “Through” style despite the BlackRock fund being managed with a “To” approach. This resulted in an apples-to-oranges evaluation and an unfair comparison. Today, most TDF providers utilize the “Through” investment approach in recognition that more workers are maintaining their retirement savings in the plan even after retirement.
There is of course a certain tendency among plan fiduciaries to seek the comfort of the majority when making significant decisions such as those pertaining to plan design, investments, and vendor selections. This is understandable when one considers the gravity and personal liability that is associated with many fiduciary decisions. However, the allegation against the fiduciaries that held the BlackRock TDF appears to make the tie implication that any glide path that varies from the pack (or “through” in this case) is imprudent. Moreover, it’s peculiar that the lawsuits claim the poor performance of the products was a fiduciary breach as regulators and practitioners have been stating for years that poor performance isn’t necessarily indicative of an imprudent process.
These lawsuits seem to equate the underperformance of the BlackRock product to be a result of peer investment decisions by the managers rather than a deliberate path taken as a result of the design of their products. The LifePath funds seem to have simply done what TDFs were intended to do which is to follow its glide path and de-risk the portfolio as the fund approached the target date.
Record Increase Scheduled for 2023 COLA and Retirement Plan Contributions
The announcement of the official COLA and retirement plan contribution limits is still a month or so out, but early projections suggest that nearly all qualified retirement plan limits will increase by unprecedented amounts for 2023.
The 2023 limits will reflect increases in the Consumer Price Index from the third quarter of 2021 to the third quarter of 2022. Using this measure, inflation is projected to reach its highest level since indexing began, causing 7%–11% increases for most limits.
Using the Internal Revenue Code’s cost-of-living adjustment and rounding methods, it is projected that retirement plan contribution limits will increase across the board, including:
- Plan elective deferrals (and designated Roth contributions) will likely increase from $20,500 this year to $22,500 in 2023.
- The 415(c) DC plan maximum annual addition is projected to increase from $61,000 to $67,000.
- The highly compensated employee and top-paid group limit is projected to be $150,000 in 2023, up from $135,000 in 2022.
- Catch-up contribution limit may increase from $6,500 to $7,500 in
- DB plan maximum annuity limit may rise from $245,000 to $265,000.
- Maximum compensation limit for retirement plan contributions may rise from $305,000 to $335,000.
The IRS typically announces official limits for the next year in late October or early