Making Target Date Funds the Default Option in Retirement Plans Impacts Investor Behavior

Researchers looking at recent changes to retirement plans found that the number of funds held and the equity exposure changed for participants when target date funds became the default option.

Regulatory and plan design changes have altered the investment menus and menu defaults in employer-sponsored retirement plans such as 401(k) plans. These changes have included the auto-enrollment of employees into the plans, the adoption of target date funds as default investments and offering a larger number of investment options from multiple fund companies.

TIAA Institute researchers used data from a 2012 cross section of more than 645,000 TIAA participants working at 98 large employers. As part of their analysis, the researchers separated participants into three distinct groups: 1) those who joined when money market funds were the default investment, 2) those who joined after some [but not all] plans had target date fund defaults and 3) those who joined after most plans adopted a target date fund default.

A significant reduction in the number of funds held was found among workers who joined workplace retirement plans after the target date funds became the default allocation option. The effect of adopting target date fund defaults did have varying levels of impact on different investors. Those who had more experience with TIAA held more funds even if joining a plan with a target date fund default. Women who joined plans after target date funds became the default invested in fewer funds than when there was no target date default.

Target date funds also impacted equity exposure. Women in the 25 to 30 age group sharply boosted their equity exposure, as a result of the target date fund’s allocation. The increase for men was smaller, but still significant. Controlling for age, equity allocations rose by slightly more than 13% when a plan established a target date fund as the default option.

The switch to target date fund defaults has had a significant impact on investing behavior. As TIAA researchers noted, more than two-thirds of participants who joined a plan with a target date fund default invested in only one fund and more was allocated to equity (with women holding the same average equity as men). Furthermore, the impact of a plan’s menu size became insignificant in terms of how many funds participants held.

Source: “The Effect of Default Target Date Funds on Retirement Savings Allocations,” by Robert L. McDonald, David P. Richardson and Thomas A. Reitz; TIAA Institute Research Dialogue, June 2019.