Target-Date Fund

The year in the name is the fund’s target date, usually the year you expect to retire, so a fund called Lifecycle 2060 is built for people retiring in or near 2060. Most target-date funds are funds of funds: instead of owning individual stocks and bonds, they own shares of other funds, such as a US stock index fund, an international stock fund and a bond fund.

The fund’s adviser starts with mostly stock funds and moves money toward bond funds as the target date nears, on a timetable called the glide path. Some glide paths stop at the target date and others keep getting more conservative for years after it. The managers also rebalance the underlying funds back to the current target, so you never have to.

Target-date mutual funds and ETFs are regulated by the SEC. Some funds inside workplace plans are collective investment trusts instead, which the SEC does not regulate, so ask your plan for their disclosures.

A Labor Department rule shields employers that invest a worker’s money in a qualified default investment alternative, or QDIA, when the worker makes no choice. The rule lists four main kinds: a target-date or life-cycle fund that grows more conservative with age, a balanced fund with a fixed mix, a managed account that allocates each worker’s money by age, and a capital-preservation product that can serve only for the first 120 days after the first contribution; a fifth, stable-value option covers only money invested before December 24, 2007. The plan must give you notice, generally at least 30 days in advance and then yearly, and you can move the money to any other option in the plan at least once every three months, with no transfer fees during the first 90 days.

SECURE 2.0 made defaults more common. Under Internal Revenue Code §414A, a 401(k) or 403(b) plan established on or after December 29, 2022, the day SECURE 2.0 became law, must automatically enroll eligible workers for plan years beginning after December 31, 2024. The starting rate is 3% to 10% of pay, rising 1 percentage point a year to at least 10% but no more than 15%, and contributions a worker does not direct must be invested under the QDIA rule. SIMPLE plans, governmental and church plans, businesses less than three years old and employers with 10 or fewer employees are exempt.

Start with the year, then look past it. The SEC’s investor education staff warns that funds with the same target date can follow different strategies and glide paths and charge different fees, so the date alone tells you little about risk. Before investing, check the fund’s stock share today, at the target date and at its most conservative point, and whether it reaches that point at the target date or years later.

Next, check costs at both layers. A target-date fund can charge its own fees on top of the fees of the funds it holds, and the prospectus fee table shows both. Because the fund may be your only holding for 30 years or more, a small difference in its expense ratio compounds into a large difference in what you keep.

Finally, pick the date that fits your risk tolerance, not only your birth year. The SEC notes that someone planning to retire in 2060 might decide a 2050 or 2070 fund suits them better. An earlier date means less stock sooner; a later date means more stock for longer.

Target-date funds fit most naturally in tax-sheltered accounts such as a 401(k), 403(b) or IRA, where their internal trading, bond interest and distributions create no current tax. In a taxable brokerage account those same features cost money. The bond funds inside pay interest that is taxed as ordinary income every year, and selling inside the fund to rebalance can produce capital gain distributions. The IRS treats capital gain distributions as long-term gains however long you have owned the fund’s shares, and they are taxable even when you reinvest them.

One fund also removes two tools. You cannot practice asset location, holding bonds in tax-deferred accounts and stocks in taxable ones, because the fund keeps both in a single wrapper. And you cannot harvest a loss on the stock side while the bond side is up, because the fund’s price reflects both. For money invested outside retirement accounts, separate index funds or a robo-advisor that harvests losses may leave more after tax.

A target-date fund is built to be your whole portfolio for one goal, and most mistakes come from treating it as one ingredient among many or from reading its date as a promise. The SEC stresses that target-date mutual funds and ETFs do not guarantee any level of retirement income at or after the target date, and a fund at its target date still holds stocks that can fall. These are the errors that come up most often.