Personal Finance
Are target-date funds — the most popular 401(k) investment — right for you?
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Target-date funds are a way for 401(k) participants to put their retirement savings on autopilot — and they capture the lion’s share of investor contributions to 401(k) plans.
About 29% of assets in the average 401(k) plan were held in TDFs as of 2023, according to the Plan Sponsor Council of America, a trade group. That share is the largest of any fund category, and is up from 16% in 2014, according to PSCA data.
By 2027, target-date funds will capture roughly 66% of all 401(k) contributions, and about 46% of total 401(k) assets will be in TDFs, according to a 2023 estimate by Cerulli Associates, a market research firm.
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That popularity is largely due to employers’ broad adoption of TDFs as the default investment for workers who are automatically enrolled into their company 401(k) plan.
While the funds carry benefits for many investors, they may have drawbacks for others, financial advisors said.
“Target funds have a place for some investors, but they certainly aren’t and shouldn’t be used for everyone,” said Winnie Sun, managing partner of Sun Group Wealth Partners, based in Irvine, California, and a member of CNBC’s Financial Advisor Council.
How target-date funds work
Financial experts generally recommend investors de-risk their nest eggs as they age — typically by shifting from more aggressive (and volatile) holdings like stocks to more stable ones like bonds and cash.
TDFs do this automatically, based on an investor’s estimated year of retirement.
For example, a 35-year-old investor who expects to retire in 30 years would likely choose a 2055 fund. A 55-year-old may pick a 2025 fund. (The funds typically come in five-year increments.)
The fund’s asset allocation slowly becomes more conservative in the years leading up to, and sometimes after, that retirement year.
A one-stop shop for 401(k) savers
Advocates often laud the simplicity of TDFs, known as a one-stop shop for 401(k) savers who may not have the time or knowledge to adequately manage a custom portfolio.
“From where I sit, target-date funds have been nothing short of the biggest positive development for investors since the index fund,” Christine Benz, director of personal finance and retirement planning at Morningstar, wrote in June.
They take important decisions like asset allocation and investment selection “wholly out of investors’ hands,” Benz wrote.
TDFs amount to inexpensive and reasonable investment advice for people who may not be able to afford hiring an advisor and who may be prone to making “kooky” investment choices, she wrote. TDFs also discourage behavior known to erode investor returns, like buying high and selling low, she added.
“They’re designed to be easier-to-manage investments for those who just prefer simplicity and more convenience,” Sun said.
There may be drawbacks
However, there are some reasons why TDFs may not work for certain investors, especially those with ample savings outside their 401(k) plan or who want to take a more hands-on approach, advisors said.
For one, just because investors expect to retire around the same age doesn’t mean the same asset allocation is appropriate for each of them.
“What if you’re more conservative or instead prefer more growth, aggressive tech investing, or prefer to invest in socially responsible investments?” Sun said.
From where I sit, target-date funds have been nothing short of the biggest positive development for investors since the index fund.
Christine Benz
director of personal finance and retirement planning at Morningstar
Asset managers have different investment philosophies. Certain fund families may be more aggressive or conservative than others, for example.
Employers generally only offer TDFs from one financial company, and the funds that are offered may or may not align with an investor’s risk profile, experts said.
“It is important that a person understands how much risk they are taking in their target-date fund,” said Carolyn McClanahan, a certified financial planner and the founder of Life Planning Partners in Jacksonville, Florida.
“For example, you would think a 2030 target-date fund would be conservatively allocated, but most are 60% equities because they assume you’ll be drawing off those funds over a long period of time,” said McClanahan, a member of CNBC’s Advisor Council.
Investors may be able to build a less expensive portfolio on their own by using a mix of index funds, though this approach would take more work on investors’ part, she said.
Additionally, TDFs don’t allow for “tax location” of different assets, McClanahan said.
This aims to boost after-tax investment returns by strategically holding stocks and bonds in certain account types.
For example, assets with potential for high growth are well-suited for Roth accounts, since investment earnings are generally tax-free in retirement, said McClanahan.
Experts also generally recommend holding many bonds and bond funds in tax-deferred or tax-exempt accounts.
Despite shortcomings for certain investors, “do target-date funds help investors who are unaware of the basics of investing find their way to a sane investment mix given their life stage?” Benz wrote. “A thousand times yes.”
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Why your take-home pay could be higher
If you’re starting 2025 with similar wages to 2024, your take-home pay — or compensation after taxes and benefit deductions — could be a little higher, depending on your withholdings, according to Long.
“When all the tax brackets go up, but your salary stays the same, relatively, that puts you on a lower rung of the ladder,” he said.
The federal income tax brackets show how much you owe on each part of your “taxable income,” which you calculate by subtracting the greater of the standard or itemized deductions from your adjusted gross income.
“Even if you make a little more than last year, you could actually pay less in tax in 2025 compared to 2024,” because the standard deduction also increased, Long said.
For 2025, the standard deduction increases to $30,000 for married couples filing jointly, up from $29,200 in 2024. The tax break is also larger for single filers, who can claim $15,000 in 2025, a bump from $14,600.
‘It ends up nearly balancing out’
Despite tax bracket changes, many Americans won’t feel the pay increase amid elevated prices for certain expenses, said Sheneya Wilson, a CPA and founder of Fola Financial in New York.
“It ends up nearly balancing out,” she said.
While inflation is no longer accelerating, there was an uptick in the cost of groceries, gasoline and new cars in November, according to the Bureau of Labor Statistics.
Whether take-home pay is higher or lower than expected, it’s important to monitor your state and federal income tax withholdings throughout the year, especially during major income or life changes, Wilson said.
Typically, if you withhold too much from your paycheck, you can expect a refund, whereas not withholding enough often results in taxes owed.
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