Unlike some retirement investments, such as annuities,
which can trigger penalties for moving your assets once you’ve invested them, target date funds allow you to change your mind. If you’re not satisfied with the return the target date fund is providing, or if you decide to change your approach to planning for your long-term goals, you can move money out of a fund at any time.
If you’re participating in a target date fund through your employer’s retirement savings plan, you can move your assets to any combination of individual funds if you prefer. While there may be transaction fees, there are no penalties or tax consequences.
If you own shares of a target date fund in a tax-free or tax-deferred account,
you can move the money to any other investment option that’s offered by your custodian, such as the financial company that holds the account. You may also decide to roll over your account to another custodian whose target date funds or other investment options better meet your needs. However, you probably don’t want to move your tax-deferred or tax-free target date investment to a taxable account. In that case, you owe income tax on your earnings and any pretax contributions, as well as a potential 10% tax penalty if you’re under 59 1/2.
Remember, too, that in a taxable account, if you sell shares in a target date fund for more than you invested, you may owe transaction fees plus capital gains taxes on your profits for the year you sold. In addition, if the managers of the underlying funds held by the target date fund trade regularly, this can lower your potential return by triggering short-term capital gains,
which are taxed at your regular rate.
Account types
Depending on the type of account where you hold your target date fund, there are some specific things to keep in mind.
For tax-deferred and tax-free accounts, you’ll need to follow the government’s annual contribution limits. If you’re contributing to the fund as part of an employer-sponsored retirement plan, you’ll need to stop contributing when you stop working. Your plan administrator can explain what options are available to you at that point.
If you own a target date fund in a traditional IRA, you can continue to contribute until you turn 70 provided you have earned income, and you must begin taking minimum required distributions after you turn 70 1/2. For Roth IRAs, you can continue making contributions as long as you have earned income and delay withdrawals as long as you wish.
Aiming for education
While target date funds are ideal for investing for retirement, they’re also useful for reaching other long-term goals — such as saving for college. You might consider a target date fund in a tax-free Coverdell education savings account (ESA).
You can choose an ESA custodian that offers target date funds and allocate your contributions to a fund that will mature when your ESA beneficiary is about to enter college. This way, an experienced fund manager is responsible for accumulating assets and gradually moving them into more secure investments. The age-based tracks in state-sponsored 529 saving plans are essentially target date funds.
