While many employers do consider their participants’ needs when selecting target date fund glide paths, a new white paper argues there is too much homogeneity given the heterogeneity of workers’ needs.
As such, more can be done, say Morningstar Senior Analyst Lia Mitchell and Retirement Studies head Aron Szapiro, who examined the glide paths that plan sponsors use in different sectors and offer recommendations to the Department of Labor.
In “Right on Target? Plan Sponsors May Not Always Consider Participants’ Behavior or Needs When Selecting Target-Date Glide Paths,” the researchers explain that TDFs, by far, have become the most prevalent of three investment options (managed accounts, balanced funds and TDFs) that plan sponsors could choose as QDIAs. Drawing on a database linking plan filings with the Department of Labor to Morningstar’s investment databases, they find that 58% of DC plan assets are invested in off-the-shelf TDFs.
Yet, despite large differences in salaries and likely retirement ages, plan sponsors tend to use similar glide paths, which could lead to workers with less-than-ideal asset allocations in some cases. Among other things, they find that the average equity exposure at both ages 55 and 65 is similar across sectors, suggesting that plan sponsors may not be consistently considering the specific needs of their worker population when selecting a glide path.
“Given that lower-income workers will replace significantly larger percentages of their pre-retirement income from Social Security, they should likely have higher levels of equity exposure to account for the high levels (relative to income) of bondlike, inflation-adjusted Social Security payments they will enjoy,” Mitchell and Szapiro write.
Similarly, plans in sectors in which workers tend to work past age 65 might want to take more equity risk at age 65, than plans in sectors in which workers tend to retire earlier, they note.
‘Through’ vs. ‘To’
The Morningstar analysts find that most plans offer TDFs designed for participants staying in the retirement plan through their retirement even in cases when a plan’s participants are more likely than average to roll their money out of their plans.
“This mismatch is important because these ‘through’ glide paths typically take on more risk than ‘to’ retirement glide paths, leaving participants with more equity exposure than they would have if their glide path accounted for their propensity to take money out of the plan at retirement or separation from employment,” Mitchell and Szapiro observe.
In fact, according to the research, investors in funds following a “through” glide path will hold around 13 percentage points more in equity at age 65 than their peers invested in “to” glide paths, as the average “through” series holds 46% in stocks versus just 33% for the average “to” series. During down markets, near retirees in “to” glide paths have done better than those in “through” glide paths because of the differences in equity exposure, the Morningstar analysts explain. For instance, designed for people retiring in 2020, the 2020 vintage TDFs in “through” glide paths experienced losses that were 40% greater than those in “to” glide paths during the first-quarter selloff of 2020, the paper shows.
The Morningstar researchers further observe that the percentage of distributions coming from plans with “through” glide paths is almost identical to the proportion of plans with these glide paths, indicating that participants are not generally using “through” glide paths through retirement. “In other words, participants with access to a ‘through’ glide path are pulling just as much money out as those with a ‘to’ glide path, which is inconsistent with the intent of glide paths to take smaller structured withdrawals,” Mitchell and Szapiro observe.
That said, they do emphasize that it’s possible some people are taking all their money out pre-retirement and many people are using the “through” TDFs as intended. They also see, however, that approximately the same number of assets are left in TDFs after the target date is attained in both “to” and “through” glide paths, at 11% and 14%, respectively. “Between these two pieces of data, we think it is unlikely that many participants use ‘through’ glide paths in retirement for structured withdrawals,” they suggest.
The researchers also stress that some plan sponsors are making adjustments based on their participant populations’ characteristics, but many plan sponsors do not seem to be adjusting their glide paths based on their participant population because of the “overwhelming similarities” they see across sectors. Plan sponsors that still offer a traditional pension were the most likely to adjust their glide paths.
DOL Guidance
Mitchell and Szapiro note that, in 2013, the Department of Labor (DOL) published tips for plan fiduciaries using TDFs, which included suggestions that plan sponsors determine whether the characteristics of TDFs align well with the plan participant population.
In particular, they note that the DOL identified the importance of considering salary levels, the availability of a DB plan, turnover rates, and likely retirement dates and ages. The DOL also opined that plan fiduciaries focus on the “to” and “through” decision because some “funds continue to invest in stock” and “employees’ retirement savings may continue to have some investment risk after they retire.” The DOL noted that “if the employees don’t understand the fund’s glide path assumptions when they invest, they may be surprised later if it turns out not to be a good fit for them,” the paper observes.
While noting that there are limitations to the data sources they have—including that there is no reliable data on the use of custom glide paths—Mitchell and Szapiro suggest that plan sponsors and advisors should regularly consider the key assumptions in their glide paths and their actual experience with participant behavior, as the DOL suggested in 2013.
What’s more, they recommend that the DOL assess whether more guidance could help clarify the role that sponsors need to play, particularly in their review and evaluation of glide paths, given the differences seen across sectors in their analysis.
Finally, they suggest that the DOL should also consider issuing additional guidance or even amending the safe harbor on the use of customized glide paths and perhaps even dynamic allocations between QDIA options based on a participant’s needs.
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