Participants who are defaulted into a target-date fund or other qualified default investment alternative have savings behaviors that are more varied and volatile than most retirement plan participants, according to research by J.P. Morgan Asset Management.
The organization found that defaulted participants tend to earn less in salary across their careers and make fewer active contribution changes, instead relying on auto-enrollment and auto-escalation rates, which are often too low to secure adequate retirement funding. They also take more loans and more pre-retirement withdrawals than many standard industry assumptions and withdraw the majority of their 401(k) assets relatively soon after they reach age 65 and stop working.
J.P. Morgan suggests that plan sponsors use these patterns of behavior to better understand how to help defaulted participants seek a more secure retirement. It is difficult to change participant behavior, but there are a number of things plan sponsors can do to help defaulted participants maximize the potential benefits of 401(k) investing.
- Proactive auto-enrollment and auto-escalation programs improve participation rates but they need to be set at high enough levels to put defaulted participants on a secure path to retirement. That means starting the default contribution much higher than the 3 percent that seems to be the norm currently.
- Effective participant communication is important in engaging participants and educating them about how critical their saving patterns are to achieving retirement success. As fiduciaries, plan sponsors need to help participants set realistic retirement goals and determine if certain Qualified Default Investment Alternatives meet their retirement goals and what the expected outcome will be.
- Prudent QDIA selection must address all important factors that may affect defaulted participants’ ability to achieve sufficient retirement savings. This includes an understanding of the impact defaulted participant behavior can have on potential retirement outcomes, particularly in terms of how cash flow volatility may interact with embedded portfolio volatility to compromise the probabilities of participant success, according to J.P. Morgan.
J.P. Morgan’s research found that the best way to increase retirement readiness is to save more and to do that, participants must contribute enough to have adequate funding levels. How a QDIA is designed can help achieve this goal by making participants’ assets work as hard as possible to capture attractive levels of return at lower levels of volatility.
The organization found that the portfolio design of many target-date strategies may be missing the mark on providing defaulted participants with an adequate level of retirement security. Many rely too heavily on equity performance, which increases overall volatility and exposes defaulted participants to steep market declines. Others were so conservative they drastically restricted long-term performance.
The TDFs that worked best were ones that focused on investing at controlled levels of risk through broader diversification and relatively rapid reduction in equity exposure in the years leading up to retirement. They included asset classes such as emerging market equity, emerging market debt, direct real estate, REITS and high-yield fixed income.