J.P. Morgan: Target-date fund providers underestimate DC participants' volatile behavior

Defined contribution plan participants' savings and investment behavior is much more volatile than the assumptions of target-date fund providers at J.P. Morgan, according to a new study from J.P. Morgan Asset Management (JPM).

The study, “Ready! Fire! Aim? 2012” utilizes data from more than 280 defined contribution plan clients of J.P. Morgan Retirement Plan Services.

While the industry assumes participants begin contributing at 6% and reach 10% of their salary by the time they reach age 35, the study found the average participant begins at 5% and increases to 10% only by the time they reach age 59.

Automatically enrolled participants' overall average contribution rate is even less, at 4% compared to 7.7% for those not automatically enrolled.

Also, as of Dec. 31, a total of 83% of participants withdraw their entire account balance within three years of retirement. This is an increase from 80% at the end of 2008.

The high number of participants who leave the plan shortly after retirement means that large equity allocations in target-date funds in the years leading up to retirement “subjects the vast majority of participants to unnecessary and, as the extreme stock market losses in 2008 demonstrated, dangerous risks just as they are most prone to withdraw their assets,” according to the study.

Other industry assumptions that are not mirrored in reality, according to the study, include:

  • Participants receive raises every year; they really get raises every two out of three years.
  • Participants do not borrow; 19% of participants borrow 15% of their account balances on average.
  • Premature distributions don't occur; 15% of participants over the age of 591/2 withdraw 25% of their assets on average.
  • Participants who have retired withdraw 4% to 5% annually; in reality, that percentage is actually more than 20% annually.

The study suggests that plan sponsors can increase auto-enrollment and contribution escalation rates to more realistic levels and increase education of participants to help influence participant behavior.