Defined contribution plan participants are burning through their retirement assets much faster than employers realize, which could have big implications for how much target-date funds invest in stocks, a consulting firm executive contends.
In a soon-to-be released research paper, Terry Dennison, worldwide partner and Mercer LLC's U.S. director of consulting, said the average participant withdraws more than 20% of his or her account balance per year at or soon after retirement, leaving the participant tapped out after five years.
The upshot: Glidepaths, which typically convert equity holdings to cash and bonds in target-date funds over a 15-year span, should cut the conversion period to five years so participants can better withstand stock-market volatility.
Mercer's research comes at a time when members of Congress have lambasted target-date funds — especially those with short horizons for people nearing retirement — for having stock-heavy allocations. The Securities and Exchange Commission and the Department of Labor, which held a joint hearing in June on target-date funds, are expected to impose new disclosure and fiduciary requirements on the funds (Pensions & Investments, June 29).
The problem, according to Mr. Dennison, is that typical participants in target-date funds attempt to maintain their previous lifestyles after retirement by drawing down their account balances more rapidly than is “actuarially sound” or that is considered in glidepath design.
“It seems clear the trend in glidepath development (the assumption that the long-term return advantage of equity over cash will provide a sufficient increment of wealth to compensate for short-term volatility) ignores critical asset balance and behavioral factors and is thus misguided,“ Mr. Dennison wrote. “Participants typically deplete their accounts so rapidly that long-term advantages are meaningless.”
Mr. Dennison cited data from J.P. Morgan Asset Management in his paper, showing target-date fund providers assume participants withdraw a consistent 4% to 5% annually during retirement. In reality, the average participant withdraws more than 20% per year, according to the J.P. Morgan data. Because of this high “burn rate,” participants are more sensitive to short-term volatility than once thought, Mr. Dennison wrote. As a result, this “unsustainable rate” of spending requires a shortening of the typical glidepath to little or no equity exposure by five years after retirement.
“We're finding many participants are not willing to give up their previous lifestyles, so if they happen to catch a bad period in those five years — even if they're not completely wiped out — no rebound will create enough wealth to keep them in the game, “ Mr. Dennison, who is based in Los Angeles, said in an interview.