How plan sponsors are changing their view on retirement risks
The prospect that participants may outlive their savings remains the greatest risk plan sponsors weigh in determining how to time one’s retirement, according to a recent survey.
While many plan sponsors still say that achieving the highest retirement income opportunity takes precedence among many employees, having funds available long after retirement has become top priority among participants.
This concern is also causing some sponsors to consider the option of keeping participants on a defined contribution plan even after retirement, which a subset of respondents are already taking action on.
“This survey reveals that plan sponsors clearly understand that longevity risk — the risk participants will outlive their retirement income — is a critical factor in determining retirement readiness, and that their investment choices must be designed accordingly,” says Lorie Latham, senior defined contribution strategist at T. Rowe Price, which conducted the survey.
Being an effective plan sponsor today requires an expansive view of the risks and influences on the growth of a participant’s portfolio, Latham notes.
Defined contribution plan sponsors and consultants gain a deeper understanding of their perception of risk by posing three primary questions, according to the T. Rowe Price survey:
· How do DC plan sponsors perceive and prioritize the risks that participants face when working towards achieving their retirement objectives?
· To what extent is the qualified default investment alternative selection and evaluation process influenced by their perceptions and prioritizations of these risks?
· Are their perceptions of risks logically aligned with the stated long-term objectives for their participants?
The T. Rowe Price survey – titled, “Advancing the way we think about retirement risk and outcomes” — found that plan sponsors were most concerned about participants’ longevity risk and their ability to achieve higher retirement account balances over the long-term when selecting a target data strategy or other QDIA for their participants.
When it comes to the selection process for QDIAs, DC plan sponsors largely prioritize risks in a manner consistent with long-term objectives. Even so, there is greater reported sensitivity to short-term considerations among a minority of DC plan sponsors — a position that is at odds with helping participants improve their long-term retirement outcomes.
Running out of money
Roughly 69% of DC plan sponsors indicate that retention of participant assets is preferable to retirees transitioning account balances out of the plan, which influences the decision to focus on long-term objectives over volatility.
In fact, 29% of sponsors report that keeping retired participants in plan has become more of a priority. While emphasis on providing for retired participants might suggest greater interest in limiting near-term volatility through investment selection; however further survey findings tell a different story.
DC plan sponsor report that participants running out of money in retirement is top of mind, with 42% identifying longevity risk as the topic of most concern — three times the number that prioritized more immediate and limited concerns of addressing downside risk or volatility risk.
Consistent with the other findings, only 35% of plan sponsors indicated that reducing point-in-time downside return as being the most influential consideration when selecting a QDIA.
Wyatt Lee, CFA and co-portfolio manager of retirement date strategies at T. Rowe Price, says he often sees plan decisions that overemphasize point-in-time metrics, focus on a specific subset of participants or anchor to a worst-care scenario.
“The intent may be to identify the right solution for a heterogeneous DC plan population, but it’s really important to keep the full population top of mind and to maintain a long-term view to help participants achieve the retirement outcomes they are hoping for,” Lee says.
In contrast, nearly two-thirds of plan sponsors agreed that achieving the highest retirement income opportunity is more influential priority in their QDIA evaluation process.
Concerns about adverse sequence of returns risk — the risk of low negative returns late in a participants’ accumulation period or early in a participants’ retirement withdrawal period — is sometimes cited as a factor favoring lower equity target date allocations as a means of mitigating point-in-time downside risk and volatility.
However, these findings suggest that plan sponsors are considering risk in a broader context, including the potential that a lower equity target date glide path may fail to provide sufficient growth needed for participants to accumulate adequate savings for retirement.
The majority of plan sponsors acknowledge that reducing near-term risk comes at a tradeoff, with 64% of respondents disagreeing with the statement that “there are no unintended consequences in attempting to mitigate sequence of return risk for participants.”
This suggests that most sponsors recognize that efforts to mitigate SoR risk through asset allocation could have unintended consequences, including a lower account balance entering retirement and a potential reduction of retirement income.
In the end — and possibly contrary to expectation — the increasingly long-term required to accommodate participants through their careers and potentially into retirement is consistent with a focus on preserving growth potential over time, rather than preoccupation with short-term volatility or potential downside risk.