DC Plan Sponsors Are Focusing on Long-Term Retirement Objectives

A T. Rowe Price survey discloses how defined contribution plan sponsors understand several retirement planning objectives and risks.

A recent T. Rowe Price report uncovers how defined contribution (DC) plan sponsors are evolving their views of certain retirement-related risks and objectives.  

According to the survey, “Advancing the Way We Think About Retirement Risk and Outcomes,” the largest concern among plan sponsors includes participants’ longevity risk (with 42% of plan sponsors indicating this as their top worry), and the capacity to gain greater retirement account balances over the long term, when selecting target-date strategies or other qualified default investment alternatives (QDIAs) for participants.

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During the selection process for QDIAs, the survey found DC plan sponsors prioritize risks towards long-term objectives. However, small DC plan sponsors have a higher sensitivity towards short-term objectives.

Thirty-five percent of plan sponsors said “reducing point-in-time downside return” is their top consideration when selecting a QDIA. Yet, 65% of respondents believe scoring the highest retirement income opportunity is a greater priority.   

“Being an effective plan sponsor today requires an expansive view of the risks and influences on the growth of a participant’s portfolio,” says Lorie Latham, senior defined contribution strategist at T. Rowe Price. “This survey reveals that plan sponsors clearly understand that longevity risk–the risk that participants will outlive their retirement income–is a critical factor in determining retirement readiness, and that their investment choices must be designed accordingly.”

Additionally, the risk of unfavorable sequence of returns (SoR) was cited as a reason for favoring lower equity target-date allocations among plan sponsors, the survey finds. However, T. Rowe Price says these findings suggest plan sponsors “consider risk in a broader context,” including the possibility that a “lower equity target date glide path may fail to provide sufficient growth needed for participants to accumulate adequate savings for retirement.”

Sixty-four percent of plan sponsors disagreed with the statement that “there are no unintended consequences in attempting to mitigate sequence of return risk for participants.” Therefore, the survey finds plan sponsors understand the risks associated with lessening SoR risk via asset allocation.

“We often see plan decisions that overemphasize point-in-time metrics, focus on a specific subset of participants, or anchor to a worst-case scenario,” says Wyatt Lee, CFA, co-portfolio manager, Retirement Date Strategies. “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.”

Measurement of Retirement Success Varies Based on Different Assumptions

An analysis by the Employee Benefit Research Institute finds 57.4% of U.S. households are on track to be able to cover 100% of expenses in retirement, but if long-term care costs are removed from the equation, the percentage jumps to 75.5%.

Just over half, 57.4%, of U.S. households headed by individuals between the ages of 35 and 64 are on track to cover 100% of the average costs for retirees in their age-, income-, and family-status cohorts and not run out of money, according to the Employee Benefit Research Institute (EBRI). This means that the retirement deficit for households is $4.13 trillion in 2014 dollars.

However, if expenditures are reduced to 90% of the average costs for retirees, 68.1% of households are on track to not run out of money, reducing the retirement savings shortfall by nearly 50% to $2.09 trillion, and if expenditures are reduced to 80%, 82.1% of households are on track to not run out of money, and the deficit is reduced to $70 billion.

If long-term care costs are removed from the equation, 75.5% of U.S. households are on track to be able to cover 100% of expenses in retirement.

EBRI says it has made these projections to help policymakers determine the size of the retirement deficit. At various times, EBRI says, policymakers have sought ways to increase access to defined contribution plans, and to seek ways to keep money in the system until workers retire. Conversely, policymakers have considered reducing pretax contributions. “Such policymaking can lead to unintended and undesirable consequences if not informed by sound research,” EBRI says.

If all employers that are not providing a defined benefit (DB) or defined contribution (DC) plan were required to provide an automatic individual retirement account (IRA) with an initial deferral of 3%, the retirement deficit declines by 6.5% or $268 billion, EBRI says. If the Automatic Retirement Plan Act of 2017 were passed, whereby all but the smallest employers were required to offer plans and automatically enroll workers, including part-time workers, at 6%, the retirement deficit would decline by 15.6% or $645 billion.

If all employers, regardless of size, had to offer a DC plan, EBRI says, the retirement deficit would decline by 19.4% or $802 billion. “Such initiatives would have correspondingly much greater impact on younger age cohorts,” EBRI says.

If all leakage were removed, 27.3% more participants in the lowest income quartile would achieve retirement success. For those in the highest income quartile, 15.2% more participants would achieve retirement success.

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