Guide Helps Evaluate TDF Glide Paths

A new paper gives sponsors of defined contribution (DC) plans some guidance on evaluating glide paths for target-date funds (TDFs).

According to the authors of “Evaluation of Target-Date Glide Paths Within Defined Contribution Plans,” generally the investment objectives for those plans are to accumulate wealth before retirement and to convert that wealth to income once retirement begins.

The conversion to income presents its own set of issues, said the authors of the paper, Richard K. Fullmer of T. Rowe Price and James A. Tzitzouris of the T. Rowe Price Group. “Income generation depends on the intended horizon, and sponsors face two primary considerations related to this horizon. The first is the ability of a glide path to generate lifetime income consistently over the course of retirement. The second is the ability of the glide path to limit the risk of capital loss near and during retirement, which is particularly important for participants who withdraw their balances over a more moderate-term horizon.”

Fullmer and Tzitzouris found that higher-equity glide paths are superior at providing a retirement income stream that can enable participants to maintain their standard of living throughout their post-retirement lifetime.

The authors also found that a lower-equity glide path may provide a better choice for “those concerned about the ability to recover the full amount of the peak account balance in the early stages of retirement and who may be willing to trade some lifetime income potential for this increased stability.” The benefits of this approach, compared with a higher-equity glide path, depends on the plan sponsor and participant preferences, said Fullmer and Tzitzouris.

The trade-offs depend on characteristics unique to each plan, such as participant salary levels and contribution rates, and length of their retirement horizons, added the authors.

The full paper can be downloaded from here.