Report Finds Flaws in Target-Date Participant Assumptions

A new report says actual participant behavior is more varied and volatile than most target-date funds assume.

An analysis by J.P. Morgan Retirement Plan Services of more than 350 defined contribution plans with 1.7 million participants, for which it provides recordkeeping services, indicates that participants continue to start saving too late and take too long to reach appropriate savings rates. J.P. Morgan observed noticeable declines in contribution rates in 2008.

The number of participants who lowered or stopped contributions in 2008 was 13%, up from 8% in J.P. Morgan’s 2007 report “Ready!Fire!Aim? How some target date fund designs are missing the mark on providing retirement security to those who need it most.” Initial contribution levels for those ages 20 to 25 fell, on average, to 5.7% in 2008.

The average age at which participants reached an 8% contribution rate was 40, compared to 45.5 in the original survey, and the average age to reach 10% increased to 57 in 2008 from 55 in 2006.

These results could be due to the uneven timing of salary raises that J.P. Morgan found. In its original study about 67% of participants reported they receive raises every two to three years. In 2008, this dropped to 50%.

While the percentage of participants who had a loan outstanding steadily declined from 20% in 2006 to 18% in 2007 and 17% in 2008, the average loan amount increased from 15% of overall account balances in 2006 to 20% and 25% in 2007 and 2008, respectively.

In 2008, 7.3% of participants made pre-retirement withdrawals, up from 6.2% in 2007, and 5.5% in 2006.

J.P.Morgan found a significant number of participants older than age 65 who stopped working in 2006 (80%) withdrew their entire account balances within just three years. This makes it problematic for target-date strategies to develop asset allocation models through retirement, according to the company.

“Changes in contribution rates, loans, and withdrawals have a significant long-term effect on target-date fund outcomes. These behaviors should be factored into portfolio design but most often are not,” said Anne Lester, managing director, J.P. Morgan Global Multi-Asset Group, in a press release. “Also, this study confirms that investing at controlled levels of risk, through broader diversification and relatively rapid reduction in equity exposure in the years leading up to retirement, continues to increase the number of participants likely to reach their retirement income goals.”

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