Change the TDF Debate from “To vs. Through” to “Stay vs. Leave”

Based on how asset managers actually design target date fund (TDF) glide paths, there is considerable debate in the industry regarding the equity (stock) “landing point” (Exhibit 1). For a defined contribution (DC) plan sponsor selecting a TDF, the decision on which TDF to select is greater than simply evaluating a single glide path landing point; a TDF should be selected based on its ability to provide better outcomes for plan participants in multiple markets.  

Source: Aon Hewitt Target-Date Fund Database
A commonly held belief in the DC universe is that one of the largest risks a participant faces is on the final day at his or her employer; this is when the participant’s account balance should be at its largest and when unexpected market volatility may cause the greatest loss. For this reason, philosophies behind TDF glide path construction vary to help mitigate this point-in-time market volatility. TDFs designed using a “To” glide path generally have a softer equity landing point at age 65 (the assumed age that a participant retires) in an attempt to lessen the point-in-time market risk. TDFs designed using a “Through” glide path generally maintain a higher equity landing point at age 65 in an attempt to improve a participant’s retirement savings balance throughout the early years of their retirement.

In the “To versus Through” debate, a basis for a “To” landing point at age 65 is that a large percentage of participants will leave their DC plan1 via a rollover or cash out following separation from an employer. Aon Hewitt has tracked this behavior, and while it is true that a large percent of participants (69%)2 leave their employer’s DC plan after separation, that headcount percentage does not reflect the size of participant assets staying invested within employer DC plans. Our data shows (Exhibit 2) that more than 40% of participants with a balance of at least $30,000 stay invested in their employer’s DC plan. Furthermore, about three-quarters (72%) of participants stay invested in the market as a whole, when you combine participants who remain in their employers DC plan with those who rollover assets into another retirement investment vehicle (e.g. another employer plan or IRA).  

Source: Aon Hewitt 2015 Universe Benchmarks Report
These findings suggest that the real risk when a participant reaches age 65 is not actually single-day equity market volatility, but instead longevity, inflation, and long-term market risk. 
Following the day a person retires, it is estimated that the average participant invests and lives off his or her retirement savings for another 25 to 30 or more years3. As such, we encourage plan sponsors to look past the “To vs. Through” debate and delve deeper into a TDF’s asset allocation in parallel with their DC plan’s data to illuminate participants’ behaviors at and after reaching age 65. As illustrated in Exhibit 2, by simply looking deeper at ranges of asset balances upon separation, plan sponsors may learn that participants with medium to large retirement savings balances are staying invested in their DC plan for the long haul. If this is the case, equity risk management should not be the single driving concern; other critical factors – including longevity and inflation risk – are extremely important to offering the best options for participants.
Regardless of whether a participant is elected into a TDF with a “To” or a “Through” glide path, it is most important that the TDF addresses two critical points:

  1. A fully diversified portfolio to manage multiple risks for those who stay invested in their employer’s DC plan; and
  2. That the TDF’s glide path complements a plan sponsor’s post-employment benefit design.

[1] JP Morgan Ready! Fire! Aim? 2012

[2] Aon Hewitt 2015 Universe Benchmarks Report

[3] March 2015 EBRI Notes: How Much Needs to be Saved for Retirement After Factoring In Post-Retirement Risks: Evidence from the EBRI Retirement Security Projection Model

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