Plan sponsors evaluating packaged and custom target-date solutions should take a close look at the demographics of their plan participants and how they stack up against those of a “typical” plan. It’s critical information when making a glide-path decision.
According to the Defined Contribution Institutional Investment Association (DCIIA), target-date assets exceeded $2 trillion at the end of 2017. Custom solutions were a healthy share—more than 20%.* Whether a plan sponsor chooses a custom or packaged target-date solution, fiduciary duties require that it best suit the participants who will rely on it the most. And the glide path is a key consideration, whether it’s choosing the right packaged glide path or opting for a fully customized version.
The Demographic Aspect: Who’s in Your Plan?
The attributes of the workforce play a key role in the decision. Packaged glide paths are designed for participant populations with typical wages, account balances, retirement ages and other characteristics. For many plans, this may be a suitable choice. But demographic and saving behaviors can differ quite a bit in some plans. Custom glide paths can be tailored to those profiles—and can adapt as those profiles evolve.
Here are a few of the plan-specific factors that affect glide path choice:
Retirement Age: Packaged target-date solutions generally assume 65 as the retirement age, but not every industry is the same. Companies with workers who tend to retire past the age of 65 (think of the agriculture, retail and education sectors) may need a glide path with more equity exposure in midlife than those with workers who tend to retire earlier (such as the healthcare, finance and information industries).
Glide paths should be designed to minimize catastrophic losses at and beyond retirement—regardless of age. Participants who are far from retirement want to maximize growth and diversify their assets without sacrificing returns. Those in the middle of their career need a combination of strong growth to compound savings, lower volatility and less risk that inflation will be a drag on purchasing power. Participants nearing and in retirement want to minimize sharp losses, combat inflation risk and balance downside protection with the need for growth to help their savings last.
Wage Levels: Compensation can vary for many reasons, including industry, geographic location, skill set and workweek. Packaged target-date glide paths reflect an average salary, so a company with more low-wage earners than high-wage earners may need a glide path with less equity and growth exposure. This would help reduce risk and improve wealth preservation.
A plan with higher earners and a higher savings level might require a glide path focused more on equities and growth and less on fixed income and preservation, because those earners may be able to take on more investment risk.
Employment Risk: Companies in industries with higher unemployment, like agriculture, hospitality and construction, will want a glide path that has less equity exposure. That type of design can reduce financial risk for an already at-risk employment population. Companies with participants who are less affected by unemployment trends and have more job security—including those in the finance, information and education industries—may opt for a more aggressive glide path design with a bit more risk.
Structural Factors in the Glide Path Decision
Beyond demographics and saving behaviors, structural factors play a role in choosing between a packaged or custom glide path. Plans that provide guaranteed income streams at retirement, such as defined benefits or annuities, can be a buffer against market risk. This might allow participants to tolerate more growth exposure in the glide path than would be available in a packaged glide path.
If a plan includes exposure to company stock, reliance on a single stock could translate to a lower growth allocation in the glide path. It may make sense to reduce equity exposure for midlife and senior savers in order to avoid excessive exposure to risk assets.
Although custom glide path strategies may require more effort and management, having a glide path that’s appropriately designed for the plan’s specific workforce—and that may improve the chances of success for participants—may more than compensate for the additional time or resources required.
The Bottom Line: Match the Glide Path to the Plan
If a defined contribution plan is designed to help participants retire “on time” through a combination of increased savings and informed investment design, one way to improve the potential for success is to ensure that the investment options, especially the default option, better reflect the population they’re designed for.
The glide path should account for participants’ demographics as well as the general risk tolerance and investment philosophy of the plan sponsor and consultant—regardless of whether the glide path is custom or is preset in a packaged solution.
Plan sponsors should work closely with their advisor or consultant to determine the most effective path for their plan. The Department of Labor offers tips that can help guide this decision: one of the most important tips is to document the process for making the choice and the reasons behind it.
*Custom target-date funds in DCIIA’s research included unitized funds where the glide path was designed on a custom basis for a specific plan based on participant demographics and other factors. Model portfolio-type solutions were not included.
Jennifer DeLong is Managing Director, Head—Defined Contribution at AB. Andrew Stumacher is Product Director—Custom Defined Contribution Solutions at AB.
"Target date" in a fund's name refers to the approximate year when a plan participant expects to retire and begin withdrawing from his or her account. Target-date funds gradually adjust their asset allocation, lowering risk as a participant nears retirement. Investments in target-date funds are not guaranteed against loss of principal at any time, and account values can be more or less than the original amount invested—including at the time of the fund's target date. Also, investing in target-date funds does not guarantee sufficient income in retirement.
The views expressed herein do not constitute research, investment advice or trade recommendations and do not necessarily represent the views of all AB portfolio-management teams.