How Well Do 401k Plan Sponsors Understand (and Prioritize) Retirement Risk?

Results underscore the need to better understand the balance between managing volatility and achieving growth

401k, risk, retirement, T. Rowe PriceCareful. Caaareful.

A new survey finds plan sponsors are most concerned about participants’ longevity risk, as well as their ability to achieve higher retirement account balances over the long term when selecting a target date strategy for participants.

Titled “Advancing the Way We Think About Retirement Risk and Outcomes” and released by T. Rowe Price, it posed three questions:

INTERPRET: How do DC plan sponsors perceive and prioritize the risks that participants face when working towards achieving their retirement objectives?

TRANSLATE: To what extent is the qualified default investment alternative (QDIA) selection and evaluation process influenced by their perceptions and prioritizations of these risks?

ALIGN: Are their perceptions of risks logically aligned with the stated long-term objectives for their participants?

When it comes to the selection process for QDIAs, DC plan sponsors largely prioritize risks in a manner consistent with long-term objectives.

Even so, there is greater reported sensitivity to short-term considerations among a minority of DC plan sponsors — a position that may be at odds with helping participants improve their long-term retirement outcomes.

Strengthening support for keeping retired participants in the plan

Almost 70 percent of DC plan sponsors indicate that retention of participant assets is preferable to retirees transitioning account balances out of the plan, which influences the decision to focus on longer-term objectives over volatility.

In fact, a subset (29 percent) report that keeping retired participants in plan has become more of a priority. While emphasis on providing for retired participants might suggest greater interest in limiting near-term volatility through investment selection, further survey findings tell a different story.

Longevity focus takes precedence

DC plan sponsors report that participants running out of money in retirement is top of mind, with 42 percent identifying longevity risk as the topic of most concern — three times the number that prioritized more immediate and limited concerns of addressing downside risk (14 percent) or volatility risk (12 percent).

Achieving highest possible retirement income

Consistent with the findings above, only 35 percent of plan sponsors indicated that reducing point-in-time downside return as being the most influential consideration when selecting a QDIA. In contrast, nearly two-thirds (65 percent) of plan sponsors agreed that achieving the highest retirement income opportunity is a more influential priority in their QDIA evaluation process.

More to the story than sequence of returns

Concerns about adverse sequence of returns risk — the risk of low or negative returns late in a participant’s accumulation period or early in a participant’s retirement withdrawal period — is sometimes cited as a factor favoring lower equity target date allocations as a means of mitigating point-in-time downside risk and volatility.

However, these findings suggest that plan sponsors are considering risk in a broader context, including the potential that a lower equity target date glide path may fail to provide sufficient growth needed for participants to accumulate adequate savings for retirement.

Acknowledging ‘Risk’ Tradeoffs

The majority of plan sponsors acknowledge that reducing near-term risk comes at a tradeoff, with 64 percent of respondents disagreeing with the statement that “there are no unintended consequences in attempting to mitigate sequence of return risk for participants.”

This suggests that most sponsors recognize that efforts to mitigate SoR risk through asset allocation (e.g. by selecting a target date strategy with a lower equity glide path) could have unintended consequences, including a lower account balance entering retirement and a potential reduction of retirement income.

These results show broad awareness that attempts to prioritize managing volatility and downside risk on behalf of participants — due, in part, to heightened concerns about adverse sequence of returns — may come with tradeoffs that can ultimately erode retirement outcomes.

The results also underscore the need to better understand the balance between managing volatility and achieving growth, and how to implement asset allocation strategies that take a more comprehensive set of objectives and risks into account.

In the end (and possibly contrary to expectation), the increasingly long-term view required to accommodate participants through their careers and potentially into retirement is consistent with a focus on preserving growth potential over time, rather than preoccupation with short-term volatility or potential downside risk.

“Being an effective plan sponsor today requires an expansive view of the risks and influences on the growth of a participant’s portfolio,” Lorie Latham, T. Rowe’s senior defined contribution strategist, said in a statement. “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.”

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