Defined Contribution Plan Participants Research Articles

ESG Fund Allocations among New, Do-It-Yourself Defined Contribution Plan Participants

ESG Fund Allocations among New, Do-It-Yourself Defined Contribution Plan Participants

Save more with less: The impact of employer defaults and match rates on retirement saving

AbstractEmployers control two primary levers that can motivate retirement savings among defined contribution plan participants—default savings rates and match rates. Setting a higher default savings rate can increase plan contributions among passive savers who accept the default. A higher match rate incentivizes active savers to increase contributions. This study uses a large sample of defined contribution participants to estimate the interaction between employer match and default rates on savings outcomes among new participants. Selecting a higher default rate has the largest impact on employee savings rates. Plans with low default savings rates that match a high percentage of employee earnings induce higher‐income participants to actively move away from the low default savings rate, resulting in a wider savings gap between higher‐ and lower‐income employees. When employees are defaulted in at a higher rate, fewer move away from the default savings rate and the default investment choice (e.g., a target‐date fund). A higher default savings rate results in higher and more equal savings rates among employees, and higher acceptance of professionally managed defaults investments.

ESG Fund Allocations Among New, Do-it-Yourself Defined Contribution Plan Participants

ESG Fund Allocations Among New, Do-it-Yourself Defined Contribution Plan Participants

Preferences for deferred annuities in the Japanese retirement market

PurposeDeferred annuities, which offer longevity insurance with relatively low premiums, are a potential payout option in defined contribution (DC) pension plans in Japan. This study aims to measure individual preferences for these annuities.Design/methodology/approachThis study conducts stated choice experiments using an original internet survey. This methodology provides a decision-making scenario similar to that faced by individuals when making real retirement saving decisions. Subjective valuations of deferred, immediate and term annuities are compared.FindingsThis study finds that male individuals have an insignificant preference for deferred annuities – the benefits of which begin at an advanced age. On average, deferred annuities are considered a gamble, betting against life and individuals who are married and have higher financial assets tend to value them less.Originality/valueWhile previous studies, based on theory and simulations, have found that deferred annuities should be included in individual retirement assets, this study examines annuity preferences from the demand side (i.e. DC plan participants) –an approach that has not been addressed in the literature.

How Long Is Long Enough?

Defined-contribution plan (DCP) fiduciaries are often faced with conflicting perspectives when executing their responsibilities and terminating underperforming active managers are involved. Consultants, investment managers, and capital market intermediaries generally argue that more time is needed to prove that an investment strategy is suboptimal. These parties often have inherent conflicts of interest to argue for active management over passive management. Most conflicts are economic in nature, but some are steeped in intellectual hubris. In this article, the authors enter the fray from the plan participant (PP) side. Ultimately, the very essence of a DCP is to offer a menu of investment options that enable PPs to optimize wealth aggregation in a diversified manner using a multiasset class solution. We show that PPs are better served when fiduciaries monitor active investment managers and replace them with passive alternatives in a timely manner if they underperform. Too often plan fiduciaries churn a DCP by replacing underperforming active funds with other active funds. <b>TOPICS:</b>Manager selection, mutual fund performance, passive strategies, retirement, wealth management <b>Key Findings</b> • Defined-contribution plan participants are better served when fiduciaries monitor active investment managers and replace them with passive alternatives in a timely manner if they underperform. • A three-year rolling return window to compare active fund returns with benchmark returns seems to provide the best decision criterion for the active-to-passive decision. • Plan participants are far better served by fiduciaries who have a well-structured, discrete decision framework for replacing underperforming active funds.

Practical Applications of Active Management in Defined Contribution Plans

Practical Applications Summary In Active Management in Defined Contribution Plans, which appeared in the Spring 2020 edition of The Journal of Retirement, Gerald W. Buetow, Jr. (of BFRC Services), Bernd Hanke (of Global Systematic Investors), and Maxim Zagonov (of Toulouse Business School) investigate the value of active management of defined contribution (DC) plans, given that many fiduciaries and most plan participants are not investment professionals. They find that for most DC fiduciaries, it is preferable to replace active US equity mutual funds with low-cost passive alternatives. They attribute this to three reasons: (1) the performance of active managers is inconsistent; (2) there are two levels of decision makers, fiduciaries and plan participants, which complicates effective active fund selection; and (3) the few consistently outperforming funds that exist tend to have higher tracking error, which makes asset allocation more complicated. Therefore, the authors argue, fiduciaries and DC plan participants should select passive rather than active funds. TOPICS:Wealth management, retirement, mutual fund performance, passive strategies

Practical Applications of Liabilities Matter: Improving Target Date Glidepath Construction through Liability Adaptive Asset Allocation

Practical Applications Summary In Liabilities Matter: Improving Target Date Glidepath Construction through Liability Adaptive Asset Allocation, from the Summer 2019 issue of The Journal of Retirement, author Michael W. Crook (of UBS Global Wealth Management in New York, NY) calls into question the rationale behind the most popular investment funds in today’s employee defined-contribution (DC) plans. Target date funds (TDFs)—which, for example, are held by 75% of participants in DC plans managed by Vanguard—use a preset schedule called a glidepath to reallocate assets from equities to fixed-income securities as a participant’s retirement date approaches. The author finds that this approach does not work as well as the liability-driven investment (LDI) strategy used by pension plans. LDI is more responsive to the needs of participants because it focuses not on participants’ retirement dates, but on how close they are to having enough money on which to retire. It reallocates assets to fixed-income securities as a participant’s plan balance approaches the amount needed to fund all retirement expenses. The author finds that LDI produces better outcomes, is easier to explain to clients, and makes it easier for financial advisors to provide customized financial planning and total wealth management for their clients.

Peer Effects Among Teachers: A Study of Retirement Investments

Using a unique matched-panel dataset that combines detailed demographic information from the Florida Department of Education’s annual survey of school districts with investment information from the Florida State Board of Administration for 2002–2009, this paper looks for the presence of peer effects among Florida Defined Contribution plan participants at the school level. Overall, the regression results suggest a small, but significant peer effect on asset allocations and activity level. A 1 standard deviation change in initial peer equity yielded a 0.04 standard deviation change in equity reallocation. This is in comparison to a 1 standard deviation change in the individual’s own initial equity allocation, which would yield a 0.16 standard deviation change in equity allocation. For activity level, a 5.2% change in peer activity level increased the likelihood of a participant being active by 1.8%. The findings are reinforced by similar analysis using false peer groups. These findings suggest the presence of a social multiplier for coworker investment decisions.

Retirement income strategies designed in an expected utility framework

Various classes of retirement income strategies are evaluated and their robustness tested in an expected utility framework. Fixed percentage systematic withdrawals from an investment portfolio combined with laddered purchases of immediate life annuities stands out as a superior strategy for retired defined contribution plan participants and IRA holders, yielding better outcomes than alternatives, including longevity insurance. This broad strategy is then applied, step by step, and customized across a wide range of household risk preferences and situations, with due consideration of product costs, taxes, and economic risks and returns.

Defaulting Participants in Defined Contribution Plans into Annuities: Are the Potential Benefits Worth the Costs?

The potential benefits of annuitization vary considerably from one person to the next. However, given the low popularity of annuitization in the United States and the general consensus among researchers that annuitization is the optimal retirement income strategy, introducing annuities as part of defined contribution (DC) plan defaults has the potential to create better outcomes for many workers. Overall, we find evidence to suggest that introducing annuities as part of the plan investment default is likely to result in a net benefit to DC plan participants as long as the decision is well calibrated to the demographics and financial position of the participant population. The potential gains to the plan are further increased if the plan’s default investment can provide personalized recommendations—for example, within some type of managed accounts solution as opposed to a target date fund in which the individual’s preferences are not considered. <b>TOPICS:</b>Retirement, fixed income and structured finance

Compulsive Gamblers: The Frequency and Timing of Trades by UK DC Plan Participants

In defined contribution (DC) pension schemes, participants take responsibility for a range of issues including their investment strategies. After initial asset allocation and investment product decisions, most people do little or nothing until they approach retirement. A smaller proportion of participants are more active: some are sophisticated investors, others appear to be ‘noise’ traders caught-up in market sentiment, and some are compulsive gamblers. After reviewing the relevant on market trading and the literature on gambling, we use insights from both to analyse the attributes of compulsive gamblers in a UK DC multi-employer framework over the period 2002-2012. We focus on those who switched assets within asset classes and between related products in the context of financial and macroeconomic volatility. In this environment compulsive gamblers are shown to have distinctive socio-demographic characteristics consistent with expectations from cognitive science. Implications are drawn for the design of pension products and institutions.

Illustrating Retirement Income for Defined Contribution Plan Participants:A Critical Analysis of the Department of Labor Proposal

Illustrating Retirement Income for Defined Contribution Plan Participants:<i>A Critical Analysis of the Department of Labor Proposal</i>

Illustrating Retirement Income for Defined Contribution Plan Participants: A Critical Analysis of the Department of Labor Proposal

The design solution for retirement income from individual accounts is the next major challenge to the evolving retirement system in the United States. In that regard, the Department of Labor has put forward a proposal to require sponsors of defined contribution plans to provide their participants with an illustration of the retirement income that might be expected from the assets held in their individual accounts through the use of an immediate fixed life annuity at retirement. Using an empirical analysis based on historical simulations, I show how the Department of Labor’s proposal, as currently formulated and with various improvements I recommend, will operate under realistic market conditions. I find that the proposal is a good start, but it can be improved by—among other changes—making the income flows gender-distinct and reflecting an inflation-indexed life annuity (with a load) rather than a nominal fixed annuity.

Illustrating Retirement Income for Defined Contribution Plan Participants: A Critical Analysis of the Department of Labor Proposal

The design solution for retirement income strategies from individual accounts is the next major challenge to the evolving retirement system in the United States. In response, the Department of Labor has put forward a proposal to require sponsors of defined contribution plans to provide their participants with an illustration of the retirement income that might be expected from the assets held in their individual accountsthrough the use of an immediate fixed life annuity at retirement. Using an empirical analysis based on historical simulations, I show how the Department of Labor illustration, as currently proposed and with various improvements I recommend, will operate under realistic market conditions. I find that the proposal is a good start, but it can be improved by?among other changes?making the income flows gender-distinct and reflecting an inflation-indexed life annuity (with a load) rather than a nominal fixed annuity.

The value of tail risk hedging in defined contribution plans: what does history tell us

AbstractHedging against tail events in equity markets has been forcefully advocated in the aftermath of recent global financial crisis. Whether this is beneficial to long horizon investors like employees enrolled in defined contribution (DC) plans, however, has been subject to criticism. We conduct historical simulation since 1928 to examine the effectiveness of active and passive tail risk hedging using out of money put options for hypothetical equity portfolios of DC plan participants with 20 years to retirement. Our findings show that the cost of tail hedging exceeds the benefits for a majority of the plan participants during the sample period. However, for a significant number of simulations, hedging result in superior outcomes relative to an unhedged position. Active tail hedging is more effective when employees confront several panic-driven periods characterized by short and sharp market swings in the equity markets over the investment horizon. Passive hedging, on the other hand, proves beneficial when they encounter an extremely rare event like the Great Depression as equity markets go into deep and prolonged decline.

Determinants of Defined Contribution Plan Deferral

The purpose of this study was to examine the trend of defined contribution (DC) plan deferrals before and after the Great Recession. The investment principle of “buying when prices are low” suggests that DC plan deferral should increase during years when portfolio returns are low. The sample for this study consisted of eligible DC plan participants in the 2004, 2007, and 2010 Survey of Consumer Finances (SCF). The dependent variable was the elective deferral to the DC plan expressed as a percentage of the maximum amount allowed. The descriptive statistics showed that about half of respondents deferred <20% of their maximum allowable elective deferral, about a quarter of respondents deferred between 20% and 40%, and only a little more than 7% of respondents maximized their DC plan deferral in 2004 and 2007. However, the deferral rates dropped dramatically in 2010. The results of ordered logistic regression showed that respondents who had more education, were in excellent health, had more income, were willing to take investment risk, were allowed to borrow from the DC plan, were allowed to withdraw from the DC plan, and were homeowners without a mortgage were more likely to make a larger deferral to the DC plan. In general, these results were applicable for the time period. The most important implication is that many respondents were contributing relatively small percentages of the amount possible in 2004 and 2007 and that contributions were even lower in 2010. Educators, employers, and financial advisors should help workers understand the importance of participating fully or to the extent possible when making contributions to their DC plans.

Retirement Income for Participants in DefinedContribution Plans and Holders of IRAs: Recent Developments in Immediate LifeAnnuities and Other Income Products

As more and more workers in the U.S. are covered only by defined contribution plans, and as more and more of these workers approach retirement, the use of life annuities and other newly developed retirement income products should increase. This article reviews historical and recent payout experiences with immediate life annuities, both nominal and inflation-indexed. It also explains new income product types, ranging from those that are just distributions of investments to those that contain complex guarantees from insurance companies. Finally, it provides some considerations for plan sponsors in this still understudied area of the decumulation phase of the individual account retirement plan. <b>TOPICS:</b>Retirement, wealth management, risk management

Regret aversion and annuity risk in defined contribution pension plans

The high value of the implicit option to choose a retirement date at which interest rates are particularly high and life annuities relatively cheap, leads to the possibility to introduce regret aversion in the retirement investment decision of defined contribution plan participants. As a remedy for regret aversion in retirement investment decisions, this paper develops and prices a lookback option on a life annuity contract. We determine a closed-form option value under the restriction that the option holder invests risklessly during the time to maturity of the option and without the guarantee that the exact amount of retirement wealth is converted into a life annuity at retirement. Thereafter the investment restriction is relaxed and the guarantee of exact conversion is imposed and the option is priced via Monte Carlo simulations in an economic environment with a stochastic discount factor. Option price sensitivities are determined via the pricing of alternative options. We find that the price of a lookback option, with a maturity of three years, amounts to 8%–9% of the wealth at the option issuance date. The option price is highly sensitive to the exercise price of the option, i.e. pricing alternative options (e.g. Asian) substantially lowers the price. Time to maturity and interest rate volatility are other important option price drivers. Asset allocation decisions and initial interest rates hardly affect the option price.

The portable guarantee to exchange back an old defined benefit for a new defined contribution (DC) pension plan

As a defined contribution (DC) pension plan is introduced to replace a defined benefit (DB) pension plan, the portability benefit from a DC pension plan costs the employees to bear the investment risk from managing the pension fund. To protect the retirement income and maintain the portability benefit, a guarantee to exchange back the old defined benefit is supposed to be demanded for the new DC plan's participants in the guarantee market. In light of such a demand, this article applies a claim-terminating insurance pricing model to offer a contingent claims pricing model for a portable pension guarantee. Using the new labor pension plan of Taiwan as an illustration, a guaranteed DC pension will carry an extra cost of almost 50% up to over 100% of the plan's contributions over the participant's work life, given the current mandatory minimum requirement of a contribution rate of 6%.

Asset Allocation and Information Overload: The Influence of Information Display, Asset Choice,and Investor Experience

This paper examines whether information overload might partially explain why defined contribution plan participants tend to follow the "path of least resistance" (Choi et al. [2002]) In two experiments, we test how three common differences among defined contribution plans (the number of investment choices offered, the similarity of the choices, and the display of the choices) lead to varying degrees of information overload and the probability of opting for the default. Notably, we control for the financial aptitude of each individual. The findings suggest that the success of certain plan features depends strongly on the financial background of the participant. We find that low-knowledge individuals opt for the default allocation more often than high-knowledge individuals (experiment 1: 20% versus 2%). The results emphasize the importance of plan design, especially the selection of plan defaults, and the need to improve the financial literacy of participants.