o First, the median increase from TDFs is positive, reaching a value just in How Would Target-Date Funds Likely Figure 1 shows the interquartile range for th excess of 5 percent for those e percentage increase in b in the highest tenure category. alances moving Impact Future 401(k) Accumulations? from participant direction to target date o However, the probability that a partic funds. As you can see from ipant who cashes out would have had the medians in the middle column for each age cohort, the averag a larger balance in stable value cons e impact appears to be m istently remains in th ie 40 nima percen l (less than 1 t th percent); however this can be very d range. eceiving. The 25 and 75th percentiles show that Thank you for your invitation to testify today on this important topic. I am Jack this can m ake a huge difference, especially for those exposed to TDFs at a relatively VanDerhei, research director of the Employee Benefit Research Institute. EBRI is a Finally, F young age. For those 25–29, the top 25 percent ha igure 7 shows the same analysis but this tim ve at least an 8 pe e comparing an average TDF with a rcent gain, but the nonpartisan research institute that has been focusing on retirement and health benefits for money m bottom 25 percent have at arket fund. The m le edians in this case ast a 5.9 percent loss are substantial: ranging from approximately . the past 30 years. EBRI does not take policy positions and does not lobby. 5 percent for the lowest tenure range to a pproximately 1/3 for those with 11 or more years in the plan. Moreo Given the incredible rang ve of er, the p asset a robllo abil cations because of i ity that the TDF balance exceed ndividual participant s the money Last year, as part of EBRI’s analysis of the likely impact of the Pension Protection Act’s 1 m investm arket account for this group is m ent direction, it should not be surprising that the ad onotonically increasing from option of TDFs has a large 71 percent for the lowest- safe harbor automatic enrollment and automatic escalation provisions, we developed a tenure group to 85 percent for t range of different outcom How Would Target-Date Funds es. Figure 2 shows th hose in the highest-tenure group. e same type of analysis as the previous stochastic simulation model to project future 401(k) balances as a function of various figure, although this time the relative gains are displayed as a function of the participant’s plan design variables as well as assumptions with respect to various employee behavioral Likely Impact Future 401(k) Accumulations? initial equity allocation. Obviously, the primary advantage of TDFs when viewed in this responses. context is the expected gains for thos e with an initial equity allocation of less than 40 1 Jack VanDerhei and Craig Copeland, “The Impact of PPA on Retirement Savings for 401(k) Participants” percent. Although the median gains are still relatively small (less than 5 percent for all Today I will report on the results I obtained using the EBRI simulation model to th EBRI Issue Brief, June 2008. http://ebri.org/publications/ib/index.cfm?fa=ibDisp&content_id=3948 groups other than those with zero equity exposure), the 75 percentile is in the range of a 2 determine how target-date funds (TDFs) would likely impact 401(k) participants assumed Craig Copeland, “Use of Target-Date Funds in 401(k) Plans, 2007” EBRI Issue Brief, March 2009. th 14–25 percent gain for those under 30 percent equity allocation, while the 25 percentile to be automatically enrolled. I realize that TDF use in 401(k) plans is not limited to those http://ebri.org/publications/ib/index.cfm?fa=ibDisp&content_id=4203 3 2 is only a 2–6 percent loss. autom For mo are info tically enrolled, and our March 2009 rmation on the EBRI/ICI database, seeEBRI Issue Brief Jack VanDerhei, Sa by Craig Copeland rah Holden, Luis Alonso , and Craig Copeland, “401(k) Plan Asset Allocation, Account Balances, and Loan Activity in 2007” EBRI Issue provides significant detail on the differences. However, based on our simulation results, Jack VanDerhei Brief, December 2008. http://ebri.org/publications/ib/index.cfm?fa=ibDisp&content_id=4132 While some financial advisors may argue that less than a 30 percent equity allocation it appears that this 401(k) auto-enrollment will represent the majority of TDF use in the 4 This denotes both the 401(k) balances with either the current employer or previous employers that have Research Director may be optimal for those very close to retirement age, it is likely that this will not be the future and hence I will concentrate my comments today on those results been retained as well as any IRA balances that are attributable to 401(k) rollovers. Employee Benefit Research Institute case for younger participants. To show the potential value of TDFs for young employees, 5 For more information on the return assumptions, see Young Park, “Plan Demographics, Participants’ I bifurcate the analysis in Figure 2 for those under age 45 (Figure 3) and those 45 or over The sim Saving Beu ha lation m vior, andodel sta Target-D rat ts with e Fund all workers, whether or not Investments” EBRI Issue Brief, May 2 they are currently en 009. rolled h (Figure 4). As you can see in Figure 3, the pos ttp://ebri.org/publications/ib/index.cfm?fa=ibDisp&conitive results of TDFs in the lower equity tent_id=4280 in a 401(k) plans, and tracks them through age 65 by stochastically assigning job change, th allocation range are much more pronounced with the 75 percentiles for those with less whether the new employer sponsors a 401(k) plan, cashout behavior, and financial market 3 than a 30 percent allocation in the positive 25–37 percent range, while the losses performance. In addition, we use the EBRI/ICI 401(k) database to statistically impute th Joint DOL/SEC Hearing: associated with the 25 percentile is always less than 6percent. Moreover, even the asset allocation under participant directed baseline scenarios. median gains in this range are in excess of 5 percent for all groups. Target Date Fund Public Hearing Although the model produces several output metrics, the one of most interest for today’s 4 While the previous figures illustrated that TDFs can indeed make a substantial difference discussion is the ratio of “401(k) accumulations” divided by wage at the time of June 18, 2009 in balances at retirement for some participants, another concern that was often expressed retirement—or, for purposes of cashout behavior discussed later, the time of job change. after the proposed qualified default investment allocation (QDIA) regulations were Most of the analysis presented today will focus on the percentage increase or decrease of released dealt with the potential impact on participants who were likely to cash out their those balances moving from participant-directed investments to target-date funds. 401(k) balances at job change rather than role them over to an individual retirement account (IRA) or retain them in a 401(k) plan. Figure 5 shows the expected impact on Given my time constraints, I will limit my comments today to the comparison of these individuals of moving from participant-directed investments to TDFs, as a function “average” TDF in terms of equity allocation; however, I have included sensitivity of the employee’s tenure on the job. The median impact is extremely small (1 percent or analysis in the appendix for both the most aggressive and m ost conservative TDFs as th less); however the interquartile range increases with duration, as expected, and the 75 well. percentile for those with 11 or more years with the employer exceeds 6 percent. As you can see from the table of contents on page 2 of the handout, I am bifurcating my results into those dealing with account balances at retirement and those dealing with Another related issue during the discussion period for the proposed QDIA regulations account balances at job change for those who cash out. Although the results for these The Employee Benefit Research Institute (EBRI) is a nonprofit, nonpartisan research institute that dealt with the potential utility of including a stable-value alternative. Figure 6 shows the seven figures all assume baseline rate of return assumptions (which are provided on the focuses on health, retirement, and economic security issues. EBRI does not take policy positions results of an average TDF vs. a stable-value fund on those who cash out. Two last page of the handout), results for alternative return assumptions are provided in the and does not lobby. www.ebri.org 5 interesting, but conflicting, messages come through: appendix (Figures 8–12). Figure 10: Increase in balances (401(k) + rollover IRA) at retirement age as a function of initial Figure 1: Increase in balances (401(k) + rollover IRA) at retirement age as a function of initial Figure 2: Increase in balances (401(k) + rollover IRA) at retirement age as a function of initial Figure 3: Increase in balances (401(k) + rollover IRA) at retirement age as a function of initial Figure 4: Increase in balances (401(k) + rollover IRA) at retirement age as a function of initial Figure 9: Increase in balances (401(k) + rollover IRA) at retirement age as a function of initial Figure 11: Increase in balances (401(k) + rollover IRA) at retirement age as a function of age Figure 12: Increase in balances (401(k) + rollover IRA) at retirement age as a function of age Figure 8: Increase in balances (401(k) + rollover IRA) at retirement age as a function of age Figure 5: Increase in balances for those assumed to cash out when they change jobs as a Figure 7: Increase in balances for those assumed to cash out when they change jobs as a Figure 6: increase in balances for those assumed to cash out when they change jobs as a in in in Table of Contents Baseline Asset Class Return, Volatility, and Correlation equity allocation (average target date vs participant direction): Participants ages 45 and older, equity allocation equity allocation equity allocation average target date vs participant direction: alternative (lower) return scenario age in average target date vs participant direction: Baseline return assumptions function of tenure equity allocation in in in function of tenure function of tenure average target date vs participant direction: Participants ages 45 and older average target date vs participant direction: Participants younger than 45, average target date vs participant direction: Participants younger than 45 aggressive target date vs participant direction conservative in in average target date vs participant direction target date vs participant direction average target date vs participant directed in in average target date vs money market average target date vs stable value Standard Non-U.S. Fixed 1. account balances at retirement alternative (lower) return scenario alternative (lower) return scenario Expected Return Deviaton Correlation Matrix U.S. Equity Equity Income 10.0% U.S. equity a. account balances at retirement: TDF vs. pa U.S. equit rticipant directed (baselin y 1 e ror assum ptions for aver age equity allocation) 8.9% 18.0% 8% 7% 15% 40% 30% 20%30% 70% 4% Non-U.S. equity Non-U.S. equity 0.54 1 i. results by age (Figure 1) 8.9 19.1 Prob TDF > SV = .59 14% 6% Fixed income Fixed income 0.26 0.21 1 ii. results by initial equity allocation under par Appendix ticipant direction 6.3 2.9 8.0% 6% Prob TDF > MM = .85 Source: Grant Gardner and Yuan-An Fan, Russell’s Approach to Target-Date Funds: Building a Simple and Powerful Solution to Retirement Saving, August 25% 1. overall (Figure 2) 25% 3% 12% 2006. 5% 60% Prob TDF > SV = .61 10% 6% 30% a. account balances at retirem 2. under age 45 (Figure 3) ent: TDF vs. participant directed, expressed as a percentage delta (alternative lower ror 15% 5% 6.0% assumptions f 3. oage 45 and over (Figure 4) r average equity allocation) 10% 20% 4% 20% 2% 2. account balances at job cha i. results by age (Figure 8) nge for those who cash out 50% 4% Alternative Asset Class Return, Volatility, and Correlation 8% 3% 4.0% a. account balances at job change for thos ii. results by initial equity allocation un e who cash out: TDF vs. participant direct der participant direction ed, expressed as a percentage delta Fixed 15% 20% 5% Prob TDF > MM = .79 4% 10% Expected Return Standard Deviaton Correlation Matrix U.S. Equity Non-U.S. Equity Income (baseline ass 1.u m under age 45 (Figure 9) ptions) 15% 3% U.S. Equity U.S. equity 1 6% 4.45% 9.00% 1% 2% Prob TDF > SV = .59 i. average TD 2. age 45 and o F (Figure 5) ver (Figure10 ) 40% Non-U.S. Equity Non-U.S. equity 0.54 1 2.0% 4.45 9.55 10% b. b. account balances at retirem account balances at job change for those ent: TDF vs. pa who cash out: TDF vs. stable value, expres rticipant directed, expressed as a percentage delta sed as a percentage delta (truncated (baseline ror assumptions 2% Fixed Income Fixed income 0.26 0.21 1 4% 25th percentile 10% 3.80 1.75 1% 10% 0% tim for aggressive equity allocation) e series) 2% 5% Source: Park (2009) and Grant Gardner and Yuan-An Fan. Russell’s Approach to Target-Date Funds: Building a Simple and Powerful Solution 0% 25th percentile median 25th percentile 25th percentile 25th percentile 25th percentile 25th percentile 30% 0.0% to Retirement Saving, August 2006. 25th percentile 1% i. i. average TD results by age (Figure 11) F (Figure 6) 2% 5% 25th percentile 25th percentile 25th percentile 25th percentile 0% 75th percentile Median median median median Median Median 5% Prob TDF > MM = .71 c. c. account balances at job change for th account balances at retirement: TDF vs. pa ose who cash out: TDF vs. m rticipant directed, expresse oney m d as a percentage delta arket, expressed as a percentage delta (baseline ror assumptions Median median median median median 75th percentile 75th percentile 75th percentile 75th percentile 75th percentile 75th percentile 0% 0% (trunc for conserva ated tim tive equ e series) ity allocation) 75th percentile -1% -1% 75th percentile -2.0% -5% 0% 75th percentile 75th percentile 75th percentile 0% 0% 20% 0% 1-5 6-10 11+ i. i. average TD results by age (Figure 12) F (Figure 7) 0% -2% -1% Truncated Asset Class Return, Volatility, and Correlation Using Historical Data from 1989 to 2008 d. Mean and covariance assumptions for: -2% 1-5 6-10 11+ Standard Correlation Non-U.S. Fixed Money -5% -4.0% Annualized Return U.S. Equity Stable Value -2% i. Baseline Deviaton Matrix Equity Income Market -4% 10% -2% -10% -3% -10% U.S. equity 1 -5% ii. Alternative (lower) scenario 8.43% 20.16% -2% -5% Non-U.S. equity 0.73 1 3.14 21.13 iii. Truncated scenario -10% -6% -6.0% Fixed income 0.25 -0.16 1 7.43 5.31 -3% -4% -3% 1 0%-10%2.82 1.26 Money market 0.17 0.08 0.15 -8% 0.51 1 6.17 1.37 Stable value 0.30 -0.18 0.53 -15% -15% -5% -20% 1-5 6-10 11+ -4% -4% -8.0% 0 1 - 9 10 - 19 20 - 29 30 - 39 40 - 49 50 - 59 60 - 69 70 - 79 80 - 89 90 - 99 100 -10% Source: Standard & Poor's, Morgan Stanley Capital International, Barclays Capital, and Hueler Analytics. 0 25 - 29 1 - 9 30 - 34 10 - 19 20 - 29 35 - 39 30 - 39 40 - 44 40 - 49 50 - 59 45 - 49 60 - 69 50 - 54 70 - 79 80 - 89 55 - 59 90 - 99 60 - 64 100 00 11 - 9 - 9 10 - 19 10 - 19 20 - 29 20 - 29 30 - 39 30 - 39 40 - 49 40 - 49 50 - 59 50 - 59 60 - 69 60 - 69 70 - 79 70 - 79 80 - 89 80 - 89 90 - 99 90 - 99 100 100 -4% 25 - 29 30 - 34 35 - 39 40 - 44 45 - 49 50 - 54 55 - 59 60 - 64 Tenure Note: S&P 500 I 25 - 29 ndex is used for 30 - 34 U.S. equity, MSCI35 - 39 EAFE Index for Non-U.S. e 40 - 44quity, and Barcla 45 - 49 ys U.S. Aggregate I 50 - 54 ndex for fixed i 55 - 59 ncome. 60 - 64 0 1 - 9 10 - 19 20 - 29 30 - 39 Initial equity allocation (percent) 40 - 49 50 - 59 60 - 69 70 - 79 80 - 89 90 - 99 100 -15% -10% Initial equity allocation (percent) Age 25 - 29 30 - 34 35 - 39 Initial equity allocation (percent) Initial equity allocation (percent) 40 - 44 45 - 49 50 - 54 55 - 59 60 - 64 Age Hueler Analytics Stable Value data are used for stable value funds. Initial equity allocation (percent) Initial age Tenure Tenure Age Source: Author's simulations based on June 16, 2009 modifications to the EBRI/ERF Retirement Security Projection Model. For additional Source: Author's simulations based on June 16, 2009 modifications to the EBRI/ERF Retirement Security Projection Model. For Source: Author's simulations based on June 16, 2009 modifications to the EBRI/ERF Retirement Security Projection Model. For ad Source: Author's simulations based on June 16, 2009 modifications to the EBRI/ERF Retirement Security Projection Model. For ad ditional ditional Source: Author's simulations based on June 16, 2009 modifications to the EBRI/ERF Retirement Security Projection Model. For additional Source: Author's simulations based on June 16, 2009 modifications to the EBRI/ERF Retirement Security Projection Model. For ad Source: Author's simulations based on June 16, 2009 modifications to the EBRI/ERF Retirement Security Projection Model. For ad ditional ditional Source: Author's simulations based on June 16, 2009 modifications to the EBRI/ERF Retirement Security Projection Model. For additional Source: Author's simulations based on June 16, 2009 modifications to the EBRI/ERF Retirement Security Projection Model. For additional detail on the model, see VanDerhei and Copeland, "The Impact of PPA on Retirements Savings for 401(k) Participants," EBRI Issue Brief, Source: Author's simulations based on June 16, 2009 modifications to the EBRI/ERF Retirement Security Projection Model. For additional Source: Author's simulations based on June 16, 2009 modifications to the EBRI/ERF Retirement Security Projection Model. For ad Source: Author's simulations based on June 16, 2009 modifications to the EBRI/ERF Retirement Security Projection Model. For ad additional detail on the model, see VanDerhei and Copeland, "The Impact of PPA on Retirements Savings for 401(k) Participants," ditional ditional detail on the model, see VanDerhei and Copeland, "The Impact of PPA on Retirements Savings for 401(k) Participants," EBRI Issue detail on the model, see VanDerhei and Copeland, "The Impact of PPA on Retirements Savings for 401(k) Participants," EBRI Issue Brief, Brief, detail on the model, see VanDerhei and Copeland, "The Impact of PPA on Retirements Savings for 401(k) Participants," EBRI Issue detail on the model, see VanDerhei and Copeland, "The Impact of PPA on Retirements Savings for 401(k) Participants," EBRI Issue detail on the model, see VanDerhei and Copeland, "The Impact of PPA on Retirements Savings for 401(k) Participants," EBRI Issue Brief, Brief, Brief, detail on the model, see VanDerhei and Copeland, "The Impact of PPA on Retirements Savings for 401(k) Participants," EBRI Issue Brief, detail on the model, see VanDerhei and Copeland, "The Impact of PPA on Retirements Savings for 401(k) Participants," EBRI Issue Brief, detail on the model, see VanDerhei and Copeland, "The Impact of PPA on Retirements Savings for 401(k) Participants," EBRI Issue June 2008 Brief, detail on the model, see VanDerhei and Copeland, "The Impact of PPA on Retirements Savings for 401(k) Participants," EBRI Issue detail on the model, see VanDerhei and Copeland, "The Impact of PPA on Retirements Savings for 401(k) Participants," EBRI Issue EBRI Issue Brief, June 2008 Brief, Brief, June 2008 June 2008 June 2008 June 2008 June 2008 June 2008 June 2008 June 2008 June 2008 June 2008