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Insights
Exploring the Plan Ecosystem
Off-the-shelf target date funds offer a convenient and cost effective solution for retirement saving that works well for most participants and employers. Yet some plan sponsors believe that their plan has unique features that require a customized solution.
Here we highlight the 3-prong framework we use to evaluate and model the impact of customization:
- Evaluate the Ecosystem: We begin by assessing the sponsor’s objectives and the context — or ecosystem — in which a target date fund operates, including its benefits structure, participant demographics and investment philosophy.
- Determine the Customizable Options: Pending the appropriateness of a custom solution, we explore the plan dimensions available for customization, and the potential benefits yielded.
- Model the Solution: Starting with our standard glidepath, we assess a range of options to ensure customizations are differentiating, impactful and consistent across the plan.
Evaluating the Retirement Ecosystem
Before creating a custom glidepath for a target date fund, it is important to have a clear understanding of the context in which the glidepath will be implemented and the objectives that the plan sponsor is trying to achieve.
At State Street, we examine the infrastructure surrounding the investment vehicle, including the way in which participants are enrolled in the plan, the rate at which they and their employer are contributing, and the other savings vehicles that they have access to. This holistic view of glidepath design allows us to identify the most efficient way of achieving the plan sponsor’s goals.
Understanding the Customization Opportunities
Once we have an understanding of the retirement ecosystem and the plan sponsor’s main objectives, we can start the glidepath modeling process. We analyze which factors can be addressed through glidepath customization (e.g., retirement age, risk tolerance, and investment allocations) and which can be solved effectively by modifying features of the plan design (e.g., participant rate and deferral rate)
In order to successfully serve as a basis for a custom glidepath, the factors for customization need to be:
- Differentiating: Does this characteristic truly make the plan different from other plans?
- Impactful: Does this differentiating characteristic have a material impact on the population’s ability to meet retirement goals?
- Consistent: Is this differentiating characteristic consistent across the plan population or separable population subsets?
Designing a Custom Solution
The starting point for the quantitative phase of our custom analysis is our standard target date fund with a glidepath that initially holds a high allocation to equities. As participants approach retirement, the fund starts to de-risk at an accelerating rate.
We can build on this base depending on a sponsor’s needs. Our analysis includes the following factors:
Demographic Characteristics of the Population
In our off-the-shelf glidepath design, we assume that participants retire at an average age of 65 and experience fairly steady wage growth throughout their careers. If the plan participants have a very different retirement age or wage growth path, this could be a reason to design a custom glidepath aligned with the plan demographics.
Many adjustments for “demographic characteristics” can be effectively addressed through plan design modifications rather than custom glidepath design. For example, if employees are not participating in the retirement savings plan, design modifications like automatic enrollment may provide an effective solution.
Asset Class Selection
The second reason to choose a custom approach is to incorporate different asset classes such as company stock or annuities. We include defined benefit (DB) plans and Social Security benefits in this category, as they are essentially equivalent to a fixed income investment that pays a steady coupon. Likewise, a retirement income solution is essentially a new asset class (an annuity) that is added to the glidepath.
DB Impact
DB payments change the profile of the fixed income allocation for defined contribution (DC) participants in two ways:
- A DB payment means that participants hold more fixed income in their portfolios than a target date participant without a DB plan, and
- Most DB plans pay a fixed, nominal amount, so the real value of the benefit will decline over time with inflation.
As a result, sponsors can customize a glidepath for a plan with a DB benefit by reducing the allocation to fixed income and increasing the allocation to inflation protection. Consider the following chart, which illustrates a custom glidepath for a sponsor with a DB plan. The custom plan includes more equities to balance the low risk income coming from the DB plan.
The Importance of a Holistic, Qualitative Assessment
While our ecosystem analysis is deeply quantitative, we appreciate that exclusively relying on the numbers, while mathematically sound, may not be feasible in practice. That’s why we also apply a qualitative lens to our analysis, allowing us to uncover insights that could point away from a custom target date solution. For example, one plan sponsor found that participants were responding to unclear communications by allocating to multiple target date vintages, another found that older participants were invested primarily in stable value due to legacy investments from the previous default option. In both these cases, rather than adjusting the glidepath, the solution was to improve communications and remap the misallocated participants to the existing glidepath.
By seeing differently, and holistically, we are able to help sponsors identify the right solution for their organization.
The views expressed in this material are the views of SSGA Defined Contribution as at 28 January 2019, and are subject to change based on market and other conditions.
This document contains certain statements that may be deemed forward looking statements. Please note that any such statements are not guarantees of any future performance, and actual results or developments may differ materially from those projected.
The information provided does not constitute investment advice and it should not be relied on as such. It should not be considered a solicitation to buy or an offer to sell a security. It does not take into account any investor’s particular investment objectives, strategies, tax status or investment horizon. Investing involves risk, including the risk of loss of principal. The whole or any part of this work may not be reproduced, copied or transmitted or any of its contents disclosed to third parties without SSGA’s express written consent.
SSGA Target Date Fund are designed for investors expecting to retire around the year indicated in each fund’s name. When choosing a Fund, investors should consider whether they anticipate retiring significantly earlier or later than age 65 even if such investors retire on or near a fund’s approximate target date. There may be other considerations relevant to fund selection and investors should select the fund that best meets their individual circumstances and investment goals. The funds' asset allocation strategy becomes increasingly conservative as it approaches the target date and beyond. The investment risks of each Fund change over time as its asset allocation changes.
Diversification does not ensure a profit or guarantee against loss.
Investing involves risk including the risk of loss of principal.
All information has been obtained from sources believed to be reliable, but its accuracy is not guaranteed.
There is no representation or warranty as to the current accuracy, reliability or completeness of, nor liability for, decisions based on such information and it should not be relied on as such.
The whole or any part of this work may not be reproduced, copied or transmitted or any of its contents disclosed to third parties without SSGA’s express written consent.
© 2020 State Street Corporation. All Rights Reserved.
2411387.3.1.GBL.RTL
Exp: July 31, 2021