Saturday, March 24, 2007

When You Assume…

We live in an uncertain world, and when it comes to retirement planning, we are forced to make assumptions about an uncertain world some uncertain number of years in the future.

However, a recent white paper by JPMorgan Asset Management (JPMAM) calls to mind that old adage about what happens when one assumes (see Participant Behavior Matters in Target Fund Strategy).

First, retirement projection tools tend to overlook the reality that many, perhaps most, participants dip into their retirement savings from time to time: some for only awhile—JPMAM’s research found that 20% of participants borrow, on average, 15% of their account balance—and some forever. JPMAM’s data noted that a full 15% of those over the age of 59 ½ (the age when one avoids the 10% premature distribution penalty) withdraw, on average, a quarter of their account balance. The research, which looked at the behaviors of 1.3 million participants in some 350 plans recordkept by JPMorgan Retirement Plan Services, also found that the average participant withdraws over 20% of their account balance per year at, or soon after, retirement—not the even 4-5% drawdown implicit in most projections.

Additionally, most projections also tend to be optimistic about the rate of participant deferral. JPMAM found that, on average, participant deferral rates start at 6%—and stay there for a sustained period—increasing to 8% only by age 40, and not attaining 10% until age 55. More significantly, while most projections still contemplate annual pay increases, JPMAM found that, on average, people only get raises only every two of three years (and I’ll wager that, filtering out the occasionally distortive impact of averages, many aren’t seeing increases that often). Even more troubling—but a reality in an era of soaring health-care costs, rising fuel costs, and the economic squeeze being placed on the “Sandwich Generation”—is that, on average, 10% of participants lowered their rate of deferral—or stopped contributing altogether—each year!

Finally—though the JPMAM paper doesn’t touch on this—in this space, I have previously cast a doubtful eye on the rate-of-return assumptions often applied to participant investment patterns.

Optimistic Undercurrents

Now, there is an undercurrent of optimism associated with the Pension Protection Act—a confidence that its automatic enrollment safe harbor will usher more participants into the discipline of retirement saving; that the associated provisions on deferral acceleration will, over time, transform current savings rates to the requisite levels; that the application of professionally managed asset allocation funds as a default choice will impart a rational investment result to participant savings. Certainly these tools have the ability to modify some of the most egregious savings behaviors, and doubtless they will encourage some—perhaps a significant number—to come off the sidelines and begin a responsible preparation for retirement.

They’re not likely, however, to stem the premature drawdown of retirement savings, or to accelerate the pace or regularity of salary increases. In fact, it’s not beyond the realm of believability to envision how the adoption of these tools could, certainly in the short run, serve to reduce the rate of deferrals (participants auto-enrolled at the 3%, rather than the 6% rate they might have enrolled at if they had completed the form), and perhaps even decrease the rate of return (a more balanced portfolio might experience losses in the short-run that a stable-value-only portfolio might not).

What’s attendant upon us all in this emerging age of “automatic” solutions, IMHO, is to realize that they aren’t.

- Nevin Adams

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