Data & Research May 28, 2014

EBRI Examines Factors Behind Rollover Decisions

The average retirement plan participant’s decision to leave 401(k) assets in-plan or actuate a distribution when leaving an employer often hinges on whether they are retiring or taking a new job.
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New research from the Employee Benefit Research Institute (EBRI) focusing on the financial behavior of job changers over age 50 finds that, among those still in the labor force, the most common decision when leaving an employer was to leave 401(k) assets in the previous employer’s plan. Conversely, those who retire from the work force and stop working tend to either take a cash distribution or roll the money into an individual retirement account (IRA).

However, the EBRI analysis shows that a number of other factors also play a role in influencing the choice for any particular worker. For example, the decision to take a cash withdrawal of accumulated savings declined with higher account balances, higher incomes, existing ownership of an IRA and higher financial wealth, according to EBRI. On the other hand, the decision to take a cash withdrawal rose with debt levels.

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The decision to roll over a defined contribution (DC) distribution (typically from a 401(k) to an IRA) is the mirror image of the characteristics influencing cash withdrawals, EBRI explains. In other words, rollover decisions increased with higher account balance, higher income, previous ownership of an IRA account, and greater financial wealth. They also declined with higher debt, EBRI says.

 

Sudipto Banerjee, EBRI research associate and author of the report, cautions, however, that there is no clear trend with respect to these variables and whether workers decide to leave their retirement balances in the prior employer plans.

“This suggests that there may be behavioral factors—such as inertia—driving what in some cases might be seen as a ‘non-decision.’ Additionally, those who are postponing the distribution may simply be deferring the decision until they need the money,” he explains.

As the report points out, one of the most important decisions that workers with 401(k)-type retirement plans face is what to do with the money in their account when they switch jobs or retire. EBRI says a poor decision on this matter—for example, withdrawing the money prior to the minimum required age, which results in a 10% penalty in addition to income tax on that distribution—could reduce a worker’s retirement assets significantly. Rolling over the assets to an IRA is a common way to preserve the savings, EBRI says, even though doing so may also bring higher investment or administrative costs than a 401(k) plan.

EBRI’s analysis is based on 2008 and 2010 data from the organization’s Health and Retirement Survey, a study of a nationally representative sample of U.S. households with individuals age 50 and over. The full report, “Take it or Leave it?  The Disposition of DC Accounts: Who Rolls Over into an IRA? Who Leaves Money in the Plan and Who Withdraws Cash?,” is published in the May 2014 EBRI Notes and is available online at www.ebri.org.

 

The Markets May 28, 2014

Should Your DC Plan Include Absolute Return Strategies?

A paper from Towers Watson recommends, for defined contribution (DC) plans, up to 25% of traditional U.S. aggregate bond assets can be switched to absolute return assets.
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“Unconstrained Bond Investing: Examining the Case for Absolute Return Strategies for DC Participants” looks at how switching a portion of conventional bonds into some form of absolute return strategy may improve DC plan outcomes. The paper cautions, however, that investors need to be mindful of the risks introduced and ensure sufficient focus is placed on retaining a robust strategic asset allocation and achieving value for money.

“The paper challenges the conventional mindset around how defined contribution plans gain bond exposure,” Lorie Latham, senior investment consultant for Towers Watson, tells PLANADVISER. “Through review of the changing fixed income landscape and investment opportunity set, the paper explores how adjusting bond exposures away from core mandates can add value.”

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With interest rates at or near historic lows across developed worlds, absolute return investing is attracting much attention, says Latham, adding, “There is a great deal of emphasis on evolving defined contribution plans to aim for improved retirement outcomes. DC plans have historically been anchored to a simple Barclay’s Aggregate benchmark, resulting in a U.S. interest rate and geography bias. Our analysis concludes that a more diversified approach can have a meaningful impact over the long-term for DC plans. In a total portfolio context, our analysis reveals that diversifying bond exposure beyond traditional structures has the potential to improve the risk and reward profile and outcomes for participants.”

The paper notes that the idea of interest rates and yields being more likely to increase than decrease has important implications for the sort of bond products that asset managers are launching. Recent years have seen a variety of products launched to exploit or protect against the “seemingly inevitable rise of bond yields.” This includes funds that are variously labeled as absolute return bond funds, unconstrained bond funds and numerous other strategies.

The paper defines absolute return bond funds as funds with a goal of creating an “all-weather” portfolio that is robust across market environments. In addition, such funds should deliver strong returns over the medium term, but will regularly have single years of negative returns. Absolute return bond strategies have low interest rate sensitivity, typically with a neutral duration position close to zero, and may have the scope for small negative duration, benefiting directly from rising yields.

The paper defines unconstrained bonds as those utilizing strategies that seek to generate positive returns in all market environments. These funds typically permit the flexibility to lever up returns, express an absolute negative duration position and generally carry more and lower quality credit risk, including sub-investment grade credit.

While the attention surrounding absolute return bonds has been driven by expectations and concerns over rising interest rates, the paper notes that it is important to retain a more holistic and longer-term perspective when assessing the merit of adding these strategies. The paper further notes that most investors do not have the time and investment insight required to successfully switch between strategies across an economic cycle, pointing out that it is “unrealistic and dangerous to try to optimize portfolios to a specific macro regime that may prove to be relatively short-lived, or indeed take some time to materialize.” Instead, the paper recommends identifying a structure that is a good fit for the current macro regime and across a market cycle.

In terms of how a DC plan sponsor can determine the best route for implementing various absolute return type solutions, Latham explains, “In our analysis, we shifted a portion of a total portfolio to an absolute return strategy, which resulted in improved risk-adjusted returns in a total portfolio context. We do not believe offering an absolute return strategy as a stand-alone option on a DC platform is the right approach. Our view is that DC plans should de-emphasize single style investing and aim for simplification to aid participants in decisionmaking.”

Latham clarifies that strategies such as absolute return should be offered within a diversified structure such as white label funds or as part of a custom target-date fund series. She acknowledges that while this approach is a higher governance proposition, it also allows portfolios to be approached in “a more holistic manner.”

The paper also recommends an assessment framework for different absolute return strategies involves testing their efficacy against key goals of such an allocation. These rules for assessment include:

  • Do not increase the correlation to equity. Any investment strategy change must be assessed against the impact on the overall sensitivity to equity markets and overall level of risk.
  • Improve returns in a rising interest rate environment. This can mean either structurally different exposures or more dynamic management of exposure.
  • Improve robustness of returns in all environments.
  • Do not increase correlation to current investments or the dependence on existing managers.
  • Find a solution that is appropriate to DC participants. “Appropriate” is defined as being liquid in nature and easily understandable to participants.

The full text of the paper can be downloaded here.

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