Retirement Income and Alternative Investments

Art by Melinda Beck

Swapping target-date fund (TDF) equity allocations for private equity investments in defined contribution (DC) retirement plans resulted in more participants being able to retire at age 65 without running short of money in retirement, according to new research from the Employee Benefit Research Institute (EBRI). 

Jack VanDerhei, director of research at EBRI, examined the impacts of replacing TDF equity allocations with 5%, 10% or 15% allocations to private equity in a research paper, “The Impact of Adding Private Equity to 401(k) Plans on Retirement Income Adequacy.”

“We found that every level of private equity modeled resulted in additional 401(k) participants (who are currently ages 35 to 64) being able to retire at age 65 without running short of money in retirement,” the paper states.

EBRI used its Retirement Security Projection Model (RSPM) to estimate that the total retirement deficit for all U.S. households between the ages of 35 and 64 was $3.68 trillion in 2020. The study noted that not every U.S. worker has access to an employer-sponsored DC plan, despite several legislative efforts to increase access, including the Setting Every Community Up for Retirement Enhancement (SECURE) Act of 2019, and the push for additional legislation to build on those policies.

For example, EBRI says, the SECURE Act’s provisions to expand access to employer-sponsored DC plans were estimated to reduce this deficit by $114.9 billion.

But, aside from expanding worker access to DC plans, another approach to improving retirement readiness is to boost expected investment returns. To determine how to improve such returns, EBRI examined the impact on participants’ retirement readiness with greater allocations to better-performing investments and the attendant impact to EBRI’s Retirement Savings Shortfalls (RSS), which calculates the present value of the simulated retirement deficits at retirement age.

“When 15% of the equity in the TDFs is assumed to be replaced with private equity, the RSS reduction varies from 4.8% for the youngest cohort to 2.1% for the oldest cohort,” the paper states. “The RSS reduction varies from 3.2% for the youngest cohort to 1.5% for the oldest cohort when 10% of the equity in the TDFs is assumed to be replaced with private equity, and it varies from 1.8% for the youngest cohort to 0.8% for the oldest cohort when 5% of the equity in the TDFs is assumed to be replaced with private equity.”

EBRI also used its Retirement Readiness Ratings (RRRs) to estimate the effects of changing allocations to participants’ retirement income and peg the probability that a household will not run short of money in retirement.

“For the youngest cohort (those currently ages 35 to 39) who have the longest period to benefit from the change, the RRR increases by 1.3 percentage points,” the paper states. “This differential decreases with age, and those currently ages 50 to 54 are simulated to have RRR increases of 0.6 percentage points.”

The scenario modeled in this paper would only impact some of the current aggregate retirement deficit, since some households will be simulated never to have a 401(k) plan, and even those who do would need to be simulated to invest in a TDF for this scenario to apply.

Last year, the U.S. Department of Labor (DOL) published an Information letter about adding private equity investments as a component of asset allocation funds offered as an investment option for participants in DC plans.

The letter stated that a plan fiduciary would not violate the duties of a fiduciary solely by offering a professionally managed asset allocation fund with a private equity component as a designated investment alternative. The letter did not authorize plan sponsors to make private equity investments available for direct investment on standalone basis.

Despite the favorable stance from DOL under then-President Donald Trump, Serge Boccassini, head of institutional global product and strategy at Northern Trust Asset Servicing in Chicago, previously told PLANSPONSOR that plan sponsors in the U.S. might have concerns about including private investments in DC plan fund menus.

The EBRI research was completed before the DOL, now under President Joe Biden’s administration, issued a supplemental statement last month to clarify the 2020 letter. 

The recent DOL supplemental statement cautioned plan fiduciaries against the perception that private equity is generally appropriate as a component of a designated investment alternative in a typical DC plan, in response to stakeholder concerns.

Editor’s note: This article was originally published as ‘Increasing Exposures to Private Equity Boosts Retirement Security’