Evaluation of Target-Date Glide Paths within
Defined Contribution Plans

Abstract

In this article, the authors present a methodology to support sponsors of defined-contribution (DC) plans when evaluating the allocation to equity over a target-date fund’s glide path. When evaluating glide paths, sponsors must pay heed to two primary goals: The first is to generate lifetime income consistently over the course of retirement; the second is to limit the risk of capital loss near and during retirement, which is particularly important for participants who withdraw balances over short horizons. The challenge of glide path selection is striking a compromise between these competing goals. This compromise cannot be achieved via objective analysis alone and must also be informed by the subjective horizon and risk preferences of the sponsor acting as agent for the plan participants. The authors find that higher-equity glide paths offer greater efficacy for lifetime income replacement, while lower-equity glide paths offer greater efficacy for stable account balances with lower risk of capital losses. These conclusions hold over a wide range of plan characteristics and assumptions, although the relative magnitude of the trade-off depends on characteristics unique to each plan.

TOPICS: Retirement, portfolio construction, risk management