Exposed to too much riskNews added by Benefits Pro on August 27, 2014

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By Nick Thornton

The U.S., U.K. and Australia, the world’s leaders in transitioning retirement assets into defined contribution plans, are exposing their participants to a degree of risk beyond their capacity to bear, according to a PIMCO research paper.

As the three countries have become more dependent on self-directed plans, and are expected to grow more so in the future, each has developed “dramatically different” plan design and investment management styles, according to Pimco’s perspective.

That fact alone should raise some red flags, says the paper.

“There is no obvious rationale for these differences, given the basic similarities in the institutions of retirement income finance,” write the paper’s authors. “These similarities argue for the application of common principles of investment strategy, which could enhance the role of DC plans in the provision of a secure retirement.”

A Towers Watson 2013 study showed Australia with 81 percent of total retirement assets in DC plans, the U.S. with 58 percent, and the U.K. with 25 percent.

Each country’s respective self-directed retirement systems are expected to provide 60 percent of all retirement income in order support existing lifestyles into retirement, according to the Organization for Economic Cooperation and Development.

In the U.S., the authors site the auto-enrollment and escalation provisions of the Pension Protection Act of 2006 as having significant positive affects on contribution rates and levels.

But an estimated 10 percent of DC assets flow out of plans annually. “Plan leakage” is a particular threat in the U.S., as the workforce has grown more mobile over time. When workers change employers, and DC assets are rolled over into IRAs, the high costs of retail options relative to employer-sponsored plans results in reduced asset growth, according to the paper.

The U.S. would be wise to note Australia’s existing, aggressive approach to required contribution rates, along with regulations that will be fully implemented in the U.K. by 2017, the PIMCO paper says.

In Australia, employees are currently required to contribute 9.25 percent of pay to DC plans, rising to 12 percent by 2020. In the U.K., contribution rates will be mandated at 8 percent, with at least 3 percent contributed by employers.

Participants in the U.S.’s counterpart countries are generally not allowed to withdraw funds until full retirement, preventing the plan leakage currently experienced in the U.S.

“Clearly, DC account values will build far more swiftly in the Australian and U.K. systems, given their higher contribution rates and their firmer control of leakage,” write the authors.

Asset allocation principals in default investment products also differ greatly by county. Unlike the U.S. and U.K., Australia’s default funds include alternatives, up until the age of retirement. In the U.K., participants are shifted nearly completely to fixed-income upon retirement, when they typically purchase an annuity.

Heavy risk in equities as participants draw closer to retirement, particularly in the U.S. and Australia, may promote “self-destructive behavior” in the event of a market correction, when those nearest to retirement may excessively flee to cash, the PIMCO paper says.

The paper notes that, in the U.S., movement from equities to cash within target date funds correlates with fluctuations in the S&P, especially in down markets, and particularly with participants closest to retirement.

Given the variations in approach to enrollment and contribution rates, and significant differences in how assets are defaulted and allocated, the paper concludes that participants in all three countries may benefit from increased risk analysis and, not surprisingly, diversification.

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