Editor’s Desk
Editor’s inbox: Reader suggests fixes to target-date funds
Defined contribution plan spon-
sors, participants and providers
are on the verge of having an an-
nuity-type retirement distribution
imposed as the default plan when
employees reach retirement. This
is the direct result of having based
asset-allocation glide paths and re-
tirement-income forecasting on the
belief that withdrawal rates of 4%
of account balance at retirement
escalated by 3% per year yields a
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more than 90% probability of not
depleting the retirement account
within 30 years. However, a flaw in
this belief was exposed when investments in 2010 funds dropped
as much as 40% during the recent
bear market.
First, retirement-date fund
managers should replace the bond
component of their fund with a
closed-end income generating
fund that has a managed distribution policy that seeks to deliver the
fund’s long- term potential through
regular monthly distributions at a
fixed rate per common share. Such
funds have demonstrated the ability to pay 6% to 8% dividends.
The second major improvement
in retirement-date funds would be
to distribute a percent of the equity component, such as .35% per
month, rather than 4% of the initial
balance increased by 3% per year.
This would automatically adjust
the payout from the equity component as its value fluctuates over
time, thereby eliminating the probability of exhausting the retirement
account. Additionally, if the equity
component were used to meet the
required minimum distribution
rules, the portfolio would become
more conservative and smoother in
the later years of retirement.
These two relatively easy improvements would overcome much
of the criticism directed at retirement-date funds that arose from
the market meltdown. They provide
for sound automated retirement
distributions. They are relatively
easy to project and explain. They
avoid the major drawbacks of annuities by maintaining flexibility
in the participant’s control of the
account, not exhausting benefits at
the participant’s death, remaining
accessible for late-in-life expenses,
and avoiding the risk that participants misunderstand the annuity
provisions that will almost certainly
occur even with very rigorous employee educational programs.
John VanderMeer
Executive VP of Finance
Tube Processing Corp.
Indianapolis, Ind.
