New research finds that de-risking is commonplace, with 75% of retirees reducing their equity exposure when they roll over their assets from a 401(k) to an IRA, but doing so at an inopportune time could have significant consequences.
In Mystery no more: Portfolio allocation, income and spending in retirement, J.P. Morgan provides an illustration of the potential impact by comparing the experiences of two hypothetical 401(k) participants who rolled over their balances to an IRA during the height of the COVID-19 market volatility. Under the examples, each participant had to retire sooner than expected due to issues related to COVID-19 and rolled over assets between March and April 2020. At retirement, one participant’s portfolio was bond-heavy at 40% equity/60% bonds, while the other participant’s portfolio was stock-heavy at 60% equity/40% bonds.
The bond-heavy participant rolled over at the same asset allocation; the participant had de-risked prior to reaching retirement age and fully participated in the April market recovery. Meanwhile, the stock-heavy participant reduced equity exposure by 20% through a rollover, locked in March market losses and did not participate fully in the April recovery.
At the end of 2020, J.P. Morgan’s research revealed a 5% difference between the two—which the firm notes can result in a significant gap when compounded over the many years of retirement. Both of the hypothetical participants started 2020 off with approximately $100,000 in their accounts, but following rollovers and reallocations that took place, the bond-heavy investor who maintained their allocation ended 2020 with a balance of $111,700, but the stock-heavy investor who de-risked from 60% equity/40% bonds to 40/60 after their rollover ended the year with a balance of $105,800.
“It’s critical that a 401(k) have a prudent level of risk at retirement so as not to lock in market losses if a rollover occurs at an inopportune time,” write J.P. Morgan Asset Management’s Chief Retirement Strategist Katherine Roy. “There has been a lot of speculation about whether and how people change their asset allocation when they roll over their 401(k) balances. Our data indicates that change was the norm: As many as 75% of retirees—a bigger majority than we would have expected—decreased their portfolios’ equity concentration after rollover.”
The median decline was found to be 17 percentage points. And as shown in the report, the greater the equity share of 401(k) portfolios, the more de-risking happens through a rollover. The research found that participants with greater than 40% equity in their 401(k)s de-risked at the median level.
The underlying research in the report draws on EBRI’s database of more than 23 million 401(k) and IRA accounts, and JPMorgan Chase & Co. data for around 62 million households, studying 31,000 people as they approached and entered retirement between 2013 and 2018.
RMDs for Guidance?
Other key findings reveal that required minimum distributions (RMDs) appear to be the dominant withdrawal “guidance.” The research found that most retirees—particularly those with less observable wealth—do not take distributions before RMD age and those older than RMD age choose to take only the RMD amount. “Interestingly, people who don’t take any distribution before their RMD age had much less observable retirement wealth (roughly a quarter) than those who were taking early withdrawals. This suggests that the need to efficiently draw down wealth is more critical for this less wealthy segment of the population,” says Roy.
The report goes on to suggest that the RMD approach is inefficient, as it does not generate income that supports retirees’ declining spending behavior and may leave a sizable account balance at age 100. “This finding underscores the importance of a goals-based planning approach. People tend to do well when they manage their money based on their goals, time horizon and risk tolerance,” Roy emphasizes. In principle, this means taking on greater investment risk (and potential return) for assets intended for the end of a projected lifetime that could be 20, 30 or even more years away, she explains.
On the consumption front, the report suggests that the most effective way to withdraw wealth is to support actual spending behaviors, as spending tends to decline in today’s dollars with age. “Unlike the RMD approach, reflecting actual spending allows retirees to support higher spending early in retirement and achieve greater utility of their savings,” the report observes.
