The Transition Risk Zone

Multi-Asset | December 2020

Where Retirement Perception and Reality Diverge

By Nancy Pilotte and Glenn Dial | 15 - 20 minutes

Executive Summary

It’s important for plan sponsors to recognize that participant retirement planning is different than participant retirement reality. On average, most workers plan to retire at age 65, but data show nearly half of all retirees retired earlier than expected.

Significantly, this was often the result of unplanned early retirements because of health reasons or changes at the company level. In addition to unexpected/early retirements, participants can also diverge from their pre-planned retirement paths due to panic selling/abandonment or an ill-timed change in the default investment alternative. Such changes in the final 15 years before the planned retirement date are particularly consequential. That’s because workers typically accumulate two-thirds of their wealth in those final 15 years before their targeted retirement date. As a result, we deem the 15 years before planned retirement the “transition risk zone.”

We define transition risk as the risk of a sudden or extreme change in a participant’s income level or retirement asset allocation. For plan sponsors, we believe this retirement reality means participants need increased downside protection in the transition risk zone. Prudent allocation in the default investment vehicle in the plan can help manage some of this risk.

Target-date fund (TDF) glide paths with a high degree of equity exposure and that make significant allocation changes can also exacerbate transition risk. In contrast, we believe a flatter, more risk-aware glide path in this zone can help minimize transition risk. Ultimately, we argue that plan sponsors should be particularly cognizant of downside protection in the transition risk zone. This likely better reflects the actual risks and investment horizon many investors face.

Key Takeaways

Retirement perception doesn’t equal reality for many TDF investors. The assumption that plan participants “set and forget” their target-date retirement allocations and stay fully invested on a smooth ride to retirement at age 65 is false.

Nearly half of retirees never make it to their target dates. Not only do many workers retire early, but they unexpectedly retire early. Changes at a company (e.g., downsizing, restructuring) and unforeseen health changes for individuals mean retirement is involuntary for a large portion of the workforce.

The 15-year period before planned retirement is the transition risk zone. The 15-year marker is important because that’s when investors typically accumulate two-thirds of their wealth at retirement.

Transition risk zone defined. Transition risk is the risk of a sudden or extreme change in a participant’s income level or retirement asset allocation. It’s the time when participants may need increased downside protection from the potential to lock in losses. Unexpected/early retirement, panic selling/abandonment or an ill-timed change in the default investment alternative fuel this risk.

Losses are particularly consequential in the transition risk zone. Because investors accumulate so much wealth during this period and there’s so little time before retirement to recover any losses, a downturn at this point can significantly impair investors’ incomes in retirement. Therefore, plan sponsors should evaluate

TDFs with particular attention to equity risk in this zone. Investor behavior also accentuates the importance of the transition risk zone. The global financial crisis and pandemic-related bear market show that when faced with significant losses, many investors near retirement move to cash or stop making contributions to their accounts.

Transitions to managed accounts can pose additional complexities for participants in the transition risk zone. Investors who move from aggressive equity glide paths to conservatively allocated managed accounts may be particularly vulnerable to losses in the transition risk zone.


Transition Risk: An Underappreciated Risk on the Road to Retirement

Boxer Mike Tyson famously said, “Everybody has a plan until they get punched in the mouth.” Students of military history might be more familiar with this formulation: “No plan survives first contact with the enemy.” Retirement planning, too, has its own plans and certainties—until it doesn’t.

Certainly, retirement plan design and investing mean we as an industry have made massive progress toward providing better outcomes for plan participants. Today, virtually every defined contribution retirement plan offers a TDF as a qualified default investment alternative (QDIA). TDFs are popular precisely because they effectively address a highly consequential financial need. But we believe this success may have caused plan sponsors, consultants and asset managers to overlook certain risks.

Life and financial markets constantly throw punches at plan participants. In practice, this means retirement perception doesn’t equal retirement reality for many defined contribution plan participants. Crucially, perception diverges from reality at precisely the most important period in a retirement saver’s life—the 15 years before retirement.

We call this period the transition risk zone. Transition risk we define as the risk of a sudden or extreme change in a participant’s income level or retirement asset allocation. From the plan sponsor’s point of view, the transition risk zone highlights where participants may need increased downside protection from the potential to lock in losses. This risk comes from unexpected/early retirement, panic selling/abandonment or an ill-timed change in the default investment alternative.

First-Round Knockout—Nearly Half of Retirees Never Make It to Their Targeted Retirement Dates

One of the most jarring divergences between retirement perception and reality is how few plan participants reach their retirement dates. As shown in Figure 1, the latest EBRI survey data show that nearly half of all retirees retired earlier than expected. The catch is not just that these plan participants retired sooner than planned, they often unexpectedly retired early. An unforeseen punch in the financial mouth forced them to change course.

Figure 1 | Retirement Perception vs. Reality—Nearly Half of All Retirees Retired Early

Source: Employee Benefit Research Institute (EBRI) and Greenwald & Associates, 2020 Retirement Confidence Survey.


The most common reasons for unplanned early retirements were health reasons or changes at the company level, such as downsizing, closure or reorganization. Unfortunately, the current coronavirus-related recession has created another wave of early retirements. A recent National Bureau of Economic Research report showed labor markets have reacted quite differently to the COVID-19 crisis as compared to a typical recession.1 The researchers found a significant decrease in labor force participation by eligible workers (a drop of seven percentage points), with retirement cited as the reason for leaving the workforce in fully 60% of cases. Nearly half of this group were ages 50 to 65.

This raises the question of how much earlier do people retire than planned? We answer this question in Figure 2. At the median, the difference in retirement is three years, from ages 65 to 62, according to the 2020 Retirement Confidence Survey by EBRI and Greenwald & Associates. Those three years don’t seem like a huge difference, but when we peek under the hood, we find a broad range of outcomes. For example, while only 11% of workers expected to retire before age 60, a whopping 33% of them did so.

Figure 2 | More Workers Than Expected Retire Sooner Than Planned

Source: Employee Benefit Research Institute (EBRI) and Greenwald & Associates, 2020 Retirement Confidence Survey. Figures and n-sizes exclude respondents who said “don’t know,” had never worked or declined to answer.


Entering the Retirement Boxing Ring, aka Transition Risk Zone

We believe this reality calls for looking at TDF risk differently. Rather than thinking of participants on smooth journeys to single retirement dates, it makes more sense to think of a zone of transition risk in the 15 years before retirement. First, this transition-risk framing better recognizes the fact that many workers never make it to their planned retirement dates.

Second, this zone coincides with the period of greatest wealth accumulation for retirement plan participants. A significant market downturn in this period can have lasting consequences for plan participants. As a result, it’s essential to consider downside risk during this time even before retirement. We think that’s an important break with the conventional wisdom that downside risk is primarily an issue during the post-retirement period.

Third, we must recognize the risk that investors will abandon the plan during market downturns by withdrawing money from their retirement accounts or moving out of equities/TDFs into “safe” investments. Investors who reallocate to cash or other perceived safe-haven investments during this particular window of wealth accumulation do serious potential damage to future retirement outcomes.

Heavyweight Title Bouts Go 15 Rounds; Investors Are in the Transition Risk Zone for 15 Crucial Years

Figure 3 helps clarify the extent to which wealth creation concentrates in these 15 years leading up to the stated retirement date.

Figure 3 | Wealth Accumulation and Downside Risk Is Greatest in the Transition Risk Zone

Source: American Century Investments; Vanguard, “How America Saves 2020.” Realized returns simulated (size 10^5) using the glide paths of six major firms then averaged across all results. Salary at age 25 assumed at $45,000 growing to $146,000 at age 65 (in nominal dollars). Assumes annual contributions consistent with 2020 survey demographics, starting at 8.3% total deferral rate and ending at 13.5% at age 65. Hypothetical results shown for illustrative purposes only and are not a guarantee of future results.


Under certain reasonable assumptions about retirement investing behavior, we see that a typical person who starts investing at age 25 and retires at 65 will have accumulated about one-third of their expected final retirement wealth by age 50. That’s 15 years before their stated retirement date. This means in the last 15 years, a typical retirement investor accumulates the other two-thirds of their wealth at the target date.

As a result, what happens during this period is key to an investor’s final retirement account balance. A great run of market returns, and they may be well ahead of target. But a poor run of results, and they could lose years of retirement income. We think the need to manage downside risk in this vital period before retirement is evident. Where we differ with other practitioners is that we believe the market underappreciates this risk, as evidenced by risky target-date allocations in the transition risk zone.

Leading with Your Retirement Chin—Exposure to Potential Losses in the Transition Risk Zone Depends on TDF Glide Path Equity Allocation

Exposure to potential losses and transition risk depends on the target-date glide path allocation in these final years before retirement. We will focus on TDF glide paths because they are the main default savings vehicle across defined contribution retirement plans. We see two issues—the level of equity exposure and the slope or rate of change in the equity allocation up to retirement. Figure 4 contrasts the American Century “to” retirement target-date glide path with that of a leading “through” retirement TDF provider as they move through the transition risk zone. The point here is to highlight the significant differences in the level and rate of change (slope) of equity exposure through the transition risk zone.

Figure 4 | We Believe the Level and Slope of Equity Glide Path Are Crucial in the Transition Risk Zone

Data as of 9/30/2020.
Source: Company materials and websites.


We believe glide paths with a high equity allocation and/or a steep slope may exacerbate the risk of bad market returns in the transition risk zone. The level of equity allocation relates to the magnitude of loss, while the slope of the glide path relates to the ability to recover from such losses. Slope is relevant in the context of transition risk because we know some participants might leave a company, but their assets may remain in the plan. Nor is there any shortage of examples of workers who lose high-paying jobs during an economic downturn and who never go back to work or do so making a fraction of their original salaries. In these cases, we think investors should care greatly about the slope of the glide path and their ability to recover from a market downturn.

Sequence-of-returns risk intensifies if the TDF de-risks rapidly (if the slope is steep) in the years leading to retirement. That is, the sequence-of-market returns are critically important when account balances are high, and the glide path is rapidly de-risking. This is because one period’s losses can effectively be locked in when account balances are large as the portfolio rapidly reduces equity exposure. In this sense, sequence-of-returns risk and the transition risk zone are related. In these years when participants are at greater risk of unexpected early retirement, a large loss has more impact.

Finally, some account holders switch out of TDFs into managed accounts in the transition risk zone. Here, the risk is that of switching from an aggressive TDF to a conservatively managed account just after a market downturn. Such a change can seriously impair wealth recovery and result in years of lost retirement income. The mere fact of experiencing a large loss of wealth can have the untimely impact of lowering a participant’s risk tolerance just as they are assessed for the managed account risk level.

Being Able to Take a Punch Is Key to Retirement Success—We Believe Equity Exposure Is Key for Downside Risk and Recovery Potential

To demonstrate the impact of glide path allocation on transition risk, Figure 5 shows a simulated example of a participant invested in “to” and “through” retirement glide paths from ages 25 to 55. The first panel shows the median wealth that would accrue in each TDF by age 55 based on the glide path and average return assumptions. Naturally, account balances are slightly lower in the less aggressive glide path and higher in the typical “through” TDF glide path.

Figure 5 | High Equity Allocation and Steep Glide Path Can Magnify Risk in the Transition Risk Zone

A Hypothetical Simulation

Source: American Century Investments; company materials and web sites. See the appendix for a complete description of the assumptions used for this simulation.
IMPORTANT: The projections or other information generated by American Century regarding the likelihood of various investment outcomes are hypothetical in nature, do not reflect actual investment results and are not guarantees of future results.


In the second panel, we deliver the punch by showing the potential impact of a market shock, averaging the losses of the COVID-related sell-off and the 2008-09 financial crisis. This hypothetical example shows the full extent of the losses suffered by our investor at age 55 across each glide path. It also shows the dramatic reordering of highest to lowest balances after the loss, emphasizing the risk of a market shock close to retirement.

In Figure 6, we show hypothetical outcomes for investors who stay in the plan following the market shock detailed above. In Scenario 1, we look at outcomes for investors who no longer make contributions to their accounts. This could be a result of separating from the company or stopping contributions because of fear of loss or economic need. In Scenario 2, we assume the participant resumes contributions as normal following the market sell-off.

In both hypothetical scenarios, we find investors do well in a comparatively flatter glide path with a more modest level of initial equity exposure. Said differently, we think these panels show that paying attention to downside risk and slope in the transition risk zone can be beneficial.

Figure 6 | We Believe Slope Matters for Investors Who Remain in the Plan After the Initial Market Shock

A Hypothetical Simulation

Source: See the appendix for a complete description of the assumptions used for this simulation.
IMPORTANT: The projections or other information generated by American Century regarding the likelihood of various investment outcomes are hypothetical in nature, do not reflect actual investment results and are not guarantees of future results.


Consider the implication of this simulation given what we know about transition risk. The premise of TDFs with comparatively high equity exposure is that investors require more equities for longer periods to fully fund retirement. But this calculus must account for the nearly 50% of participants who retire before age 65, including the sizable group who leave the workforce before age 60. And look at the context—the COVID downturn occurred alongside Depression-era levels of unemployment. As of October 1, 2020, the U.S. Bureau of Labor Statistics reported more than 11 million Americans were unemployed, with nearly four million of them considering their job losses permanent.2 That’s the worst possible one-two retirement punch—your account balance takes a beating, and then you find yourself forced into early retirement. A literal punch in the mouth might be less unpleasant.

Even Champions Make Mistakes in the Ring … Investors May Also Make “Bad” Decisions When Losses Are Large and Retirement Looms

In addition to investors involuntarily forced into retirement, we must consider plan participants who react badly to such steep losses and abandon equities/TDFs in favor of perceived safe-haven investments. Abandonment risk is a hotly debated topic. But intuition and experience tell us that investors make buy-and-sell decisions based on latest market performance and account gains and losses. And we know sensitivity to loss is greatest when account balances are large, and retirement is near.

Detailing TDF flow data for the 2020 COVID bear market, we show a real-world example of abandonment in Figure 7. This demonstrates just how quickly investors can become risk averse when they see market losses erode their retirement savings. What’s notable is these outflows occurred not just in funds at or near the retirement date, but also in TDFs as much as 15 years from the expected retirement date. This is further evidence for why managing downside risk is so important across the entire transition risk zone. Selling out at the wrong time—after a large loss—is a sure way to lock in losses and limit the ability to fund retirement.

Figure 7 | We Believe Slope Matters for Investors Who Remain in the Plan After the Initial Market Shock

A Hypothetical Simulation

Source: Morningstar. Data as of 3/31/2020.


Knocking Out Transition Risk

No one wants to get punched in the financial face, but we believe plan sponsors can do things to mitigate transition risk. Whether an unexpected job loss, panic selling during a market downturn or a participant switching to a managed account at an inopportune time causes transition risk, prudent asset allocation in the default TDF can help manage some of this risk. We believe glide paths that are very risky and/or steep in the transition risk zone may heighten sequence-ofreturns risk and abandonment risk. In contrast, we believe a flatter, more risk-aware glide path in the important years before retirement may help minimize such risks.

As a result, we encourage plan fiduciaries to consider equity allocations at multiple points along the glide path, with particular emphasis on the 15-year period before retirement. Understanding the potential impact of a serious market downturn across the range of potential TD solutions should be a key focus. We argue for strong consideration of potential downside protection in the transition risk zone. This likely better reflects the actual risks and horizon many investors face. We don’t believe one approach or plan fits all occasions. Rather, the “best” TDF selection is the one that most closely aligns with the needs of each plan’s participant population and risk appetite.



1 Olivier Coibion, Yuriy Gorodnichenko and Michael Weber, Labor Markets During the COVID-19 Crisis: A Preliminary View, NBER Working Paper no. w27017 (April 20, 2020).
Available at SSRN: https://ssrn.com/abstract=3580575.

2 “The Employment Situation—October 2020,” News Release, U.S. Bureau of Labor Statistics, November 6, 2020. https://www.bls.gov/news.release/pdf/empsit.pdf.

Assumptions for Hypothetical Scenario

Simulation assumptions: Returns simulated (size 10^5) using the American Century Target Date and competitor glide paths (competitor is a top 10 target-date series as measured by AUM). Assumes annual contributions starting at 8.3% total deferral rate at age 25 and ending at 12.5% at age 55. Age 25-55: Participant invested in the glide path allocations for the target-dates shown. Returns are simulated based on capital market assumptions from ACI Multi-Asset Strategies’ long-term forecasts. Age 55: Shock scenario losses based on average stock and bond returns over the last two equity bear markets (2007-2009 and Q1 2020) using Russell 1000 Index and BloombergBarclays U.S. Aggregate Bond Index returns. Loss is simulated based on level of strategic equity and fixed income allocation in each glide path at age 55. Scenario 1 simulation assumptions (age 56-65): Participant ceases contributions after age 55 while remaining invested along strategic glide path until age 65. Scenario 2 simulation assumptions (age 56-65): Participant continues contributions to age 65, ending at 13.5% total deferral rate while remaining invested along strategic glide path until age 65. Salary at age 25 assumed $45,000 in year 1 growing to $146,000 at age 65. All results expressed in nominal dollars. Glide path data from Morningstar, company websites, and ACI as of 9/30/2020. 

IMPORTANT: The projections or other information generated by American Century regarding the likelihood of various investment outcomes are hypothetical in nature, do not reflect actual investment results and are not guarantees of future results.

Investment return and principal value of security investments will fluctuate. The value at the time of redemption may be more or less than the original cost. Past performance is no guarantee of future results.

The opinions expressed are those of American Century Investments (or the portfolio manager) and are no guarantee of the future performance of any American Century Investments' portfolio. This material has been prepared for educational purposes only. It is not intended to provide, and should not be relied upon for, investment, accounting, legal or tax advice.

Diversification does not assure a profit nor does it protect against loss of principal.

The information is not intended as a personalized recommendation or fiduciary advice and should not be relied upon for, investment, accounting, legal or tax advice.

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